Bubblewatch

From Broadstuff's Bubblewatch Dept:

Dominic Rushe over at the Grauniad asks for our thoughts on the Twitter IPO. which he summmarised in this article. To give a bit more background, we think that:

1. Twitter is far more sensibly priced than Facebook and other "Social Media darlings" like Zynga and Groupon were at float

- Twitter valuation in price per user terms is $14bn/c 240m users (assumed at IPO) = $58/user, i.e. about 50% of FB ratio at flotation
- Ditto, its valuation/revenue is about 25% of that of FB's at float

2. Compared to Google's IPO, it is very similarly valued.

- GOOG was $23bn valuation on (est) 500m users and $970m revenues,
- Twitter is $14bn on c 240m users and c $500m revenues, so the ratios are not that different

3. It has higher future growth potential that Facebook

- 240m users to FB c 1 billion at time of IPO
- It is not just a social network, it is a flexible comms medium - the various uses to which it has been put in the last 5 years are exraordinarily wide compared to a pureplay Social Network
- Twitter is truly native on mobile, and has a very small footprint so can be used by fairly simple devices
- The emerging Internet of All Things and other unified multimedia approaches play well to Twitter's capability

4. It is more reasonably priced within its own fundamentals and lifestage than Facebook was

- (Assumed) c $0.5bn revenues, 240m users = c $2 per user, 50% of Facebook's IPO, but at 15% of valuation.
- Very early days in its revenue model, advertising is only beginiing and there are possible (owing to its comms system nature) other potential streams
- At only 240m users so IMO more upside than FB with its 1 billion - Facebook growth was alraedy peaking at IPO, with half the c 2bn available onine people on the planet on the service already. Twitter has much more headroom

5. Twitter probably has a longer life than Facebook post IPO - there are so many directions it can still grow in, whereas you exactly knew what FB was at IPO, and you even could see the competition emerging. That is not so clear with Twitter.

6. As always though, realizing potential comes down to execution.

- The FB team are very focussed, Twitter is harder to judge - lots of change at the top over the years, we wouldn't be at all surprised if they bring in an "Eric Schmidt" figure.
- There is always a risk that. like email, Twitter becomes a "$0 trillion industry" - ie everyone uses it but it is ubiquitous - but as the first one out the traps, it has more chance of capturing its value.

7. Facebook took a year to find its IPO price, so that pricing debacle is also unlikely to be repeated with Twitter.....we hope. (Hype springs eternal, as you all know....)

In other words, by the standards of stupidly overhyped and overpriced Social Media floats so far (excepting Linked In) it is almost rational - its lower priced, with more future potential, than the most recent ones. With Twitter you only have to believe it has a similar future potential to Google at IPO, not 4x the potential of Google as as you do with FB.

Hot on the heels of the wisdom (or not) of acquiring Summly, Yahoo has now apparently also acquired Tumblr for $1.1bn. Tumblr, for those of you who don't know, is somewhere between a a blog and a microblog (a Mediblog), has revenues of $13m. So why pay $1.1 bn? The argument is the user numbers - Next Web:

With more than 300 million monthly unique visitors and 120,000 signups every day, Tumblr is one of the fastest-growing media networks in the world. Tumblr sees 900 posts per second (!) and 24 billion minutes spent on site each month.

So lets value it the old, boring way:

300 million x 12 = 3.6 billion unique visits (not necessarily different visitors of course) and 120,000 new ones a day x 360 days = c 43m new users per annum, the hope no doubt being that this will continue to grow like topsy. Lets assume that this growth gives c 1 billion users in 5 years, so we get a 50% increase PA on 50m new users, and assume we lose none, and that gives a Net Present Value of about $ 0.33 margin (at 15% IRR) to get to c $1.1 bn fully discounted free cash flow.

Or thereabouts.....we can also do it another way - by comparison:

Another Mediblog, Facebook, has an Average Revenue per user is about $1.25, and it's user base is about 1.1 billion and slowing. It is valued at $60bn in an open market. Applying Facebook's valuation to Tumblr today, with c 1/2 the user base gives us $60 bn x 1/2 user base x (0.03/1.25) ARPU = $0.75bn. Throw in a 33% uplift fir future optimism, and there's your $1.1bn

So you can believe on of two things:

(i) The Bubbletime will continue after Yahoo's acquisition, and the business will stay as good as Facebook is now, or

(ii) Yahoo's acquisition will cause a near immediate jump in ARPU from $0.03 to something like $1.25, it will better Facebook by extracting not C $0.01 profit per user but more like $0.33 profit per user per annum.

But of course you can - or Yahoo thinks so anyway, heck they even paid with cash, not shares!

Alternatively, one could take the opening line from Cockney Rebel's "Tumbling Down" anthem.

"Gee, but it's hard when one lowers one's guard to the vultures"

The refrain of which is Oh dear, look what they've done to the blues, blues, blues.....

It would seem the Next Bubbletime is here, just unevenly distributed - Business Insider:

Yesterday, Yahoo announced it bought a startup called Summly. Summly made a news aggregation app. According to All Things D, Yahoo paid $30 million – 90% cash. $30 million isn't much for Yahoo, which has more than $4 billion in cash (and access to much more). But there are some elements to this deal that make even that small price seem strange:Summly never really set the world on fire. It had fewer than one million downloads. Yahoo is shutting Summly down. So basically, Yahoo is acquiring Summly's talent. Summly's talent is founder Nick D'Aloisio and two other people. Yahoo is saying D'Aloisio's is to lead Yahoo more boldly into the world of mobile

As well as all this, Summly is "pre-revenue". Not only that, but it appears even the underlying aggregation technology is not all theirs but partly SRI's (and thus unlikely to be patentable in any valuable way)

So - small userbase, fairly easy to replicate (or licence) technology. Fairly easy to do it in Yahoo for a few $ million absolute tops, and Yahoo owns the IP - and quite a few other people have already done something like this on PCs and Apps, its no great biggie to build such an App. Also, if Summly falls into someone else's hands it hardly leaves Yahoo without options, so there's no "only pebble on the beach" valuation kicker. It's thus fairly clear to me that Yahoo way overpaid for just the technology, user base and staff - you would probably get to tops about $5m for all that, at absolute best. So why pay $30m, of which 90% is cash, and then shut it down - thats 5x Goodwill over asset value - it beggars belief, unless there is some bigger fish to fry here.

The answer is apparently (reading the news reports) any or all of:

- The "Cool" factor of getting a smart, personable 17 year old (D'Aloisio is still at school) to be the "face of Yahoo's mobile mojo". Now there is nothing wrong with teenage kids, especialy smart ones who are very technologically literate as they are hip and younger than Yahoo itself is, but can this gambit...
- Persuade Wall St that Yahoo actually has any Mobile Mojo (Yahoo's shares have jumped since Marissa Mayer took over, profits have not)
- Persuade talented people that Yahoo is Cool again to work for
- Get the current sticky Yahoo Bad News Story (no more working from home) off the front pages (except that the young entrepreneur in question here will, in fact, have ti work from home - and school - for 18 months more)

Now, in a Wildean sense, the only thing worse that being talked about is not being talked about, all publicity is good publicity etc, and this is certainly being talked about*. So if some of the above come to pass this may be a great idea. If.

- Everyone believes that $25m is a decent price to pay for such PR fireworks, and focusses on the Human Interest spin rather than the "You paid What???" Bubbletime bid, and

- The face of Yahoo doesn't therefore get splattered with egg instead

Now don't get me wrong - I'm all in favour of young entrepreneurs selling their inventions for oodles of cash (or old ones for that matter). Especially British kids, British Tech needs all the encouragement it can get. And I'm in awe of anyone who gets the likes of Wendi Murdoch, Ashton Kutcher, Yoko Ono and Li Ka-shing as investors, (Ka-Shing before it was even called Summly apparently). It's teriiffic news for Summly, but right now this seems to be a very dumb buy from a Yahoo, unless more information comes to light.

(Update - so far, the stuff coming to light is pointing the other way - look at the justification here for eg)

*Fwiw Twitter is ticking over like a Geiger counter on this, but sentiment is running about 50/50 on this deal right now by our measure, and much of the smart press is more or less incredulous or playing a very straight bat - that certainly is not worth $25m yet, its going to want a blizzard of puff pieces to get off the ground (I predict a snow-storm in the coming months )

PS - Slashdot are also calling the bubble

Update 2 - d'you know, the more I think about the price, the product, the investors, the people at Summly, the comments by the real technorati, the lack of actual users, the more I go "hmmmm". And realise the MSM and Tech Gushblogs have been bamboozled, yet again.

The size of the rise in the burgeoning Startup Seeding and Incubation industry (lets not call it a bubble) is well explained in the above waterfall chart (courtest CBInsight, as seen on TechCrunch) of the US funding market. The evolution of the problem is that, since 2009 when startup companies getting seed funding in the US, and companies getting the next stage, Series A funding were both at about 100 per quarter.

(Seed funding is in the tens to a few hundreds of thousand dollars range, Series A typically in the low millions of dollars range)

Roll forward to mid 2012 and it was about 500 startups seeded per quarter, compared to only c 200 Series A rounds, a 5-fold rise in seedings vs a 2 - fold rise in Series A funding. By Q4 2012 it had droppped to c 350 Seedings to c130 series A - if not the sound of a bubble deflating rapidly, certainly one of animal spirits evaporating.

The downside will be the culling of a 1000+ only recently seeded startups - the red bar in the waterfall above (thinning out seedlings, I believe gardeners call it). Some believe this adds up to a writeoff of up to $1bn but that seems to be a high estimate, I'd suspect its more like about half that (a quick calculation will tell you that 1000 startups funded at way less than $1m each will not reach $1bn of losses). Now, seed funders may do some form of additional funding rescues, but that is by and large not in their business models (and not always in their piggy banks either) so one suspects it will be unlikely. Now this is US specific, but you can bet that a similar story will soon start to play in Europe, though I'm not sure that the startup bubble was quite as frothy here (in dollar terms,that is - in hype terms its cup ranneth over).

The ubiquitous Startup industry drinkups will thus probably shift from living it up to drowning sorrows in 2013.

As usual, at the peak of a bub....sorry, exuberant financing phase, there is always some method that gets invented to allow more and more people to put in smaller and smaller amounts of money, hence the move by AngelList and SecondMarket to open a service for investments of as low as $1000. (Actually, I think more being able to trade shares in startups will be a useful thing, but the timing is unfortunate)

The good news, also as always, is for those who get funded just before the gates snapped shut, as they know that they won't have to look over their shoulders for other startups on their tail for some time, and people ahead of them with less cash left probably won't get more either - and last man standing is always a good place to be. Now they probably will raise a glass or two of bubbly next year....

Update - thoughts from Broadsight's Andy Wise:

- Surprising statistic that “startup companies getting seed funding in the US, and companies getting the next stage, Series A funding were both at about 100 per quarter”. Suggests that the natural process of thinning out was happening before the seed funding stage. No other similar process has a 1 to 1 ratio – it’s far more usual to back 10 horses for every winner. (My comment - I think that's the seeding bubble effect)

- It would also be interesting to know what happens to those that don’t go on to Series A funding – what percentage fold with a zero return to the investors and what percentage stumble on with organic growth or get bought out or in some other way eventually return something to the investors. (My comment - in my day the rule was for every 1 hit, there were 3 trade sales, 3 "zombies" and 3 deadpools. I suspect the deadpool ratio has rocketed, looking at these numbers)

Evidence that the Incubator/Accelerator bubble is close to bursting - Forbes:

Nike is the latest to jump into tech incubation with its Nike+ Accelerator, for helping the latest health-related startups. The program, organized by TechStars, focuses on startups in areas such as training, coaching, gaming, data visualization and the quantified self.

Accelerators are the new business schools, at least in the tech startup world. These programs, which typically involve a small amount of funding and mentorship and connections in exchange for a small amount of equity, have exploded in popularity. The ten week program, which will accept ten companies, will begin in March 2013 in Portland, Ore.

When companies that know next to nothing of technology jump into it, while people who know a lot are scaling back (eg Y Combinator) or pulling their money out at the same time, you know you are getting close to the "pop" moment.

"Just do it" is one saying, but "look before you leap" is another.....

Update - my friend James Cooper totally disagrees with me in the comments.

News today that HP is asserting Autonomy had dodgy finances - FT articles the travails:

The struggling US technology conglomerate has alleged that “serious” accounting improprieties at the British software company were responsible for more than $5bn of the writedown.

Meg Whitman, chief executive, said that information provided by a member of Autonomy’s management team after Mike Lynch, its founder and former chief executive, was fired in May had prompted an internal investigation. This revealed improprieties, “disclosure failures and outright misrepresentations at Autonomy”, which occurred before the acquisition.

Whether there was dodgy dealing or not, all you need to know about the Autonomy/HP Brouhaha is contained in these 2 paragraphs from Jonathan Weil at Bloomberg:

HP said in its 2011 annual report that it paid $11 billion for Autonomy, a software company based in Cambridge, England. In connection with the acquisition, HP initially recorded $6.6 billion of goodwill and $4.6 billion of other intangible assets. HP later revised the goodwill to $6.9 billion and reduced other intangibles by about $300 million, according to its most recent quarterly report.

The goodwill figure is especially telling. Goodwill is the bookkeeping entry that a company records when it pays a premium to buy another company. More precisely, it’s the difference between the purchase price and the fair market value of the acquired company’s net assets. Goodwill can’t be sold by itself. The goodwill in this instance tells you that HP paid $6.9 billion more than it believed Autonomy’s net assets were worth.

When you are valuing your $11 bilion purchase at 2/3 Goodwill and your market cap is only c $28bn, you have not just overpaid, you have overpaid ludicrously on a big bet, and it will really hurt if things go wrong...I didn't write about this deal at the time, I saw it as yet another typical Bubbletime deal, and I felt I'd been writing a continual litany on large desperate corporates overpaying for less-than-meets-the-eye-but very-cool small companies (that they believe they can add value to, despite all the historical evidence) for the past year or so.

It would appear that all the HP Board bar one were in situ at the time. Be interesting to see which heads roll.....

With Candide, Voltaire trook several hundred pages to satirise the silliness of unthinking optimism. Gillian Tett took a few hundred words in the FT. She was a young and enthusiastic Euro-optimist, her father was a grizzled Euro-cynic. Here is her apology:

...what is also clear is that my father was entirely correct to be cynical in the face of my optimism. So the question I keep asking myself today is, why did so many people (like me) get swept along by the hype – while others (like my Dad) did not? Why was his cynicism a minority view, in a sea of hope?

One easy explanation, perhaps, might be our relative ages. By the time we had our argument in Val d’Isère, my father was 58 and had lived through numerous economic cycles. I had only worked as an economic journalist for a few years. I had never stared a recession deep enough in the face to become truly wary, rather like those young mortgage traders who stoked up the subprime boom a decade ago.

Then there was the nature of my father’s career. Although he was a brilliant student of economics in the US and UK, he did not go to work in the City or on Wall Street; instead, he headed for the distinctly unglamorous world of British manufacturing, working mostly in midsized companies. So instead of worrying about complex financial products or public policy rhetoric, my father has spent his life thinking about making widgets, such as fire detection equipment.

In that earthy world, there is little place for punditry or wishful thinking: either your sums (and widgets) add up, or they do not. Stock rooms cannot be conjured up by rhetoric alone. Little wonder, then, that my father considered it madness to run a single monetary policy without free labour flows or fiscal union. If the eurozone was a business plan, in his eyes it simply did not add up.

There was also a more subtle factor. Precisely because my father worked in the (then relatively unfashionable) manufacturing world, he was less subsumed by fashionable policy group-think. By 1996, as the financier George Soros says (quoting the psychoanalyst David Tuckett), the euro had become a “fantastic object”: it was unreal but immensely attractive. Or to put it another way, political idealism had subsumed economic gravity. My father, outside the intellectual echo chamber of the eurozone elite, was never infected by the hype.

This sort of explains my complaint from 2006/7, when it was plain that there was a huge problem coming, and nary a peep from the Financial journalism community. I thought they were in the pocket of the Financial industry (as the regulators were), but being mainly "teenage scribblers" (as an earlier Chancellor asserted) who had never seen anything like it is alao a reasonable analysis. But teh real question is "what are the lessons" to avoid unwarranted optimism?

So what are the lessons? One is that it shows the value of retaining older people – or at least, a diversity of life experience – in the workforce. If nothing else, a range of ages helps guard against group-think. Another moral is that it shows the value of having some people from “real” businesses sitting in the corridors of power: handling widgets or running small companies is a good reality check. But perhaps the biggest lesson of all, which journalists, financiers and politicians should all have posted up on their desks, is how wrong we can sometimes be, especially when we are excited by a “cause”.

These lessons are as valid for Technology as Finance, of course - which is why I wrote about it. So if I may abstract, here are...

The 5 Lessons to Guard Against Irrational Optimism.

Run for the hills if:

1. If the issue is a "cause" with a "belief system" rather than based on any hard data
2. If the believers are all young and idealistic, and saying "this time it will be different"
3. If Old Fogeys who have been there before start to get sceptical about it
4. If the numbers don't add up without "heroic" assumptions, and requires everything to go right at all times
5. If the people calling for the New New Thing have never run a business in their lives.

Otherwise, your only hope is to pray "Apres Moi le Deluge"

In late 1999 you couldn't move in San Fancisco's South of Market St area (SoMA) without tripping over a dot-commer. By late 2001 you couldn't move without tripping over derelict cardboard boxes and winos (I was there both times....). Now the Bubbletime seems to be in full swing again - San Francisco magazine:

In spite of the obvious urban warts, the word is out: San Francisco is the world’s leading tech paradise. At a rate eclipsing the dot-com boom of the 1990s, tech companies are setting up shop in the city by the hundreds, drawn by its beauty and livability, as well as the deep pool of engineering talent here and, yes, city hall’s increasingly tech-oriented policies.

Young entrepreneurs from as far away as Denmark, Singapore, and France can be seen with real estate agents in tow, roaming through converted South of Market lofts still vacant from when the previous bubble burst more than a decade ago. The city is currently home to more than 1,700 tech firms, which employ 44,000 workers, up a whopping 30 percent from just two years ago. And San Francisco has been the nation’s top magnet for venture capital funding for three years in a row. Consequently, the distinction between Silicon Valley and San Francisco has all but disappeared. It is us, and we are it.

I'm sure I could probably find the same breathless-yet-anxious prose in Red Herring or similar in 1999. Now there is probably a long term restructuring going on, as for a variety of reasons the Smart Young Things are gravitating to cities rather than campus complexes, but not this fast. Next will come the sky high rentals and deteriorating services for families moving in*. Those who cannot remember the past etc....

(*Hint. Property prices collapse as well as rise....)

100 days on, and Facebook share price has crashed c 40% from its IPO, It joins Zynga and Groupon in a downward plunge (see sheet above).

Nowadays of course everyone knew it was overvalued, but beforehands many were saying it was a snip at its IPO valuation. We were one of the few who didn't and were called "analyst heroes" because of it. But, as Henry Blodgett points out, all you pretty much needed to do was read the prospectus, and Mark Zuckerberg's letter, and it was easy to figure out.:

Didn't anyone even read Facebook's IPO prospectus? The answer, I can only assume, is "no." Because if anyone had read the Facebook IPO prospectus, they would have learned, among other things, the following:

Facebook's growth rate was decelerating rapidly.
Facebook's user-base was rapidly transitioning to mobile devices, which produce much less revenue.
Facebook's operating profit margin was already an astounding 50%, which suggested it had nowhere to go but down.
Facebook's CEO had a nearly unprecedented amount of control over the company.
Facebook's CEO had set up this astounding level of control intentionally. Mark Zuckerberg knew all about how impatient public-market shareholders are. And he set up the whole company so he would never have to pay attention to their whining.
In the 9 months following the IPO, insiders would be free to sell more than 2 billion shares of Facebook that they had been holding for years.
Facebook was going public at an astoundingly high price for a company with these characteristics—about 60-times the following year's projected earnings, in a market in which other hot tech companies like Apple and Google were trading at less than 15-times.

I agree, most of what you needed to know was right there, it wasn't rocket science - but of course, in the Bubbletime the only way is up!

Which makes me wonder what all those analysts who were forecasting $100m valuations and up were doing, exactly. Or, whether the reforms since 2001, that were supposed to make analysts independent, have worked at all?

News today that NASDAQ is going to compensate traders for its system glitches during the Facebook IPO to the tune of $40m (Sharecast via Yahoo):

LONDON (ShareCast) - Nasdaq OMX Group has decided to return 40 million dollars to those brokers whose orders were mishandled in Facebook's initial public offering (IPO) due to technical errors. Specifically, the US stock exchange operator said it will pay $13.7m in cash and the remaining amount would be credited via lower trading fees for those brokers that were affected. A series of glitches when Facebook went public delayed the start of trade by half an hour and left many trades unexecuted.

The traders are still not happy though. But, given the drastic reduction in the Facebook share price (down 30% in a flat market over the period), and the Great Social Media Selloff overall (see chart above), you'd think that these pension funds etc would offer to pay NASDAQ in gratitude, for preventing them from buying even more of a tanking stock at even dumber prices.