Wizards of bullshit: How Forbes turned $6.5 million into $20 billion | Hacker News Reader

Wizards of bullshit: How Forbes turned $6.5 million into $20 billion

37signals.com

157 pointsjoshuacc57 comments

Just more linkbait from 37signals. This article is being really pedantic by only focusing on the last transaction.

Facebook sales on SecondMarket have been hovering around the $70BN range since 6 months ago (1) so there is clearly enough interest in a private market auction to place it there.

Calling this "Grossly Irresponsible" is laughable. Facebook's stated revenue and earnings are ahead of Google's pre-IPO numbers, probably enough to justify the 3x valuation (Google IPO'd at around $25BN IIRC) they will seek in their offering.

1. http://techcrunch.com/2011/01/27/facebook-shares-dip-7-in-mo...

Not to mention that this is the exact same math used to determine the market capitalizations of all companies.

Linkbait gets you links, it also destroys your credibility. Which, by the way, is the reason I read hacker news and not any of the other numerous alternatives.

HN (front page) is still very susceptible to linkbait, though - Techcrunch are particularly good at "gaming" HN.

I wonder if people on this site have always been so weary of 37signals, or if the company's reputation has just slowly eroded with all the meagre diatribes.

The 37signals folks are interesting: as product designers and product managers, I have the utmost respect for them. As observers of the VC scene, their opinions and observations are often useless. That said, if you don't want to go the VC route and instead want to have a go at building a successful business without outside financing, I think Getting Real and Rework are must-reads.

Genius is rarely universal. William Shockley invented the transistor — yes, a gross oversimplification — but was an advocate of eugenics. Henry Ford and Charles Lindbergh? Nazi sympathizers. No, I don't think Jason Fried, DHH, and co. are monsters, but these high-profile examples show that skill, talent, or insight in one area do not necessarily transfer to others. Not everyone is a Leonardo da Vinci.

You could have found other examples than supporters of eugenics and nazi sympathizers to argue that "genius is rarely universal".

Instead you make hair-raising comparisons and close by writing: "I don't think Jason Fried, DHH, and co. are monsters, but".

This is a low form of an ad-hominem attack.

Deleted comment

I'm not attacking 37signals; I'm offering a nuanced opinion. Notice that I highly recommend much of their work. As for the examples I chose, I suppose it would have been better to choose blander ones, but no bland examples popped into my head as I wrote — nor have any occurred to me in the hour since I originally wrote my comment. There must be some example of a baseball player who had great hitting ability yet insisted on trying to steal bases despite being universally acknowledged as a horrible base stealer. But I don't know who he is.

Shockley, Ford, and Lindbergh possess precisely the sorts of nerd, capitalist, and ballsy qualities that we as HN readers often admire. They serve as disquieting reminders that people like us can be guilty of terrible lapses in judgement, perhaps because of the success they experienced doing the things we (reservedly) admire them for.

P.S. You completely changed the content of your comment over a half hour after originally posting it. Is that considered a faux pas or is it a completely legit thing to do?

Yeah I wonder how 37signals decided critiquing the finance press was in their circle of competence.

What's next, a forbes article debating static and dynamic typing? :p

Makes me wonder who the real wizards of bullshit are.

This is not linkbait.

This post by 37signals is criticizing the way market capitalization is often determined. Facebook's current valuation is just an extreme example.

Your choice to ignore the argument doesn't mean there is none.

It is linkbait because the article doesn't actually argue for his point in any meaningful way or suggest any alternatives, its just a headline written to catch attention, which we both admittedly fell for given our comments here.

The article suggests we can only determine market cap by a larger percentage sale of the company. I think this is a poor argument for a number of reasons:

1) Bid ask pricing is a very well established economic model. In active market, which I would argue Facebook has due to SecondMarket et al, it tends to closely approximate the value of the asset. Certainly there are market or sector wide bubbles, but that is an entirely different argument.

2) The counterexample used is poor. He uses the example of Digg which was almost completely illiquid at the time of that article. Additionally, had Kevin Rose actually wanted to sell Digg at that point in time he probably could have actually garnered that price. The 37signals $100Bn valuation is a straw man argument that is not based in reality at all.

The most recent investors would not have bought the stock if they had assumed that their investment would be worth less in the future, therefore, yes, they are valuing the company at $80bil or whatever the number is. This is unlike the "37signals is worth $1bil" link-bait stunt in that people expect to make money on their Facebook investment.

Of course, GSV is simply betting that Facebook will be valued by the public markets for more than $80bil at some point in the future, not necessarily for any extended period. They might very well be hoping to make money off Facebook in a greater-fool-theory play.

"The most recent investors would not have bought the stock if they had assumed that their investment would be worth less in the future,"

This is true.

"therefore, yes, they are valuing the company at $80bil or whatever the number is."

But this does not follow. They are valuing their investment at the price they paid. They aren't (necessarily) valuing the rest of the company at all.

For instance, they could believe that Facebook's total value will crash to nothing in the next couple of years, but that (due to demand for Facebook stock) they will be able to make a 500% profit by selling off their investment beforehand.

That's an extreme example, but illustrates a problem with extrapolating a company's value from the sale of a small percentage.

I'm sure others have studied this, but intuitively something like a rolling average seems to make more sense for that sort of extrapolation.

How else should we determine market capitalization then? If that were in the article it would have been worth a read.

AFAIK, market capitalization has not much meaning for pre-ipo stock. Problem is that, IPO price isn't just the last price at which the stock was bought in secondary market. Also, there is no indication if what kind of stock was sold. If it is not common stock, then this definitely wont be indicative of the actual valuation.

There is no way this sale, or any of the recent ones were not common stock.

Which is more compelling: "I don't think the last price this asset traded at is realistic" or "What's the best way to short Facebook?"

The funny part of this is that GSV has bought FB at a discount to the prevailing price over the last few weeks. Here's an interview about how they got such a low price:

http://finance.fortune.cnn.com/2011/06/27/how-gsv-got-facebo...

It's fine to say that FB is overvalued. You can definitely make the case for that. But every financial asset is valued based on recent trades. This trade is down from the last few. So the argument here is flimsy.

(By the way, if you're an accredited investor and you're interested in shorting FB, please contact me--email's in the profile. I've been kicking around an idea for how this might be done.)

Out of curiosity, why short FB?

To me, shorting a single equity seems really risky. Even if you think the current Facebook product and business is overvalued, Mark Zuckerberg and company have an incredible track record of making smart pivots and growing the company.

Betting against the current business might be somewhat smart, but betting against that team? That sounds really risky to me. They could take the company anywhere and are clearly committed to doing just that. I'd put them in the same league as Jobs, Bezos, et cetera. And shorting Amazon or Apple anytime in the past decade would have proved disastrous.

I'm going to make an argument why, though I'm not entirely sold on it.

I think that many people believe that the current valuation isn't based on fundamentals as much as survivor (or Greater Fool) investing. These valuations are based not on revenues but how much the current investors will be able to sell their shares to some later investor. The issue becomes that once Facebook goes public investing tends to skew much more towards fundamental, which may cause a dip in the stock price. Facebook's current P/E somewhere between 70-110? (I'll source these numbers in a sec). This would indicate an extremely high growth company ie in the front of the hockey stick. I think many would start to argue that Facebooks growth is going to start to flatten out. They already say about 500M active users so thats 1/12 the worlds population their user base doesn't have much more room to grow (though increasing revenue per user still still probably has some room to move).

Personally as a small investor I'm staying away from Facebook when it goes public its too volatile (unless I can get pre IPO shares ;-) But at least an argument could be made that a short isn't a horrible play. There's a really good chance of Facebook's IPO starting extremely high and then seeing a significant dip a few months out of the gate as people start taking their money out.

P/E Numbers - 70B valuation (widely reported)

Earnings 1B - 600M.

P/E 70 - 116

http://www.msnbc.msn.com/id/41521349/ns/business-us_business...

http://www.computerworld.com/s/article/9203999/Facebook_s_le...

Very good response, thanks for sharing.

I'm a value investor but my investment philosophy when it comes to tech stocks is slightly different. When it comes to tech stocks I look at the fundamentals, but most importantly I look at the leadership. If the founders are still the leaders, and if I believe that the founders will be there until they die or get really old, and if I believe the founders care about building timeless, excellent products above all else, then I'm willing to invest as long as the P/E isn't above 100.

This is my strategy because I believe the best tech companies will keep growing over the long term until technology completely transforms the world.

I'm moderately bullish on FB. Not bullish enough to buy, but bullish in general.

However, plenty of people are obviously eager to short it, and if there are enough of them it might be possible to arrange something.

Ah, very cool. Thanks for answering. I'm kind of curious how you would do it. If you could post your idea or privately email it I'd be interested.

I'm not dying to know and have no interest in actually doing it but I'm just intellectually curious to hear your idea because it sounds like you know what you're talking about and I bet it's neat.

Also, that interview link you posted with the GSV CEO was really good, thanks.

Shorting an equity != Betting against the team. Also, Shorting an equity != Really risky.

Shorting a vector of spots is just taking their dot product with a set of negative weights. After a time increment has elapsed, you switch the sign of the weights and do it all over again. Purely arithmetic operation, has nothing to do with team, company, risk etc etc.

In plain English - there are tons of securities whose short interest is quite high, every single day. You short cause you believe the spot is high. Once the spot is at a reasonable level you go long. If the trade sours you close out & eat your loss.

Heh heh. Quite hilarious to see my premise voted down to minus one when its math ( two nodes below ) is voted up two points! If the premise is wrong, so is the supporting math. If the latter is right, then so is the premise. If the premise & the math are both wrong, I spent 2 years and 50k on a useless quant masters at the university of chicago where the above premise and math is gospel. Mommy where's my refund...

I have no idea what any of this means. To me, if you short a stock, and the price goes up, you lose money. And there's no limit to your potential losses, so you could lose a whole ton of money.

um... ok. Mathematically it helps if you don't think in naive terms as stock, company, team, risk, price etc. First of all, there are no stocks. A stock is just a call at zero strike with infinite maturity. So you short a stock, you're just going short an instrument at some weight. The weight is the number of stocks you short. So you short 5 shares of google, the spot right now is 497 and the weight is minus five. So you do this with a bunch of equities ( google, apple, linkedin etc ). Then you obviously get a vector of spots and a vector of negative weights. The money you make is simply the inverse of the dot product of both vectors. What do you do with that money ? Obviously you don't sit on it. You buy protection on upside and speculate on downside simultaneously. ie. You buy X OTM calls on goog, say at 550 strike the OTM call is 70 cents so you buy that. Then you speculate on the downside ie buy say Y 485 weekly put at 70 cents.

So if your bet is right, the Y puts make money, the X calls lose money, and overall you come out winner. You wait until google is say 487 and then buy back your shares making 10 buck per share plus the money off your Y puts minus the money from the X calls. So thats just another dot product ie. C = 5 times 10 + Y times a - X times b.

Now say the trade goes south. Then you lose on the put, lose on the short, but make money on the X calls, so the dot product looks like above but with different weights. In either case, you can only lose a fixed sum worstcase ( so you statement " there's no limit to your potential losses" is definitely false ). So maximizing the money is then a constrained linear optimization problem. In a polynomial vector space, you can find X & Y quite easily using Dantzig. ( http://en.wikipedia.org/wiki/Simplex_algorithm )

HTH.

Embarrassingly enough, I'm not smart enough to parse your comment for correctness. If I were, I would be building a product to model that exact understanding of the market if it is, indeed, accurate.

EDIT: grammar

0.01% is actually a much larger transaction than market cap is normally computed on. The last trade at anyone time in a company can be as small as a single share. Of course you can object to this, but it makes no sense just pointing out a single case like this.

Regarding the estimation of the personal wealth of Zuck-whats-his-face: since the wealth of the rest of the bunch of billionaires he's compared to is estimated roughly by extrapolating the last transactions on the mass of equity they own, it would be unfair to not do the same with his.

Forbes calling MZ's holdings a "mostly paper fortune" is in fact themselves questioning the underpinnings of the valuation mechanics. I think they are keeping their heads fairly leveled.

The last transaction is a reasonable way to access market cap when a reasonable number of the shares are out in the open for free trading. 2/3s of Google shares are floating, so what the last trades happened at determine the worth to a reasonable approximation. When just a tiny, tiny sliver of the shares are floating freely, these transactions are a terrible way to access the grand worth of the company.

You don't need to extrapolate much further from the 0.01% of the shares bought in this transaction to see how ridiculous that is. That's how 37signals became a $100B company with a $1 investment following the same template.

Extrapolating to the one-dollar case is extrapolating too far. Whoever bought 0.01% of facebook, they were investing real money which they didn't want to lose.

... or were they? If the buyer were already a big facebook shareholder I suppose they might just be trying to build up the company's on-paper valuation prior to the float. Does GSV own a chunk of facebook already?

Of course scarcity plays into the equation, but Forbes does not try to misrepresent this fact. As a whole, the Forbes article can just as well be read as criticism of using extrapolation as the main valuation apparatus. The journalist very casually dismiss Zuckerberg's wealth as a paper fortune, which turns the headline's hyperbole into irony if you will.

My point is that what's actually written in the Forbes article is very open for interpretation, which makes it less of a thing to stomp your foot and grind your teeth about.

In my humble view, 37s is much closer to jumping the shark here, than what Forbes is.

I think some of you are misunderstanding the idea DHH is advocating. This is just part of 37signals' campaign to recognize profit as the primary measure of business success, as opposed to valuation.

It's more of a common sense understanding of business, and it involves less hand waving. Pretend you know nothing about stock markets. How do you become rich from running a business? Simple: take in a lot more money than you spend. If you don't do that, any secondary estimates of your "wealth" are in danger of collapsing.

Except the process of raising money, which is where the valuation question comes up, is usually happening during the moments you don't have any profitability.

I think it is actually a good point. Because there is very little liquidity for facebook stock at the moment and no way to short the stock, it is very easy for 2 or 3 investors to collude and just for $6.5 million, increase the stake of other investors by billions of dollars.

This is also what happens in real estate markets in some cities in India. 2 or 3 property brokers (real estate agents) will come together to buy a plot of land at double the existing price and create a lot of hype in newspapers around that. And with a small investment they increase the value of their portfolio many fold. Something like this can be happening here also as FB is still not public.

not to go all CFA-ninja on the article, but the valuation paid for a minority stake is less than that for a controlling stake...this is most often demonstrated with acquisitions (you can buy a few shares at mkt, or the whole thing for far higher), PE, and premiums between voting and non-voting shares

I love 37s, but this is pure hyperbole and totally backwards

I think this is more a symptom of the low volume and liquidity, not necessarily Forbes's math. There are public stocks trading on the major exchanges that have extremely low volume, but the last trade is still the last trade and as a result they tend to fluctuate wide day-to-day.

This is consistent with how the market capitalization of every company is calculated.

DHH had the same complaint when private transactions valued Facebook at $30B as he does now, when they value Facebook at $70B. See:

http://37signals.com/svn/posts/2585-facebook-is-not-worth-33...

DHH can write my web framework but I wouldn't let him manage my money.

> So the relatively modest investment of $6.5M snowballs into a $20 billion creation of “wealth”

I don't understand. What's this $20bn number? Where did that come come? They bought 0.01% for $6.5m. Unless the stock has traded again at a higher valuation, the paper value of their stake is still $6.5m. And... so what?

The paper value of their stake is still 6.5M. The paper value of Facebook as a whole (the market cap) is now 20B higher than it was prior to that trade, if you take that share price as the new share value, which is what Forbes did, and what 37signals objects to.

Ah ok got it, cheers.

The last financing round valued Facebook at $50B, and now with this latest buy in of $6.5M it increased the valuation to $70B. That is where the $20B figure is originates.

That's the increase in the value of everybody else's stake. Since the stock traded at a higher valuation, they're presuming that increases the value of all the other shares too.

Many people strongly believe that Facebook will IPO at 100 billion or more. Valuing it at 70 based on the most recent large transaction seems perfectly reasonable to me.

I don't think it makes sense for it to be valued that highly, but that is not the same as saying it isn't valued that highly. It clearly is.

The valuation is a bit back of envelope, which might be considered grossly irresponsible at your discretion — other comments in this page seem to support the share price range, I honestly don't know. But the concept is correct: market cap = total shares * share price.

What's slightly disturbing is how they extrapolated that into a valuation of Mr Zuckerberg's personal wealth. (Then again, the need to gauge and rank people's personal wealth is a bit beyond me TBH.)

The fact that we can even debate these numbers means that Facebook or it's investors are breaking the law and should be investigated.

Private companies are not allowed to publicly broadcast their share price for exactly this reason. Until something hits an open market market you really don't know exactly what something is worth.

Great article, it really puts it in perspective.

As an afterthought, does anyone have any good information on how to sensibly value a product or company ?

Actually I don't understand why this valuation is being considered null/void. It _is_ a simple issue of "extrapolation". (whether the stock is over-priced is a separate issue).

If this firm spent 6.5m on 0.01% of common stock, and assuming there is no other value tied up in the deal - i.e. it's a simple share purchase - then yes that values the firm at $70bn or whatever. The investor is expecting to get his money back, he hopes the firm will IPO at this value or higher.

This is a separate issue to the actual valuation. You (and me) might well consider such a valuation absurd. But that's where it's trading. C'est la vie.

Edit: ah ok, I got his argument - he's saying that a 0.01% trade is too small a trade to value facebook as a whole with. He could be right (altho $6.5m is not to sneezed at). But a $50m trade _would_ give confidence around a valuation ;)

     It _is_ a simple issue of "extrapolation". 
    (whether the stock is over-priced is a separate issue).

I agree, but that's not how "extrapolation" should work.

Considering how kick-ass and promising Google was before its IPO and what Facebook is right now, it's clearly an overpriced company, especially in the context of the current economic recession which is far from over and might even bring further surprises down the road (Greece, Spain, Portugal defaulting, etc...)

Based on this valuation, Facebook (pre-IPO) right now is in the same league as Google and Apple, which is absurd.

Of course, markets aren't always rational. That's why we have bubbles and economic recessions. What can I say; most people dream about investing $1 and getting $3000 back.

The most rigorous methods of valuation are usually reserved for publicly traded companies, in which financial statements and reporting can be examined thoroughly by a large number of analysts. In other words: actual company assets, liabilities, and equity can be assigned values. These fundamentals can be analyzed pretty tangibly, serving as the partial basis -- along with other performance metrics, and market and industry analysis -- for estimations of future performance.

The going gets tougher for privately held and traded companies. Transactional volume, secondary market pricing, liquidity, exit options and timing, etc., are usually the bases for valuation in the case of entities like FB. To be fair, analysis of the company's fundamentals does take place -- but it is inherently limited, due to the limited publicly available documentation and knowledge from which to work. Hence, a large degree of speculation is baked into the value. We needn't conflate speculation-qua-speculation with "irrational" speculation, as the press often does. Indeed, sometimes speculative valuations prove conservative. Nevertheless, speculation exists in this case because most analysts have no other choice.

The same way you sensibly value anything else: what the market will bear. In other words, it's worth whatever someone is willing to pay for it.

Mr Warren Buffett knows how to do it. He says anyone can learn the essence of what he practiced for decades as investing style from a book written by his university teacher Benjamin Graham. The book is called "The Intelligent Investor". Mr Buffett has described it as "by far the best book on investing ever written" and it is available from Amazon.

For good valuation information check out the mergers & acquisition literature (Finance, Accounting, Business textbooks), and the "value investing" literature (Ben Graham's Intelligent Investor, Seth Klarman's Margin of Safety, etc).

I think the article missed the point though -- net worth isn't about liquidation price so much as the cost of getting to your position at a given moment... which forbes seems to have done a decent job calculating...

So true, these valutations are crazy @DHH really writes things that make sense about this stuff;

Also an interesting/funny read: http://37signals.com/svn/posts/1941-press-release-37signals-...

I'd love to see a similar DHH takedown of Groupon's valuation. And then Jason Fried, Groupon advisor and former corporate director, could refute it!

I wrote a much more detailed takedown of Groupon's evaluation, in fact. You can find it here: http://shortlogic.com/post/6142108636/groupon-ipo-pass-on-th...

If this stuff is your flavor, I also wrote one on Pandora: http://shortlogic.com/post/6586713689/pandora-should-be-trad...

Enjoy!

Thanks, I forgot about that. It should be at 37signals! :)

I agree with you on Groupon as much as I disagree on Facebook. Groupon has a nice gimmick that's easy to copy and has been fueled by novelty and unsustainable incentives – and in my personal experience, even some outright corporate dishonesty.

Facebook has strong lock-in effects and unique targeting capabilities. On any screen in any net cafe worldwide, you're likely to see many people using Facebook. It was worth more then $30B last year when you dismissed that valuation based on a 3% investment, it has a good chance of being worth more than the $70B suggested by multiple small private transactions today.

BS.

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