James Altucher penned a column in today's WSJ titled The Internet Is Dead (As An Investment). James is a fund manager and well read columnist on investing and he is entitled to his opinion. He puts his money where his mouth is. But so do I and since we continue to invest heavily in the Internet, I thought I'd take the opposite side of this debate.
We (my partners and I at Union Square Ventures) think the Internet is one of those transformative technologies that changes everything. We see it like the industrial revolution or the invention of the printing press. It is a huge game changer. The Internet has been a commercial technology for about fifteen years now. And we are beginning to see the impact of it on everything around us. The industrial revolution and the Renaissance before it lasted a century or more. It takes a long time for such fundamental changes to work their way through the system and produce a new "normal".
Periods of great change produce fantastic investment opportunities and also destroy stable predictable businesses. Investors have the choice to take a chance on the new opportunities, stick with the stable predictable businesses, or sit on the sidelines. I prefer to do the former.
James says:
Nobody can figure out a business model.
Time Warner
would rather keep their legacy old-media businesses like People
magazine than hold onto one of the biggest Internet companies out
there, AOL. And News Corp. is shaking up its MySpace business as it figures out its next steps. (News Corp. owns Dow Jones, publisher of this newswire.) Microsoft has spent billions on Internet strategy without a dime of profit.
These are the "stable predictable businesses" that might be destroyed by the changing dynamic. I am not saying they will be. But they could be. The fact that Time Warner is selling AOL and holding on to magazines doesn't convince me that it is going to be a long term survivor. AOL itself is a business that has been negatively impacted by the Internet. AOL was never a pure Internet business. It was a dial-up access business connected to a proprietary online service.
And James goes on to say:
even Google can't seem to find any other business model other than the
one they stumbled into when they bought Applied Semantics in 2001 that
had a little piece of software called AdSense. And the new guys:
Twitter and Facebook are still scrambling for profits despite
blistering usage growth.
I'll leave Twitter out of this because it is too close for comfort. But Google can easily monetize its huge and growing apps business (which is a huge threat to Microsoft) and also its local franchise. Who doesn't use Google Maps these days? And Facebook is going to produce $550mm in revenues this year, is EBITDA profitable, and has a self serve ad system that is growing like weeds and giving local advertisers the best local targeting around right now.
And what about Amazon, eBay, and Craigslist? And international businesses like Baidu, Lastminute, Vente-Privee, Tencent, and Sohu? There are easily a dozen and probably two dozen worldwide Internet businesses that investors should own today and for the long haul.
I expect that number will grow over the next couple decades to include hundreds of large global Internet businesses that investors can own and make money with. Yes, barriers to entry on the Internet are low and there are no regulated monopolies that James likes to own. But network effects, data leverage, and scale are huge economic advantages online and if you look for businesses that have them, you can and will make a lot of money as the Internet revolution changes business, society, and the world around us. I think you have no other choice other than keeping your money under your mattress.
I've written about this idea in the past and I think it is badly needed. Not everyone can wait until the exit comes or the IPO market comes back. We are seeing a lot of founders selling portions of their stock privately, mostly to the other investors in their companies. But that is not a transparent or particularly liquid market and it is not clear that the founders or the investors buying their shares are getting a fair deal.
A better idea is to create a marketplace where sellers and buyers can meet and where both sides can get price discovery. When you know the latest prices and can get a price history, you can be more confident of your purchases.
Last week Mike Arrington wrote a post on Facebook turning down an offer to invest at a $2bn valuation. I left a comment on that post saying that I thought that $2bn price was low given the prices being paid in the Facebook secondary market. Later that day, I got a private email with a price chart for Facebook common since January 2008. I was asked not to publish that chart so I won't. That chart showed that Facebook common has traded as low as $6/share earlier this year but is now trading around $8/share. That translates into $3bn to $3.5bn, lower than I had suggested in my Techcrunch comment.
Seeing that chart was a real "aha moment" for me. There is enough activity in Facebook common that we can tell at any time what the market price is and we can also see how that price has changed over time. Like I said in a post last week, it's like Facebook is a public company without really being public.
I understand that there are issues with this development. It will be harder to strike options at low prices when the company's stock has a price history. It will be harder to control who the shareholders are and it will be harder to keep employees motivated to stick around if they can cash out early. These are all problems companies usually don't face until they go public. Now they will have to face them earlier.
But I still think this is a really good idea. Claire talked to me about this story and I told her:
Entrepreneurs won’t start companies and investors won’t invest in them
if there is no path to liquidity on the company stock. A secondary market for private company stock can
fill the gap that the lack of an I.P.O. market has created.
I don't believe that the secondary market will replace the public markets and M&A as the primary liquidity options for venture backed startups. I think it's a third choice that we need. And I think it represents a tier in the market that is missing between venture capital and the public equity markets. There are about a half dozen other startups working on creating markets of this kind and I expect we'll see all of them launching in the next six months. I hope that one or more of them makes it and that we'll develop a robust, liquid, and transparent secondary market in the next few years. I know we need it.
This happened a bit with Google early this decade and it was certainly part of their decision to go public (reluctantly). Now it is happening to Facebook, and has been happening for some time.
There has been an active secondary market in employee shares in Facebook for the past year or two. Though I've never bought in that market (contrary to some comments on Techcrunch's post last night), I know a few people who have. That market has been in the $9/share to $11/share range which equates to something like a $4bn to $5bn valuation.
And Facebook's numbers have become public as well, partly because Mark Zuckerberg has made them public and partly because Facebook is a leaky company. Eric Eldon wrote this last night:
Based on our first quarter results, we now believe we are on track to
see our revenue grow by at least 70% this year. We just completed our
fifth straight quarter of EBITDA profitability. And most importantly,
we expect to achieve free cash flow profitability next year.
So while it is not quite like preparing and sending a 10Q or 10K to the SEC every quarter, Facebook is letting the world know the basics of their financial situation. We also know, apparently, that Facebook has over $200mm in cash on its balance sheet.
And now comes the news that Facebook is finally receiving offers for more funding (they have been seeking to raise additional capital for some time). And we are getting to see that play out right in the public. Arrington says the price offered is $2bn. Eldon says the price offered is $4bn.
Who knows if either of these stories is correct. I've learned from personal experience that you cannot believe much of what is written in the tech blogs, particularly about deals. When you are in the middle of these deals and you read some of the stuff that is written about them, you just have to wonder sometimes.
But when there is smoke, there is usually fire. I suspect that Facebook is getting offers to invest and they are coming in at prices that the Board doesn't like. And they are coming in at prices that are substantially below Microsoft's $15bn. That should not be surprising to anyone. First, the public markets are down 40-50% since then. Second, we all knew that $15bn price was a premium based on the strategic relationship the two companies have.
Is $4bn (the more credible number) the right price for Facebook? I don't know. It's in the ballpark. I suspect if they are EBITDA profitable now and if they will be cash flow positive next year, it's a reasonable call to wait for a better price.
Say what you will about Facebook, and a lot of people are trashing the company these days, it has 200mm users worldwide. It is building the social graph of the world. It is a very valuable and important asset. And apparently it is profitable.
It is also essentially a public company now. There is a market in their shares. The company's basic financial information is available for our consumption and analysis. And we even are getting to see it's financing play out publicly.
I suspect that Facebook is seriously considering doing what Google did and biting the bullet and going public. The IPO market is coming back (that's my gut). And at this point, there isn't much cost (other than finacial costs of being public) that Facebook isn't already paying.
At the end of November last year, I wrote a post comparing the NASDAQ and the Dow and suggested that the NASDAQ was a much better place to be investing than the Dow. Of course, to some extent, I was talking my own game because the kinds of companies we invest in most often end up trading on the NASDAQ if they go public. The NASDAQ is full of venture backed success stories and the Dow is full of tired old multinational companies that are "too big to fail".
But this evening I decided to go back and look at how the two indices have fared since I wrote that post. Here's the chart:
In the four and a half months since I wrote that post, the NASDAQ has been up 6.2% and the Dow has been down 8%, for a net spread of 14.2%.
Now first I will say that I did not put on a trade to go long the NASDAQ and short the Dow when I wrote that post so shame on me. And further, this could all unwind in the coming months and not last.
But I think otherwise. I believe the NASDAQ has many companies that are worth investing in and owning and the Dow has many companies that aren't. If I had to bet, and like last November, it's unlikely that I will, I'd bet that the NASDAQ will continue to outperform the Dow for some time to come.
I also believe that we will see the return of an active IPO market this year. We've already seen one IPO, ChangeYou, a chinese online games company, and I think we'll see at least a few more in the coming months.
The NASDAQ is down 60% this decade and the Dow is only down 40% this decade. And yet, the NASDAQ has way more companies that are built for the 21st century than the Dow does. That's a recipe for outperformance in my book.
I read with interest the Brad Stone piece in the NY Times this morning suggesting that Niklas and Janus might buy Skype back from eBay. I think this is a wonderful idea and I hope it happens.
Back when eBay bought Skype in 2005, I was skeptical that eBay was the right home for Skype. I also thought the price was in the right ballpark. I got the first part right but the second part wrong. In hindsight, eBay paid too much and bought a non-strategic asset.
Now eBay is rumored to be thinking of unloading Skype for $1.7bn to $2bn and the Skype founders are trying to round up as much as $1bn of cash (including their cash I assume) to combine with seller financing from eBay to get the deal done.
Brad says in the Times that Skype did $145mm in revenues in the fourth quarter. If that's true, and I assume it is, then Skype could do as much as $700mm to $800mm in revenues in 2009 if it is growing at a reasonable rate. Is $1.7bn to $2bn a reasonable price for a business that is doing $800mm in revenues in the current year? I don't know, it really depends on how profitable that business is.
I do know that Skpe is a great freemium business model. Most of the conversations on Skype are free because they are between Skype users. But some of them are paid and according to TeleGeography, Skype now makes up 8% of all international calling minutes. If Skype can be a $800mm revenue business this year and capture more than 10% of the international calling market, I think $1.7bn to $2bn may well be a very good price.
But the best thing about this is getting the asset back into the hands of the entrepreneurs who created it and built it. We all saw what happened at Apple when Jobs took back the reins of the company and I suspect Niklas and Janus would not be thinking about this if they didn't have a strong strategic plan for Skype.
I've said this many times on this blog and I'll say it again. Big companies mostly mess up entrepreneurial companies when they buy them and it really is best that companies like Skype stay independant and run by their founders if that is possible. And it looks like that might be possible with Skype. That makes me happy.
Judging from the run that the market has been having in the past month, including a successful tech IPO on the NASDAQ (a games company from China which says a lot in itself), you might think we are headed out of the economic doldrums.
I think that is wishful thinking and that this "bounce" is unlikely to be the cure for all the problems our economy is facing.
There are some positive signs; housing in some of the hardest hit regions might be bottoming, healthy banks are making money and sick banks are making money in their good lines of business, and consumers are not in as foul of a mood as they were at year end.
But the macroeconomic picture is not good. We've got a federal government running up staggering deficits, we've still got trillions of assets that have bid/ask spreads that are so wide we don't have functioning markets in some assets, and we've got an auto industry that at best is headed for a wholesale restructuring this year.
A rally was inevitable. People can't keep their money under mattresses forever. A small shift in sentiment can lead to big moves at the extremes.
My head is in the same place it was last October and November when "the world was coming to an end". I think we are in for a bad 2009 and a weak 2010 and maybe a better 2011. I also think we are going to see many large industries changed fundamentally by this downturn.
So what is an investor to do? First, I believe you must be investing, but carefully. Second, pick your sectors with care and stay away from sick companies, balance sheets, and industries. And third, have a defensive posture with plenty of cash in reserve.
It's certainly not as bad as many thought in the fall of last year and it's not as good as everyone secretly wishes it would be. We've gone from greed to fear to something else now. It's a better place but not necessarily a safer place.
The discussion in the tech/media blogs this weekend is Rupert Murdoch's comment:
“Should we be allowing Google to steal all our copyrights?” asked the News Corp chief at a cable industry confab in Washington, D.C., Thursday. The answer, said Murdoch, should be, ‘Thanks, but no thanks.’ “
Some people will paint this as an old-media dinosaur not understanding new media, but I’m not so sure. If you’ve read Michael Wolff’s biography of Murdoch, you’d realise that he rarely says something like this without thinking it through, and without having an agenda.
I agree with Ian that Rupert is as smart and sophisticated as they come and he has thought this through. But unfortunately for Rupert and News Corp and other newspaper owners, you can't take your toys and go home on this one.
News Corp can easily block Google from crawling its pages at the WSJ, NY Post, and elsewhere. They can also sue Google and litigate for a rev share or whatever else it is that Rupert wants from Google.
But here's the thing. Google is distribution. It is the newsstand. If Rupert or any other newspaper owner chooses to take its content out of the Google index, there will be plenty of content left that can take its place.
Look at the top of the page on Google finance right now:
On Friday, an asian online games company called ChangeYou went public here in the US and had a very successful offering. This is interesting to me on many levels as you might imagine. Google shows three stories on the ChangeYou IPO; the lead story from SeekingAlpha, a story from Forbes, and a story from the FT. Note that there is no story there from the WSJ.
And I could care less. I had the option of all three links and I selected the SeekingAlpha link. SeekingAlpha is a network of stock bloggers. It is slowly but surely building a brand as a trusted source of stock news and opinion.
Google is not News Corp's problem. Their problem is us. We know a lot. But we don't own a printing press. And that's a good thing. Because printing presses are expensive. But we do own a computer and many blogging services are free. The explosion of "user generated content" has created some very compelling news services in all sorts of verticals. Not just tech, but finance, fashion, music, travel, lifestyle, and on and on. And there are a bunch of companies like Seeking Alpha that are aggregating up the best user generated content in verticals and creating awesome news, information, and entertainment services.
Steven Johnson, the popular author and founder of our portfolio company Outside.in put it very well in his keynote at SXSW last month.
What’s happened with technology and politics is happening elsewhere
too, just on a different timetable. Sports, business, reviews of
movies, books, restaurants – all the staples of the old newspaper
format are proliferating online. There are more perspectives; there is
more depth and more surface now. And that’s the new growth. It’s only
started maturing.
More perspectives is the most important thing of all. News and information content is becoming much richer and better. And that is Rupert problem at the end of the day. It's not that he can't compete with Google. It's that he can't compete with us.
I can't exactly explain why I am so fascinated by the Treasury's PPIP plan, but I am. I was also fascinated by the RTC back in the day but had no involvement with it. I love the idea that one man's toxic asset can be another man's (or woman's) gold.
Yesterday, I asked everyone for their opinions on this plan and I got a bunch in the comments. We also heard from JLM, who called it "Dr Tim's Excellent Elixir". I promised that I would publish links to posts everyone liked and I got a ton of them.
So here are some highly recommended posts from the AVC community. Just in time for your Sunday morning reading pleasure.
I've spent some time in the past few days looking at Geithner's plan to stimulate the purchase of toxic assets from banks. I've also spent some time reading what my favorite finance bloggers think of it. My friend Roger Ehrenberg is mildly impressed but concerned that there is no forcing function to make the banks sell. I have not spent much time reading the opinion pages other than to note that Krugman hates it (surprise surprise - he wants us to take over the banks).
But I am most interested in what you all think of it. We've got plenty of sharp investors and smart people who can read, think, and analyze here at AVC and I'd really like to know what you all think. You can leave a comment with your thoughts and if you leave a link to a post of your own, I'll link to it here.
To get the conversation going, I've turned to no other than my "treasury secretary" Jeff Minch (who I disagree with on all things politcal, but agree with on most everything else). You all know him as JLM and he was our first guest blogger a month or so ago. Here's his thoughts on the Geithner plan. Please let us know yours. ----------------
Dr Tim’s Excellent Elixir
The circus is back in town and Dr Tim is peddling a new potion promised to cure the problem of “legacy loans and securities” or toxic assets. These bad boys have been creating gas and obstructing digestion at the banks and thereby have prevented the flow of loans as current values have caused painful deleveraging of balance sheets absorbing available capital and have exacerbated the natural unwillingness of these banks to extend credit to jump start the economy. Whew!
The call to action of this plan is to finally and bravely (well, a four martini kind of bravery) attempt to PRICE the toxic assets. There is a real timid, coy element at work here, not a bit unlike winking at the pretty girl across the bar.
To dispel the suspense, the plan --- The Five Guys Toxic Assets Auction Plan --- intends to do this by conducting a beauty contest to select five (5) Fund Managers to form, fund and manage Public-Private Investment Funds to competitively bid on packages of loans and securities offered for auction by banks which currently hold the toxic assets. That’s it. That’s all there is!
The rest of the plan is simply about how the government intends to co-invest on the equity side (match the equity raised), loan money to finance the transactions (up to 85%) and participate in the upside on the sale side (pari passu w/ the private equity).
As a plan, it is the recognizable journeyman-like work product of a competent investment banker complete with an executive summary, white paper, term sheet, FAQ and application to participate. It is not a prospectus, it is a deal sheet. You have to give them good marks for the general thoroughness of the communication. Take a look at the Treasury’s website and you will see all of this. The only thing missing is the Power Point presentation. Hell, they even have an e-mail address to ask questions.
There are things to like, a few to dislike and a few to question. In no particular order:
1. We are finally doing something about the 800 lbs gorilla sitting in the corner and frankly the plan is well laid out from a communication perspective. Any reasonably perceptive financier could understand and model the plan. I leave it to you, the markets, the economy and the banks to decide whether it is a good plan. It is an understandable plan.
2. The toxic assets initially are only assets which were once upon a time rated AAA. Huh? This is not a huge portion of the universe of toxic assets and this is likely the low hanging fruit. So I wonder how effective the process is really going to be.
3. The big job of the “private” participants is to price the toxic assets. This has always been the object floating in the punchbowl. I don’t like the idea that only five (5) bidders will attend the auction. My sense is that at a certain level of pricing there could be many more folks who would make a bid. My market sense is that more bidders means higher auction prices.
4. Here is a subtle point --- as bidders exhaust their funds available, isn’t there the possibility that realized auction prices will go down dramatically? Simple liquidity trap. This argues for a wider set of bidders and a more expansive embrace of bidders who might bring their own financing. Should a deal be viewed differently if NO public money is involved?
5. In addition to the auction not being very broad, the sellers can withdraw the toxic assets from the auction if they do not like the prices. Hmmmm, this kind of feels like a cheap way for a bank to get an appraisal on their toxic assets. Maybe I am overly suspicious.
6. The government financial leverage is huge. The government will match the equity raised and will fund up to 85% of the deal. The private Fund Managers therefore only have to contribute about 7% of all the money in order to get half of the upside and some negotiable fees.
7. There even seems to be an argument that the private money could use NO public money on the equity side and thereby achieve a 6:1 leverage by providing up to 15% of the funding. A 15% equity investment earns 100% of the upside. That would be my personal favorite. In for 7% to get 50% or in for 15% to get 100%?
8. The expansiveness of the government’s funding also argues for a broader field of auction bidders because the government is “non-recourse” and secured solely by the assets.
9. The Fund Managers --- picked by the swimsuit and talent portions of a Treasury run beauty contest --- are sure to be large firms and I worry that they are not nimble enough to deal with the vagaries of litigation, foreclosure, renegotiation or obtaining payment on a huge, huge, huge number of individual mortgages. There is a skill set required to liquidate the underlying assets which is not the normal ken of big asset management firms. Isn’t that how we got into this problem in part?
10. OK, the line forms to the right for all folks who WANT to be partners with the government given the recent AIG/Wall Street demonization. What happens if you make too much money? Sure, the government gets their chunk but who wants to be successful and get demonized? Perhaps there is a derivative security that can be developed to hedge this risk? LOL
11. It is not clear how this plan will coordinate with HASP and other mortgage plans.
12. The Fund Managers can charge fees to run the deal with almost no restrictions on what they can charge the private money but the government --- in a welcome display of savvy deal making --- will only pay fixed fees from its share of the distributions or winnings. Bravo!
13. The banks find themselves in a very odd situation as it relates to their regulatory capital. Without boring you with the details most of these assets are going to be Class II or III assets for regulatory purposes and if the selling prices are very low could cause real regulatory capital problems. On one hand, the government flushes out the toxins and on the other hand the government must subsequently further shore up the bank’s capital. Proving that no good deed goes unpunished.
14. There is a 10-year mind set at work here while the real engagement phase of the RTC/S&L crisis was more like 5 years. Note that almost everything this Administration tackles has a 10-year time frame involved.
15. This needs to happen quickly to be effective and it clearly will not happen quickly. There is a chemotherapy element to the timeline which troubles me greatly. Right now, unfortunately, I would be long cancer. A ghoulish analogy for which I apologize.
Let me conclude by saying --- this COULD work. This is the RTC but with a public-private wrinkle and with the financing pre-arranged. The paltry list of bidders seems a real flaw to me. It is difficult to imagine a rallying cry being: “Rally around the asset managers, boys! And give them hell!” But, hey, it COULD just work.
Let’s give credit where credit is due. While it has been easy to take cheap shots at the Secretary of the Treasury and he added a bit of fuel to the fire with his timing, this plan is the best piece of work that has been presented thus far indicating that he is teachable.
Who would have expected less from a guy who grew up in Zimbabwe, India and Thailand and has an Ivy League degree in Asian studies and government with a graduate degree in international economics and East Asian studies? BTW, did you know that his father while in the employ of the Ford Foundation worked with Ann Dunham-Soetoro on Indonesian microfinance programs? Who is AD-S, you ask? Barack Obama’s momma! Karma, kismet! We are saved!
I was talking to my friend Michael today and he used a term to describe our mutual fear of a populist revolt against wall street and the financial sector: Financial McCarthyism
It got me thinking about the wisdom (or actually the lack of wisdom) in making wall street and the investors and executives that inhabit it the scapegoats of this financial mess we are in.
Yes, a lot of people in the financial industry made a lot of bad bets, were paid excessive sums for making those bad bets, and are at least partly to blame for the mess we are in.
But there's plenty of blame to go around; the politicians who created the political environment for the housing bubble, the regulators who didn't regulate, the borrowers who didn't think about the ramifications of paying too much and borrowing too much, and I could go on and on.
Not all of us are complicit in the making of this mess but certainly a lot of us are.
And the thing that concerns me is we need our financial system to get us out of this mess.
The people who built the house of cards are the ones who know how to take it down without it collapsing. And by turning them into the scapegoats, taxing their bonuses at 90 percent, and by vilifying them in public, we run the risk that they take their knowledge of how to unwind this mess most cost effectively and go home. Many already have.
I think Obama and his financial team are not stepping up to the plate and showing the right amount of leadership on this one. They are allowing the financial industry to take the lion's share of the blame and are not educating the public on why we need wall street's cooperation in getting us out of the mess.
Don't get me wrong, I'm not arguing that we should pay millions of dollars in guaranteed compensation to each and every wall street executive. But I am arguing for a balanced perspective, rationality, and an effort from our leaders to educate and explain instead of just scapegoating.
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