Tuesday, November 30, 2010

3/5 of a mile in 10 seconds

Following are some numbers which have a common link (posted after the video).

Coca Cola 19,806,778
BMW 3,793,208
Walmart 2,572,429
Microsoft 204,500
Google Chrome 4,094,906
ExxonMobil 213

The above numbers represent the number of people who 'liked' these corporate pages on Facebook. Social based applications have obviously exploded due to their ability to connect people on a common social dial tone (it's happened so fast that 'Facebook' still comes up as a misspelling in Blogger). It's now obvious that this dial tone is rapidly expanding its coverage into the business sector too. Tens of thousands of applications are tapping into the 'open social graph' concept introduced only in April '10 and bringing incredible depth and value to their extended relationship chain. It took less than 5 years from the introduction of the browser for virtually all companies to establish a web presence. I can't imagine it taking more than 12 months for the same to happen using Facebook's social graph.

This is a huge opportunity; using relationships as the base to rewrite the rules used by vendors of services ranging from communications to commerce and search. Moreover, it's being embraced by a community of 500 million strong. Of course, the graph is fraught with many risks (beginning with control of the dial tone by one vendor)...but it's an ecosystem with the potential to be far deeper and rewarding than that supported by the Google search utility and its army of one lonely algorithm.

Think about it, Google, for all its incredible success mostly stands alone. There's little relationship (and zero passion) between me, GOOGLE, my applications and my personal ecosystem (Buzz has been an abysmal and rare non-beta failure). Instead, GOOGLE is surrounded by a cadre of companies employed by the likes of you, me, and Wal-mart, determined to legally break its black box search ranking via search engine 'optimization'. We seldom, if ever, spend any energy or resources to improve GOOGLE as its mostly a remote abstraction. On the other hand, we are, and will volunteer to become far more invested in our personal and professional dial tones.

Monday, November 29, 2010

A short tale of three cities

Rumors of a $+3B Groupon acquisition have been rife over the past few weeks. The attractiveness of the company is centered around their pioneering an efficient 'call to action' for local advertising, which is such a positive win/win for advertisers and consumers that the 2 1/2 year old Groupon's revenues have surged to more than an anticipated $500mm this year.

With this background of how innovation is creating a virtuous cycle of value creation, I thought it would be worthwhile to take a 30 day 'innovation' look at three of the internet's larger players:

Let's start with AOL. It's mission is "To inform, entertain and connect the world" and touts its brand as something that "stands for creativity". In the past 30 days, here's the innovation they've announced:

AOL Disrupts the Inbox with Project Phoenix by AOL Mail


AOL Grant Program

Yahoo's vision "is to be the center of people's online lives by delivering personally relevant, meaningful Internet experiences".

Yahoo is in the midst of a multi-year turnaround effort and Bloomberg ran a piece here where they mentioned Yahoo's interest in buying Groupon and voicing concerns about the company's direction and growth prospects.

Here is their product related announcements from the past 30 days:

Local Offers (Groupon competitor)

Contributor Network An extension of their Associated Content acquisition for self-publishing

As a contrast to it's senior brethren, here's what Facebook's remarkably similar mission is:

"Facebook's mission is to give people the power to share and make the world more open and connected." As background, more than 4 Billion messages are sent through FB every day.

Two important product announcements made in the past 30 days were the outline of their imminent messaging product and a commerce engine "Deals" which fits with their 'check-in' facility 'Places'.

FB Messaging

Facebook Deals

Finally, a tribute to Leslie Nielsen..RIP

Thursday, November 18, 2010

Bulls, Bears and Bubbles- how wrong we can be

Yesterday, I posted on the 'investing bubble' which many participants and analysts feel is building today. We obviously won't know if they are right for a couple of years. This thinking sparked me to dust off the Sequoia Capital presentation which they presented to a gathering of portfolio companies during the height of the financial crisis in October of '08. It was well thought out, reflected the cold sentiment of the time, and lauded by the press and pundits.

It was also dead wrong advice. It missed the 'change' in the financing environment, missed the 'social' business model basics of building an audience and missed the drivers for exit (growth vs profitability). In hindsight, the time was right to be contrarian; use capital to fund innovation to gain market share and seize expanding opportunities.

Sequoia is a great firm with decades of success behind it. Sometimes, smart and informed people just get it wrong.

Here it is:

Wednesday, November 17, 2010

Bulls, Bears and Bubbles

Much has been written recently about whether we are approaching, or are already in an investment 'bubble'; it's enough to conjure the ghosts of '00. Rather frightful musings, but I think it's valuable to refrain from blanket 'bubble' statements, and instead look beneath the waves at some market fundamentals to determine if the valuation spikes we are seeing is the cause, or the effect of market shifts.

The technology industry is an ocean of trial and error, failure and success. Participants learn lessons, test theories and derive principals. Such principals often are not transportable across shifts in markets and technologies. For example, the harnessing of 'eyeballs' was the watchword of '99, the cussword of '02, and the mantra of '10. There is no economic inevitability of a company's success or failure. Market conditions, execution challenges, and competitive hurdles contribute to a sea of uncertainty which must be navigated to achieve success. Much of the industry's uncertainties can be tied to a decade of overall failure, where, despite some shining moments, we have produced negative returns for investors.

In large measure, we are still paying for the disappointment the technology industry gave shareholders at the beginning, and the end of the past decade. The public markets continue to punish companies with a skeptical attitude towards financing the next generation of leaders. The probability of securing Company investment/shareholder liquidity via an IPO is, and has been, a difficult path. According to VentureDeal, a scant 6 software/digital media/internet companies went public during the 1H '10, resulting in $612 million raised. (A contrarian view, recently posted by Bill Gurley is here)

Moreover, the venture market is shrinking. Here's a quote from Mark Heesen President of the National Venture Capital Association:

“With funds sizes getting smaller and fewer firms raising money, we are experiencing a
period of time in which venture capital investment is consistently outpacing fundraising,
creating an industry that will be considerably smaller in the next decade”

With this background, you would expect a universal slowdown in funding by venture firms. But that's not happening, and in some areas, the bidding for investment is reaching a pitch that sober people, such as Fred Wilson are lamenting:

"I think the competition for "hot" deals is making people crazy and I am seeing many more unnatural acts from investors happening. If it were just valuations rising quickly, I'd be a bit less concerned. But we are also seeing large deals ($5mm to $15mm) getting done in a few days with little or no due diligence. Investors are showing up at the first meeting with term sheets. I have never seen phases like this end nicely."

Moving to a lower level in the funding food chain, I recently did an analysis of the NY Angel and Micro funding environment. I tracked 24 funds/groups which have completed 406 seed/first round transactions in the past 30 months. Assuming that 20% of these companies graduate to an institutional expansion round, and 20% of these again raise a growth round, then NY will have a requirement for more than $800mm of expansion capital in the next 18 months. All the while the institutional investment pie is shrinking. Perhaps, people are looking at these investments the same way as they invest in the lottery?

This begs the question of who is being irrational? Are funds/people over investing in mirages, or are the institutional backers of venture funds not seeing the full picture? While it will take hindsight, viewed from at least two years out to judge these actions, a few things are clear today.

1. Self-publishing/expression by the masses can and is no longer a questionable value proposition. It's being monetized today and has huge potential for tomorrow. Facebook, at least for now, has done the industry a service by establishing the de facto social 'dial tone' platform for others to plug into. In doing so, they have created massive wealth for shareholders and a huge opportunity for fast followers. Unlike Amazon, eBay, AOL and Yahoo, their ecosystem seems to leave opportunity for others akin to MSFT's OS in the '80's.

2. Tapping into the social dial tone enables companies to hyper-scale. Union Square Ventures has done an admirable job finding, nurturing and realizing great returns for shareholders by executing on the social trend. For example, courtesy of Compete.com here's the traffic graph for Zynga

And here's one for Tumblr

Finally, Twitter's growth has been widely documented (here's the Wikipedia post with citations)

'Twitter had 400,000 tweets posted per quarter in 2007. This grew to 100 million tweets posted per quarter in 2008. By the end of 2009, two billion tweets per quarter were being posted.[citation needed] In February 2010 Twitter users were sending 50 million tweets per day.[25] By March 2010, Twitter recorded over 70,000 registered applications, according to the company.[26] In the first quarter of 2010, 4 billion tweets were posted.[citation needed] As of June 2010, about 65 million tweets are posted each day, equaling about 750 tweets sent each second, according to Twitter.[27] Twitter has experienced rapid growth as noted on Compete.com, Twitter has moved up to the 3rd highest ranking social networking site in January of 2009 from its previous rank of 22nd.[28]'

To date, Twitter has raised $57mm in three rounds of fundraising. The last round, completed in September, and reported by Bloomberg to raise $100mm valued the company at $1B

In May '08 the company raised $15mm at a reported $80mm pre-money

In February of '09, Twitter raised $35mm. The pre-money was not reported, but company benchmarks were 29 employees, minimal revenue and 900% growth year over year.

The first round of capital was raised in July '07. I can assume the valuation was not more than $10mm.

3. We have seen a first wave of social commerce embodied by the 'flash' commerce sites such as Gilt group and Groupon. I believe the stunning success of these firms will be dwarfed by successors who harness relationships, in a positive way, to recommend and sell goods and services. Think of Amazon or Ebay's star system, but from people you actually know, respect, and can easily verify. This arena can support many firms with a large market capitalization, and a host of successful 'satellite' firms too.

4. Predictably, most of the leading Web 1.0 Companies have become stagnant. Just compare the innovation behind the concept for Facebook's new messaging product, vs AOL's way overdue facelift of 'you've got mail' as a prime example of incremental vs fresh thinking. The incremental product advancements of AOL, Yahoo, eBay et al (with the notable exception of Amazon), has opened the gates for this new generation of entrepreneur and funding sources (e.g. Spark, Union Square, Andreessen Horowitz) to ride and expand upon the social dial tone within established, large markets.

5. The mobile web, better screens and upcoming tablet form factors will fuel a dramatic increase in engagement and time on site. Key metrics which will accelerate the move of advertising from desktop to phones/tablets.

In the past few years, we have seen great innovation in the three bedrock internet arenas; Communications (Twitter), Commerce (Gilt and Groupon), Community (Facebook and YouTube). The only laggard bedrock segment is search. Wolfram tried something new, and a host of others are challenging GOOG, in much the same way GOOG challenged Yahoo, which vanquished Alta Vista and Lycos.

Putting the pieces together....

1. I really do not see a bubble in the growth/expansion arenas. Instead, there's a stampede of homogeneous players looking to invest in a few hypergrowth companies. Valuation here involves more art than science and the law of supply and demand trumps all. Definitionally, with so few transformational opportunities, the few which achieve hyperscale will be valued quite dearly. The NPV and efficient market theories of Finance 1 go out the window when you are presented with companies with less than 30 employees, growing 900%/year, are in multi-billion dollar markets and only requiring minimal capital to fund its operations. Phenomena like Twitter are special, and deserve to be treated so.

2. The market today seems balanced in the more 'normalized' 50-100% growth per year expansion stage firms. I do, however, suspect valuations will decline in this arena as less capital supply will meet enhanced capital demand. Of course, if Bill Gurley is right, and a vibrant IPO market is around the corner, this segment will ignite and be the biggest beneficiary of the public largess (heaven knows, the industry can use a refresh of middle market M&A buyers).

3. The Angel/Microfund arena seems to be too active. While many fresh and innovative opportunities have arisen, they are in danger of being overwhelmed by too many 'me too's'. Consistent with history, but magnified by scale, I expect the vast majority of firms funded by Angel groups and Microcap firms to fail. The combination of too little capital and too little innovation are a killer cocktail.

4. Great returns were garnered by investments made in the ashes of '00, Venture firms will find great opportunities recapping worthy opportunities from #3 above. They could, and should 'steal' start-up capital as this category will be less risk, lower hold time, and equal reward to their start-up brethren.