Valuation and Misbehavior

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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What even is value?

It's a strange time for private company fundraising. Snapchat is maybe or maybe not raising money, in any case at a $19 billion valuation, rather higher than the $3 billion that Facebook offered in 2013. Pinterest is "in talks to raise $500 million" at an $11 billion valuation, rather higher than its $5 billion valuation last May. And can you figure out how much money Uber has raised now? I am lost. The latest news is that its Series E venture round was upsized by $1 billion, to $2.8 billion, yesterday, "just weeks after the company closed a $1.2 billion round of financing," and "on top of some $4 billion Uber raised, including a recent $1.6 billion round of convertible debt financing from the clients of the private wealth arm of Goldman Sachs." Much of this seems to be at a $40 billion valuation, but at some point they're going to have more than that just in cash.

Here at Bloomberg View yesterday Justin Fox got all discounted-cash-flow-y on Snapchat, a sobering exercise given the lack of cash flow to discount. I am not an expert on valuation or game theory or social media (I'm on Ello), but my model for social media valuation is:

  1. Facebook actually generates mountains of cash.
  2. Most other networks are in a game to credibly threaten to displace Facebook so that they can (a) get bought by Facebook, (b) get bought by some other deep-pocketed player with dreams of displacing Facebook (Google?), (c) raise piles of money at huge valuations and just enjoy themselves, or (d) I don't know, displace Facebook.

Making money off your platform is not an absolute prerequisite for the strategies in 2(a) or (b) or even really (c). Or (d)? The game allows creative strategies. Here is a 2006 post from Joe Weisenthal about disruption arbitrage:

So, how about a fund which simultaneously makes an investment in a startup, like a free classifieds service, while coupling it with a short-sale of a newspaper stock?!  Or an investment into free online productivity software, while shorting Microsoft?  The startup wouldn't be burdened with the objective of making a profit.  Simply delivering a good product, and bringing down an entrenched public company would be enough, and as the stock went down, the money would come rolling in. 

That's how I plan to fund my social media startup. Elsewhere Evan Williams says of digital media that "Wall Street does not have a sophisticated understanding of what creates value in this world."

A scam so good you can't even see it.

Here's just a lovely Securities and Exchange Commission lawsuit "against two operators of a Colorado-based pyramid and Ponzi scheme that promises investors extraordinary returns of 700 percent through a purported 'triple algorithm' and '3-D matrix.'" What was the triple algorithm, you ask? Well, I can't tell you, because it's not in the complaint, and also because it is not perceptible to the human eye. The complaint quotes the alleged scheme's website:

I thought, what can I do, what can I make, what can I design, that has only what works and none of what doesn’t, and one day, honestly this is what happened, I just saw it. I just saw it in my head. This matrix is 3D, which is why we can’t put it on paper. It’s a triple algorithm. And I can’t for the life of me tell you why I could figure that out in my head. But I could.

Whatever this 3D thing was, though, there's one thing it wasn't:

Indeed, TAC expressly disclaimed being an improper pyramid or Ponzi scheme. In a short video on the TAC website narrated by Johnson explaining TAC, Johnson announces “what we are not… We are not a pyramid scheme.”

Amazingly this raised $3.8 million, some of which was allegedly paid out in Ponzi returns and some of which was allegedly taken by the promoters. The SEC's announcement is accompanied by a handy Investor Alert on how not to invest in pyramid schemes, but here is a simple heuristic: If you go to a website to watch a video, and the video is about how the website is not a pyramid scheme, it's probably a pyramid scheme.

Some risky lending.

Here's a nice parable for how banking works. There was a mortgage crisis a few years ago. It was caused, let's say, by banks securitizing subprime mortgages. So now banks don't securitize (or, thus, make) subprime mortgages: "Some $4 billion of subprime mortgages have been given out annually since 2009, down from a peak of $625 billion in 2005." But that leaves a lot of money looking for a place to go. Where does it go? "Almost four of every 10 loans for autos, credit cards and personal borrowing in the U.S. went to subprime customers during the first 11 months of 2014," is part of the answer. Some of that is banks moving out the risk curve on products -- credit cards, auto loans -- that are not the mortgages that got them in trouble in 2008. And some of it is non-bank peer-to-peer lenders that didn't get in trouble in 2008, or didn't even exist in 2008, and are therefore unfazed by the banks' subprime lending hangover. John Carney points out that "Much of the information supplied by borrowers never gets verified by Lending Club," and remember when that's how mortgages worked?

On the other hand, "A Federal Reserve governor said risks in the leveraged lending market aren't likely to endanger the biggest U.S. banks," which you can interpret either as evidence that regulators' comically frequent pleas to the banks to stop making loans at more than 6 times leverage have succeeded, or as evidence that they've decided to give up. And banks are keeping less junk-bond inventory. And is there too much finance?

Some bad behavior.

Here is a profile of the lawyer suing big international banks for supporting terrorism. Obviously if you violate anti-money-laundering rules or sanctions, that is bad, and you are responsible for breaking those rules. But should you also be held responsible for the deaths caused by people whom you allowed to transfer money? People sometimes say that banks should be like utilities, but no one blames the electric company for providing light to terrorists. So far, though, he's winning against the banks.

In lower-stakes misbehavior, the story of Jesse Litvak, the former Jefferies managing director convicted of a felony for lying to customers about the prices he paid for bonds, is one of the financial stories that most perplexes me. I feel like every time I mention it, I hear from bond traders saying that what he did was beyond the pale and he should go to prison, and I hear from bond traders saying that what he did was a little cheeky but well within the bounds of normal trader one-upmanship. It is very confusing. Anyway here is a story about how everyone is confused by the new don't-lie-to-your-trading-customers enforcement efforts: "People in the industry are scared of making a mistake or even asking a question," says one of their lawyers. And even the Securities and Exchange Commission sort of concedes that it's going after normal industry practice: Opacity "just creates an atmosphere where people feel they can get away with things -- and they largely have for a long time," says the guy cracking down on those things. 

And remember that guy at Morgan Stanley who took a bunch of client data home with him, and then it was posted on the Internet, and he was all "well sure I took the data but I didn't post it on the Internet"? Apparently he didn't? He was hacked? Like, on his home computer? The world is very strange.

Should law firms go public?

I don't know, why not? (I mean besides that American legal ethics rules prohibit it, though that seems like a dumb reason.) There's a pretty good book called "What Happened to Goldman Sachs," and, spoiler alert, one thing that happened is that it went public and became less of a partnership culture and more of a public company whose managers were not tied to each other by the cozy bonds of unlimited liability. It is easy to be nostalgic for the partnership culture and unlimited liability and the mission of serving clients rather than public shareholders, because, I mean, that really does sound nice, right? But nice nostalgic things are swept aside by the relentless logic of modern capitalism: Investment banks went public because the business demanded it, and you see some of the same exigencies in law firms. When you have thousands of partners on four continents, it is sort of hard to maintain the old-timey partnership culture anyway, and you might as well take shareholder money to further expand. 

Some Greece.

But not very much; "GERMANY REJECTS GREEK EXTENSION PROPOSAL, GOVT OFFICIAL SAYS" is the headline that I'm seeing right now so, like, stay tuned? Turn on your TV? Here's Bloomberg News. Here's some more game theory; apparently wearing your shirt untucked and showing up late for things are good ways to get what you want, which explains all of my dazzling success. 

Things happen.

Citigroup is talking about climate change. The private equity secondary market is booming. Credit Suisse is launching a wealth-management app or something. Dan Loeb, robots and capital allocation. 8 Tax Loopholes the Obama Administration Could Close. Virtu is going to try again to go public. Why Do Dual-Class Firms Have Staggered Boards? 18th-century Chinese accounting. Somehow it takes "most of a full year" and "thousands of hours of work" for PwC to count Oscars ballots. An interview with a dog

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This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net