The Lifespan of Dot Coms

A while back I read an editorial that argued,

It appears to take about 10 to 15 years for technology to improve enough to make a new idea powerful enough to dislodge the incumbent money maker on the Web. To date, no one has been successful at turning around an Internet company that is past its peak.

I agree with that in part - it has proved to be very difficult to turn around a failing Internet company. But I disagree with the author's concept of the 10-15 year lifespan, or her reasoning behind asserting such a lifespan.

Consumer-oriented Internet companies are brought to life through the application of a new technology and then unseated about 10 years later by a newer technology. Yahoo had an incumbent advertising platform (display ads) that couldn't do advertising as well as Google search. Google today has an incumbent platform that can't do better than Facebook because Facebook began with a clean sheet of paper and an extra 10 years of technology.

But take a look at MySpace, "unable to turn itself around despite its first-mover advantage", and ask yourself whether that had more to do with outdated technology, or its acquisition by a company that didn't know what to do with it. For an example from much earlier in the life of the Internet, Yahoo! and Excite ran neck-in-neck until Excite was acquired by @Home Networks, and its subsequent tanking seemed to have a lot more to do with post-acquisition management decisions than with technology. I similarly find no merit in the notion that Facebook has an a technological advantage over Google - I suspect the opposite, particularly in relation to its core service of social networking - or that it's nascent advertising platform is going to be Google's undoing.

But as I see another dot com bubble emerge, with our being urged to believe that perennial money-losers like Angie's List, companies with no clear path to significant earnings like LinkedIn, or companies like Groupon and Facebook that respectively claim that their brand is so powerful that we can ignore their unprofitability or that their valuation is justified by their potential to develop new revenue streams from a large user base, I can't help but be reminded of the first dot com bubble.

First, the thing that makes Internet companies so attractive to investors or buyers (and here I'm speaking of VC's, angels and corporate acquisitions, not ordinary investors) seems to be the same thing that makes them vulnerable to collapse. You can start a dot com with a good idea, a tiny core staff, and a seven figure investment. You can create a company ostensibly worth billions that has (or rents) a server farm, and has a few hundred to a couple of thousand employees. But if what the company does is not special, or does not remain special, a competitor will have the opportunity to take most of its market share. When a genuine competitor is available, minor missteps by management can have serious consequences for the company's long-term viability.

Although it's an imperfect test, one interesting thing about companies like LinkedIn, Groupon, Facebook, Twitter and the like is how little disruption there would be if they dropped off the face of the planet. If you woke up tomorrow morning and you weren't an employee of Zynga, how much would your life change if you found that Facebook was gone? Minutes? Hours? If it would take you days, odds are you're either a major online marketer or you simply aren't invested enough in Facebook to take the time to set up, say, a Google Plus account.

Second, no company can survive in the long-term unless it has a path to profitability. If you want to roll the dice on the IPO of an unprofitable or barely profitable Internet company and you're not an insider, recent IPO's confirm that you should wait for the dust to settle as the share price is likely to drop significantly within days to weeks. Even then, you're evoking the expectations of the first dot com bubble - that "eyeballs" will translate to massive profits before the company burns through its cash and investor confidence wanes.

If an Internet company brings nothing special to the table, and barriers to entry remain low, and they lack either the vision or the capital to preempt a "new kid in town," it's reasonable to expect that they will eventually be replaced by a "cool new" alternative. And once your popularity tanks, no matter how cool you were the first time around, if you want to pull off a comeback you will probably need to rebrand.

Groupon Deal: Buy Early Shares for $10 and Get $50 Worth of Investor Money

That's not intended to be a literal expression of Groupon's business model or IPO, but as Frank Reed notes, early investors have been doing very well on their Groupon shares:

And remember when Groupon raised $950 million not so long ago? Guess what that did? It simply paid out the early investors in handsome sums. It did little to build the business. You can get the details in the All Things Digital post.

If history should teach us anything, it's that the financial industry loves bubbles. It loved the profits it made during the first Internet bubble. It was ecstatic over its profits during the housing bubble. And now, having been bailed out, pampered, and guaranteed immense profits and compensation at taxpayer expense on the ground that they're "too big to fail", why not do it again? Besides, a few IPO's that result in pumped up valuation, enormous, easy profits for early investors, insiders and investment banks, and... well, quite possibly not much for ordinary investors in the longer term, if that counts for anything... don't make for a bubble, do they? It's just a few hundred billion, maybe a trillion. Chump change.

I am of the impression that Groupon's founders want to build a sound, dominant business. But that doesn't mean they don't want to cash in. Is that the new economy? Build a $billion business, a $5 billion business, a $10 billion business, a remarkable accomplishment in itself, take it public at a ridiculously inflated valuation, the bankers, and investors and founders get rich beyond fabulously rich. As for the ordinary people left holding the stock? Sure, they may have paid $50 for $10 worth of company, but they got the exact number of shares that they paid for. Whose fault is that?

"Conventional Valuation Models Don't Apply to Us"

I recall, back in the days of the first Internet bubble, how the popular wisdom was that there was incredible value in "eyeballs" - the volume of traffic to your site, and information you might glean from your users, was far more important than turning a profit... or even generating revenue. As it turns out, although there have been innovations in how traffic and information can be monetized, it is important to generate that revenue.

I commented recently (and cynically) on the LinkedIn IPO, taking the position that the argument that the bankers put one over on LinkedIn's owners was a stretch. It seemed, and still seems, more symbiotic. LinkedIn, its owners and the investment bankers who handled the IPO made tons of money. Whether or not LinkedIn ever generates enough revenue to justify a tenth of its present valuation, its owners and early investors will walk away with truck loads of money. Meanwhile, the businesses of the nation's proverbial "Main Streets" have difficulty obtaining financing. Wow. There's less risk in floating a multi-billion dollar IPO for a business that has no clear plan or path to justify its valuation, than in investing in traditional brick and mortar businesses. There must be, because you can see for yourself what banks are doing.

Groupon plans to be the next business to clean up through an IPO:

The IPO, which could value Groupon at $15 billion to $20 billion, prompted Richard Brenner, president and CEO of financial-advisory firm The Brenner Group, to say that he would tell would-be investors to “sit out” the IPO because Groupon “doesn’t appear to have a sustainable business model yet.”

“Why would the public support a company that can’t figure out how to be profitable?” Brenner said.

But Mark Lehmann, a Wilmette native who heads up JMP Securities in San Francisco, said investors are clamoring for a long-awaited IPO by a company that shows such terrific growth.

“Groupon has the brand and the first-mover advantage, and it is extremely well-regarded,” Lehmann said.

Groupon came into business with a simple but clever idea, and its latest efforts suggest that it is capable of innovation. But this type of thing makes me nervous:

We don’t measure ourselves in conventional ways.

There are three main financial metrics that we track closely. First, we track gross profit, which we believe is the best proxy for the value we’re creating. Second, we measure free cash flow—there is no better metric for long-term financial stability. Finally, we use a third metric to measure our financial performance—Adjusted Consolidated Segment Operating Income, or Adjusted CSOI. This metric is our consolidated segment operating income before our new subscriber acquisition costs and certain non-cash charges; we think of it as our operating profitability before marketing costs incurred for long-term growth.

A more sophisticated explanation, certainly, but why does the phrase, "We make it up on volume" come to mind?

A Craigslist Version of Groupon?

One of the interesting things about the battle to "take on Groupon" is how much money is being thrown at LivingSocial and at any number of competing concepts. People see the amount of money being tossed as Groupon and projected valuations and all they see are dollar signs.

But then I think, what was it that sucked billions of dollars out of the newspaper classified ad business? Was it another multi-billion dollar venture, or was it a plucky little start-up that (while now worth a lot of money) killed a newspaper industry cash cow while operating on a relative shoestring?

The difficult part of creating such a competitor to sites like Groupon would be to find an inexpensive way to verify the deals posted - pranking would quickly undermine such a service - but if you can find a cheap way to verify deals you would be in a good spot to knock out the multi-billion dollar "deal of the day" sites with your inexpensive, more inclusive alternative.

Google Cash or Facebook "Stock"

What a bidding war:

Executives at both Facebook Inc. and Google Inc., among other companies, have held low-level talks with those at Twitter Inc. in recent months to explore the prospect of an acquisition of the messaging service, according to people familiar with the matter. The talks have so far gone nowhere, these people say.

But what's remarkable is the money that people familiar with the matter say frames the discussions with at least some potential suitors: an estimated valuation in the neighborhood of $8 billion to $10 billion.

I would take the cash.

Seriously, I understand why Google is willing to overpay for a company to gain a strong brand and advantage in the marketplace, particularly given its own faltering efforts to enter social networking, and I understand why Facebook would want to keep a significant potential competitor out of Google's hands, but until the Facebook IPO occurs its stock value is every bit as speculative as Twitter's - and it's very complicated to sell, even assuming that the terms of the sale don't require Twitter's investors to sit on the stock until after an IPO. So I would be grateful to Facebook for forcing Google into a bidding war, would sell to Google and, as they say, "Take the money and run."

Despite the high valuations, Twitter's executives and board are continuing to work on building a large, independent company. People familiar with the situation said the company believes it can grow into a $100 billion company.

Because you would expect them to be saying, "We hope we find a sucker to buy this place for vastly more than it's worth before it goes belly up?" Hey, guys, I think my company can grow into a $100 billion company as well. I'll let it go for a mere... let's say $5 billion. A bargain.