Tuesday, February 12th, 2008
When will the M&A market wake up?
I hate seeing business mistakes that happen over-and-over again and each time someone tries to make up a justification for the same trend. In the late 90’s it was Netscape and then AOL, AOL, AOL. Now those failed ridiculously – there’s always a hit platform of the day – something as fleeting as the popular bar of the week in a major city. Now it’s MySpace, YouTube, and Facebook, and this nonsense continues. To be worth extraordinarily high multiples, a company has to generate revenues – hear me? Revenues; yes, that means money.
Sorry, just a rant of the day, but think about how similar some of these “Web 2.0″ acquisitions and valuations can be compared to AOL. It’s a platform for social networking – and social networks change. Perhaps they’ll be popular in certain crowds for some time, but how will they generate revenue? (ads is the only obvious one… and those are predictable revenues). Beyond that, what justifies such a ginormous valuation? The user population may grow, but even at a peak estimate, what is the revenue stream? Does it match the valuation? Revenues are simple and any company has good average estimates to predict ad revenues. The formula is simple: $/click * average clicks …. not too difficult.
I get the scary feeling M&A activity in some IT circles has become too much of a billion dollar dartboard game. Bet on this new hit platform, that exploding platform, next year’s hottest platform… nonsense, bet on revenue streams that you can predict. If you have some other business model, so be it, but any decent analyst can predict the 3 yr future. If you’re using over 5 years to justify a high multiple valuation based on what should be a predictable revenue stream… come talk to me and I’ll help you spend it wisely on something else.
And with that backdrop, think about Yahoo! and Microsoft…
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February 12th, 2008 at 8:53 pm
stephen o'grady said:
To an extent, agreed, but there’s also room – in my view – for speculative investments. For example, IBM failed to perceive the revenue opportunities of the operating system because they were myopically focused on the revenue stream of the hardware. Microsoft in turn failed to perceive the advertising revenue stream because they were myopically focused on the operating system and office software revenue streams.
You are entirely correct that most of the M&A activity today will not return the original investment. But that’s not terribly different than the M&A in other historical contexts; it’s the nature of speculative investment.
My own view is that the data in aggregate of a Facebook or a Google is significantly undervalued relative to the “simple” revenue measurement. Not that the current valuations are appropriate, just that I don’t think the determining process is quite as simple as you make out.
More focus on the underlying financials is undoubtedly a good thing, but I think that there needs to be a happy medium where firms can lift their heads up occasionally and take a risk.
February 13th, 2008 at 11:18 am
md said:
I agree on there being room for more calculated risks, it’s just these mega-valuations are nonsense. They have no viable underlying business case that makes sense. Sure, you can whip out a model and justify it, but I’m severely disappointed in the rigor of testing these models and cases. It’s as if “volume” now equals “profits” and while in some cases, that may be true, but often these communities of users around platforms are often fleeting (MySpace->Facebook) in a shorter span than a business case typically runs. Look at AOL, when TW bought them we all knew dial-up was dead in 5 yrs time and that was the biggest advantage to AOL (access). The press, AOL and analysts wanted to convince you it was the content, but look where that landed AOL. It turns out the driver was the brand and the access to the Internet that drove AOL. Once cable and DSL came along… Once Facebook came along….
Google did things differently for its own business – it established key links into everything – and now Google has an ad distribution platform that no one can get around. Now that is a savvy move and justifies its stock price. These latest valuations are dangerous. If I was a Microsoft looking at buying Yahoo…. If I was looking at buying Facebook…
February 15th, 2008 at 9:09 pm
Tel said:
I’m pretty sure google cannot live up to its current valuation either. Yes they are a good search engine, yes there’s steady advertising revenue rolling in off the search engine and off their blog ads. Is that revenue going to be big enough to justify all the other stuff that google dabbles in? Having said that, if you got in early with google then you would be laughing now, and there’s the trick with investing… picking the right moment to buy.
The next big risky investment is VoIP. Seems like all the VoIP companies were zooming up in valuation and now they are getting deflated again. ASX:ENG dropped down to 5c and I’ll come clean and admit that I bought a few at that lowly price… see what happens. Never gamble more than you are willing to lose, that’s the rule.
There’s also a theory that the Internet is going to grow and eat up other communications channels. Thus, even a slim revenue stream now will fatten up over time. Growth fixes everything as they say. That’s what investment markets are all about, people making guesses about the future and where it goes.