Real vs. Perceived Value

I already had a post ready for today, but I’ll keep that one in the can for later. Instead, I felt I had to interject on a topic in the news today that seems to defy any sort of logic or common sense.

Percieved VAlue

Below is a quote from an article in the Wall Street Journal about a two year old business who was recently offered 3 billion dollars as a buyout option by the social media giant Facebook. Sounds like a great deal right? Marc Cuban made out fairly well from a similar offer. So, what did 23 year old co-founder Evan Spiegel decide to do with his mega offer? He rejected it.

Snapchat Inc. co-founder Evan Spiegel in recent weeks spurned an all-cash offer from Facebook Inc. FB for close to $3 billion, according to people briefed on the matter. The offer, and rebuff, came as Snapchat is being wooed by other investors and potential acquirers. Chinese Internet giant Tencent Holdings Ltd. TCEHY  had offered to lead an investment that would value Snapchat at $4 billion.

According to the WSJ article above, that is not the only offer on the table. All this is great. I’m normally really happy for someone who puts some good work into a product, it takes off, then they make a killing when someone buys it. It’s a model many have tried to copy. But something doesn’t’ sit well about this story, and here’s why.  The very next paragraph of the same WSJ article tells why.

Mr. Spiegel’s company has no sales and no business model—but it does have a smartphone app that delivers hundreds of millions of messages, mostly from teenagers and young adults, that disappear in 10 seconds or less.

This brings us back to the title of this article, “Real vs. Perceived Value”. That title is fairly self evident given the quote above. Obviously, several companies perceive the value of Snapchat to be quite great, but what is the real value? Before we try to answer this, below is a piece from an article on Yahoo that highlights this issue with Snapchat as well as a few others.

Snapchat specializes in ephemeral mobile messages, including text or photographs, that disappear after a few seconds. The service has not generated any revenue, but is especially popular among teenagers and young adults, who use the app to send messages to friends.

The approaches to Snapchat come amid rising exuberance for social media, and mobile-messaging upstarts in particular. Twitter, an unprofitable short-messaging service, is valued at roughly $25 billion after its initial public offering last week. Pinterest, an image-sharing app, last month raised $225 million from investors who valued the company, which also has no revenue, at $3.8 billion.

Now, go back through the quote from above and read only the bold words. Values are being assigned to companies that generate no revenue. How is this possible? I realize that Facebook would get the benefit of getting a lot of teens back to using one of their products. And, whoever eventually ends up with this app will have the opportunity to monetize it, but they run the risk of killing it when they do.

I just do not get how a company that generates ZERO revenue can be valued at billions of dollars. Let’s say I was walking around downtown and saw a sign in the window of a local business that read “Business for Sale”. So, I go in and speak with the owner. After inquiring about, the owner informs me that they are in the business of giving candy to kids. Giving, not selling. The company actually makes no revenue and is funded out of the owner’s pocket. Thinking this is a great concept, I immediately offer him a million dollars for his store. Yeah, doesn’t make sense to me either.

While this may vary significantly, the general rule of thumb for pricing an existing business to take the amount of inventory and property on hand, add one year’s revenue, and that should roughly be your selling price. This is an over simplification, but stick with me. If we applied this method to Snapchat, we would start with their inventory value which is $0. Next we would add property, in this case some web hosting server space, so at most we’ve got a couple hundred bucks. Include the app itself, which to duplicate would cost around $10,000. Now add the annual revenue, another goose egg. Throw in a little extra to sweeten the pot (if not just to round to a nice whole number) and a fair offer woudl be around $11,000.

Again, back to our title, “Real or Perceived Value”.

Real Value = Approximately $11,000

Perceived value = $3,000,000,000 according to the Facebook offer.

Again, I know Facebook and others could say that the value is not in revenue generated directly, but rather in customer acquisition and retention. I get that, but for 3 BILLION?!?!?! I could help them acquire new customers for WAY less. Facebook could pay me a mere 3 million and I’d bring them new customers for life. By the way, that offer will stand if anyone from Facebook decides it sounds like a good idea.

Looking back at that last piece from Yahoo, I’ve come to the conclusion that we are headed for another dot com bubble. Look for my next post in the next few days on Bubble Burst 2.0.