Depending on who you ask, talk to or read, Facebook’s $19B acquisition of WhatsApp provoked three principal emotions since the deal was announced last week – disbelief, fear and envy. Sometimes all three at the same time.
Considering that 235 of the S&P 500 companies, including venerable names such as Southwest Airlines and The Gap have market caps to the south of that magical number, at the heart of the matter lies the question – where did $19B come from?
Here to help us understand this acquisition from a Value vs Pricing perspective (one that makes a lot of sense to me) is Prof Aswath Damodaran, a Professor of Finance at NYU (his blog is eminently worth following; AFAIK, many that are interested in Corporate Finance and Valuations do), who starts off his excellent post by saying:
The first is that there are two different processes at work in markets. There is the pricing process, where the price of an asset (stock, bond or real estate) is set by demand and supply, with all the factors (rational, irrational or just behavioral) that go with this process. The other is the value process where we attempt to attach a value to an asset based upon its fundamentals: cash flows, growth and risk. For shorthand, I will call those who play the pricing game “traders” and those who play the value game “investors”, with no moral judgments attached to either. The second is that while there is absolutely nothing wrong or shameful about being either an investor (No, you are not a stodgy, boring, stuck-in-the-mud old fogey!!) or a trader (No, you are not a shallow, short term speculator!!), it can be dangerous to think that you can control or even explain how the other side works. When you are wearing your investor cape, you can be mystified by what traders do and react to, and if you are in your trader mode, you are just as likely to be bamboozled by the thought processes of investors.
Cash flows, ROE, growth, users and valuation based on comparables (of sorts) all follow before he draws some conclusions:
- If you are an investor, stop trying to explain price movements on social media companies, using traditional metrics – revenues, operating margins and risk. You will only drive yourself into a frenzy. More important, don’t assume that your rational analysis will determine where the price is going next and act on it and trade on that assumption. In other words, don’t sell short, expecting market vindication for your valuation skills. It won’t come in the short term, may not come in the long term and you may be bankrupt before you are right.
- If you are a trader, play the pricing game and stop deluding yourself into believing that this is about fundamentals. Rather than tell me stories about future earnings at Facebook/Twitter/Linkedin, make your buy/sell recommendation based on the number of users and their intensity, since that it what investors are pricing in right now.
- If you are a company and you want to play the pricing game, I think that the key is to find that “pricing variable” that matters and try to deliver the best results you can on that variable.
Go read the full post. And when you do that, don’t forget to read its near-poetic and semi-philosophical final paragraph.