By Max Jedeur-Palmgren March 17, 2014
(©Zoltan Acs)
In an effort to minimize the time I’d have to spend reassuring my family that I was safe from attacks from New York City’s giant rats and that I was eating more than pizza slices, I had my parents and siblings download WhatsApp before I moved to the Upper West Side from my native Sweden. An online messaging system for smartphones, WhatsApp messaging is similar to the texting that phones have been able to do since Nokia invented SMS technology in the nineties, but is more flexible and far less expensive. The app let me add my family members to one group, and enables me to send daily, simultaneous text updates – for free – to my parents and siblings reassuring them from whatever troubling fantasies they could make up.
These conversations are admittedly ordinary, bordering on dull. (Typical observation: Swedish-branded children’s backpacks are the hippest thing in Williamsburg.) But as I followed the news about initial public offerings and mergers and acquisitions, I realized that these conversations were also worth something. In fact, I concluded that Wall Street actually values my small-group text conversations with my family at $210, according to the price that Facebook paid to acquire WhatsApp last week. (I’ll show how I calculated that in a bit). What did this insight tell me, I wondered, about the relative valuations of social-media companies?
First off – if you want to become an expert at company valuation, you should quit journalism and make yourself some real money. There’s a large literature in corporate finance on the subject, and many time-tested ways to analyze financial statements. That said, doing your own back-of-the-envelope calculations about company value can provide insights for journalists who want to add another layer of understanding to their reporting.
The first thing to do when thinking about a company’s value is to understand what it actually does. What is the company’s business plan? How does it bring in revenue? Answering those questions lets you identify similar companies, and from there you can make comparisons about their valuations. It’s easy to see why Chrysler’s numbers should be compared to GM’s and Ford’s, but it may be less obvious to consider whether LinkedIn can be compared to Snapchat, which I’ll do below. This may be more arbitrary, and it might even be debatable. But this is the nature of the industry that start-up tech companies operate in, so for now – just get with it!
When you’ve got your group of competitors in order, you need to pick what numbers makes the most sense to compare. The P/E ratio (price as a multiple of earnings per share) is a common measure, but depending on what industry you’re looking at, it might make more sense to compare other variables. For private companies where the market value isn’t publicly updated on a day-to-day basis on the stock market, mergers and acquisitions or rejected bids circulating in the business pages of the press might give you a hint. Once you’ve identified a peer group and picked valuation methods, you can move on to the even more interesting question of determining why the value is what it is.
We’ve all been curious about the astronomical values of the platforms that often are grouped together under the umbrella term “social networks” or “social media.” The media reaction is the same every time, whether it the Facebook and Twitter IPOs or the acquisitions of Instagram and WhatsApp. As the story breaks, the first response is a wave of awe about the sheer size of their market capitalizations, especially since many aren’t earning any revenue, along with astonishment on how it’s possible for a simple app to be worth, say, 76 Washington Posts, as in WhatsApp’s case. Then – sometimes within hours – Twitter fills up with experts and analysts defending the prices and explaining why these valuations are sensible, even though anybody trying to make these claims the day before probably would’ve been ridiculed.
What is the underlying reason that Facebook can be worth $175 billion or Twitter around $30 billion? That’s where my musings about the value of my family conversations come into play. I’m a general user of social networks. In addition to WhatsApp, which is increasingly taking over my text communications. I spend far too many hours on Facebook. I browse on Twitter (and Tweet hesitatingly), use Instagram’s glowing filters to nurture my inner wish to be artsy, and have a sparsely filled LinkedIn account because “I should.” I even downloaded Snapchat when it was in the news, but never understood it. By taking all these companies’ market caps (or, for the private ones, the valuation suggested by their takeover prices – and in Snapchat’s case, last year’s rumored $3 billion dollar rejected bid from Facebook) and dividing it by the number of users they have, I can calculate their market cap-per-user-ratio – essentially what I am worth to the social media giants.
All in all, the markets are valuing my social presence at $563. That might seem strange, seeing that I’m only paying $0.99 (WhatsApp’s annual fee) in total for all these services, but it suggests some interesting things about the mechanics of social media revenue.
A recent study by BI Intelligence shows that, the amount of time consumers spend on media has shifted dramatically over the past few years. In 2012, use of mobile devices shot up – grabbing a 12 percent share of total media consumption, with a high growth trajectory. Web consumption also rose to 26 percent, at the expense of TV, print and radio. But what makes mobile apps exciting at the moment are the expectations they carry.
The same study shows that ad spending on webpages seems to be reaching maturity, with spending on web ads (22 percent of market) catching up to consumer behavior. Meanwhile, as consumers are staring at smartphones more and more, advertising revenue is still far from its potential, and the markets are expecting this category to be the next ad-Klondike. (This reality is flipped for print news, which still has 23 percent of advertisement revenue with just 6 percent of consumer attention.)
When Facebook launched its IPO in 2012, it did so without a mobile strategy, and investors punished them for it. First offered at $38 per share – a market capitalization of around $90 billion – the stock price soon went south, causing bad press. Three months later, the stock lost almost half its value, trading as low as $20. Now, after a year, with Facebook actually making more money from their mobile app than the website, the stock is up to almost double the initial price.
Other factors in the equation for market price include the nature of the social network and its growth potential. Why is Twitter is worth about a quarter of Facebook, while having just one-tenth of its users (and given the fact that users spend five times more time on Facebook than on Twitter)? One reason is that people use Twitter uses to actively obtain information and engage with the wider world, while they use Facebook more as a private ecosystem for friends. It’s logical to assume that users looking for more exposure to external content are worth more than their wallflower counterparts to advertisers.
Ultimately, a company’s value is nothing more than the net assets on its books plus the discounted present value of its expected future earnings. For most social networks, it’s the latter part that an investor pays for, making user growth the single most important characteristic. There are hundreds of similar apps like WhatsApp, for example, but none other are growing by 1 million users per day – heading towards 1 billion users by the end of this year, according to Facebook CEO Mark Zuckerberg’s expectations. Investors are seeking the platforms that are positioning themselves as large players in this growing market.
Expectations work both ways, of course. When Twitter released numbers earlier this month showing that growth rate had been slowing down, the stock price fell from $65 to $50 in a single day.
Sometimes an obvious question, along with a simple valuation technique, can help cut through the clutter of forecasts, commentary and social-media hype, and provide insights about what’s really going on in the financial markets.
