Valuations and Values

Facebook whistle-blower Frances Haugen stirred up a lot of trouble for her former company with her recent appearance on Capital Hill. A vivid picture of Facebook’s internal culture came to light in her recent testimony. One of the more disturbing revelations was that the angry emoji reportedly carried five times more weight in the Facebook algorithm than the like button.

Dear Reader,

Facebook whistle-blower Frances Haugen stirred up a lot of trouble for her former company with her recent appearance on Capital Hill. A vivid picture of Facebook’s internal culture came to light in her recent testimony. One of the more disturbing revelations was that the angry emoji reportedly carried five times more weight in the Facebook algorithm than the like button [1]. Apparently, all the emojis had equal weight, but it was the angry face that tended to serve as a counterpoint to the Like button, which isn’t technically an emoji. The result was that stuff that makes you angry was five times (later cut to four times) more likely to end up in your newsfeed than stuff you liked. Facebook was apparently aware of this but didn’t take sufficient steps to fix it, which was an optical disaster. After years of saying their goal was to connect people, these revelations left the impression that their real goal was to maximize clicks, even if it led to division.

The situation was obviously really broken, but who or what was to blame? The problem with assigning a single culprit for such a fiasco is that you imply that the only issue is the implementation: If it weren’t for a process snafu or a few bad actors, everything would have been fine. In fact, the system itself is the problem, and I’m not just talking about the kooky and often irrational Internet advertising economy (which certainly is a problem). The deeper problem is the business of business, or, more specifically, the business of how new companies get off the ground.

Facebook got off the ground sometime around 2003/2004 in Mark Zuckerberg’s college dorm room, but for public investors, Facebook arrived on the scene with the Initial Public Offering (IPO) on May 18, 2012. The IPO was one of the largest in history for a technology company, with a total capitalization coming in at over $104 billion. At the time, commentators were wondering how the company would ever make enough money to justify the price. As San Francisco Chronicle technology editor James Temple wrote just after the IPO [2], “The problem is that the smart money on Wall Street simply doesn’t think the company’s [Facebook’s] prospects justify the $105 billion that the offering price implied. And no wonder. That values the company at 108 times 2011 earnings, requiring almost ridiculous financial growth to make sense. By way of comparison, Google trades at less than 19 times earnings.”

Price to earnings (P/E) ratios are best discussed elsewhere, but suffice it to say, average P/E ratios are much lower than Facebook’s was at the time. Startups often have higher P/E ratios, because the whole point is that people are investing in potential, but you also need to figure in the basic uncertainty about Facebook’s revenue model. As I write this column, the electric truck company Rivian just had a successful IPO with no earnings so far, which give it a P/E ratio of infinity, but everyone knows what a truck is and how to sell a truck. At the time of the Facebook IPO, the world was just beginning to see what a Facebook ad was, and no one had any way to predict whether Facebook would ever sell enough to justify a $104 billion valuation. Back-of-the-envelope calculations showed that they would have to capture a very large percentage of the global Internet ad sales market to achieve the earnings necessary to justify what the stockholders paid for their shares.

When emojis arrived on the scene in 2017, Facebook was still methodically working their way back from the oblivion imposed by their shareholders’ obsession. Fast forward to today, and the company actually succeeded. They really did capture a very large percentage of the global Internet ad sales market, and their P/E ratio is currently down to around 32. In terms of execution, the company should be commended for succeeding in clawing their way to stability after the ridiculous early expectations, but the point is, they didn’t get there by playing nice. From the date of the initial public offering, it was clear that Facebook would have to grow at an explosive, exponential rate in order to justify their share price, and they weren’t in a position to lead with benevolence.

To be fair, they are trying to fix it now – they say they have already fixed it, but it is a little hard to tell, since there is no real oversight. There are lots of reasons to be angry with Facebook, but if you want to get angry about the anger, just remember that it was our stark and soulless corporate finance system that defined their culture. Their shareholders gave them an impossible task back in 2012, and like any good gamers, they made it the object of their single-minded focus. Their rocket to the stars ran on anger because that was the cheapest and most abundant fuel, and they needed a whole lot of lift.

Joe Casad, Editor in Chief

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