
Filed under: opinion
Earlier this week, I wrote about what Moneyball‘s Peter Brand called the “epidemic failure to understand what is going on” plaguing the business, marketing and advertising worlds – when it comes to understanding that social media and social business are not just extensions of traditional “digital” strategies. Yesterday, I was reminded by both Christopher Barger and Justin Whitaker that the same type of off-target thinking is also plaguing other aspects of the world of business, particularly when it comes to the ever hot world of the dot-com.
If you read that post, you’re already 80% of the way there. What follows will fill in the remaining blanks for you. Here is basically how this plays out:
Christopher Barger (on Facebook): And the bubble burst countdown is officially on in 3…2… 1. The “logic” behind this claim is utterly insipid. And we’ve seen this movie before, folks. It came out in 1999 and was called the Dotcom boom. Dear social media business: Stop it. Just. Stinking. Stop it.
Here is the story he is referring to: Forbes – Pinterest is a $7.7 Billion Company. Below are a few clips from that Forbes piece.
Facebook values Instagram at $1 billion and LinkedIn (LNKD) has a market cap of $10 billion. Twitter claims it is worth $8 billion. So where does that leave the new kid on the block Pinterest? Well, it looks like you can pin $7.7 billion on your Pinterest board.
Pinterest is important because the traffic is growing and statistics are impressive. It is known for its magazine quality images. Pinterest is to artful images what Twitter is to artful words. What’s more, Pinterest appeals to college-educated females between the ages of 25 to 44. A sweet demographic known for its spending decisions and habits.
According to the scoreboard from Experian Hitwise data from March 2012, Pinterest is the third most popular social media platform in the United States. It is running close behind Twitter in the number of total visits. Facebook is the big beast at seven billion total visits, Twitter while very far behind, is logging 182 million visits. Pinterest is next with 104 million and gaining quickly.
[…]
Pinterest scored 21.5 million visits for one week at the end of January which was an increase of 30x from six months prior. So we can try to place a value on Pinterest by visits alone. If LinkedIn has 86 million visits and a market cap of $10 billion that values the visits at $116. By that method, you could pencil in a value of say $12 billion for Pinterest.
I am not making this up. It gets better.
Worth of Web, a website value calculator places Pinterest’s value at $267 million. It says the company has 10.8 million daily visits and 324 million monthly visits. It claims daily revenue is $74,520 with annual earnings of $26 million. Unfortunately Worth of Web seems to be way off on its valuations. For example, Worth of Web only values Yelp! (YELP) at $115 million, while it currently has a market capitalization of $1.5 billion. It also grossly underestimated Instagram at $2.6 million. But if we take the Yelp undervaluation and apply that to Pinterest, you get roughly $3.4 billion. Not so far-fetched these days.
[…] Thus, grabbing an envelope and scribbling on the back, I split the difference between the two previous valuations and come up with $7.7 billion.
Don’t get me wrong: I love Pinterest, and I think there’s big potential for the platform, but I’m also not stupid. I can put its potential value in perspective. And I know how easily bad metrics, bad measurement schemes, bad assumptions can put us all in the weeds. Forbes evidently… not so much.
Look at that ridiculous valuation model. This is how a young company with $75,000 in daily revenue (according to that piece), by being compared to other overvalued companies, can magically find itself valued at $7.7 billion. Even if its revenue grew 30x in the next year, (and that is a very big “if”), you would be looking at $780 million/year. Can we say now that Pinterest has a 10-year shelf life? Where is that $7.7 billion coming from? Or that even more fascinating $12 billion figure? This? Nope. Pinterest, like every other social platform won’t be disrupting the market that long. Something else will come along to take over and kill its momentum, and it won’t take ten years.
So thanks, Forbes, for that enchanting little ride on the magic math train. Welcome to the fairy-dust world of equivalency equations – the same equations that lead agencies and brands to mistake the cost of acquiring an impression to the market value of a follower, to the notion that a Facebook fan is worth $372.99 without ever taking into account that fan’s purchasing behaviors, to the notion that a random start-up with no revenue model might simultaneously be $70M in the red and worth more than Luxembourg and the Isle of Man combined.
As Chris points out, we’ve been here before. But this is just the layup. There’s more:
Justin Whitaker (on Facebook): Olivier, did you see Calacanis’ newsletter on recent valuations? Gives you some insight into what is going on. His end result is that we have competition for good teams, and that’s pushing valuations up. To my mind, that’s exactly what’s wrong with what’s happening . We’re valuing teams, not revenue models.
That last sentence. Sound familiar? Remember Peter Brand’s conversation with Billy Beane from yesterday’s post? Hold that thought. Here is what Jason Calcanis had to say on Launch:
Is the internet industry experiencing a bubble? Yes there are bubbles, but those bubbles make up the froth on top of the massive rising tide of value being startups are creating today.
The $210M sale of OMGPOP and the $1B Instagram purchase feel like a bubble, but you have to step back for a moment and realize that OMGPOP was purchased for 2% of the value of Zynga and Instagram for 1% of the value of Facebook.
Now, are Zynga and Facebook overvalued? Well, that’s a separate email of 2k words. The short version is they are aggressively valued based on their massive growth. I’ve heard folks say that $10B for Zynga and $100B for Facebook are anywhere from 0 to 30% rich. Most folks believe we are seeing a premium for growth — not a bubble — in these stocks.
[…]
What we’re seeing now is founders doing their jobs: getting the best price for their teams. Angels are willing to pay under these terms, so they are essentially saying they’ll give up the first 2x to 3x of a deal’s return in the hopes of getting YC’s next Airbnb or Dropbox. (Those two investments are up 50x to 300x since their YC days.)
Most angel investors have their activity covered by one big hit. Bottom line: It feels like a bubble, but it’s really just a hot market.
[…]
We’re not in a bubble. We’re in a revenue tsunami like nothing any of us have ever seen in our lifetimes.
In a market like this, founders shouldn’t optimize for valuation. They should optimize for getting the involvement and attention of the best investors who provide the best long-term value.
And there you have it: “We’re not in a bubble. We’re in a revenue tsunami like nothing any of us have ever seen in our lifetimes.” Us meaning founders and A-round investors, industry insiders who invest in, buy and sell companies early, based on “potential growth,” rather than real world, sustainable revenue models (that’s a very different game). Every time one of these “we don’t know how to make money yet” companies gets slapped with an inflated value before being sold off to a Facebook or a Google, what do you think the real game is? That’s right: maximizing profit for the team of early investors who got them all prettied up for their big market day. There’s nothing wrong with it, mind you. Calcanis isn’t a bad guy. His business model works for him, his team and the people who spent a couple of years building really cool technology. But because most of the game is being played pre-IPO, the further down the river you are in the investment chain, and the higher the “valuation,” the further away you are from the reality of what dividends that company can actually produce for its late investors. At least Zynga has a revenue model. It’s being run and managed like a real business. But most of these young companies either don’t, or what meager revenue model they have is not nearly on par with their market cap. That’s a problem.
$7.7 billion for Pinterest. I want you to think about that. I want you to think of the gap between that $26 million in actual annual revenue mentioned in the Forbes piece and its subsequent $7.7 billion valuation fantasy. Why not $300 billion? Why not a zillion dollars? Could happen, right? And maybe if you follow the same thinking, maybe if VCs keep telling us all day that this isn’t another dot-com bubble, we’ll all stop asking.
So one more time, in case you missed it earlier, from Moneyball:
Peter Brand: There is an epidemic failure within the game to understand what is really happening. And this leads people who run Major League Baseball teams to misjudge their players and mismanage their teams. I apologize.
Billy Beane: Go on.
Peter Brand: Okay. People who run ball clubs, they think in terms of buying players. Your goal shouldn’t be to buy players, your goal should be to buy wins. And in order to buy wins, you need to buy runs. You’re trying to replace Johnny Damon. The Boston Red Sox see Johnny Damon and they see a star who’s worth seven and half million dollars a year. When I see Johnny Damon, what I see is… is… an imperfect understanding of where runs come from. The guy’s got a great glove. He’s a decent leadoff hitter. He can steal bases. But is he worth the seven and half million dollars a year that the Boston Red Sox are paying him? No. No. Baseball thinking is medieval. They are asking all the wrong questions.
Now here’s Justin again:
“To my mind, that’s exactly what’s wrong with what’s happening . We’re valuing teams, not revenue models.”
Let the wheels turn.
But because I am neither a VC nor a startup founder, maybe I have this all wrong. But then again, maybe all it is is just a big game of hot potato whose object is to keep all of the potatoes in the air while investors like me and you and our banks get sucked into collectively investing billions of dollars into fledgling companies that have yet to generate as much as 1% of their market cap in revenue.
The VC game might just be this: get in with a million bucks, get out with a billion, pass the hot potato on down to the suckers who see a score but haven’t figured out that unless these companies find a way to actually make money and pay investors back, it’s all basically a big fat ponzi scheme. What’s the secret? Everyone needs to stay focused on the imaginary bag of money at the end of the road, the Google dollars, the Facebook pesos. If the value of these startups keeps growing exponentially (like a Pinterest or an Instagram going from $5M to $1B+ in 18 months) we can all believe that we’ll become internet millionaires if we only invest in them when we get a chance. It’s that simple. The bigger the valuation, the more attention it attracts. $8B? Wow. Let’s all buy that dot-com lottery ticket!
Have you ever chatted with a VC or an angel investor? Nine times out of ten, here’s what you’ll hear: “We’re not investing in the company. We’re investing in the people. Because we know that even if this company doesn’t make it, eventually, these people will build something big. That’s what we’re really investing in. That’s how it works.”
We’re not really investing in the Brooklyn bridge. We’re investing in the architects. Unfortunately, to do that, you have to get people to back up your investment by buying the bridge from you, preferably for a lot more than what you paid for it. If 5x is good, 30x is better. How do you do that? By convincing them that your bridge is worth 100x of its actual value. The process behind that isn’t all that hard. The pieces are already on the board. All you really need to get things started is for someone with an imperfect understanding of where value actually comes from to write a piece about you in a publication like Forbes, Mashable or the WSJ. Five years ago, it was hard to get that done. Today, most big circulation publications also have online versions whose editorial standards are… well, lax. Their contributors aren’t always journalists or even analysts. Many are little more than glorified copywriters, underpaid to create content whose only purpose is to drive page views. A simple phone call from a senior exec promising an exclusive, or a friendly beer and a little attention can score you the story you want them to write.
Here’s another dose of reality: Companies like Google and Facebook are businesses, just like Nike and Apple. They have to be able to run in the black at some point. That means that there comes a time when buying $7B companies that don’t generate enough revenue to pay for themselves eventually comes to an end. That acquisition game only makes sense in the very short term on when it comes to sacrificing black ink for a strategic move that hopefully isn’t entirely Pyrrhic in nature. Growth through the acquisition of upside down companies just isn’t sustainable. Look at it this way: If you’re eagerly buying stock in a company valued at $15B that only generates $200M per year in revenue from, say, advertising, and inflates its market value by buying $1B startups with no significant revenue stream every six months to make it look like they’re growing and making big moves, it doesn’t take a genius to see where the value of that stock is really going. What’s the company’s plan, then? To keep borrowing money from investors? To get banks in so deep that they can’t pull out without taking a huge hit? To keep acquiring overvalued companies with Monopoly money and hope no one ever decides to cash-in their chips?
This is part of the mechanism that creates bubbles.
No matter how many companies with zero revenue you acquire, math is math. Profits are profits. You can’t keep promising “next year” forever. And when company valuations start hitting the stratosphere and the gap between price and value starts to look like the Grand Canyon, people finally stop being stupid. That’s when things get dicey.
Think of it as a game of hot potato. What’s the objective? To keep the potato in the air as long as possible. The way it works is nobody stops to look at the potato. Nobody wants to get burned or miss the next toss because then it’s game over. How do you keep people playing? You convince them that the longer the potato stays in play, the more value they will get out of it. And as long as no one flinches, as long as no one asks questions, as long as all the potatoes stay in play, the game goes on; people who know how to get in and get out at the right time make money and the rest keep on paying and playing, not realizing that what happens when the music stops is they find themselves holding a old wrinkled-up overpriced potato. They were so focused on playing the game that they never stopped to look at what they were really buying. It’s what happened with the first dot-com bubble, it’s what happened with mortgages in 2008, and it’s what is brewing here too.
We’re valuating teams, not revenue models.
Here’s some perspective: Apple sells iPhones and iPads and media all over the world. It’s the biggest tech company on the planet. It’s so big it generates profits on the same scale as the world’s biggest energy companies. Starbucks sells zillions of gallons of coffee in little cardboard cups at an insane premium, and every day, millions of people eagerly pay for the privilege of walking around the office with their logo in their hand. McDonald’s sells burgers and fries and soda in almost every country in the world. Every morning, there’s a line of people getting their McCoffee and Egg McMuffins at virtually every McD’s on the planet. Ford sells cars. Lots of cars. Cool cars, even. Levi’s, RayBan, Coca Cola, Amazon, they all sell something a lot of people want. They generate insane amounts of revenue. What’s Pinterest selling? What is its revenue model, to be worth $7.7B?
Oh yeah… it gets web traffic. 104 million visits in March. My bad. $7.7B it is then.
Based on that equation – or more to the point, that kind of thinking – this blog should be worth $2.7M.
Tell you what: here’s a bargain. If you’re willing to pay cash, I’ll sell it to you right now for $2M even. Any buyers? No? I didn’t think so.
There is an epidemic failure within the game to understand what is really happening. And this leads people who run Major League Baseball teams to misjudge their players and mismanage their teams.
That. And this: there is a disconnect between the message and what is actually happening.
Do yourselves a favor: think. Ask the hard questions. Don’t just read Forbes or some industry white paper and take what’s being sold to you as gospel. Don’t surrender to marketing religions or measurement cults or self-serving sales pitches disguised as business philosophies. Challenge whatever conventions that make you raise an eyebrow or gasp in surprise. If you don’t understand something someone just presented to you, don’t delegate. Don’t leave that room until you understand every aspect of it. Don’t make a decision until you have left no stone unturned.
Why should we invest in a company with no revenue model?
Why is a Twitter follower valued the same whether she is a transacting customer or not?
Why are these qualifications even relevant to this role?
Why is content king?
What do you mean, “we’re investing in people, not the company?”
What’s your angle in this deal?
Question whatever business thinking that keeps you stuck in the same cycle of “why aren’t we doing better?” Bad insights lead to bad decisions. It’s painfully simple. The way you run your business, the way you hire people, the way you invest your resources, even the things you believe are real because you read about them in a magazine, it’s all the same thing. Mistakes all come from the same place. You want to know what the hottest product is in 2012? It’s bullshit. The stuff gets sold by the ton. It’s hotter than gold, oil and cocaine combined. It’s even bigger than internet porn. My advice: Buy something better.
Then again, I could be completely wrong. You tell me.
* * *
Here it is. A whole book on how to make social media work from a business standpoint. ROI is covered, along with a lot of process elements that tie back to it. If your favorite social business “expert” doesn’t seem to get this stuff yet, don’t feel bad about sending them a copy. Knowledge is never a bad gift.
CEO-Read – Amazon.com – www.smroi.net – Barnes & Noble – Que
We already had this chat…keep telling the truth Olivier….it’s the only way to stay sane : )
Thanks for what you do, and most definetly this Blog!
Many Blessing Friend.
Well, I’ll be honest. I have no background in valuation except for cars I have bought/leased/sold, and that was always a most depressing experience. But cars remind me of something that always seems to be missing from these valuations of social media and that’s depreciation. We all know that as soon as you buy your precious new metallic baby off the lot, it’s lost about half its value.
What’s the social media equivalent?
I bet you could make a pretty strong argument that once a platform is declared “hot” it loses its value for most people. I’ve seen people talk that way about Twitter and I’ve certainly seen people talk that way about Pinterest.
Perhaps these lofty value dreams and dotcom bubbles keep happening because nobody figures depreciation into the mix. Eventually people move on to other new things. Eventually the value for any group of people will go down. As people leave, suddenly you’re worth less (not to be confused with worthless, of course).
I still need really need to watch Moneyball.
That’s an interesting twist on the topic. here are my two thoughts on that. (Maybe even three.)
1. Some companies can continue to stay hot almost indefinitely. All they have to do is keep innovating and solving problems for their customers/users. Apple seems to have managed it over the last decade and shows no signs of slowing down. BMW has definitely managed it. Intercontinental Hotels, Zynga, Oakley, HBO, Specialized bikes, they’re doing it. I think that the secret there is that they aren’t trying to be bought by a bigger company. They really want to dominate their markets and become the biggest and the best there. That puts you in a completely different mindset. When a company’s intent is to just make a good show of it for a year or two so the Googles and Facebooks of the world will offer to acquire them, you have a very different mindset.
2. A car doesn’t make money, so it’s natural that it should depreciate. Now imagine if that car made $.40 every time someone looked at it. You would be driving the crap out of it, right? Talk about the goose with the golden eggs, right? So you have this car that makes $.40 every time someone looks at it, and you’re driving the shit out of it because that’s how it makes money. And so you’re going to highly populated areas and raking in $400, $500 per day. And now you have Forbes or Mashable writing about this magic money car that makes $15K a month. Guess what happens: people want to buy it from you. Wow. A car that makes $15K a month and all you have to do is drive it around?! Sign me up! But the reality is that you’re really spending $10K a month on gas and tires and upkeep, and you bought it for $100K because magic cars aren’t cheap, and the interest on that loan is a bitch. So now the math doesn’t look so great anymore. But hey, if people focus on the magic of it, on the awesomeness of it, maybe you can sell it for $200K. The trick there is to do it before people get tired of looking at it.
So… it isn’t exactly like a car that just sits there depreciating. Unless it’s a 1982 Jeep Grand Wagoneer with the wood panels, in which case you own a magic car that actually appreciates.
3. In a sense, there is a depreciation in the social space. Hot doesn’t stay hot long. (See the last sentence of the first point.) These companies don’t know how to stay hot. They build a one-trick pony for the most part. Empire Avenue, Quora, Gowalla, even Pinterest… They’re fun for six months, but then we kind of grow tired of the same thing day after day. Two, as soon as they get big, they get swarmed by social media douchebags and lazy advertisers, and we kind of stop loving them so much. Three, something else always comes along, another shiny object, another sexy app or platform. And almost overnight, that hot little start-up everyone was talking about gets tossed out like a used condom. It takes savvy to keep catching waves and stay on the water. You can’t just rely on a team of software engineers. You need real management at the helm, real leadership, and vision beyond the next round of funding.
So… yeah. Kind of like a hot car everyone drools about for a few months and then kind of loses our interest.
Strongly arguing that we have seen this before.
Call me a jaded businesswoman, but as an alum of the dot-com boom and subsequent bust, there will always be companies who are over valued.
It is short-sighted for VC’s and investors to be focusing on “buying teams” because I have witnessed so many employees come and go from one hot company to the next. It’s like trying to catch a wave. The employees are taking advantage of their market worth and leaves a company vulnerable.
Thank you so much for posting your thoughts on this, it is a subject that has been mulling in my brain for the better part of a week.
I think we all see it. And yet, here we are again. It puzzles me.
I was a tech investment banker in the late ’90s, and we’re in the same scenario today. It’s called the “greater fool” theory. Just sell the P.O.S. to the next greater fool before the house of cards collapses.
Today, I am building a consumer outdoor product company that makes real things. The question I ask myself daily is, “how do I sell something TODAY?” Social media has not been the answer. Just as banner ads killed themselves with analytics that proved they were ineffective, so too will social media. We can see exactly the impact that these technologies have on sales.
Right. Absolutely. But don’t discard SM altogether though. It’s kind of a force-multiplier for other forms of marketing and customer service. And when done right, it can yield solid results for a fraction of the cost of advertising. It’s just a completely different medium though. Almost everything we do in traditional Marketing is wrong for it. By the same token, it isn’t going to work for every kind of company, so I totally understand.
Cheers, Tom.
Must be the “greater fool” theory. What else could it be? Yet social media can’t be dismissed altogether, just like traditional marketing methods should not be discarded (and I would disagree that SM is completely different than what we’ve done). As a professor of mine once said, “Don’t throw out the baby with the bathwater.”
Saw Moneyball… and these 2 posts tied it together for me as it applies to the world of overvalued companies.
Awesome Olivier.
Thanks, Joseph. 🙂
Great stuff once again.
I’ve actually “been there” as a tech founder (web portal in higher ed called U Sphere, 2006-2009). I found the greatest days as part of the business the ones when we were actually focused on building something sustainable.
That’s probably what is sticking with me in both of your posts on Moneyball: sustainability, not in a “make playground equipment out of recycled Crocs” way, but in a “what are we building here that’s going to stand the test of time?” way.
Here’s another analogy that is scary when you think about it: I saw a stat that there are 9 current Major League players who are considered “lifers:” 10 or more years of service with only one team. The old baseball mentality of getting these guys on your team for their best years and paying dearly for them – well, yeah, that sounds a lot like getting 20 investments and overpaying for all of them, but hoping against hope that one of them is Albert Pujols.
I’m convinced we’re in another bubble – as much as I’m convinced that there are some who will always be spiritually blinded to the bubble that they’re in.
Denial is a much bigger force in some people’s lives than self-preservation and even greed. Once you realize that, the picture gets a lot clearer. 😉
Epic Article, post, facts,opinions,examples,data,assumptions and points. I agree with everything you wrote in your article. This should be published in Harvard Business Review and be a wake up call to everyone in the and out of the industry.
Thanks. I don’t think HBR’s online editors go for pieces like this anymore, though. Last time I brought up a pretty big factual error in one of their pieces, I was basically told to go fly a kite.
“You want to know what the hottest product is in 2012? It’s bullshit. The stuff gets sold by the ton. It’s hotter than gold, oil and cocaine combined. It’s even bigger than internet porn. My advice: Buy something better.” Man, if I had stock in b.s.?! I could cash out my billions and retire. Just mentioned on Spin Sucks, it’s virtual, paper money and stock swaps – but no one selling ‘stuff’ or making money. Hurts when you’re Ted Turner and thanks to AOL/TimeWarner deal, you’re worth half the billions today your were yesterday .. but doubt he’s clipping coupons out of the Sunday paper. If you’re gullible enough to believe this insane valuations, maybe buy Groupon when you think it hits its bottom.
“You need real management at the helm, real leadership, and vision beyond the next round of funding.” Amen. See also Apple spending billions to lock up components like flash memory years ago. Oh, loved Moneyball – it should be required watching for anyone running a business. FWIW.
Absolutely love this article. I think what throws people off so much in this space is the growth models that power these types of companies. If you’re running a hotel or restaurant franchise, you can’t just magically expand to every market with a $0 CPA. Your individual locations also isn’t going to magically invent a way to make twice as money from each customer who walks in the door, so investors know that if you want to reach a certain size, it’s going to take a certain amount of time and dollars to make that happen.
On the web, because every once and awhile a company can buck the trend and harness viral growth to make tons of money in a short period of time, suddenly it seems possible for everyone, and the story perpetuates itself.
Love the article. Well thought out and very relevant. I think the performance of the FB IPO should serve as a wake up call to avoid the mistakes of our dot com past.