Tech Valuations and Attach Rate

The second thing often misunderstood about tech valuations: How M&A acquirers decide how much money to pay for companies they buy. The key: The value of a tech company to public or private markets may be completely unrelated to the value of the same company to a corporate acquirer. Value of company X to acquirer Y often = Potential impact to acquirer Y’s business, which has a lot more to do with Y than X.

For example, in product businesses, you’ll often hear the term “attach rate” — acquirer Y can attach company X’s product to Y’s sales engine. Example: I sell $20B of servers/year; I buy storage company X doing $100M revenue/year; and I can attach X’s product to 20% of my server sales. I can generate new $20B*20% = $4B/year of storage sales attached to my server business. X’s standalone revenue is irrelevant. So I can pay up for storage company X based on its projected impact on MY business, way beyond X’s independent valuation.

Of course, for the deal to be good, I have to deliver that attach rate. But when it works, and it often does, it’s magical and worth doing. This is the literal meaning of attach rate, but there are other, such as, maybe I know how to better monetize something I buy than they do.

Large dollar acquisitions of small companies that seem irrational to outsiders almost always have a rigorous plan like this within the acquirer. It’s just nearly impossible to see from the outside, which is why many outsiders get so confused and upset at the time of acquisition.

But, on the other hand, we do not consider it safe for a tech startup to have a plan that DEPENDS on a large acquirer applying this logic. We only invest in startups that have a plan to be large independent dominant companies on their own, with great businesses in the long term. And the act of building for long-term independence makes you more attractive to potential acquirers, not less. So you can win both ways.

Source: Tweets – 1,2,3,4,5,6,7,8,9,10,11,12,13,14

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Follow Up: Current Information On Large Capital Technology Valuations

Following up on the earlier post on new tech growth company valuations, here’s some current information on large cap tech valuations.

Since some big tech companies now have gargantuan cash reserves. I like to look at the Price/Earnings ratios adjusted for cash on balance sheet.

Apple, the shining jewel of American capitalism, has chinned all the way up to the 2014 estimated Price/Earnings ex-cash of 11.2. Google, the company everyone agrees is the General Electric of the 21st century: 2014 Price/Earnings ex-cash of 19.4. Big legacy tech foursome 2014 Price/Earnings ex-cash: Oracle 12.6, IBM 11.1, Microsoft 10.7, Cisco 9.5.

These are still so low as to qualify as generational lows. Public tech Price/Earnings haven’t traded this low, for this long, since the 1970s. I’ve said it before and I’ll stay it again: If this is a new tech bubble, it’s managing to bypass all of the big public tech companies. So to rationalize all of this, you pretty much have to believe one of three things:

  1. This is the weirdest equity bubble ever. It ignores the large capital companies that are easy to trade which is not what happened in the late 90’s.
  2. The public market is still scarred after the 2000 and 2008 crashes, hates tech equities, except a handful of companies delivering rare growth.
  3. Many large-capital technology companies are in dire trouble. They are about to be taken apart by a new generation of disruptive challengers.

Source Tweets: 1,2,3,4,5,6,7,8,9,10,11,12

Data On The Recent Stockmarket Downdraft

Some data on the recent stock market downdraft, assembled by my partner @skupor.

For the seven top consumer tech stocks (FB, TWTR, ZU, TSLA, LNKD, P, YELP): the median is off -37.4% from highs. For four of the top enterprise tech stocks (WDAY, SPLK, FEYE, NOW): the median is off 42.0% from highs. NASDAQ overall is off -8.5% from its high. Google is off -12.4% from its high; Netflix is off -27.8% from its high. Tech IPOs in 2014 so far; the median is off -22.0% from high but up 0.3% from the offering price (equals effectively flat to offering price).

People who want to see a tech bubble look at this data and say, “See! I told you it was a bubble, and now it’s crashing.” People who don’t want to see a tech bubble look at this data and say, “See! I told you it’s not a bubble; the market mostly still hates tech.” One cautionary note: This kind of market behavior with big up and down swings often correlates to high short activity.

When shorts take a big position, stocks fall. When shorts liquidate, stocks rise. When shorts are squeezed out, stocks really rise. It can be tricky to try to divine where the market wants the price to settle in the middle of a vigorous long/short battle, like arguably now.

Source Tweets: 1,2,3,4,5,6,7,8,9,10

How To Kill The Public Stock Market In 8 Steps

How to kill the public stock market.

Step 1: The number of public companies naturally shrinks each year due to mergers, takeovers, and bankruptcies.

Step 2: Use regulatory “reforms” to radically reduce the rate of new IPOs, shrinking the number of public companies from 8,800 to 3,600 since 1997.

Step 3: Steadily increase the number of regulators, lawyers, activists, pressure groups, and “governance experts” against the shrinking number of public companies.

Step 4: The “Pounds per square inch” of pressure on each public company increases, further disincenting new IPOs and incenting private takeovers.

Step 5: Private growth companies go public much later or not at all, shifting growth and capital gains from the public to the private market.

Step 6: Without growth, it gets harder and harder to realize the gains in the public market required by investors, particularly for retirement plans.

Step 7: Layer on top a healthy dose of market manipulation, mutual fund front-running, and HFT profit extraction.

Step 8: Repeat as necessary until the blood is completely squeezed from stone, then wonder what happened to the good old days.

Source Tweets: 1,2,3,4,5,6,7,8

Similarities Between Venture Capital and Value Investing

Venture capital and value investing fundamentally differ in one key way: VC = long change; VI = short change.

Otherwise I think venture capital has more in common with value investing than any other kind of investing. For example: Both VC and VI believe in deep fundamental analysis, really understanding the fundamentals of a company and ignoring surrounding noise.

Both VC and VI believe in thinking in terms of “owning the entire company” (or a meaningful chunk of it) vs share price speculation.

Both VC and VI believe in taking long view – there is arbitrage opportunity in investing against short-term traders which equals most of market.

Both VC and VI believe Mr. Market is manic-depressive and should be ignored. Prices only matter on day you buy and day you sell.

Both VC and VI believe in portfolio concentration, in making relatively concentrated bets: “All eggs in one basket and watch that basket”.

Both VC and VI believe in the “prepared mind” — always be learning as much as possible at all times to be prepared for big opportunities.

Finally, both VC and VI believe in the “circle of competence” – know what you know and invest in that, not things outside that.

Source: Tweets – 1,2,3,4,5,6,7,8,9

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Are Chinese Companies Bulletproof?

JP Morgan on China:

“3,398 corporate and enterprise bonds outstanding in China 2013, 22.9% AAA rating, 77.0% AA rating, 0.1% have A+ rating or below… The difference between the average coupon rates of AAA bond and CCC bond is less than 400bps… Shanghai Chaori Solar…is the first default in China’s bond market since the first Chinese corporate bond issuance in 1983.”

So, the $1 trillion question is: Are Chinese companies bulletproof beyond any precedent? Or are the current ratings mostly nonsense?

Source: Tweets – 1,2,3,4

Big Breakthrough Ideas and Courageous Entrepreneurs

Marc Andreessen, Co-Founder & Partner at Andreessen Horowitz, discusses his philosophy on investing in technical founders and the role of technology in today’s startups. Andreessen also addresses the kind of entrepreneurs and ideas his venture capital firm look for: “Big breakthrough ideas often seem nuts the first time you see them.

Published by the Stanford Graduate School of Business.

America Didn’t Decline. It Went Global

Outstanding piece in Politico by Sean Starrs: America Didn’t Decline. It Went Global

We’ve been obsessing over the decline or persistence of American power [and American economy] for more than three decades now…Debating wrong data…[US economy judged by] national accounts: GDP, trade, debt, world share of manufacturing; versus other nations…This made sense before globalization–production largely contained within national borders; US firms export to compete abroad…Now, as largest companies have vast operations across the globe, equation between national accounts and national power breaks down…Even though China has virtual monopoly on export of iPhones, it is Apple that reaps the majority of profits from iPhone sales…More broadly, more than three-quarters of the top 200 exporting firms from China are actually foreign, not Chinese….National accounts like GDP & trade seriously underestimate American power, and seriously overestimate Chinese [& other] power…Of 25 economic sectors, American firms have leading profit share in 18 sectors, and dominate (w/profit share of 38%+) in 13 sectors…US firms dominate tech with whopping 84% of profit share…plus 89% of health care equipment+services sector, 53% of pharma and bio…US dominance of financial services has increased since 2008 crash, from 47% in 2007 to an incredible 66% profit share in 2013…US companies still ultimately owned by US citizens–of top 100 US transnational companies: average of 85%+ of the shares are owned by Americans. 

Source: Andreessen’s tweets quoting the article: 1,2,3,4,5,6,7,8,9,10,11,12

Responses:

High-Functioning Business Organizations Are Not Disneyland

Disneyland

photo credit: Fotografik33cc

I’m torn over this story, Inside the Showdown Atop Pimco, the World’s Biggest Bond Firm. On the one hand, it’s clearly excellent reporting, from top-notch reporters and a world-class newspaper. On the other hand, story implication seems to be Bill Gross is an out of control egomaniac who is going to ruin his firm if left unchecked.

I should start by saying I don’t know Mr. Gross, I’ve never met him, I never deal with him in business, he’s in a totally different domain. But the behavior described is completely typical of any highly successful, high-functioning organization in any field I’ve ever seen.

High-functioning business organizations aren’t Disneyland. There’s always stress, conflict, argument, dissent. Emotion. Drama. This exact same behavior or pattern is often found in both the best-performing companies in any space and in the worst-performing.

I often see young people entering business think it’s all going to be patty cake happy land and if not, something must be wrong. So I read this story and I literally think to myself, boy, that sounds like Apple, Oracle, Intel, Cisco, Google, Amazon, and Microsoft. Moral of the story? Business is stressful. There’s constant conflict, emotion, even anger. Building a company is an intense experience, period. Harnessed properly, this is the crucible out of which high performance and great results emerges. Satisfaction of overcoming challenges.

To quote Jim Barksdale:

This isn’t a family and I ain’t your daddy. But together, we can build great things and make our grandkids proud.

Source: Andreessen’s tweets on High-Functioning Business Organizations Are Not Disneyland: 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12