Fred Wilson's response to "Paul Graham's Letter to YC Companies"
avc.com
avc.com
FB is arguably the most hyped IPO in history. There was a blockbuster movie made about it. If ever there was a positive sign that we are not in a bubble, the poor performance of FB on the open market is it.
It's great to not be in a bubble. That means we won't wake up one day to discover it has popped. But to see the lack of a bubble on display so publicly has more important benefits. All the sub-par investors and entrepreneurs who flood the valley just to cash in on bubbles will be repelled.
Of course, there are a lot of great startups out there, where a person can learn a lot very quickly, but those are not all of them and joining a company because "it's a startup!" is, without more knowledge, a bad idea.
That's the bubble I see: people taking jobs in dodgy startups for ridiculously low equity slices based on information that's either biased or only validated by the ridiculous echo chamber, thinking that their position as Employee #57 is going to make them real founder material in 8 months (because the CEO will just give them investor contact). It don't work that way.
The first 1000 people at Facebook are millionaires. http://www.washingtonpost.com/business/technology/facebook-1...
Any early Facebook employee has both the money and the name brand to be a credible founder.
By contrast, have you founded a successful startup? Have you raised money from investors? If not, why would you feel qualified to offer advice on the matter?
Just being "early" at Facebook isn't enough to create credibility. A person also needs a track record of promotions. Millionaire or not, no one's going to fund someone who joined Facebook in 2007 and didn't get promoted in the interim.
Startups are a lot worse than people assume when it comes to internal promotion. The selling point of a position at a startup is the ability to get in early and have promotions be "inevitable" with growth, but it's equally common that as the company needs to scale, it has to bring on more established people, and those people tend to want leadership roles if they are going to join.
It does sometimes happen that someone joins a startup out of college and is a VP within five years, but that's not the norm. Just as common is for a person to end up a "paper millionaire" but languish in vesting twilight, not getting the raises and promotions that would be available in a more stable company with a better sense of career development.
The poor performance on the open market is in comparison to the offering price. If the offering price had been considerably different (for whatever reason) the performance would be in comparison to a much lower number potentially. Since the pricing decision was made by people (who have all sorts of motives) not sure that this is (although it maybe of course) representative of a positive sign of a bubble.
I find it somewhat refreshing that with the number of people who use Facebook and feel it has significantly impacted their lives, that there wasn't a upwards pop on this.
I agree this trend the investor posited to pg is a good one. It will force startups to focus on profits not hype and VC. That will make for better startups that can perhaps become longlasting companies.
Facebook is all hype. That is not the formula for a longlasting company. As long as the hype is high, they are in good shape. How long does hype last? Our society is more deficient in sustained attention than ever thanks to the internet. Facebook needs to acquire any Facebook alternatives early and often. People are more than ready for the next new thing.
There is no value in data itself. You have to do something with it to produce income. You need a plan. Facebook lacks a plan. Facebook will stand as a good historical example for those who wantonly collect personal data and dream of its value. The amount of personal data Facebook has collected is unparalled. But that does not magicaly create a business. Unless the business is cold calling or some similarly annoying tactic to generate sales.
Facebook's business is running on hype, not data. If the hype slows. It traffic dies down, it's game over.
The idea that the sucess of Facebook is just a matter of flipping the switch and asking Facebook's users to buy things is unsupported by any evidence. However we have the dot com bubble as an example that just acquiring users without a solid business plan is not enough. Grow big, fast, is not enough. Facebook dreamers still think it is.
As investors see that the general public understands that Facebook has no plan, as reflected in the media, and that only have lots of users and personal data, investors will be more cautious. Investors read newspapers. And they believe what they read.
The hype wears off. People see that these companies are smoke and mirrors. And suddenly you can't pull another Groupon so easily.
Complete nonsense. One or two companies != Bubble.
So as long as the market punishes this kind of hubris and rationally prices companies relative to real revenue and potential, I feel better about us not having a bubble.
Facebook's IPO is not really a huge issue in and of itself, and as Wilson points out the numbers they have are staggering. Other IPOs, like GroupOn's, have had similar issues and FB will probably look pretty awful by the time they reach the end of their lock-up period too. But this stuff is largely all indicative of market sentiment, and that's the issue.
People aren't necessarily disappointed with the performance of any of these companies, but they are getting very twitchy as investors. When people stop investing, and sentiment becomes increasingly bearish, it's like the tide going out and inevitably some boats will end up getting beached.
I know from companies attempting to raise capital in London right now that things have been difficult for a while now, and look set to get even more difficult (not that London is necessarily the greatest place for doing this, or a good barometer) - so those companies that have done decent rounds recently (HailO, BagThat, etc) will probably need to baton down the hatches somewhat, and those who were expecting to raise later this year / early next are probably in for a shock - a nasty one, if they can't operate without a raise (I know at least a couple of companies in that exact position).
Facebooks issue is one of perception - one they help perpetuate. They've continually been thrust into the top-tier of tech companies (Apple, Amazon, Google, MS) and the Facebook "problem" is that right now they not. They have the lowest market cap today of any of these companies, (besides having the largest P/E outside of Amazon). And what they don't have a is clear path to how they're going to grow revenues in a manner which will keep them on pace with a Google or Apple.
Building a 25-50 (I think FB is going to continue to slide) billion dollar company in 8 years is an unbelievable achievement and is why people will continue to invest heavily in early stage tech. I think the effect on startups is that VC's and later stage investors have always assumed that users == money. Twitter and Facebook have both raised billions of dollars using this formula. I think this belief is going to be shaken a bit by Facebook's trouble's monetizing their user base. But maybe thats just a reality check that Silicon Valley needs.
Contrast this with GroupOn, whose product IS the business model...
Most people (such as your post) completely ignore that, and focus on a good brand that is Facebook, and how the internet revolves around this company now.
with a P/E ratio of 85 it is priced as HIGH GROWTH stock. this means that you are paying $85 for $1 of profits.
Meanwhile FB is having hard time continuing its growth because everyone is already signed up (1 for every 8 people in the world), so they try to increase revenue by attempting to keep users on longer, making the service more intrusive and annoying to a portion of its inhabitants.
I'm no financial analyst, but I don't see above as sufficient to multiply its revenue and live up to the hype that is it's stock price. They would need to make some really breakthrough moves to do this.
> If you're not paying for it, then you're not the customer; you're the product.
Facebook's product is it's database of user information. If the actual customers, which currently consist mostly of ad companies, aren't interested, then they have a serious problem indeed.
That means FB has to create a product people are interested in using and has to protect their privacy just enough while giving their advertisers what they need to successfully market products.
In terms of having a Product That People Really Want (ads), it appears there's mixed emotions about that currently.
I think arturadib was talking about the user-base BEING Facebook's product.
You are correct as well, when you say that the user-base is their competitive advantage. It is a competitive advantage in the production of their product... a centralized pool of users.
You are mistaken, however, to categorize the UX as the product. The UX is simply a clever widget used to build the product... again, a centralized pool of users.
My unsolicited advice to all startups is to put your energy into the things which matter. Debating 3-6% more/less dilution with investors is not a good place to be investing your time and energy.
I suspect the companies who go into this bubble focusing on convertible notes and caps will be the companies who suffer most.
really, would that be such a bad thing to the overall economy? People tightening their spending, instead of recklessly borrowing debt, and buying nice things that ultimately aren't necessary? I guess if you're a company that targets discretionary spenders, you're doomed.
other than food clothes & shelter, everything in the world is by definition discretionary spending.
You can't say before the IPO that the company is worth 75 B or 100B and then after the fact say it's their fault for investing at those valuations. That destroys the integrity of the silicon valley investment environment.
There is now some rethinking of that assumption as more financial information from these brands is made public.
But if some analysts are pumping Facebook and no one from the silicon valley is trying to temper expectations, people assume that the valley believes the same valuation numbers. The result is long-term damage to the credibility of SV and a contraction of the investment supply. After all, if someone comes up next year and describes DuckDuckGo as a $100B company, why would anyone believe the valuation? Everyone would point to Facebook and give it a much lower valuation even if it probably deserves a much higher one.
To make it clear, I think that this type of chicanery from wall street is scorned yet expected in the eyes of most people. We have all accepted the fact that they will pump stocks, especially at the top (http://www.scribd.com/doc/86194691/Long-Good-Buy was Goldman's paper which essentially gave a bullish case for equities at the top). But there is still some credibility lent to silicon valley, which people should not squander in the interest of one investment.
"I think it will be particularly impactful on the late stage and secondary markets where most of the IPO valuation speculation is happening." - AVC [2]
We are now in a contracting market where funding for earlier stage startups, late stage and secondary markets is drying up.
AVC referenced PG's letter, but didn't address the letter. Now that we are in a post-frothy market and the froth is drying up, where does this leave early stage startups that are feeding the late stage startups with talent? It would be nice for AVC to address PG's letter directly and not just provide financial analysis to the Facebook valuation.
Have some data for that assertion? PG's letter never said that. He just identified sentiment and provided warning advice. I think it's still too early to see if there is a material impact.
What part of this is unclear? PG was sure enough to write a letter to the startups warning of the oncoming contraction. I am guessing the VC was someone of the caliber of Ron Conway.
I do not have data as data is a historical record (in this context), not a prediction of the future. This is why it is a warning of thing will come, but the question is HOW MUCH will the market contract, not IF if will contract.
"I think it's still too early to see if there is a material impact."
I believe this should read, "I think it's still too early to know the extent of the impact."
EDIT: I don't have any hard data, I am using PG and AVC to assert that what they say is true based on the information they know.
You said "late stage and secondary markets is drying up." You need actual data (even if it is a few months old) to back that up.
What actually happened in the case of Facebook is that the price was run up so high on the secondary markets that the public markets missed out. That's not the same thing as drying up. It could lead to that in the future but I think it's still premature to say it is happening now (especially with no data).
A draining tide sinks all ships.
While i feel this is (mostly) true, I also think that we are in so much of a stronger position than the last time the bubble burst that the tech market is not going anywhere any time soon.
Valuations will be lower (which is a good thing) but investment will still be strong.
What this means for early stage startups is that they will have to be built upon solid small business cash flow business models while the market is contracting.
If they do this and are dependent of investment they will likely attract the attention of investors.
This contracting will filter out the startups that lack a business model that works in the "real world" (aka small business).
Beautifully put.
I'd imagine then, that the Instagram deal at $1B+ is the sweetest deal of this bubble era.
Those guys got bought out when facebook was thinking their IPO was going to result in ~250 share price.
I'm not understanding what you mean by "~250 share price".
In other words, total delusion on the part of anyone who thought that FB would pop 7x on the IPO.
Not that one shouldn't be concerned about the broader venture market, but I'm a little less worried about the institutional money than I am about the Angels disappearing.
I hope it helps fellow hackers who don't know finance (like me) to understand the article a little better.
Edit: Better explanation of what I mean by spend.
It's a generally accepted proxy for cash earnings since it looks at profit and takes out:
- non-operating costs such as interest and tax. These are "non-operating" because they have nothing to do with delivering your service/product.
- non-cash costs such depreciation and amortization.
It is worth noting that EBITDA is non-GAAP, which is to say that it's not an officially recognized accounting term. You won't see it in an audit and if you do there will be a big disclaimer next to it. The term gained popularity in the 80s with the rise of private equity. It's used in debt agreements to approximate how a business will pay back loan principal and interest.
The thing is, however, how much you owe the government is affected by how much debt you have (i.e. your financial structure), because the debt interest is deductible. It's largely because of this that EBITDA is the preferred thing to use, as opposed to say earnings or cash flow, because it enables you to compare companies at a fundamental level unaffected by whatever financial structure they might currently have. One of the things PE guys like to do is fiddle with the financial structure (aka load it up with debt ;-), so it's important to understand the value ex whatever impact the current structure might have. But even if that's not your motive, it's a useful measure for the same underlying reasons.
It's also true that EBITDA is a useful number for PE because it tells you the amount of money available to service debt, as dcaranda points out.
That would be revenue. EBITDA is a way of only accounting for operational expenses a company faces. There's also EBIT, which subtracts the depreciation and amortization.
The key execs and advisors involved in IPO were not conservative with the valuation. Do not be surprised if those same biases influenced some of the pre-float numbers.
A cautious CFO may not always tell people what they want to hear short-term - but they will deliver a much stronger performance over the long.
What about at 0.1% of those numbers?
Facebook (while it obviously has a ways to go on direct customer monetization), is an extreme outlier whose numbers across virtually any metric are far more extreme than most startups will ever come close to. IMO it is their outlier status combined with the lackluster performance relative to that status that is the killer.
Trying to anchor other startups to Facebook's numbers at something like "half" or even a "quarter" is kind of handwavey because a startup would have to be improbably, insanely successful just to get a small fraction of the userbase Facebook enjoys.
Of course institutional IPO investors don't like it, because they want to buy stock at a discount and sell it with a big bump the next day. But the early investors are the losers in that scenario.
I guess you could argue that the IPO investors just won't play ball if they can't get their free money, but I think more likely they'll just be more careful about pricing next time.
The bigger those multiples are, the more "overpriced" a company is, so it should actually be less attractive of an investment.
Right. The OP is considering the situation as a seller, not a buyer. He would be overjoyed if everything he sells is overpriced similarly.
Facebook full year 2011 EBITDA was roughly 55%, demolishing google's 37% and apple's 42%. Wilson approximates a 40% margin in Q1, but ad businesses tend to be Q4 heavy due to holiday shopping. Facebook has demonstrated exceptional leverage in its model.
Facebook has growing pains for sure, but that is likely a result of being the first to scale in its market.
Who knows what the market will do, the general sentiment here and in other places seems to be largely emotional and indicate that it will go down further. But even if you strip away Facebook's brand name and sexy market, the numbers are impressive and the business performs very very well.
Also, the profit margin doesn't say much about a company that doesn't do much other than its core product, while Google and Apple have their hands in other products as well. If anything the chances for long-term survival look better for companies that diversify successfully and Facebook hasn't demonstrated an ability for that.
market cap + debt - cash
valuation $57.5bn
cash on the books $14bn
enterprise value $43bn
(Disclaimer: I do not own FB stock and this is just my speculation)
I don't see a lot of potential in Facebook. They're just another rung on the ladder of social network churn, and luck may have played strongly into that.
Facebook is generating revenue, but nothing I would consider 'solid' for a company with a ~85 billion market cap.
The company is incredibly overvalued, and time will show that to be the case.
sadly that's a common fallacy on any business plan - the Market is x million and we could get 10% of that then ...
So what's a better argument?