Posts from stocks

Some Thoughts On The IPO Market For Web Companies

We have an IPO market for web companies again. I don't have all the names in front of me, but this year has brought IPOs for Pandora, LinkedIn, Groupon, Zynga, and TripAdvisor. These five companies are all trading for north of $1bn market cap. Pandora is at ~$1.5bn. LinkedIn is at ~$6bn. Groupon is at ~$15bn, Zynga is at ~$7bn, and TripAdvisor is at ~$3.5bn.

We can (and surely will in the comments) argue about these valuations. Some will say they are too high. Some will say they are too low. That's what makes a market. But in the aggregate, these valuations do not seem ridiculous to me. The public market investors are valuing these companies at prices that have some rationality to them.

What is possibly more interesting is that the public markets are valuing these companies at less than the late stage private market might value them at. Again, I don't have the data in front of me (I'm on vacation), but I believe that some of these companies had private financings at our above these current market caps.

The past decade (post Internet bubble, post Sarbox) brought a new normal to the late stage venture capital market. Companies are staying private longer. They are doing multiple rounds of growth financing privately. And they are doing multiple rounds of secondary liquidity for the founders, angels, and early investors. Mike Moritz calls these financings the "new IPOs".

This "new normal" is allowing these companies to stay private and develop into real businesses. With a lot of revenue. The five companies I mentioned at the top of this post will have close to $5bn in revenue this year. The company with the least amount of revenue is Pandora which, as of its last quarterly report, is operating at a $300mm annual revenue run rate.

These companies also have built sophisticated management teams that are highly capable of managing a business to meet the expectations of public market investors. They have strong operating executives, strong financial executives, and strong product and engineering leadership. They should be well run public companies.

The five companies I mentioned at the top of this post are carrying a combined market cap of $33bn. So they trade at an average of 6.6x revenues. And that is not including the cash they have on their balance sheets. I am not going to do the math, but I would bet if you back out the excess cash, you might see revenue multiples of less than 6x for this cohort. These are full valuations in a historical context, but these are not crazy valuations. If these companies can continue to grow at the rates they are currently growing, and if they can generate significant cash flow from their businesses (some of these companies already are doing that), then they should be more valuable in the next couple years, generating gains for the public market investors who hold the stock.

When Zynga was pricing its offering last week and getting ready to start trading its stock, I got a note from a friend who said "let's hope for a '99 style first day pop." I responded that was the last thing I wanted to see. And thankfully we did not get that.

It is not healthy for companies to trade at prices well beyond what they are worth. It puts incredible pressure on the team to deliver results that can't be delivered. And when the stock inevitably comes back to reality, the team feels like they somehow failed. Morale is impacted. The whole things is madness. And who benefits from that first day pop? Only the best customers of the banks who led the offerings. Why should they get a windfall when they did nothing to build the company and when they will be out of the stock so fast it will make your head spin?

The IPO market for web companies we have right now is rationale. We can argue whether it is pricing thse offerings correctly. But it feels about right to me. I believe we will see a bunch of IPOs next year, led by Facebook, which is the poster child of this whole "stay private longer" movement. If we as an industry can be patient, keep our companies private longer until they are truly IPO ready, then we should have a sustainable IPO market. That's where we seem to be headed. Let's not get greedy and screw it up.

Disclosure: USV has a significant holding in Zynga therefore I am long that stock through my interest in USV.

Whither Netflix?

When you see a stock chart like this you have to wonder, what the hell is going on?

Netflix stock chart

Netflix has been one of the hottest stocks out there, rising from $50/share in Feb 2010 to $300/share in July of 2011. That's six times your money in 18 months. And now the stock has given back well over half of those gains in two months and that freefall in the past week seems particularly scary.

But as Dan Frommer points out in this excellent post on Splatf, the street may be overreacting to Netflix's downward guidance. Netflix has pulled off one of the most amazing customer transitions I've seen. They used a dominant position in the physical distribution of DVDs to build a dominant position in the streaming business. That's damn hard to do and it is something you rarely see because it is difficult for most companies to cannibalize a highly profitable franchise.

But that transition isn't always easy and right now, consumers are abandoning DVDs more quickly than they are adopting streaming. And Netflix' recent price increases haven't helped.

But let's go back to Dan's post. Look at this slide:


Netflix told the street that they are now expecting 1mm less subscribers by the end of this year. That's a big miss. But as Dan points out, 80% of that miss is coming from the DVD side of the house. By the end of this year, if the current guidance is correct, Netflix will have 21.8mm streaming customers. That's a huge customer base for the next important film and TV distribution format.

Netflix will produce about $500mm a year of EBTIDA based on a "back of the envelope" calculation I did using Google Finance. With a market cap that is now down to about $8bn, the stock now trades at 16xEBITDA. That's a lot better than 32xEBITDA where it was two months ago.

I don't own Netflix. I don't own any public stocks in my own account these days and haven't since I closed out positions I bought (and blogged about) during the market meltdown in 2008. I do have some managed models on Covestor and some hedge fund interests. They may own Netflix, but I'm not aware of it and if they do, my exposure to Netflix would be minimal. I am not going to go out and buy Netflix after writing this post.

But I do think what we are witnessing here is the speculative forces coming out of a stock in reaction to some bad news. My instinct is that Netflix is still the company to beat in premium streaming video and that they are building a killer franchise in the next important distribution system for film and television shows. And thanks to some excellent analysis by Dan, we can see why that is so.

Some Thoughts On Public and Private Markets

I had breakfast with Alan Patricof last week. Alan is the dean of NYC VCs, he's been at this game longer than any of us. He was in the business when Intel and Apple went public.

The breakfast came about when Alan wrote this blog post in Business Insider about the problems with the IPO market. I read the post and emailed him with some feedback on the parts I agreed with and the parts I disagreed with.

We decided to have breakfast and chat about it.

My going into breakfast position was that the IPO market isn't all that it is cracked up to be. That the emerging secondary market is allowing companies to stay private longer (maybe forever) while allowing founders, angels, and early stage VCs to get liquidity. I believe that the IPO market should only be for the very best companies that can sustain value creation for long periods of time for their shareholders post the public offering. I think that is a very high threshold that most VC-backed companies cannot meet.

Alan's going into breakfast position is that we have lost our way (read his BI post for details). Back in the days of the IPOs of Apple and Intel, great tech companies would go public at low valuations, there were dozens of small market makers who would do research on the stocks, and most of the investors in these deals were individuals. Now we have markets that are largely closed to the individual investor. VC investing is largely instititional and limited to "qualified investors" (ie rich people). The secondary markets are also largely limited to qualified investors. And the IPOs these days are sold to a dozen or so large hedge funds who are also dominated by institutional investors and rich people.

Like all good discussions, we both came away with an appreciation for each other's point of view. I agree with Alan that we need a way to allow the individual investor to participate in the value creation that large tech companies can provide. And I recognize the the vast majority of people who have participated in the value creation from Facebook, Zynga, Twitter, and Groupon have been institutions and the very wealthy. That doesn't seem right or fair.

I think the SEC needs to rethink the capital market regulations and structure we have in our country. The secondary private market is a good thing and does allow great companies to stay private longer while providing liquidity for founders, angels, and early VCs. But there are issues with the secondary markets as they exist today. There are no disclosure requirements. There is little or no way for individual investors to participate. The 500 shareholder rule is creating all kinds of problems for companies. And we don't have a public market system that allows companies to be public at lower valuations with less capital raised. Alan believes we need a "new nasdaq" where companies can list for $250mm or less and have liquid markets in their stocks that individuals can participate in.

The US has a vibrant tech economy, a VC industry that is the envy of the world, and public markets that are highly liquid. We can and should stimulate the development of some additional layers of capital markets between the VC market and the current IPO market. A vibrant and fair secondary market that provides individuals some access and a new "low cap public market" are the natural additional layers to our current system. I'd also like to see more access for individuals into the VC market.

I hope the SEC is thinking about all of this. I hope they read Alan's post and this post. It is important stuff.

Greed and Fear

My friend Howard Lindzon sent me this great piece by Carl Richards. It is now hanging in my home office right behind my desk:


I believe we are on the upswing in the web investing space right now. There could well be a fair bit more to go. But we will get to the valley at some point. If you still own whatever you bought on the upswing, don't sell it there. Hold on until the next upswing.

Markets come and go. Good businesses don't. Thanks Howard for my daily reminder of that.

The Second Coming Of The Internet IPO

Most of what I've been saying recently about valuations here at AVC has been negative. I think we are in a "focus on the upside" phase in the web investing sector and I've been pretty liberal with my thoughts on that.

But when friends have privately asked me whether they should take some of the Facebook shares their Goldman representative has offered them, I mostly tell them I think they should. I don't think anyone should bet their net worth on Facebook at $50bn, but I think it is a pretty good bet that Facebook will one day be worth more than $50bn. Is it today? Hard to say. I don't have access to Facebook's P&L, cash flows, and balance sheet. But from what I have heard Facebook should do between $1bn and $2bn of EBITDA in 2011 and possibly more. 25x to 50x EBITDA for one of, if not the premier Internet company in the world is not crazy. And if you just think how much market power (i'm talking driving traffic, audience, brand, attention, value) Facebook has relative to the other Internet services which are valued well north of $50bn, I think it is pretty obvious that there is more value to be created in Facebook stock.

My friend John Battelle has similar thoughts on his blog in a post everyone interested in the second coming of the Internet IPO should read.

How do I reconcile these conflicting thoughts, that the web sector has gotten overheated and that the coming Internet IPOs might in fact be good buys? Well, to be honest, I haven't completely reconciled those thoughts. First of all, we don't know how these deals will be priced. Will Facebook shares be offered to the public at $75bn, $100bn, even higher? We just don't know. And how will Groupon, Demand Media, LinkedIn, Skype, and other offerings be priced? Don't know yet.

But it is very possible that some or all of these deals will be good buys even in the face of an overheated valuation environment. The public Internet names, most of which went public eight to ten years ago (or more), are mostly carrying full but not crazy valuations. If this new crop is priced off of those comps, then they could be worth buying and owning. And, as John points out in his post, if these companies contiue to grow rapidly and throw off ever larger amounts of cash, then they could easily be worth well north of what they are worth today.

In the spirit of complete transparency, I do not plan to purchase any of these offerings. I have plenty of personal exposure to the web sector right now and am adding to it every day via our firm and other private deals and funds I am part of. I don't particuarly like to buy and own public stocks unless we are in a really down market and I see unbelievable values. So I am not going to be calling the banks and asking for allocations. But that doesn't mean you shouldn't. But whatever you do, make sure to do your work and understand what the price is and that it makes sense. Blindly buying something just because it is "hot" is never a good idea.

Apocalypse and Bubbles

Peter Thiel, entrepreneur, VC, angel, Facebook board member, and hedge fund manager, penned a long and thoughtful piece about the possibility of an impending apocalypse and how that might lead to financial bubbles. It was written in 2008 but I only came across it yesterday (on Hacker News). He calls it The Optimistic Thought Experiment. I you are an investor and haven't seen it before, I suggest you go read it in its entirety.

For those who would rather have the cliff notes, Peter's argument goes like this (Peter's words are in italics, mine are not):

1) if the truth were to be told, our slumber is not as peaceful as it once was. Beginning with the Great War in 1914, and accelerating after 1945, there has re-emerged an apocalyptic dimension to the modern world. In a strange way, however, this apocalyptic dimension has arisen from the very place that was meant to liberate us from antediluvian fears. 

Peter argues that science in all of its form (nuclear weapons, biological catastrophes, etc) has vastly increased the probability of some form of apocalypse.

2) A mutual fund manager might not benefit from reflecting about the danger of thermonuclear war, since in that future world there would be no mutual funds and no mutual fund managers left. Because it is not profitable to think about one ’s death, it is more useful to act as though one will live forever.

Peter argues that betting on the apocalypse makes no sense so rational investors don't do it.

3) Globalization may end by accident or by terrible miscalculation: It may end by world war.  Because there would be no winners in a new world war, every path away from globalization will end in catastrophe. Thus, in spite of the many uncertainties surrounding the costs and benefits of a more globally integrated world, investors have no choice but to bet on globalization. There are no good investments in a twenty-first century where globalization fails.

Peter argues that globalization is the anti-apocalypse bet.

4) Even the most preposterous bubbles of recent decades — Japan in the late 1980s and high-end real estate today — would have been far more restrained, had they not been stoked much further by the narrative of globalization.

He goes on to connect financial bubbles with bets on globalization. This is the most fascinating part of the essay to me. I've gone back and read it a few times now.

5) the pace and amplitude of these booms has accelerated tremendously, in complete contradiction to the widespread notion that markets are becoming more smooth and efficient over time. During the last quarter century, the world has seen more asset booms or bubbles than in all previous times put together: Japan; Asia (ex-Japan and ex-China) pre- 1997; the internet; real estate; China since 1997; Web 2.0; emerging markets more generally; private equity; and hedge funds, to name a few.

And then Peter explains that the recent slate of financial bubbles, which he calls unprecedented in history, are related to the growing sense of impending doom.

And here is the money quote:

But because we do not know how our story of globalization will end, we do not yet know which it is. Let us return to our thought experiment. Let us assume that, in the event of successful globalization, a given business would be worth $ 100/share, but that there is only an intermediate chance (say 1:10) of successful globalization. The other case is too terrible to consider. Theoretically, the share should be worth $ 10, but in every world where investors survive, it will be worth $100. Would it make sense to pay more than $10, and indeed any price up to $100? Whether in hope or desperation, the perceived lack of alternatives may push valuations to much greater extremes than in nonapocalyptic times.

It's a fascinating argument. I can't say whether I buy it or not. But it's in my head now and as a result it will be part of the way I look at the world, investing, and valuations. How much it will be a part of that remains to be seen.

At the end of the essay, Peter talks about China, Web 2.0, and hedge funds in the context of this "optimistic thought experiment". I've been thinking a lot about all three having most of my eggs in the middle basket and having taken a lot of eggs out of the latter basket and thinking about putting some eggs in the first basket. It was a good time for me to come across this essay.

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When you want to look up information on publicly traded companies, it helps to know the ticker symbol. Microsft's ticker is MSFT, Google's ticker is GOOG, Apple's ticker is AAPL. Every publicly traded company has a ticker.

But private companies don't have tickers. And as more and more private companies are attaining status and drawing the attention of mainstream media and the investment community, it is time for that to change.

Yesterday Stocktwits and Second Market proposed a set of tickers for popular privately held companies. The proposed list of tickers is here.

I'd like to see services like (a portfolio company of ours: $TRACK), Google Finance, Yahoo Finance, Crunchbase, Wikinvest, and their competitors adopt these tickers. If everyone supported the TWIT symbol for Twitter, the FBOOK symbol for Facebook, and the SKYPE symbol for Skype it would make it a lot easier to aggregate financial and other information on these companies.

I have been an investor and on the board of a company called Alacra for over ten years. We made the investment in the Flatiron partnership. One of Alacra's most successful services is called Concordance. They manage symbology for large enterprises with large datasets. It is a critical service for large banks, brokers, accountants, consultants, law firms, and other knowledge driven industries.

Unique identifiers are so helpful when you are trying to make sense of large amounts of data. It is particularly helpful in the case of company specific information and it is also expected in the investment community.

So I hope this effort by Stocktwits and Second Market gains traction with the other web services that aggregate information on private and public companies. I'll do my part by tweeting with these tickers (using the $ticker standard set by Stocktwits) when I talk about private companies on Twitter. I hope others will do the same.

And Stocktwits and Second Market can make my life easier by making sure that companies like Alacra and Wikinvest that don't have private company symbols get them asap. I wonder if they should open up this database in some way so that companies can issue themselves tickers. It seems like trying to manage this as a closed system won't scale very well and some kind of open system will work better. I'm curious what others think.

My Favorite Money Manager

The Gotham Gal and I have our assets spread across a number of asset classes and money managers and our allocations and managers have changed a fair bit over the years. We’ve seen a bunch of managers in action up close and personal.

Right now, my favorite money manager is an optical surgeon named Robert Freedland. Robert is 56 years old, he’s been managing his own investments for 42 years, and he’s been blogging and podcasting about stocks for the past seven years. I invest with Robert on Covestor (which in the spirit of full disclosure is a portfolio company of Union Square Ventures).

About a year ago, we put a modest but non-trivial amount of cash into a Covestor account. We only invest with model managers in risk tiers 1 and 2 to keep our capital at lower risk. There were about five or six model managers in those tiers at that time so I put the minimum on all of them. I would check each month and slowly I left most of the managers. But I kept putting more money with Robert. And he kept performing. Now we have close to half of our Covestor portfolio with Robert and I am thinking of giving him even more.

We are up about 11% on the money we’ve had with Robert in the past year. Since some of those funds went in a year ago, but most went in more recently, I suspect our annualized returns are closer to the 17% return he’s annualized since he started on Covestor.

I like that Robert has delivered excellent performance with an emphasis on value investing in highly liquid stocks. I like that he doesn’t short stocks and doesn’t own anything I don’t understand or recognize. I like the fact that he has a strategy and he sticks with it. And most of all, I like that he is investing his own capital as well as mine.

If you want to invest with Robert, you can. He has a $5,000 minimum and you’ll need to open a Covestor account to do it. This is not a recommendation to invest with Robert, but it is an acknowledgement that there are great investors out there who don’t work on Wall Street and that thanks to the Internet they can manage your money as well as their own money and that is a very good thing.

Why I Don’t Like Stock Buybacks

RIM, the company that makes Blackberries, announced a weak quarter yesterday, and then announced they were initiating a stock buyback. I don't like stock buybacks and I figured this was an opportunity to explain why.

A decade ago, I was Chairman of the Board of a public company called It is still a public company but I have not been involved with the company for eight or nine years.

The company raised a huge amount of money in its IPO in 1999 and then after the market broke in early 2000, the stock was trading below its cash value. We talked about this at the board and decided to do a stock buyback.

For those who don't know what a stock buyback is, it is when a public company announces that they will be going into the market and start purchasing their own stock. When they purchase their stock, they typically retire it so that the number of shares outstanding goes down.

Stock buybacks are very popular with some investors as a way for a company to transfer value from the company back to the shareholders. It is like a dividend, except it is taxed as a capital gain, not ordinary income.

I don't remember the exact details of the buyback at but we started buying the stock and it kept going down. We kept buying it. But we were losing money on each buyback because we were overpaying for our own stock as it kept going down. 

I didn't understand what was going on. We had more cash than it would take to buy back every share in the company and yet the stock kept going down. We eventually reduced the number of shares outstanding by a pretty significant number. I don't remember what it was but it could have been as high as 25% of all the shares that were outstanding before we started the buyback.

Eventually the market came back and the stock rose. And the company started making money and its reported earnings per share were higher as a result.

But I don't view that stock buyback as successful. It didn't fundamentally change the company in any way. We just gave back a lot of cash to the investors.

This was all happening in 2000 and 2001. If I think about what we could have done with $25mm or more of cash in 2000 and 2001 to transform that company, there are so many obvious ideas in hindsight. We could have invested in new lines of business. We could have bought a bunch of companies. We could have made a number of moves that would have fundamentally changed the company. And we had a lot more cash than $25mm. But we let the cash sit in the bank and worse we gave a lot of it back to investors in a manner that did not do much for the company.

So if you go back to the reason that the stock kept going down as we were buying it back, I think I understand why now. With our stock buyback we were signaling to the market that we had no good ideas about how to spend that cash. We were signaling that we didn't see much of a future in our business. And smart investors bet against those kinds of companies, managements, and boards.

So when I saw the headline this morning that RIM was doing a buyback, I was saddened. I've been a Blackberry user since 1997 or 1998. RIM has been a great company that has driven so much innovation in the past fifteen years that has made my life better and the lives of many others better. I have to believe that if they got aggressive, they could find uses for all of that cash they are sitting on. I wish they would do that instead of buying back their stock.

Gold vs Real Assets

A lot of wealthy people I talk to are building up sizable gold assets in their portfolios. They look at the long term fundamentals of the US economy and don't like what they see. So they are accumulating gold as both a hedge and to some extent a capital gains play. Here's a price chart of gold over the past five years:

Gold price chart
You can see that those who have owned gold for the past five years have made three times their money. And I've heard gold bulls say that $3000/ounce is their price target. So that's 2.5x where it is now.

We've had a number of conversations about gold in the comments to this blog, but I've never posted about my thoughts on the subject. So I thought I should.

I'm not a fan of gold. It does not produce any income. It is not a productive asset. It does have value in many commercial uses but that is not what drives its fundamental value.

Gold is valuable because it always has been. It has been used many times over the years as a backstop for currencies under a monetary system called the Gold Standard. The theory is that when investors lose confidence in a government's currency, they can exchange the bills for gold.

So investors have been trained that in times of crisis, you want to own gold. And if you look at that five year gold chart, it sure looks like more and more investors want to own gold right now.

I'm not sold on gold. I don't really know what I'd do with a bunch of gold. On the other hand, I do understand the need to have a portion of your net worth in tangible assets that you can touch, control, and physically own.

I prefer real assets like commercial real estate and land. These assets can be scarce, you can own them outright, you can touch and feel them, and most importantly you can generate income with them.

Let's say you had $1 million of cash in the bank that you wanted to use as a hedge against a major financial disaster. You could purchase gold bullion and take delivery of it and put it in a safe at a bank. Or you could purchase a building with a number of apartments for rent with it. The gold will sit safely in the bank earning you nothing. A building purchased for $1mm could produce something like $100,000 per year in rental income if you buy it right.

If the financial disaster was really terrible, your building might go down in value, but as long as you own it outright and don't have a mortgage on it, there is no reason that you'd have to sell it. You could continue to generate the $100k per year of income assuming rental rates hold up. And generally speaking, real estate will maintain its value over the long haul.

The same logic applies to productive land (ie farmland). If you buy it right and don't borrow against it, land will produce income regularly and should retain its long term value.

So that's my case against gold and in favor of real assets. I think it is very smart to have a percentage of your net worth in non-financial assets (stocks, bonds) and non-cash assets. We all saw what can happen with the financial system has a meltdown. And it could have been a lot worse had the government not stepped in.

So if you have a nest egg that you want to protect, think about putting some non-financial assets into the mix. But I'm just not sure that gold is the best way to do that.