Even Facebook’s biggest fans should be thrilled its stock traded down today


zuckerberg-got-disThe market is trying to save Facebook from itself.

The company’s stock is down today —  just under 7 percent and it’s recovered a tiny bit of that in after hour trading. And Facebook CEO Mark Zuckerberg loves to emphasize how much he doesn’t care about that stuff. But still the drop — however modest or shortlived it proves to be — is the best thing that could have happened to Facebook today.

It’s a sign that not everyone agrees that spending $ 2 billion on a company that has yet to ship a product in a wildly unproven field is a great idea. It’s a sign that some investors are concerned that Facebook’s acquisition strategy has gone from “the borg” — where smart talent is gobbled up and assimilated into a stronger core team — to the Balkans — where divisions with promises of independence are bolted on all around the company while the engineering core weakens. It’s a sign that some may be worried about the prices Facebook is paying for these things — and how the valuation math seems to be escalating.

And maybe — maybe — some on Wall Street share the concerns of those in Silicon Valley: That Facebook — a company that has always claimed to be all about “hacking” — has utterly lost its own product and innovation mojo. We saw that with failed mega-launches like Home and messaging. We saw it in the escalation of the shameless copycatting. Now we’re seeing it in pay-any-price acquisitions. It’s no longer just a concern amongst Valley insiders that Facebook can no longer make products users love. The company seems to be understanding that too and buying what it can no longer build.

Still, all the negatives on this deal and potential red flags aside, I understand why Facebook is doing it and I don’t totally disagree with the logic. (I’ll get more into that in a moment.) But of course I think this way. I think in Valley terms. I’ve lived here for nearly 15 years, and most recently I became a founder myself after quitting a lucrative job while on maternity leave in a crushingly expensive city. I drink the disruption Kool-Aid as much as anyone. I think a risky bet on the future is always better than protecting the past. I think waiting until your business is declining is the worst time to make bold moves. I didn’t think YouTube was crazy; I didn’t think Instagram was crazy at $ 1billion. And while I thought the price for Whatsapp was indeed crazy — I get why Facebook is willing to bet insane amounts of money on something that might not prove its value for years.

What scares me — and others I’ve spoken to since the deal was announced yesterday — was that so much of the mainstream media also “got” Whatsapp. The coverage of the deal was almost universally positive, including many blindly repeating the lie that Whatsapp was so secure it was virtually NSA-proof.

When mainstream America feels that positive on a deal that carries a ludicrous price tag, alarm bells start to ring. The Whatsapp deal — and the glowing aftermath discussing it — was the first moment in some eight years of arguing that we are not in a bubble, that I wondered if maybe we are. People in the Valley should be thinking crazy. People outside the Valley should shake their heads and insist that we’re all delusional and that billion dollar valuations are ridiculous.

When our crazy spreads, we’ve got a problem.

Had the market cheered Facebook’s similarly nosebleed purchase of Oculus Rift — a company most of the world hadn’t heard of — Facebook would have no reason to slow down a trend that is clearly escalating. After all, at least the rationale with Whatsapp was that it was growing faster than anything we’ve ever seen before. It’s a horrible rationale; the market for the mobile Web is expanding dramatically so anything hot will necessarily grow faster than what we’ve seen before. That alone isn’t a great reason for Facebook to do a deal worth 10 percent of the company. But at least it is a rationale.

The rationale that Oculus Rift may be Facebook’s equivalent of Google’s Android purchase is absurd. When Google bought Android it was hardly a sure thing. Taking on Apple and other huge incumbents in the mobile industry is scary and without Google’s several hundred million dollar investment, Android would likely never would have become the size it has. Android will go down in Valley history as one of the best purchases made… maybe ever. But that deal had two things going for it that Oculus Rift does not: First, smartphones were far enough along we could see how a winner could become huge and, second, it had a reasonable price tag.

Although today’s stock drop isn’t a big one, that initial “huh?” moment by the market really matters — particularly on a day when the markets were only modestly down overall. The higher the company’s stock goes, the wilder Facebook’s acquisition currency gets, making crazier prices more defensible inside the company. After all, if even Wall Street gets it, these deals are a no brainer.

Make no mistake: Just a few years after Facebook went public, acquisitions are fueling the company’s future. We can all agree Instagram was a game changer for Facebook, and a bargain at $ 1 billion. It was worth that to keep Instagram out of the hands of a rival. But billion dollar acquisitions are like shots of tequila. Too many right in a row and you are soon puking your guts out.

Now. There’s a difference between skepticism of Facebook’s messaging of the rationale for these deals and arguing the company was crazy to do the deals. As I said, I get their logic. And here’s where we get into the mind of Mark Zuckerberg and Facebook’s board. As I’ve written before, when analyzing Facebook’s purchasing decisions you have to adopt a different mindset. This is a company that has its own math. And it’s born out of sage and — ironically — conservative thinking.

Mark Zuckerberg — a man everyone thinks of as invincibly cocky — is actually insanely paranoid. He’s not quite Andy Grove paranoid, but neither does he have any  of Larry Page’s calm conviction and confidence that he can disrupt any industry he turns his vision to as if by magic. (Poof! Now we’ll map the ocean! Tomorrow: Hacking death!) Nor is there a whiff of the lies that so many successful CEOs tell themselves: That their network effects are so great they can’t possibly be disrupted (eBay); that their eyeballs are so big they’ll always be worth insert-number-of-billions (Yahoo); that any young upstarts are doing something different, not challenging the giants’ core market (MySpace).

Look at Zuckerberg’s carefully handpicked board. It’s constructed of a similar mindset that dominance can always be challenged, that nothing is permanent, and that you have to be willing to disrupt yourself to survive. It reflects an obsession with deep long term thinking — so called “long term greed” — that you don’t typically see in a public company.

Reed Hasting of Netflix is a man who was okay with destroying his DVD business to own the streaming future. Don Graham has watched one of the most revered newspaper brands of all time — the Washington Post — crumble in the hands of the Internet. (Pando investor) Marc Andreessen earned his stripes fighting Microsoft’s monopoly, then selling Netscape to AOL, who refused to embrace broadband and lost its edge. And Peter Thiel never met a contrarian thought he didn’t like. His firm — Founders Fund (also a Pando investor) — has a manifesto against playing it safe.

But to really understand the mindset of any founder-dominated company, you have to go back to its early, formative days. In the early days of Facebook, wherever the company went in the Valley it heard two things: Friendster used to look just as great before collapsing, and MySpace had an insurmountable lead in social networking.

That was echoed by a piece of advice Thiel gave Mark Zuckerberg just after he invested. Zuckerberg told me about it years later, and said it had stuck with him. It’s stuck with me too. Thiel shook his hand after signing the paperwork and said five simple words: “Just don’t fuck it up.”

The message was clear: Sure this is going great now, but it could all go away. Zuckerberg was young, naive and on top of the world and could have been arrogant enough to brush it off as if Thiel simply didn’t understand Facebook. But he didn’t. It resonated.

Further, Thiel challenged Zuckerberg to break what he called the four year curse. Up until that point, most companies that became the darling of the consumer Web had about four years on top after they went public. Netscape, Yahoo, eBay. Amazon was always an up and down outlier.

Google ultimately broke the pattern; hacking the way to stay dominant well before Facebook had the chance. And Facebook waited so long to go public compared to those late 1990s companies, it’s not a fair comparison. Still, the sentiment of Thiel’s comment was a sound observation and the reason people in the Valley hate to work at public companies: They get caught up in quarter-to-quarter drama losing all sight of the long term. They get in their own way. They’re forced to think of protection not internal disruption.

Facebook never has. I don’t know first hand if Zuckerberg still thinks about these early conversations with Thiel or if his journey has changed his thinking. But he has always acted like a man terrified this could all be taken away at any moment. That’s incredibly rare in the CEO of a major public company with a billion users and a surging stock price that has more than doubled over the last year.

When Facebook was valued at billions but still privately held, Zuckerberg would pay attention to any nascent threat that got the Valley’s insiders excited. He bought Friendfeed. He tried to buy Twitter. He copied Foursquare. He copied Quora. He bought Gowalla. He bought Instagram. After his IPO, he tried to buy Snapchat and bought Whatsapp. When it came to Instagram, he was happy to pay double what Twitter had offered. And while we don’t know the truth of rumored and disputed conversations between Google and Whatsapp, I’m fairly certain he didn’t have to go as high as $ 19 billion simply to get the deal done.

Here’s the shocking truth if you are used to following public companies: Zuckerberg simply doesn’t worry about “overpaying,” because his math is different than most public company CEOs.

When it comes to negotiations Zuckerberg is the anti-Larry Ellison — which is an interesting comparison given Ellison may have been the last Valley mogul to go on a wild $ 20 billion-plus spending spree. The way Ellison did it — and his intention — was far different. He waited until his competitors were on the ropes and dying, snapping them up on the cheap. He’d keep the idea of buying Siebel Systems or Sun or BEA slowly burning in Wall Street’s mind for years, constantly trashing the companies and their leadership and technology. Making them as weak as he could in the process. And then he’d pounce and pay only what he had to. He was like a patient predator waiting in the jungle for the wounded gazelle.

Zuckerberg is the opposite. As I’ve written before, he knows from the deal he turned down with Yahoo the power of putting a number starting with a B in front of an entrepreneur. So what about more Bs? His stock currency has given him plenty to play with. It’s the way the Valley has come to think about startup valuations. Consumer Internet success is binary. It’s a home run or a disappointment. As long as there is a liquidation preference to protect you on the way down, if the difference in winning the deal or not is a $ 1 billion valuation, you are better off to pay it. If it works, you won’t give a shit about the extra cash you could have made because you are just glad you won it. If it doesn’t, well you would have lost money at a lower valuation anyway. And again, the liquidation preference ensures you likely get your money back.

This mindset has likely become more pronounced because Facebook has been failing in terms of product innovation — the thing it says is the bedrock of the company — despite succeeding financially. That kind of disconnect tears at paranoid leaders. They want to correct it before the rest of the world catches on.

Look at Instagram. It was the one company — other than Twitter — that anyone could realistically see becoming another strong social network contender. A $ 1 billion price tag was nothing to protect a (then presumed) $ 75-billion plus company. Now look at Whatsapp – one of the Valley’s fastest growing companies ever, and focused squarely in Facebook’s wheelhouse of messaging and photos. Is it worth $ 19 billion? Most definitely not. Uber wasn’t worth $ 3 billion at the time of its last funding either. And Facebook wasn’t close to being worth $ 15 billion when Microsoft invested. But venture-style math isn’t about what the company is worth in the abstract. It’s about what getting in that deal is worth to the person writing the check.

Is it worth 10 percent of Facebook to take out a future threat that could seriously undermine its dominance? It requires venture-style math to get there, but yes. In hindsight, Yahoo would do that deal for a young Google all day long. And yet, Google and Facebook are the only two public companies that I see continually embracing this kind of math, and that’s why they win so many deals.

That brings us to the bizarro deal with Oculus Rift. It’s a wild experiment. I get the frustrations of people in the industry who want hardware to become big, and people who backed it and feel cheated. I don’t think Facebook bought the company with the intention to crush it. But let’s be honest: There’s no way virtual reality is going to be such a major thrust for the company that it puts its full muscle behind it. This is a gamble on the upside, and a hedge against Google’s hardware spending spree on the downside.

But while the venture math explains some of these gambles, the prices and stakes are definitely going up, which is why a market correction is exactly what Facebook needs to save it from its own  thinking.

[illustration by Brad Jonas for Pando]