November 27 2013
by John Backus

Forget the Bubble. Consumer Tech is Under-Valued!

A lot has been written lately about a valuation bubble in VC-backed consumer technology companies. In the New York Times, the Wall Street Journal, and inc Magazine.

I am on record saying that this is not anything like 1999. That today’s crop of highly-valued companies are very different than those which led to the tech collapse in March of 2000. That we are far, far away from being in a tech bubble. In fact, 18 months ago I predicted that we were about to enter a new Golden Age of Venture Capital. I stand by that prediction today. Let me tell you why.

Although many many words have been written about the valuations of Twitter, Snapchat, Pinterest, Spotify and others of late, I have seen very little analysis to support the opinions of these writers. Here is how I see it.

Public markets lead private markets. Public market valuations change quickly. Private market valuations change more slowly. 2013 has been a great year for public equities with the DJIA, NASDAQ and S&P each reaching all-time highs. Most big consumer Internet stocks have also seen their all time highs in 2013, including Amazon, eBay, Google and Netflix. Lets call this group of four companies the established players in the consumer internet. Respectively, their market values are $175B, $64B, $356B and $21B, and their user bases are 100M, 112M, 540M and 31M. While imperfect, dividing these market caps by users yields a public market value per customer of $1750, $571, $659 and $677. Amazon is the outlier, for what I think are clear reasons (lots of repeat high margin business per customer per year), but the other three are pretty tightly grouped with a value of about $635 per customer.

To be fair, these are established businesses in markets that have winner-take-all characteristics, where the spoils go disproportionately to the market share leader. But what about the recent crop of high profile consumer internet companies, like Facebook, LinkedIn, Pandora, Twitter and Zulily? Doing the same analysis, their market values are $112B, $26B, $5B, $22B and $4B, and their user bases are 1.2B, 200M, 70M, 230M and 2.2M. Again, while not a perfect science, their public market value per customer is $93, $130, $71, $96 and $1,818. Again, as with Amazon, Zulily is an outlier (with an eerily similar public market value per customer) but the other four are once again pretty tightly grouped with a value of $97 per customer.

Why would the customers of the established internet companies be $635 per customer while the newer companies are only $97? Should they really ‘trade’ at an 85% discount? The market clearly thinks so. What I think is going on is that the established internet companies have had time to lock in their business models, and are already profitable. The younger companies are still figuring it out. But especially with regard to Facebook, LinkedIn and Twitter, they have also already won their categories. So, over time, I believe that they too will lock in their business models and turn profitable. And as they do so I expect their public market value per customer will rise towards that $635 number. So I see a lot of running room in the public market values for these stocks.

What about the high profile recent private financings? Pinterest just raised money at a $4B+ valuation. It has 70M users. That is $57 per user. Looks like a fair discount to the recently public companies. Snapchat? A $3.8B valuation round. 400M photos a day (and lets say 4 photos per person) so 100M active daily members? $38 per user looks fair as well. Spotify? Well at $600M, its 2012 revenue was bigger than Pandora’s (which was $425M), so its $4B valuation for 30M users is $133 per user. Looks pretty fully priced to me.

What all of these recent private financings have in common is that the underlying companies have exhibited hyper growth in the number of users – in businesses with winner-take-all characteristics. And with very low customer acquisition costs.

So for the gutsy investor, perhaps it is the time to buy the basket of recently public and still private consumer internet companies. I think it is a bet that pays off big in three years.

What does this mean for VCs? Three things.

1. There is a tremendous amount of value inside VC portfolios for 2007+ vintage year funds. The 18 companies in our 2008 early stage portfolio, as an example, will do $125M+ in revenue this year. They did <$3M in 2008.  That is a 110% portfolio Compound Annual Growth Rate.  Lots more winners to come from existing venture funds

2. Now is still a good time to invest. Think about this. According to the NVCA, VCs as an industry have invested more money, in each of the last five years, than they raised. Yes, fundraising is hard, but the investing climate still looks good or we wouldn’t be investing ahead of the fundraising.

3. The much-maligned 8+ years to a good exit has a silver lining. The longer we hold good companies in our portfolio, the more value we extract for our LPs at exit. We just sold a company, GlobalLogic, which we first invested in 13 years ago. But that is OK. It returned the fund. By itself. An exit worth waiting for.

Now, for a few predictions.

1. VC returns will continue to climb over the next 5-7 years and top quartile venture funds vintage 2007 – 2015 will easily beat the NASDAQ by 1000+ basis points.

2. Investment into VC funds will come roaring back beginning in the second half of 2014. I think we see a $30B+ year in each of 2015, 2016 and 2017.

3. The basket of new consumer internet companies (public and private) will outperform the basket of established companies by at least 3:1 over the next five years. I think I will buy now!

What do you think?

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