This week we have entry #5,740,412 in the ledger documenting "Why Not Every Market-Based Outcome Is Optimal." And that’s the Yahoo purchase of Tumblr.
You may have heard of Tumblr: It's a quasi-social publishing platform that's sort of a mix between the old Blogger and Twitter. It's quite successful in its way. Yahoo's celebrity CEO Marissa Mayer (I like to think of her as the Danica Patrick of tech tycoons) says that Tumblr has 300 million users. The external numbers suggest that it's closer to 200 million and that its user-base has been flat since last November. Other estimates put the number of Tumblr users closer to 134 million worldwide, with only 44 million in the United States. But even so, that's not nothing.
Now, the purchase price for Tumblr? $1.1 billion. With a "B." (And Yahoo paid cash.)
Now let's play a little game. Guess what Tumblr's revenues were last year? No, no—not the profits. No one in the tech world worries about "profits"—that's so last-century. Just guess the revenues.
Got a number in your head? Okay, now guess again, and this time I'll give you a hint: Go lower.
Got your new number? Great. Now here's the answer:
In 2012, Tumblr's total revenues were $14 million. That's right—Tumblr is a 5-year-old company with $14 million in revenue.
That's not a lot of money. The average Apple store brings in $13.1 million in annual revenue. To underscore, that’s not for the Apple retail concept—it's just for the 2,000 square foot brick-and-mortar joint with the white walls and wood floors at your local mall. To put it another way, as a writer at Forbes.com notes wryly, Tumblr generates "as much annual revenue as a moderately well-managed New York deli."
There's a certain kind of adherent to the free market who insists that, whatever your lying eyes are telling you, Tumblr must be worth $1.1 billion. It's worth it because someone was willing to pay it. The thing is, while the free market is a pretty good thing in the very long run, it makes mistakes all the time. Lots of them.
Don't believe me? Let's conduct a little experiment and pretend that Tumblr really is worth $1.1 billion. That would make it, by market capitalization, the 1,990th biggest company in the America.
Now, if you look at the list of companies with similar valuations, their fundamentals areradically different from Tumblr's. For instance, ranked two slots above Tumblr at 1,988 on the list is a company called Orbital Sciences Corporation. Like Tumblr they're a tech company. Or perhaps I should say, unlike Tumblr, they're a real tech company—they make satellites and satellite launch vehicles. Real things, that perform real work, that you can touch, and that people pay for. These things are difficult to make. So difficult that there's a common expression for the degree of difficulty: "rocket science." In 2012, Orbital had $1.4 billion in revenues with a profit of $340 million.
The company ranked 1,989 on the list—just one slot above Tumblr—is called Alon Energy. They refine oil and make petroleum products. They own big plants in Texas, Louisiana, Oregon, and California. Alon's revenues in 2012 were $8 billion, with profits of $908 million. Just as a thought experiment, if you were an investor which company would you guess is more likely to still exist in 15 years—Tumblr or Alon?
Why do I bring all of this up? Because in order to believe that markets never reach incorrect outcomes you have to believe that Tumblr, Orbital, and Alon are all worth exactly the same sum—despite the gargantuan disparities in incomes, outputs, and assets. As a philosophical matter, I suppose this isn't impossible. It's just insane.