Posts from stocks

Bypassing Wall Street

Ron Lieber has a column in today's New York Times called "A Financial Plan For The Truly Fed Up" where he lists some alternatives to investing your savings with the banks and brokerages that make up Wall Street.

His roadmap is basically what the Gotham Gal and I have been doing since the aftermath of the financial market meltdown in 2008. We invested pretty heavily in the stock market as the market was melting down in 2008 and I blogged actively about that here at AVC. But we took our gains early, in the first half of 2009, and then have more or less stayed out of the stock and bond markets since then (we do use our portfolio company Covestor's service).

We are in cash, real estate, venture capital, and private investments centered around our neighborhood and city (retail, restaurants, etc). Other than cash, we are invested in things we can touch and/or impact and understand.

As Ron talks about at the start of his piece, the never ending blowups on wall street are eroding confidence in that system. It certainly has eroded our confidence in that system. So we are staying out of it for the most part.

We do have our cash at a large money center bank. Ron advises credit unions instead. We haven't made that move and I am not sure we will.

Ron also advises people to check out peer to peer lending markets and mentions our portfolio company Lending Club. I was very happy to see that Ron has come around on peer to peer lending. Our firm is a big fan of these markets, having invested in two of them and looking at others.

And he describes a movement he calls Slow Money described in this way:

“Let’s just take some of our money and invest it near where we live in things we understand, starting with food,” as the movement’s founder, Woody Tasch, puts it. He describes returns as being in the “lowish single digits,” ranging from roughly 3 percent to a few percentage points higher.

The Gotham Gal and I are big fans of this approach. We have invested in a number of busineses in our neighborhood and city with expectations properly set for the occasional loss and in general low returns on the portfolio. But we are helping folks start their own businesses and create establishments we can use and that we want to see in our neighborhood. It feels good and I think it will turn out to be as good an investment as cash in the bank. At least I hope so.

As one system seems to be failing on a regular basis, it makes sense that there are new systems that operate differently that are emerging. We are seeking to invest in the ones that can scale at USV and the Gotham Gal and I are also looking to support these efforts in our personal investing. I am optimistic about this emerging movement and I am pleased to see mainstream media starting to talk about it.

Yahoo Is No Longer Dead To Me

A few months I threw a public hissy fit and declared on this blog that Yahoo is dead to me. And they were.

But in four months since I wrote that post, they did some good things.

1) they asked the CEO who led them down the patent troll route to leave the company

2) they invited some smart shareholder activists on the Board

3) they settled with Facebook and abandoned the patent troll route

4) and yesterday they selected Marissa Mayer as their new CEO

That's a string of good decisions culiminating in the wooing of Marissa. As Marc Andreessen said in this interview yesterday, "I didn't think they could get someone like Marissa".

The Yahoo! board went out and got Marissa to lead the company. And they kept their mouths shut in the process and the news surprised everyone. That's how you run a company, a board, and a process. Well done.

It feels like a new leaf has been turned. Marissa has a tough job turning around a company that has had failed leadership forever. I have not worked closely with Marissa but I have seen her up close. She is serious, intense, crisp, data driven, and opinionated. When I think of Marissa, I think of this Jim Barksdale quote:

"If we have data, let’s look at data. If all we have are opinions, let’s go with mine."

That approach should serve her well. I wish her and Yahoo! luck and I am rooting for them.

Some Perspective

I don't disagree with PG when he says that Facebook's IPO performance (or lack thereof) has the potential to impact valuations in startup land. I think it will be particularly impactful on the late stage and secondary markets where most of the IPO valuation speculation is happening.

But let's put Facebook's current valuation in perspective. At the closing price of $26.90, Facebook commands a valuation of $57.5bn (according to Google Finance). Facebook had around $4bn of cash prior to going public and raised about $10bn so let's assume they have $14bn in cash on the books. That means Facebook has an enterprise value of roughly $43bn.

In its last quarter Facebook had $1bn of revenue and 40% pre-tax operating margins. If we annualize those numbers, that would be $4bn of annual revenue and $1.6bn of annual pre-tax operating margins. Let's use pre-tax operating margins as a proxy for EBITDA, because this whole post is back of envelope quality analysis and please take it for what it is.

That means that Facebook's enterprise value is greater than 10x current revenue run rate and greater than 25x EBITDA. These are big multiples folks. I am happy to take those numbers for any company out there.

Clearly Facebook is a premium company and commands a premium valuation and entrepreneurs should not expect to get 10x revenues and 25x EBITDA for their companies in a sale or an IPO. But even at half those numbers there are fantastic returns for investors and entreprenuers to be had.

If speculators are disappointed with the performance of the Facebook IPO it is because they had ridiculous expectations of what rational investors would pay. The market has put a premium valuation on a great company and we should be happy about all of that. I certainly am.

The Next Invest Conference

I guess this will be online learning weekend. Yesterday I talked about MBA Mondays Live and the fact that it will be available via livestream and via archive.

Today, I'd like to tell you about an online conference being put on by our portfolio company Covestor. It is called the Next Invest Conference and it takes place this tuesday and wednesday (3/20 and 3/21). The conference partners include Motley Fool, Stocktwits, Seeking Alpha, Benzinga, TedX Wall Street and many of the biggest names in online investing.

Best of all, it is free to attend. If you are into online investing, either personally or via your startup, you should check this conference out. Details are here.

Profitable: To Be Or Not To Be?

Mark Suster has a great post on this topic. In typical Mark fashion, it is long, with a lot of detail and substance. I highly recommend all entrepreneurs take the time to read it end to end.

For those who won't take the time to read it end to end, I'll summarize it.

Many high growth companies can be profitable. They have enough revenue to cover their essential costs and could easily decide to show a profitable income statement. But they don't make that choice. Instead they invest heavily in the business with the expectations that those investments will produce more revenue (by hiring salespeople), or additional products (by hiring engineers and product managers), or additional geographies (by hiring an international team), or any number of other value enhancing aspects of the business. The result of that decision is that the business loses money or simply breaks even (I prefer the latter approach).

There was a discussion of profits (or the lack of them) in the comments to the IPO Market blog post I wrote last week. A number of commenters pointed out that many web companies lack profits. I don't think that is actually true (certainly not for many that have gone public), but it is true that most, if not all, web companies are not optimizing for profits this year or next year. They are optimizing for the ultimate size of their businesss and the total amount of cash flow they can ultimately expect to generate when the business gets to maturity.

This is tricky stuff. If you are going to take all of your potential profits and reinvest them in the businesss in search of higher growth and greater profits in the future, you had better be right about those investments. And it is often hard for investors to see how those investments are going to pay off, so at times you can be penalized for making those choices. Right now the public markets seem to be paying companies more for long term growth than for near term profits, so it seems that public market investors (and VCs) are aligned in this respect. But that is not always the case. Markets are fickle. But the best entrepreneurs are focused on the long term vision and will invest in their businesses without paying too much mind to what investors want at any point in time.

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-guidance-pie-chart

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:

IMG_20110121_074539

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.