Now for some jaw droppingly bad analysis …

… Matt Yglesias in Slate. Now I should preface that I generally like Yglesias’s writings which is why I read them but today something happened.

The Wall Street Journal reported today that Snapchat turned down a $3 billion acquisition offer from Facebook.

I say three cheers to Snapchat!

The company’s founders and investors may or may not be making a terrible mistake. But from the sidelines, I think one should almost always root against the acquisition exit. It’s boring. It’s lame. The bet when you turn down $3 billion is that there’s some chance that in the future your company will be worth $30 billion or $300 billion and you want to reach for those stars and dare to dream. …

Will Snapchat develop a revenue stream? Will it find more plausible use-cases for its service that let it continue to grow? I don’t know. Probably not. Most business ventures fail. But good for them for trying. The founders are smart and young and if it doesn’t work out they’ll do something else.

Wow just wow. Where to begin? Let’s try and understand Yglesias’s position. Snapchat — a company with no revenues that currently targets young people — apparently got an offer from Facebook for $3 billion that does have a revenue stream but is worried about losing young people. Now, $3 billion is alot of money. For instance, it is twice what Google bought YouTube for. Moreover, there are only a handful of start-ups that actually make it to a billion dollars in valuation, let alone an exit. Snapchat also faces competition and, put simply, it wouldn’t be hard for others to replicate their function of deleting photos. Indeed, Apple made it easier for such development in iOS 7.

snapchatBut Yglesias is cheering for the rejection of that offer. First, he thought that would be boring and lame. These have carry the formal definition of “not providing fodder for journalists to write about in the future.” I guess that is true but why one should ask entrepreneurs to think of the journalists when making commercialisation decisions is anyone’s guess. Second, he thought that they were taking a bad bet. The bet is apparently that you give up $3 billion in the hope of earning more. Yglesias thinks they have a chance at $300 billion; you know, AT&T in its heyday numbers. I think we can dismiss that as sheer innumeracy. But let’s imagine $30 billion is a possibility. How much of a possibility does it have to be?

OK to “The Algebra” app:

$3,000,000,000 < p*$30,000,000,000

implies p > 1/10.

So to believe that is a good bet, Snapchat has to have a 10% chance of becoming a $30 billion company — somewhere higher valuation than Twitter and lower than Facebook (its would be suitor). Did I mention that it has no revenue, no revenue plans and a young customer base that don’t like things like expenditure for digital services? If you look at the last decade of billion dollar companies and condition on Snapchat being one, they don’t have a 10 percent chance of a fraction of that.

Finally, Yglesias says that the founders will be fine. So they try and fail, they’ll do something else. Yeah sure. But throwing away $3 billion isn’t failure, it is deciding not to succeed. That is a different proposition. What are they going to learn? I guess we shouldn’t through away more than our business is worth again?

Ultimately, while it is easy to pull apart these arguments, the actual real history of entrepreneurial firms tells us that most of them succeed by cooperating with established firms rather than competing with them as Yglesias is cheering here. As a person responsible for much of that research (see here, here, here and here to name but a few), let me tell you that the struggle in getting acquired is getting a big payout from stronger incumbents; something Snapchat, like Groupon before them, seem to have overcome. To be sure, there are companies like Google and Dropbox (who each turned down a small amount), that end up doing quite well. But they are the exceptions rather than the rule. Snapchat may prove me wrong but I have to say, kids, you should have taken the money.

18 Replies to “Now for some jaw droppingly bad analysis …”

  1. There is some bad analysis here, but it doesn’t come from Yglesias.

    He is not claiming to analyze anything. All he’s saying, and he’s right, is that if facebook bought snapchat it would likely become some submodule of facebook, and that would be that.
    But by going it alone, there’s a chance, however slim, for them to do something really interesting.

    When snapchat eventually regrets passing on that offer (I suspect they will regret it), then the rest of us are no worse off. But if they make it big, we’re all better off for them going it alone.

    1. You say that when snapchat regrets passing on that offer the rest of us are no worse off, and if they make it big we’re better off.

      I don’t see how that is relevant to Josh’s article at all. His post was analyzing the wisdom of the choice from the perspective of the founders of Snapchat, not from a societal perspective (hence the expected value calculation only being about Snapchat’s profits).

      Perhaps your point is that Yglesias is correct if we look at this from a social standpoint. I don’t know if that’s true or not, but neither Yglesias nor Gans seemed to be talking about that, they were talking more about the wisdom of the choice from the perspective of the Snapchat founders.

      1. Actually that’s exactly what Yglesias was talking about. From Yglesias’ original:

        “The company’s founders and investors may or may not be making a terrible mistake. But from the sidelines, I think one should almost always root against the acquisition exit. … Many individual companies have suffered for daring to dream—think of Groupon, which had an offer on the table from Google—but it’s hard to imagine the world suffering from that outcome. … Apple seems to have seriously considered buying Dropbox at one point, which could have been a great arrangement for both firms, but it would have been bad for a world that needs cross-platform services in an universe increasingly dominated by a handful of platform players.”

        It seems clear to me that he’s talking about what’s good from a societal perspective, not from the perspective of Snapchat’s owners (who he acknowledges may well be making a terrible mistake).

  2. I would side with Mr. Gans, how much more value can they squeeze out of this app?

    It would be more productive for the creators of the app to sell snapchat, take the money and begin working on another project(s). Think opportunity cost of taking the deal vs. not taking the deal. Taking the deal free’s up the creators time to pursue new ventures and create more products and value in the economy.

  3. It seems to offend you deeply that some people might be motivated by something other than money.

    I see nothing here to get so emotional about. If some young guys want to pass up the sure money for a decision option that offers a lower expected monetary value, but more adventure, what’s it to you?

  4. While Matt’s choice of numbers might be a little unrealistic, the logic of not selling for $3bn does not rely on reaching a value of $30bn in any way. It just means that the owners of Snapchat think the value will increase by some amount (say, in the next year) that is higher than the opportunity costs of sticking with Snapchat for that period of time. That might be just $3.5bn or even $3.2bn.

    Moreover, the argument that the probability of obtaining a value of $30bn is implied to be 1/10 by a present value of $3bn is plain wrong. Why?. Distributions. That’s the why. What do I mean? Snapchat has a probability distribution of it’s future value. As a simple example, a present valuation of $3bn could be based upon a 60% chance the company will be worth $1bn and a 20% chance the stock will be worth $12bn and a 20% chance of 0. Your example assumed the downside value was always 0. Most likely, there are potential values ranging from $0 to $Xbn each with a cumulative probability that can be integrated across to obtain a present value.

  5. He says they might be making a “terrible mistake” from the point of view of financial prudence–but that the rest of us should cheer on their risky and possibly imprudent decision. And why not? It was probably imprudent for Melville to write Moby Dicl, but I am glad he did, and it wasnt SO terrible for him–just meant he had to go out and get a real job when his books didn’t sell so well…

  6. I would think that the value of dollars over $3B is fairly marginal to most people. It’s fairly dumb because they could have sold Snapchat and then do whatever they want the rest of their lives. How much do the dollars over $3B really matter? I wouldn’t bet $3B of my own money if 99/100 times I would get back $300B.

    I remember similar commentary when Draw with Friends sold for a few hundred million that this was below their valuation. However, it was pretty smart as it turned out they would have gotten nothing if they had not sold.

  7. This is a company with one “product”and no sales. It’s shocking that anyone would consider it to be worth $3billion, and likely this is a valuation that could last as long as a Snapchat image. It will never be worth $30 or $300 billion. It is highly unlikely that it will ever be worth $4 or $5billion, but even if it is, what can you do with $5 billion that you can’t do with $3 billion?

    If the worst case scenario is that the company value tumbled to $100million, it would be a risk worth taking, but the worst case is that the value will tumble to zero.

    It these guys had spent years working on a passion and had built a company that provided an income to hundreds or thousands of employees and affiliates, I could see holding out. But it’s a school project that turned into a popular app that allows teenagers to send photos of their private parts without fear their parents, teachers or future employers will find out. Can anybody really love a business like that?

    If they took the money and ran, they could build other businesses, travel the world doing good, endulge all their wildest desires, or all of the above.

    Passing makes no sense.

  8. Actually, what you have to do to figure out whether it was a bad decision is sum the utilities over all the possibilities, factoring in the likelihood that spending a few years working for Zuck would not be as much fun as staying indie, and see whether the mean utility would be greater for the refusenik side. Note that the probability of >30B valuation doesn’t have to be anywhere near .1 for this to be true. For example, suppose the probability of >6B is greater than .5, decaying rapidly thereafter, the expectation will be greater than 3B.

  9. Congrats, Gans, your shrieking got me over here from Sullivan’s site. Your willful misreading (unless it’s just garden variety stupidity) of Yglesias’s “perhaps not good for them, but good for us” argument is getting you hits. Well played.

  10. The only thing I have an issue with is that we don’t know the exact terms of the Facebook offer but you would have to assume that it was not a Cash transaction and some form of earn was required. If that were the case given the demographics of Snapchats base it was unlikely that the valuation would be achieved as the users would have walked given the purchase. Thus the equation has to be what was the cash valuation that Facebook were prepared to pay rather than stock as the downpayment on the deal. That amount has to be a significant amount lower than the internal or VC number or they would have been forced to sell by the Investors.

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