How Does Facebook = $100B Valuation??? Brand Value and a bit of Greed

I think it's fair to say that despite rational logic, the facebook IPO will be a wild success.  They will get their $100B valuation, and the VCs, PEs, Angels, IBanks, early facebook employees, and a muralist will make a mint.  BUT, this company's stock price given the current application features, will eventually significantly stagnate.  It won't be right now, it won't be 3 years from now, but mark my words this version of facebook will be in the $100B valuation range in 5 years give or take 5%.  There is no bubble, its not a ponzi-scheme either, but what it is is an opportunistic event to get people paid while the "potential" and brand is hot.  This is a classic case of strike while the iron is hot, plain and simple.

So what is the key driver in facebook's valuation?  The valuation is being buoyed by the strength of the brand (probably supported in part by the "finger-in-the-air" guesswork of value-per-user), much more than the strength of the business model (typically supported by some variation of discounted cash flow).  The key players are VCs and IBanks who have invested significant capital to keep facebook cash rich to compete with Google, acquire talent and technology, and market the company globally.  Now they need their return plain and simple, and that return will come purely from brand appreciation, not profits.  This IPO is the equivalent of the tax man, but for only for those 1%ers that want to improve the ROI for their facebook led investment funds or return some capital to limited partners to impress for their next fund raise.   Not to mention creating much needed liquidity for employees.  And why do they need liquidity for employees?  Because facebook continues to have a cash problem despite their healthy piggybank.  That's why they are raising $5B in the IPO.  You can't wage a war on talent, without paying premiums (rumored that recent facebook employees only make $80,000 annual cash compensation on average, but fair employee stock of about 40,000 shares) ... and you can only acquire so many companies with stock before employees start asking for the full benefits of an IPO versus secondary markets.  Also to support a $100B dollar valuation you have to continually defend your market and in turn your brand which can be a very expensive war to wage.  And in this case, brand is the foundation.

But, we all should know that brand is a wicked intangible.  The tech bust of the turn of the millennium was due to inflated valuations...based purely on brand and expected future profits.  The failure was that wall street and every Tom, Dick, and Harry placed bets on whether these internet brands would develop and be adopted leading to massive speculation (stamps.com we are looking at you [1999 vs 2011]).  The valuations saddled the companies with expectations that were impossible to meet over the long term, eventually to firing executive teams, key employees leaving for greener pastures, and brands falling apart all after initially cashing out investors.  Proving that brand is a hard foundation to build a house.  However, there are always big winners when things go right.  Amazon is one of those winners, so was Google.  But neither company was laden with $100B dollar pressure either.

However, facebook is a little different, and that is why this will be a hugely successful IPO.  With facebook you know exactly what you are getting, an established brand with significant value weaving itself into the fabric of all media and commerce.  But, the value today is supported solely by brand, and the future value is supported by hopes and dreams that facebook will eventually become one of the few winners in new media.  This means the need to transfer a significant amount of wealth from traditional media (the Disneys, NBCs, and Activisions of the world) to facebook and its family of competitors because the ad and consumer media pie is only so big.

The fact is that social media is quickly converging all forms of digital interaction; and media is the head pin.  So facebook's immediate future growth will be as a digital media company, not necessarily as a technology company.  facebook monetizes amateur and crowd media better than most competitors and the faster they can help amateur's make better content and applications, the more money facebook will print.

As such, they should be evaluated less with the Microsofts, Googles, and Apples of the world and more associated with the Disneys; especially if you are going to value you them at a largely mature market cap of $100B.  So, if you take Disney's current market cap of $72.7B on Revenue of $40.9B, EBITDA of $9.7B, and OCF of $7B - which results in a forward P/E ratio of 12x, 2x revenue, and about 8x EBITDA.  This is for a massive BRAND, whose media properties touch 120 MILLION PAYING VISITORS a year just on theme parks alone, and penetrates probably way more than the 850MM users facebook claims.  And they generate profits from PAYING CUSTOMERS in multiple businesses beyond just an ad model or facebook credits.  Now you look at facebook, which is at $3.7B in revenues growing at about 70-100% annually (depending on ad growth and acquisitions) with expected OCF of $1.5B with a seemingly correlated CAGR to revenue.  So an established time-honored mega-brand is worth $27B less than facebook who makes 1/10th the revenue and generates 1/7th the operating cash flow.  So unless facebook plans to sell trillions of digital hotdogs or create facebook the amusement park, I just don't see the immediate value today.  Talk about things that make you go hmmm.

In fact, if we assessed facebook from a revenue perspective, it would have to grow at a GIGANTIC 82% CAGR over the next 4 years to even equal the revenues of Disney TODAY... again with Disney valued $27B less... However, operating cash flow would only have to grow at a 63% CAGR over 4 years... but, still a Herculean effort for even the most innovative technology companies.

So what does this all mean in the end.  It means that despite anyone's claims that this IPO and its valuation isn't about the money, it has everything to do with money.  It is a very blatant play to book returns for employees and investors through a significantly forward looking valuation.  It's obvious that facebook at 100x earnings and 25x revenues is a ridiculous bet, but it will be successful.  It will be successful because 1) people LOVE brands and 2) dumb money chases smart.  But never fear, as long as you plan to be in facebook for at least 4-5 years, your $100B investment should stand pat!  And if facebook beats guidance and actually grows at that 82%, 63% or even greater than a 20% clip, the valuation will hold.  But one slip up, and that brand foundation could crumble the entire castle.  And if facebook crumbles, I'd hate to see the fallout for the other technology stocks.  So I say long live facebook...because your investment come IPO will probably have to be just as long as their life.

K

The Brave and The Bold: H-P, Acquisition Talks, and the Post-PC Era

(image is copyright of DC Comics)

The dominant headlines over the past week in the world of tech and strategy have belonged to H-P, for good or bad.  If Hewlett-Packard were a Harry Potter novel, its latest title might be something along the lines of "Hewlett Packard and the Myth of the Post-PC Era."  Or you could consider that H-P is going the superhero route trying to reboot a whole new strategic reality, similar to DC Comics and their massive effort to revitalize their entrire portfolio of super-titles.  Either way, H-P is making brave and bold decisions that would make Batman and the Flash blush.  The problem is that to some market observers H-P is acting more like a DC politician two-facing products and speaking in rhetoric than a Tech Titan with clear goals, commitment, and direction.  As such, markets have punished H-P and the jury is still out as to whether it is merited.

H-P has aggressively messaged its intent in three specific actions that took place right before their recent earnings call.  First, the demise of the webOS devices currently in the market, R.I.P Touchpad and Palm Pre.  Second, the shocker that H-P will seek to spinout their consumer PC and mobile business, most likely not retaining an ownership position.  This enhanced the declaration as to the "end of the PC era" Golden age and ushers in the Post-PC Silver age of computing.  Third, the acquisition of UK enterprise software company Autonomy for a hefty $10.2+ billion price tag.  Big hairy audacious messages that sent shockwaves through the industry.  A strategy that when reviewed should be less surprising and probably was the plan all along.

I would argue that H-P was probably on a strategic direction to exit lower margin and highly competitive consumer devices regardless of recent leadership changes.  Also, it comes as no surprise that H-P CEO Leo Apotheker wants to strengthen H-P's software offerings to provide a more powerful end-to-end enterprise offering.  To be honest, its a transition that Mark Hurd former H-P CEO started way before Apotheker's reign.  Over the last 5 years, the majority of companies on H-P's acquisition list have been in software and enterprise solutions related companies.  Not only should this not be a surprise, but it is part of the natural evolution of companies as they chase profits and seek to shift their "paradigm."

While a complete management buzzword, paradigm shifting borrowed from the classic definition of the changing of basic assumptions.  As such, it has been a base strategic tactic that requires significant reallocation of resources to expected future areas of profitability within a company.  The concept is that as markets and products evolve, so do the competitive strengths and weaknesses of companies.  Companies use metric analysis to help determine and predict the shifts in profitability to better allocate resources and realign priorities to provide current and future returns.  Ultimately, the direction of a company and the paradigms it chooses are largely determined by profit and expected profit growth.  As such, it can be predicted that certain companies are reasonably expected to enter adjacent markets with similar technology or resource profiles that exhibit extranormal profits and high potential for profit growth.  As adajcent markets take hold over a company's focus, old markets eventually commoditize and become less attractive.  As a result, companies have to make the tough decision to participate in market disruption or divest/kill the business.  H-P is no different, the bulk of its profits and margins are in the enterprise markets, and the products they build or acquire are mostly tied to filling end-to-end solution needs.  Solutions that require integrated offerings in storage, compute, software, and networking... not PCs or mobile devices.


If companies are supposed to chase profits and are supposed to maximize profitability and shareholder value, then how did H-P end up with companies like Compaq and Palm in its portfolio?  The answer is pretty simple... perceived value.  Value can take many forms of which, in business, the most important is usually profitability or cash generation.  But, the intangibles, items like talent (man-quistion or acq-hire), brand, distribution channels, marketshare consolidation, synergies, patents, and pride are all items that drive passion to purchase and contributes to seemingly irrational prices.  At the time of the Compaq acquisition, H-P under Carly Fiorina thought that it could create a PC market mammoth that could create economies of scale from market consolidation and production synergies driving growth and profitability.  10 years later, hindsight is 20/20.  The PC sales growth peaked, consolidation couldn't generate enough synergies, competition intensified, and commoditization killed gross margins.  But that is the risk you take... its like getting excited for going to Vegas... you always think you are going to be up $500 by midnight...

Also, like all companies with multiple business units and large budgets, governance and decision making is difficult to control 100% of the time.  There are independent budget allocations, product roadmaps, and commitments from hundreds and at times thousands of leaders who, based on there specific view of their business, give the approval to move forward on investments and acquisition recommendations.  At the time, I am sure that webOS seemed like the silver bullet to fire at the tablet and mobile market.  The trend was to either join the low margin Andriod fray a la Samsung and Motorola or try to differentiate through unique software/hardware offerings. 

H-P placed their bet and while it was a decent differentiated product, it fell short of Apple.  In essence, the promise and allure of profits in the "growing" tablet and smartphone market place crapped out.  As such, H-P re-evaluated its strategy and decided to not compete.  While an unpopular decision with technologists, they would have had a long hard battle to fight had they elected to continue.  Did Apotheker and H-P leaders pledge their support for the defunct Touchpad and Pre lines?  Absolutely... but what did you expect them to say to the public?  At the time, they were trying to put on a brave face, rally the troops, and do battle... they didn't want to admit weakness until a loss was reasonably assured.  Did Apotheker and the executive team ever really have faith in webOS?  My retort is that it doesn't really matter.  The product was a sunk cost by the point of release and they weren't going to damage the chances the product might have had to do well.  I believe it was always an attitude of "let's deal the cards and see what turns up."  It was the perverbial "double down" and if they won, then they would continue to invest, but they didn't win and they cut bait.

As such, the game continues on.  The purchase of Autonomy is more about looking for a software capability to enhance other offerings and create high margin growth opportunities that have a strong potential pull through for other products and services.  Its strong presence in the private-cloud solution space is very appealing and fits well with the early market trends.  But, high potential companies don't come cheap.  Autonomy is not stupid, they realize their position, they realize they can help complete or at least advance H-P's product offering really far.  In turn, they want to get paid.  If Autonomy turns out to be the lynch pin in a superior and potentially market leading cloud-software strategy, then why not pay whatever it takes.  You are still H-P, you still have significant resources and loads of talented inventors.  This could be the spark to jumpstart your innovation engine in a highly profitable growth market.  You can fill in the gaps with smaller innovators, companies with solid technologies that fill those critical gaps... those $20-100 million companies that can bolster your engineering and innovation roster.  So while H-P might be overpaying in an economic sense for Autonomy, perhaps the 'intangibles' if executed correctly will make up the difference. 

A wise man once said to me, "it is better to execute a poor strategy well, than execute a great strategy poorly."  Excute poorly and those Oracle rumors might be the least of its worries.  Execute well and H-P could do more than turn the tables.
-K

UPDATE:  H-P has just resumed manufacturing of the TouchPad due to a sudden surge of demand after liquidation price of $99 was set.  WSJ.com reports that at $99 the TouchPad is a loss leader costing $307 per unit to make... awesome catch phrase "the TouchPad is dead.  Long live the TouchPad!"

Google says $12.5B Hello to Moto... Mobile Faux Pas or Patent Envy

While we were all snug in our beds with dreams of iPhones and Andriods in our heads, Larry Page and Google's corporate development team were busy crafting the next day's (and perhaps the week's) major headline story.  In the ultimate +1 to Carl Ichan and Motorola Mobilility investors, Google announced its intent to acquire the group for a nice 63% premium at $40 per share.  The acquisition is billed as strategic in nature, stemming from the intensity of current patent brouhahas with the major tech consortiums of Apple, Microsoft, Nokia and the like.  While this seems to be clearly a case of "patent" envy, this may turn into a future mobile faux pas for the fashionable Googlistas.

The nuts and bolts of the deal can be broken down into a few basic categories using a standard mergers and acquisitions litmus test.  Let us evaluate briefly the merger's A list opportunities.  The deal earns mad props for kicking it straight old school by acquiring a business with actual profits and a means to generate them into the future.  I'm sure many investors will applaud Google finally grabbing a company that has immediate big impact to top line revenue and serious potential for cash and profits.  The move will further diversify Google's revenue mix and provides a launching pad for a Google controlled foray into hardware both for mobile and appliance.  But, this deal, so we are told, is all about patents.  17,000+ Patents that can stick their tiny little fingers in the dike to keep Andriod from a flood of litigation.  As such, we see a new valuable category of consolidation occuring in the marketplace... consolidation of the patent trolls or paying ample sums of cash to cross their patent bridge.  This deal immediately alleviates Google's well critized patent inventory and gives it plenty of ammunition to defend itself when the lawyers come servicing.

But, I'm not sure patents and revenue diversification are enough to justify a $12.5B cash purchase price.  When you consider that Motorola had already fully jumped into bed with Android for its line of smart phones, Google basically already owned the majority of search, mobile ad, and mobile marketplace revenues coming from those devices.  No incremental revenue above and beyond should be expected, bringing into question the rationale behind a 63% premium or roughly $6.6B.  Does the $6B come from fit?  Nope... Motorola is a hardware focused company that is arguably beyond its glory years of innovating products in the mobile space.  The last few years, they were at best struggling to gain market parity in mobile and if it weren't for Driod, Google might be buying those precious patents at auction today.  In addition, Google prides itself as an innovation factory in which creativity and healthy budgets abound.  Which makes it a particular struggle to pair penny-pinching value engineering cultures with free-spending innovation thought leaders.  The good news, Google has enough cash and free cash flow to keep funding the beast through integration and change. 

But, the most peculiar part of the culture issue is Larry Page's plans to run the group as a separate business.  It is a slippery slope to run Google and then have a red headed step child, Moogle, in the basement.  Without competitive help from Mama Google, Moogle will still face the same competitive pressures across the handset and tablet space that it currently faces and could be a significant drag on financials.  Google already has been critized for its spikes in OPEX and headcount, and as such, I wouldn't expect the "independent" Moogle to expect any free lunches or massages any time in the near future.  Also, Google's hardware forays have been weak to date, with struggling joint efforts for Chromebook, Nexus, and Google TV.  This doesn't bode well for the "separate" companies because the same design and collaboration hurdles will exist.

Surprisingly, Google has seemingly painted itself into a corner.  If they don't operate Moogle as a separate entity, then they risk ruining the precious channel partnerships for the product they spent massive bucks to protect.  Choose to compete and innovate and they could generate significant profits to combat Apple's growing war chest, but most likely push their ecosystem partners straight into the arms of MSFT.  Similarly, Google has justified the price with the potential of using the tech for Google TV and other lines.  However, service providers should be wary of Google's past plays at being the disruptor, while now probably playing the saint.  With wolves in sheeps clothing at every turn, expect the Comcast's of the world to be very sensitive to Google's every word.  One wrong step and punishment could be severe.

So with significant risks apparent in both its vertical integration claims and its seemingly night and day cultures, how does Google win in the end?  It doesn't need to do anything.  It already won with its purchase of the patent book, which fixes its short term issues and seemingly eliminates significant risk to its future.  Everything else doesn't matter, this was purely a "patent" play and as such Moogle better watch its back VERY carefully.  All the grand overtures and the lofty aspirations could, given the risks at hand, turn to rhetoric.  Sadly, Moogle might discover that rather than being the red-headed step child, they very likely are the family pig waiting to be slaughtered for a nice tax write off.  If given the game theory chance to choose between continuing to lock up a massive ecosystem or drive handset sales, Google probably chooses the 38 ecosystem partners over its new pet.  As so often happens with the Bachelor... in the end, Moto better pray they can bring more to the table than just a pretty patent book.

-K

Is Google the Walmart of Tech?

To start, I am not a fanboy of any particular technology over another.  I am a firm believer of no technology religion, using the best product or service that fits the job I want to do for the best price.  With my personal disclaimer out of the way, the question remains... is Google the Walmart of the technology industry?

Recently, the news has blown up with companies becoming increasingly aggressive in protecting their market turf through patent litigation, communitiy messaging, and media coverage.  As one company in technology succeeds with a breakout product, it is reasonably assured that 15 other companies will chase to build nearly identical products to flood the market.  It is a continuous cycle, in which companies such as Microsoft have been supremely successful.  But because the tech industry is a particularly entrepreneurial and idea driven community it raises the well known cry of "COPYCAT!"

So first, the business strategy.  Standard competitive strategy teaches that when new innovations occur (i.e. market transitions, market disruptions, tipping points, etc.), revenues and profits are generated.  If profits are extra-normal, then it is assured that competitors will be attracted to the same market because the market has room to accomodate them.  As such, those competitors strive to furnish products that look, feel, and function as a near match to the initial innovation, i.e. a copycat.  So entrepreneurs and idea people beware... if you have a great idea, nothing is stopping anyone from making a copy.  Now you can protect yourself and errect barriers to entry, such as patents, lobbying, market consolidation or whatever your creative and expensive brain can concoct, however, it isn't a matter of if, but when will a competitor come knocking.

As noted in a previous rant, in many cases the markets can sustain a number of large competitors in oligopoly, while numerous solid lifestyle businesses service the niche related markets and fight for industry scraps.  In most cases, companies find pricing parity and work in unsaid collusion to maintain prices and profitability.  But, where it gets ugly is when companies break from the pack, make bold strategic moves, and price competitors out of the market.  While initially great for consumers because it lowers prices, it can mean slow, painful death for competition.



By the above graphic you may think I hate Walmart... I envy Walmart.  I think Walmart is an amazing company with awesome people.  They solve all my needs in one place and I thank them for it, but this is Walmart's alleged strategy.  To be the Low Price leader Always... no matter what.  They have been notorious for allegedly entering communities and offering whole sale generic products at prices that are impossible to maintain for local businesses.  In turn business is sufficiently wounded for surrounding entrepreneurs that they end up selling their business or going down with the ship.  Once the market has consolidated, Walmart is free to offer whatever "low" prices they desire.

So is Google no different than Walmart?  They have brilliant strategists that have taken competition to a whole different playing field.  Google, like Walmart aims to be the 'Low Price leader Always' in everything but except probably search.  Like Walmart, they know that if they can grab you to use one of their 'free' services like Gmail or Google+, then they can own your data, serve you ads, and drive you to spend more time using their search products.  And when you generate as much cash as Google does from a virtually infinitely profitable business model, you can focus on creating a whole host of context products to pull through more growth and more profitability.  If a competitor has a core product in one of your hot 'target' growth markets, Google gives them the option to sell and assimilate or go down with the ship.  If the target doesn't sell or can't be bought (in terms of larger competitors like MSFT or Apple) it builds and deploys a 'copy' product, smashes the price to nil and burns the market to ashes in perfect competition.  It completely and utterly disrupts the business.  Customer's love it in the short term and it limits the possibility that the competitor ever can really reciprocate.  Brilliant...

We are seeing it again today.  Google+ recently added functionality for social gaming, probably one of the best and most powerful features facebook had to offer to its user community.  facebook makes money hand over fist by charging a generally market standard 30% fee for digital purchases through its platform, basically matching market pricing parity  with Apple for platform marketplaces that have large user bases.  facebook can charge this premium fee because it has relatively the best game in town as far as social platforms, and relies on these type of fees to feed other inventions and innovations within its model.  Games, unlike your recent status post about what food you just ate, provide tangible entertainment value and stickiness to facebook and is most likely considered a core functionality of their business.  Seeing that games and digital purchasing was core to the social platform business... Google+ had to launch games.

Now Google could have played it nice, came in at price parity for the revenue split fee at 30% and stuck to the industry standard, but that isn't the Walm... ahem... Google way.  Instead, Google launched a promotional digital goods fee of only 5% to entice developers to add Google+ to their radar.  This 'beta' digital goods fee may or may not remain 5%, but it is hyper-competitive behavior and a Vegas sized signal to facebook that there is no intention to play nice.  The point is that there is room for both Google+ and facebook in the marketplace, but hubris and ruthless strategy dictate that like the immortal Highlander... there can only be one!

Rightly so, the case for Walmart comparisons can be made for other tech companies as well, but Google has definitely been the most visible and aggresive as of late.  While Google might not particularly like being branded the modern Walmart (or even worse to them, the modern Microsoft), their intentions are clear... burn the villages, storm the castle, and take no prisoners.  Its all fair play, and it is brilliant strategy.  So the next time Google comes calling with a nice little acquisition offer... remember that you have been duly warned.  At the same time, can Google realistically maintain victorious by fighting a digital war on all fronts?  Right now, it seems so.

-K

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