Valuation Quiz

I received an email today from Tom Astle, head of Investment Strategy at Difference Capital, (I am on their mailing list). It was a good email that is worthy of discussion for startups and investors. Here is the email in full, with some of my thoughts at the end.

Here’s a Valuation Quiz: 


OK smart MBA grad / CFA type, what valuation would you give a private technology company that is six years old, had only $13 million in revenue, a 26 year old CEO, 175 employees and probably losing lots of money?  A few times revenue? More if its growing fast in hot sector?  Maybe 10 x revenue at the top end??

Wrong! Try $1.1 Billion or close to 100x revenue.  At least that’s what Yahoo valued internet blogging site Tumblr at earlier this week.  And this isn’t the first head scratcher in the internet space.  I.e. Facebook’s $1 billion purchase of Instagram also comes to mind.

But as a fellow blog writer, I’m happy to see blogs valued so highly!

So what do we chock this seemingly crazy valuation up to? Unsophisticated buyer?  Nope, Yahoo knows this space better than you or me. Inflated paper for inflated paper?  Nope, It’s a mostly cash deal.

So what are we missing?  Some other metrics might give us a clue: Tumblr has 54 million users, 70 million daily posts, 15 billion monthly page views, 108 million hosted blogs.  But the most telling or interesting thing is that the current management team was not even thinking about trying to grow revenue (let alone earnings).  It was still just focusing on the customer experience and growing traffic to the site.  It probably (and correctly) assumed that it would get bought by a larger company that would pay for its traffic and have its own view on how to monetize the traffic/user-base and what the revenue potential would be.  Must be nice to build a billion dollar business and not have to worry about pesky things like revenue, costs and profit!

Who is making money on this?  It looks like $130 million or more was invested by a very well regarded group of PE/VC players including: Union Square Ventures, Spark Capital, Sequoia Capital, Greylock Partners, Insight Venture Partners, and Draper Fisher Jurvetson’s Growth fund.  Well done lads!  And good luck to Yahoo.

At Difference, we are always studying valuations and exits – so give us your thoughts on these transactions. Is this another bubble or are buyers like Yahoo and Facebook just more forward looking than most of us?

– Tom Astle

With metric, both as founders and investors, there is always more at play than just the numbers. The Metrics that we use as founders to put the valuations on companies we build as well as the metrics we use, as investors to put valuations on companies we invest in are only a part of what is at play here.

When a company that is fighting for market share is making an acquisition, other metrics include but are certainly not limited to the future user adoption, industry politics, talent acquisition, defensive maneuvering, internal technical synergies, HR synergies and cross selling opportunities.

All of these are metrics that really only the acquirer can quantify  – though we will all have opinions and speculate. I do not view it as a matter of “is this another dot com bubble” as Yahoo and who they compete against are hardly startups.  As well, back in the dot come days there were no established Internet media giants that could make these types of acquisitions. I am not suggesting that they are underpaying or overpaying but I am suggesting that while this sends a bullish signal to the tech startup market the practical reality is that it has less relevance than we would like to think. In the world of acquisitions 90% of the time One + One equals either much less than two or substantially more than two. The real value is in how Yahoo manages this and not how they price it.