Larry Summers on WhatsApp and sluggish investment

by on February 28, 2014 at 3:43 am in Economics, Web/Tech | Permalink

Joe Weisenthal reports:

Ponder for example that the leading technological companies of this age, I think for example of Apple and Google, find themselves swimming in cash and facing the challenge of what to do with a very large cash hoard. Ponder the fact that WhatsApp has a greater market value than Sony with next to no capital investment required to achieve it. Ponder the fact that it used to require tens of millions of dollars to start a significant new venture. Significance new ventures today are seeded with hundreds of thousands of dollars in the information technology era. All of this means reduced demand for investment with consequences for the flow of – with consequences for equilibrium levels of interest rates.

I don’t completely follow that argument (does it show up in the producer price index numbers?), but I pass it along to stimulate your thought.  Ashok Rao has excellent commentary:

…software (the blue line) is still only 15 percent of private investment and not significantly higher than points in the past two decades when interest rates were a lot higher. On the other hand, residential investment as a share of private investment, hasn’t changed much in structure since the mid-’60s and is still very sensitive to changes in the interest rate.

The full (short) piece on Summers is here.

prior_approval February 28, 2014 at 4:00 am

Sony destroyed its innovative electronic business by becoming involved with Hollywood. Leading to Sony actually installing rootkits to defend music revenue – as is obvious, they have never recovered from such stupid moves.

A mistake not made by Samsung, by the way.

wiki February 28, 2014 at 6:28 am

Sony was obsessed with proprietary and closed technologies independent of Hollywood. Their missteps have included Betamax, the minidisc, the memory stick and other attempts to ignore the rise of more open market alternatives. DSD/SACD is excellent for high end audio, but again Sony worked to keep the system closed in the belief that it was all about preserving their control — as a result of which virtually no one adopted their new standard at a time when people were migrating to low tech MP3s online. They only remembered their success with the compact disc and how much money they made by reissuing back catalogue. They kept trying to replicate that success elsewhere to their detriment.

derek February 28, 2014 at 10:42 am

They’re stilling doing it! Many of their devices need special USB cords instead of the standard.

mulp February 28, 2014 at 11:04 am

Yep, Sony is going bankrupt by pursuing Steve Jobs failed proprietary lock in strategy….

Morgan Warstler February 28, 2014 at 5:41 am

1. Digital doesn’t do debt. Atoms have always promoted debt (as collateral).
2. Each year digital consumption grows, atomic consumption shrinks.
3. The giant pile of capital used to making safe debt based loans is chasing an ever shrinking # of deals. Each new WhatsApp pulls another Jenga block from the debt structures counties and companies have used to buy, own and run atoms.
4. Eventually, we are all just goggled in sucking down electricity and calories.

This is the gravity of reality.

Let’s set a nice NGDPLT of 1% to assure debt based capital holders, they won’t get outright deflation, and them goose them all into making unsafe equity bets on digital companies. This is the ascendancy not of “capital placers” but “founders” and “inventors.”

Brian Donohue February 28, 2014 at 12:34 pm

If we want to goose ‘em, wouldn’t 5% NGDPLT be better?

rayward February 28, 2014 at 8:57 am

Of course, the assumption is that WhatsApp has a value of $19 billion, a value achieved with very little capital investment, that capital is not an essential ingredient for creation of value in a digital economy as was the case in an industrial economy. My problem is with “value”. Does WhatsApp really have a value of $19 billion just because Facebook “paid” $19 billion for it? Earlier this week Matthew Yglesias showed a graph that depicts the total debt to total asset value ratio, which has been declining, and suggested that it’s “proof” we don’t have a debt problem. Again, my problem is with “value”. Could it be that WhatsApp, Facebook, and the rest have “as much value as a patch of blue sky”?

byomtov February 28, 2014 at 9:32 am

My problem is with “value”. Does WhatsApp really have a value of $19 billion just because Facebook “paid” $19 billion for it?

Excellent question.

Norman Pfyster February 28, 2014 at 9:56 am

Amount paid for something is the normal measure of how much the something is worth (economically). Or is your question around what “paid” means, since a considerable amount of the payment is Facebook stock?

john personna February 28, 2014 at 10:44 am

Say I pull into the dock with 10 tons of salmon. I sell all I can, but the rest is tarting to whiff. I trade you 5 tons of salmon for your pickup truck. Was your pickup worth 5 tons of salmon?

(To someone with a market cap of $175,626,283,169 … it’s all just salmon)

Norman Pfyster February 28, 2014 at 11:24 am

Apparently, yes. And for whatever reason, you wanted my PoS pickup.

john personna February 28, 2014 at 11:37 am

It is a mental hurdle to think that $1B to me and $1B to FB can be something different. You have to be more Shiller than Fama. It shouldn’t be that hard though. Who seriously thinks that the human minds at FB can grasp $1B as a linear increase from $1M? (Rather than a transition from real to play money of transitory value.)

derek February 28, 2014 at 11:35 am

Obviously, at the moment. That is what you could sell it for. If you had 10 tons of refrigerated salmon in your boat, it would be worth far more.

A stack of newspapers put out this morning are worth, what, 75 cents a piece. Tomorrow morning that same stack in the same place will cost money to pay someone to pick it up.

If Facebook figured WhatsApp was worth $19 billion, and paid it, then that is what it was worth. Whether it is a good investment in time will be shown by events.

john personna February 28, 2014 at 11:38 am

I can agree that $19B is what it sold for, but why do I actually have to go further? The linkage between sale and worth is actually an assertion. More, it is a strong-form efficient market hypothesis assertion … and nobody believes in strong-form anymore.

Norman Pfyster February 28, 2014 at 12:10 pm

John, I think you are confusing two things. The price of a trade (assuming lack of fraud, full information, etc.) only indicates that the sale price was agreeable to both the seller and the buyer, i.e., that both are acting rationally (the price was not lower than the seller was willilng to accept and not more than the buyer was willing to pay). The fact that buyer and seller value something differently is what makes the sale possible in the first place. The efficient market hypothesis says that the price reflects all available information. The efficient market hypothesis is consistent with parties valuing the same thing at different levels. (The linkage is that financial assets are supposed to have calculable values, so if everyone has the same information, the price is obtained immediately and there would be no subsequent trading.) Facebook might have a use for WhatsApp that extracts value in excess of what anyone else in the world might obtain, and so would be willing to pay more than anyone else.

john personna February 28, 2014 at 12:18 pm

No, I think you confused yourself there. There were more (invisible) parties to the WhatsApp trade. And just like any trade, it’s value == worth assertion is an efficient markets claim.

“Facebook might have a use for WhatsApp that extracts value in excess of what anyone else in the world might obtain, and so would be willing to pay more than anyone else.”

I hope you’ve read The Winner’s Curse by Thaler.

Brian Donohue February 28, 2014 at 12:45 pm

jp, what’s your best estimate of what WhatsApp is worth to Facebook?

My best estimate is $19 billion. Why? Because that’s what Facebook paid for it. They put their money where there mouth is.

This is information. What other sources of information bear on the question? A whole shit ton of things having to do with Facebook’s strategy, its effectiveness in carrying out the strategy, what happens to the economy, what happens in Ukraine even. There are a lot of sources of information upon which to draw for anyone interested in independently opining on the value of WhatsApp to Facebook.

Please reply to my question. Show all work.

john personna February 28, 2014 at 12:52 pm

I think I got somewhere ahead of you Brian, when I said “[s]tarting to whiff”, “$1B to me and $1B to FB can be something different” and last but not least “a transition from real to play money of transitory value.” A company with both high market capitalization and ridiculous P/E Ratio has to unload the stuff.

I went through it as a small timer in a dot-com rocket ship. Our CEO told a story. He’d asked our bankers why we were priced as high as we were. The bankers said “you are priced perfectly.” But they continued, “the market expects you to do everything perfectly, anything less than perfect and that price will fall.” So of course on a smaller scale compared to FB, our CEO went shopping … which either “inflated stock prices” or “play money.” Take your pick.

That’s why it’s so tin ear, and frankly stupid, for you to ask me for “a price” and to show my work. I don’t have $175,626,283,169 in play money, starting to whiff.

john personna February 28, 2014 at 12:57 pm

(I really hope that those of you with a 1970′s vintage understanding of price and value are at least old and disconnected. That would at least be a partial excuse. Even then, you can get reading. I’ve mentioned Shiller and Thaller. Add Mandelbrot’s “The (Mis)Behaviour of Markets or for a general overview, The Myth of the Rational Market by Justin Fox)

((Of course this is a meta example of the “myth.” Efficient market theory says you’ve read those books and understand them.))

Brian Donohue February 28, 2014 at 12:58 pm

Well jp, if you’re right and have the courage of your convictions, I hope you’re shorting the hell out of FB with the pile you do have.

In fact, I might take a flyer on this myself, on the strength of this conversation.

I mean, to be clear, you’re calling a bubble here, right?

Brian Donohue February 28, 2014 at 1:04 pm

And jp, I wouldn’t presume to read a book on software and then go around and harangue software engineers.

So I’m not impressed that you’ve read a couple books on financial markets and presume to lecture me. But please, let the condescension continue to drip. It’s so you.

john personna February 28, 2014 at 1:04 pm

To be fair, you’ve just voiced a common mistake. That is, you suggest that a disbelief in the EMH must imply a predictable market. In fact, no. If you overlay some degree of efficiency (a random walk following random news) with animal spirits (manias and panics) you actually get something LESS predictable. You have a random walk with Black Mondays thrown in. Mandelbrot in the book referenced shows this numerically.

It’s kind of like “not only is the EMH false, it gets worse” (from the standpoint of investing).

john personna February 28, 2014 at 1:07 pm

BTW, if you want condescension, a cute “Please reply to my question. Show all work.” is an excellent way to get it.

Brian Donohue February 28, 2014 at 1:29 pm

It was a simple question. I gave you my answer and rationale. You are suggesting that $19 billion isn’t the right answer. So, what is it?

OK, I knew you wouldn’t answer. I just wanted to see your magical contortions. It’s actually worth suffering through your absurd arrogance. Thanks.

Brian Donohue February 28, 2014 at 1:34 pm

Yawn. In the short run, the stock market is a voting machine. In the long run, it’s a weighing machine.

john personna February 28, 2014 at 1:37 pm

You know Brian, you make fun of my references, but all you bring is leaden insistence.

Now, I’ll make a claim that is testable, and I’ll invite people to respond. I think that what I’ve explained is (1) Shiller’s Nobel, but more importantly (2) the view now taught in econ 100. Or at least econ 100 at Yale. (as explained here)

john personna February 28, 2014 at 1:44 pm

BTW, are you really not getting my answer? It is that “what the heck, FB can pay what they want.” It could be $14B, it could be $26B, it could be $19B. It could depend on what they all had for breakfast that morning.

You are stuck on $19B being “the right price” in the strong-form EMH sense.

That’s dead, as anyone teaching freshmen in econ will tell you now (at better schools).

Brian Donohue February 28, 2014 at 1:51 pm

jp, forget Mandlebrot and the legendary Justin Fox for a second.

Let’s be concrete.

You think FB is overvalued, don’t you? I don’t know how else to interpret what you’ve said.

More generally, bubble theory claims that prices in whatever market are ‘too high’, correct? (It seems to me that the forces at work could produces bubbles in either direction, but no one ever talks about 2009 as a negative bubble for the stock market. OK, don’t be distracted by this tangent.)

BUT, it is impossible to profit from such opinions because the market can stay irrational longer than you can stay solvent. Is that it?

Brian Donohue February 28, 2014 at 1:55 pm

“You are stuck on $19B being “the right price” in the strong-form EMH sense.”

I only spoke of my best estimate of what WhatsApp is worth to Facebook. Admittedly, my estimate rests on a single data point, but this opinion says nothing about EMH or how good an estimate this is.

Stop tilting at windmills that aren’t there.

john personna February 28, 2014 at 2:02 pm

That “the market can stay irrational longer than you can stay solvent” was a good and pithy way to say it, but I wouldn’t really endorse that today, or the simple claim that “FB is overvalued.” Both of those imply “normalcy” as condition reached at some point (as does a “long run weighing machine”).

The rational and irrational duel forever in the markets. Good companies typically enjoy strong P/E’s early in life, and then transition to low P/E’s whether they deserve them or not. MSFT used to enjoy a P/E in the 60′s, right? I see that it is now at 14. That isn’t a return to normal, or a long run weight. It is a mix of rational and irrational response to MSFTs market position.

In the long run I expect FB will suffer loss of confidence as MSFT has, but I don’t know when that will be.

john personna February 28, 2014 at 2:03 pm

The only way to drop the EMH argument that price equals value is to drop value, and just call it a price.

WhatsApp sold for $19B. Good work if you can get it.

Brian Donohue February 28, 2014 at 2:15 pm

OK, this is helpful.

You prolly know that the weighing machine thing comes from Buffett, who’s not a big fan of the EMH. (Why would he be? I mean, if I had his eyes…)

My view is that market values are loosely tethered to unknowable ‘true values’.

But stocks aren’t just bits of paper being traded- they’re owenrship of a share of earnings. If you buy a stock and hold it for 30 years, your return will have a lot more to do with what the company actually earns during those thirty years than fluctuations around it’s ‘true value’ at the end points. And I can stay solvent for that long.

Brian Donohue February 28, 2014 at 2:18 pm

But remember this whole thing kicked off with Matt Yglesias eyeing personal balance sheets (like yours) and licking his chops. The effort at valuation is ubiquitous. The weight you place on them is another thing.

john personna February 28, 2014 at 2:23 pm

While I don’t believe in simple random walks, I end up with the same philosophy as the random walk folks. I own simple US market indexes. Given that I think individual stocks are wondering in both rational prospects and emotional strength, it is too scary to join Keynes beauty contest. Well, that and I think I can live with market returns.

I can do that while being a “true value” atheist.

Brian Donohue February 28, 2014 at 2:28 pm

Wow, this has taken a shockingly amicable turn.

If you don’t believe in ‘true value’, how do you interpret Shiller when he calls bubble? Relative to what?

Bob February 28, 2014 at 2:31 pm

The EMH makes plenty of sense if we were talking about shares of Facebook, or Whathsapp, purchased by many actors, with different sets of information. But there’s only one company being sold, and as far as we know, only one bid, so I’d not be sure that the price represents all public information, unless we define that as all the information facebook, and facebook alone, has. It’s not as if the rest of us could ‘short’ whatsapp’s price, if we thought that it was ridiculous: All we can do is have a different outlook on facebook’s stock after the fact.

If someone offers to buy my house for 50 million dollars, but the next 10 best bidders would give me between 250K and 200K, it’s possible that the one bidder has some extremely valuable information about my house’s value that the rest of the bidders, but he could also be a loon, or a bizarro version of Yellen trying to do helicopter drops by just buying stuff from me way outside of the market price.

john personna February 28, 2014 at 2:37 pm

Actually Bob, you are more or less reiterating The Winner’s Curse, mentioned above. It is very hard to tell “a loon” from someone who “has the best idea of value.”

john personna February 28, 2014 at 2:49 pm

On bubbles, if I take the view that we have “some degree of efficiency (a random walk following random news) overlaid with animal spirits (manias and panics)” then bubbles are overt manias. Pops are overt panics.

I might actually be more afraid to spot them, call them, than Shiller. But, I can’t doubt that they exist. Gold is a repeat bubbler. It will do again.

Brian Donohue February 28, 2014 at 3:19 pm

jp, I totally get the idea that bubbles exist in theory. And we can all look in the rearview mirror and see bubbles plain as day, cuz they popped.

But I find this mania/panic description unsatisfying. One might say, for example, that there has been a “mania” for Manhattan real estate since 1970. Was there a bubble in 1990? No, because we look back in 2000 and see that nothing popped. But damn that was a bubbly trajectory. How about today? We’ll get back to you in a few years on that.

So where does “people increasingly like something” leave off and “mania” begin?

How does bubble theory work in real time? Shiller called a housing bubble in 2006. But he also called a housing bubble in the 1990s.

john personna February 28, 2014 at 4:00 pm

I don’t think markets are well enough behaved that bubbles never happen, nor that they are always/never seen. As unsatisfying as it may feel, I think manias are only sometimes understood in the moment. (Perhaps panics are easier to spot.)

It was easy for me to call the gold run from $1000 to $1500 a bubble, but has it blown off enough at $1200? I have no idea.

Engineer March 1, 2014 at 4:05 pm

If Facebook figured WhatsApp was worth $19 billion, and paid it, then that is what it was worth. Whether it is a good investment in time will be shown by events

It’s a “bubble” valuation of the type that we saw back in the internet gold rush days. Zuckerberg is paranoid about any social media platform that might someday eclipse his own.

JWatts February 28, 2014 at 10:50 am

“Amount paid for something is the normal measure of how much the something is worth (economically).”

A better measure might be what somebody paid for it the second time.

ila February 28, 2014 at 12:03 pm

It’s not worth $19B to me.

Marie February 28, 2014 at 1:17 pm

+1

john personna February 28, 2014 at 2:05 pm

Exactly ;-), but of course if you had $176B, it might be.

Brian Donohue February 28, 2014 at 4:51 pm

Wait what? I thought your point was that the $176B was funny money.

john personna February 28, 2014 at 7:30 pm

Yes, I thought these were the same claim.

Brian Donohue February 28, 2014 at 4:48 pm

Surely it would be worth at least $18.9 billion to you, knowing you could turn around and sell it to FB for $19 billion.

Brian Donohue February 28, 2014 at 4:56 pm

On second thought, since FB paid largely in stock, you might want to knock that amount down by the difference between your view of the value of FB and the market value to the extent the FB stock you receive is restricted and can’t be immediately sold. I think $4 billion or so of the price was in cash, so work upward from that floor.

It seems to me that anyone who could intermediate between FB and WhatsApp here would prolly be happy to pay WhatsApp at least $10 billion or so.

Z February 28, 2014 at 9:03 am

Mark Cuban is a billionaire because he sold worthless companies to the stupid rich. There’s nothing new about the whatsapp deal.

RPLong February 28, 2014 at 9:21 am

A lot of this is just press, you know? You can still catch Chick Corea live in concert, he’s still making a great living playing jaw-dropping music. But if all you do is read the headlines, you’d only know him as “some old guy who’s playing with John Mayer.”

I guess what I’m trying to say is that most of the real action flies under the radar. Blue chips are still blue chips.

john personna February 28, 2014 at 10:20 am

Shooting from the hip (before reading) I think the key to the software investment puzzle is its lossy nature, the lottery effect. Tens of thousands of young people work to buy their tickets (investing a little money but far far more time) for just a few winners. And the winners certainly aren’t there because of their investment. It is the Justin Timberlake Effect, rampant and arbitrary cumulative advantage. I mean, AirBnB? It is retrospectively judged as genius …. when really it was just rolling standard web practices to rent a couch.

john personna February 28, 2014 at 10:24 am

Having read Ashok Rao, and having been a software developer in the dot-com boom, it is shocking to me how much more money is being thrown at more mature markets now. No wonder it is down to renting couches …

PJ February 28, 2014 at 10:49 am

It sounds like Summers is saying that most investment opportunities these days are characterized by small bets that pay off big with a low probability. I don’t see why it follows that investment will be too low.

If the payoff ratio is high enough, then it will make sense to make thousands of $100,000 bets. Billions of dollars invested in projects that ultimately fail still counts as investment spending.

Or think of it this way. With enough trials, a binomial distribution starts to look a lot like a normal distribution.

john personna February 28, 2014 at 10:53 am

I mostly agree, but lottery mania can also lead to over-investment and net losses. I’m kind of an outsider to this now, but I get the feeling that incubators and hackathons in every hick town are a sign of mania.

john personna February 28, 2014 at 10:54 am

(Certainly playing uncertain odds on the long tail make it hard to tell when you are over-investing.)

jpa February 28, 2014 at 6:15 pm

that’s been the early stage VC business model for 20+ years.

10 small bets. 8 will fail. 1 will break even. 1 will return 100x

Miguel March 1, 2014 at 12:27 am

That’s always been the generally accepted idea. Unfortunately, it hasn’t worked for the last 15 years. Hell, Harvard – supposedly one of the best investors in vc – essentially killed their program after seeing their vc portfolio tank over the last decade.

Just another MR Commentor February 28, 2014 at 2:56 pm

The WhatsApp purchase just shows how new technology has made it so easy to achieve success these days – there’s almost no excuse to not go out right now and start a tech business. We have so many great new technologies right now such as BitCoin, Facebook, and Twitter it’s really one of the most vibrant economic periods in history.

Oldie February 28, 2014 at 7:48 pm

As I understand it, young people are using Whatsapp in preference to Facebook. Facebook bought Whatsapp so that nobody else could have it.

If you can’t beat ‘em, buy ‘em.

Larry March 2, 2014 at 11:00 pm

All you have to do is divide either sales or profits or market cap by sales to see that new industries such as software are creating vastly more value/$ than their predecessors. The future is bright if we can survive the transition.

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