It was recently reported that Snapchat turned down a $3 billion buyout offer from Facebook. Snapchat is 2.5 years old and hasn’t earned a single dollar in revenue.
For the non-financiers reading, the valuation of any asset is as much as someone is willing to pay for it, and people generally determine how much they’re willing to pay for a given investment based on their expectation for future cash flow. In the case of a company, cash flows come from either dividends paid to shareholders (ie profit) or a liquidity event (acquisition or IPO).
Who else would be willing to pay more than Facebook in the future? I can see the logic behind Facebook’s offer. They need to prevent competition and they have a ton of cash. But how many other companies in the world would have the motivation and the budget to provide Snapchat shareholders with a liquidity event worth more than that?
(Side notes: What does this say about Facebook’s business? Do they need to spend $3 billion for every mobile messaging company just to maintain and grow their business? And was it crazier for Facebook to make such an offer or for Snapchat to turn it down?)
Not only does Snapchat need to get a higher offer for their rejection to make sense, it needs to outpace their dilution. Since the company doesn’t make money, they will need to keep raising money. More outside financing means less ownership for the team and current investors. So while future valuations might be higher, each individual will have a smaller slice of the pie. Future offers will have to outpace dilution for it to be more profitable for the team and investors.
Yes, the company could also start making money, but as Shane Snow pointed out today, it looks like that will be tough. I agree and I really like his article so I’m not going to recite it. Read his analysis. It will be especially hard to earn enough profit to make them worth more than $3 billion as a standalone company.
I actually think this might go down as one of the biggest mistakes in the history of business. I think we might look back at this in ten years and say “wow, I can’t believe how crazy things were!” Then again, maybe Apple will offer $5 billion next week hah.