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Post-IPO Versus Pre-IPO Markets ? Why Both Are Wrong
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Over the past year the following 10 private companies have all achieved $1 billion valuations based on rounds of equity raising:
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Twitter ? $8 billion
LivingSocial ? $6 billion
Dropbox ? $4 billion
Spotify ? $3.5-$4 billion
Square ? $3.25 billion
Pinterest ? $1.5 billion
Airbnb ? $1.3 billion
Yammer ? $1.2 billion (purchased by Microsoft)
Evernote ? $1 billion
Instagram ? $1 billion (purchased by Facebook)
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For comparison, here are the valuations of 7 billion dollar Internet companies that went public since the start of 2011, along with some valuation and performance metrics:
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Why public markets are wrong: In a post-2008 world, the day a company goes public, all of the existing investors are employees and venture capitalists who own the stock from much lower prices. They are only going to be sellers, not buyers. They are fairly valuation-insensitive and have restrictions on when they're allowed to transact. I got caught in one of these with Zillow (Z) back in November, as insiders were given their first chance to sell and the stock fell 25% in a handful of days. All of the likely buyers are hedge funds and day traders, for whom a company is only as good as its chart or its last quarterly earnings report, and mutual funds, who in a world of relentless equity outflows have to sell something else to buy a new stock, and thus are unlikely to be big buyers of new issues, especially ones with short-term hiccups.
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Companies that do everything right, as Zillow and LinkedIn (LNKD) have in their brief stints as public companies, can go up. All others are just a misstep away from a 40% decline, regardless of whether it makes fundamental sense.
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Why private markets are wrong: In pre-IPO companies, only the company call sell shares in order to raise capital to fund growth. And the only buyers are well-funded venture capital firms that think about the long-term potential of a firm. Short-term progress is taken into account but it's not the be-all and end-all. And all it takes is one high bidder to set the price. In a world with a lot of tech innovation taking place, unattractive yields in other asset classes, and potential cash-rich acquirers looking for growth, it means private markets will be more kind to companies than public markets.
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But here's the thing. Imagine you're looking to start a new NBA team where you can purchase the rights to both existing NBA players or amateur players. And imagine four NBA teams have declared bankruptcy and are looking to sell their players for whatever prices they can get. Why overpay for a high school sophomore when you can potentially get an NBA all-star at a discount?
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The State of Social Investing in July, 2012
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Markets have priced in three trends so far this year.
- Desktop/Web usage is losing share to smartphones and tablets.
- Facebook is losing influence to other, more open platforms, and to targeted verticals (LinkedIn for professionals, Instagram for photos, Pinterest for fashion).
- Display ad-based business models are losing out to those that have something for which people will pay.
- Avoid Facebook ? it may just end up being the AOL (AOL) or Yahoo (YHOO) of the social Internet that tries to create a walled garden that's everything for everyone, hasn't evolved past display ads, is very expensive for its growth profile, and has billions and billions of insider sales coming down the pipe over the next three to six months. As we've seen with Zynga, when you have slowing growth and a wave of sellers, valuation doesn't matter on the downside. Facebook needs to figure out how to monetize its API, which is its longer-term value proposition, not visits to the site.
- Avoid companies overly reliant on display ads (Facebook, Yelp (YELP)).
- Avoid companies for whom it costs a lot to generate that next dollar of revenue (Groupon (GRPN) with its sales force-intensive model, Pandora (P) because of what it has to pay the record companies).
- Own and tuck away Zillow and LinkedIn. Both solve problems for consumers and businesses alike, both have outstanding management teams that ?get? social (follow @spencerrascoff and @jeffweiner on Twitter), both are leaders on mobile, both have cracked the monetization code beyond display ads, both have been public for over a year and shouldn't have as much of a drag from insider selling going forward. Count your lucky stars if they miss their earnings this quarter and you get a chance to own them 20-30% cheaper.
- Take a flier on Zynga. If it wanted to, it could fire everyone not working on new initiatives, and probably earn a couple hundred million dollars this year. After all, it earned $125 million of operating income in 2010. Instead, it's investing in what it wants to be in the future. Facebook-related revenues are down from 93% of total revenues a year ago, to 85% in Q1 2012, to 80% in the most recent quarter. The transition is happening, albeit slower than impatient public markets want. Real money gaming is coming as early as the first half of 2013 in international markets. It could achieve CEO and founder Mark Pincus's ?platform for play,? hosting the games of third-party developers, providing analytics and distribution support for them, and with advertisement dollars likely to shift away from TV, print, and display ads even more in the future, provides the most compelling audience for engagement ads for leisure and entertainment products going forward. In Q2 advertising revenues rose to $40 million, up 170% year-over-year. At an enterprise value of just over $1 billion, or $800 million if you back out its $200 million new San Francisco headquarters, it's the only consumer Internet stock depressed enough, with as much long-term potential, to have the chance to be the ?Amazon (AMZN) in 2001? of this cycle.
Positions in LNKD, Z, ZNGA
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