Fred Wilson's response to "Paul Graham's Letter to YC Companies"

http://www.avc.com/a_vc/2012/06/some-perspective.html

by hendler • 14 years ago

214 78 14 years ago

Could somebody tell me what is Facebook's intrinsic value?

iand2• 14 years ago

Several hundred million people are willing to invest a portion of their finite time every day visiting and interacting with content only available via Facebook. Winning people's attention is a zero sum game (if you gain it your competitors lose it) and attention is a scarce resource. The strong network effects of having all your friends in one place makes facebook's position very defensible. All that adds up to high intrinsic value.

netcan• 14 years ago

The sum of all its future earning discounted to reflect how far off in the future they are.

georgespencer• 14 years ago

Investors will become more conservative and seek better deals for themselves. I don't think it's anything to do with Facebook. Facebook might just be the excuse they're looking for.

My unsolicited advice to all startups is to put your energy into the things which matter. Debating 3-6% more/less dilution with investors is not a good place to be investing your time and energy.

I suspect the companies who go into this bubble focusing on convertible notes and caps will be the companies who suffer most.

Retric• 14 years ago

Negotiating with investors is somewhat like negotiating your salary after a job offer. The per hour ROI can be insane, but you need alternatives before you have real leverage and you want some deal to go though even if it's not with them.

eykanal2• 14 years ago

From what I understand, Facebook's main problem is a lack of a stable income source. It's becoming more and more apparent that advertising is not going to be the panacea that it was thought to be, what with numerous studies showing poor facebook ad performance and companies like GM pulling their facebook ad campaigns altogether. Sure, they booked $1B last quarter, but annualizing that number requires some confidence that they can pull that off regularly, and I don't think people have that confidence. As an investor, I'd be worried.

arturadib• 14 years ago

As much as I think FB's valuation was high, they have the advantage of having a Product That People Really Want. This means that they have a lot of room to adjust their business model (so long as they don't screw up the UX/product while at it).

Contrast this with GroupOn, whose product IS the business model...

jopt• 14 years ago

I doubt the product itself (UX etc.) is why users are on facebook; rather, the user-base is their competitive advantage.

dchuk• 14 years ago

Facebook's product is ultimately their users via their ad platform. Their users don't really make them any money, it's the advertisers who are paying FB.

In terms of having a Product That People Really Want (ads), it appears there's mixed emotions about that currently.

SonicSoul• 14 years ago

Their valuation assumes that they will be doubling income many times over.

Most people (such as your post) completely ignore that, and focus on a good brand that is Facebook, and how the internet revolves around this company now.

with a P/E ratio of 85 it is priced as HIGH GROWTH stock. this means that you are paying $85 for $1 of profits.

Meanwhile FB is having hard time continuing its growth because everyone is already signed up (1 for every 8 people in the world), so they try to increase revenue by attempting to keep users on longer, making the service more intrusive and annoying to a portion of its inhabitants.

I'm no financial analyst, but I don't see above as sufficient to multiply its revenue and live up to the hype that is it's stock price. They would need to make some really breakthrough moves to do this.

eykanal2• 14 years ago

Are you familiar with the following phrase?

> If you're not paying for it, then you're not the customer; you're the product.

Facebook's product is it's database of user information. If the actual customers, which currently consist mostly of ad companies, aren't interested, then they have a serious problem indeed.

mikeryan• 14 years ago

I think Facebook's isn't stable income. I think they've got ads and their credits system. They have had stable revenues with a pretty consistent 25% margin. I feel FB is a large and stable company.

Facebooks issue is one of perception - one they help perpetuate. They've continually been thrust into the top-tier of tech companies (Apple, Amazon, Google, MS) and the Facebook "problem" is that right now they not. They have the lowest market cap today of any of these companies, (besides having the largest P/E outside of Amazon). And what they don't have a is clear path to how they're going to grow revenues in a manner which will keep them on pace with a Google or Apple.

Building a 25-50 (I think FB is going to continue to slide) billion dollar company in 8 years is an unbelievable achievement and is why people will continue to invest heavily in early stage tech. I think the effect on startups is that VC's and later stage investors have always assumed that users == money. Twitter and Facebook have both raised billions of dollars using this formula. I think this belief is going to be shaken a bit by Facebook's trouble's monetizing their user base. But maybe thats just a reality check that Silicon Valley needs.

ealexhudson• 14 years ago

I don't disagree with Fred Wilson, but I'm closer to pg's perspective on this. The bubble, to the extent that there was one, burst while we weren't looking.

Facebook's IPO is not really a huge issue in and of itself, and as Wilson points out the numbers they have are staggering. Other IPOs, like GroupOn's, have had similar issues and FB will probably look pretty awful by the time they reach the end of their lock-up period too. But this stuff is largely all indicative of market sentiment, and that's the issue.

People aren't necessarily disappointed with the performance of any of these companies, but they are getting very twitchy as investors. When people stop investing, and sentiment becomes increasingly bearish, it's like the tide going out and inevitably some boats will end up getting beached.

I know from companies attempting to raise capital in London right now that things have been difficult for a while now, and look set to get even more difficult (not that London is necessarily the greatest place for doing this, or a good barometer) - so those companies that have done decent rounds recently (HailO, BagThat, etc) will probably need to baton down the hatches somewhat, and those who were expecting to raise later this year / early next are probably in for a shock - a nasty one, if they can't operate without a raise (I know at least a couple of companies in that exact position).

dm8• 14 years ago

What if the stock now bounces back? Nobody can deny that the company is generating some solid revenues with lots of potential. Investors might think this is really low valuation and we might see surge in buying.

(Disclaimer: I do not own FB stock and this is just my speculation)

debacle• 14 years ago

I will deny that the company is generating solid revenues with lots of potential.

I don't see a lot of potential in Facebook. They're just another rung on the ladder of social network churn, and luck may have played strongly into that.

Facebook is generating revenue, but nothing I would consider 'solid' for a company with a ~85 billion market cap.

The company is incredibly overvalued, and time will show that to be the case.

mtkd2• 14 years ago

"In its last quarter Facebook had $1bn of revenue and 40% pre-tax operating margins"

The key execs and advisors involved in IPO were not conservative with the valuation. Do not be surprised if those same biases influenced some of the pre-float numbers.

A cautious CFO may not always tell people what they want to hear short-term - but they will deliver a much stronger performance over the long.

tocomment• 14 years ago

What is "enterprise value" and how does he come up with 43B?

wpietri• 14 years ago

He's looking at market price (number of shares times share price) and subtracting cash on hand. That would be the implied value of the operating business.

Strom• 14 years ago

Take a look at the numbers he mentions:

    valuation $57.5bn
    cash on the books $14bn
    enterprise value $43bn

If you look real closely, you will see that 57-14=43.

iand2• 14 years ago

It's the valuation of the company based on number of shares and share price less actual assets (cash in this case). What is left is the value investors see in the company simply by executing its business.

aurelianito2• 14 years ago

Enterprise value "is a sum of claims of all the security-holders: debtholders, preferred shareholders, minority shareholders, common equity holders, and others." (source: http://en.wikipedia.org/wiki/Enterprise_value)

chrisaycock2• 14 years ago

Enterprise value is

  market cap + debt - cash

It reflects how much it would cost to buy a company out.

arihant• 14 years ago

It's basically market cap plus the debt, minus the cash. So $57 billion minus $14 billion in cash. Try to think of it as the actual amount somebody would loose from pocket while buying Facebook. While they will pay $57 billion, they will get $14 billion cash from Facebook, effectively spending $43 billion.

sylvinus• 14 years ago

I'm wondering about the "even at half those numbers" bit, if Fred actually thinks it will go that low.

aurelianito2• 14 years ago

I needed to google what EBITDA is in order to understand the artice. EBITDA means "earnings before interest, taxes depreciation and amortization" (http://en.wikipedia.org/wiki/Earnings_before_interest,_taxes...). Id est, AFAIK, the money they get, without taking into account the money they spend because their "thigs" age.

I hope it helps fellow hackers who don't know finance (like me) to understand the article a little better.

Edit: Better explanation of what I mean by spend.

chrisaycock2• 14 years ago

>> the money they get, without taking into account the money they spend.

That would be revenue. EBITDA is a way of only accounting for operational expenses a company faces. There's also EBIT, which subtracts the depreciation and amortization.

dcaranda2• 14 years ago

EBITDA is a form of profit. Whenever someone says they made X in profit - you should immediately ask what kind - net income, operating profit, etc. Depending on the business, different definitions of profit can produce wildly different numbers.

It's a generally accepted proxy for cash earnings since it looks at profit and takes out:

- non-operating costs such as interest and tax. These are "non-operating" because they have nothing to do with delivering your service/product.

- non-cash costs such depreciation and amortization.

It is worth noting that EBITDA is non-GAAP, which is to say that it's not an officially recognized accounting term. You won't see it in an audit and if you do there will be a big disclaimer next to it. The term gained popularity in the 80s with the rise of private equity. It's used in debt agreements to approximate how a business will pay back loan principal and interest.

crazycanuck• 14 years ago

Further to this and dcaranda, EBITDA is used for valuations because it describes the cash flow the business has available to pay various stakeholders before any financial structures are taken into account. There are three people who have a claim on the cash a company generates after paying operating expenses: debt holders, the government, and shareholders. Their claims on the money go roughly in that order, so in other words the shareholders get what's left (directly via dividends or stock buybacks or indirectly via an increase in the equity value) after the debt holders and the man are paid.

The thing is, however, how much you owe the government is affected by how much debt you have (i.e. your financial structure), because the debt interest is deductible. It's largely because of this that EBITDA is the preferred thing to use, as opposed to say earnings or cash flow, because it enables you to compare companies at a fundamental level unaffected by whatever financial structure they might currently have. One of the things PE guys like to do is fiddle with the financial structure (aka load it up with debt ;-), so it's important to understand the value ex whatever impact the current structure might have. But even if that's not your motive, it's a useful measure for the same underlying reasons.

It's also true that EBITDA is a useful number for PE because it tells you the amount of money available to service debt, as dcaranda points out.

mipapage• 14 years ago

It seems to me this whole thing is more about sentiment than numbers. How it is perceived and the effects of that perception, rather than "does it add up"...

rjsamson• 14 years ago

My personal thoughts are that the greatest near term impact we'll see is in angel investment $$ in seed rounds. At least here on the East Coast there has been a boom of relatively unsophisticated Angels driven by hype. It is these individuals that, in my mind, will react more emotionally to a poorly performing Facebook IPO.

Not that one shouldn't be concerned about the broader venture market, but I'm a little less worried about the institutional money than I am about the Angels disappearing.

veyron2• 14 years ago

This is deceptive. The entire reason the late stage guys invested in higher valuations is because the early stage guys convinced them it was worth more.

You can't say before the IPO that the company is worth 75 B or 100B and then after the fact say it's their fault for investing at those valuations. That destroys the integrity of the silicon valley investment environment.

mtkd2• 14 years ago

The secondary market valuations were also predicated on the assumption that there was nothing very special to what Google were doing in online advertising and similar models could be applied to other high-visitor brands.

There is now some rethinking of that assumption as more financial information from these brands is made public.

fredwilson• 14 years ago

i am an early stage "guy" and I can assure you i never "convinced" a later stage investor of anything. they did all the convincing to themselves. it was like feeding pigs at a trough.

veyron2• 14 years ago

I don't think you directly told anyone that Facebook would be a $100B company. There are plenty of wall street analysts (like Lou Kerner from Wedbush, who called for $200B facebook) to do that dirty work.

But if some analysts are pumping Facebook and no one from the silicon valley is trying to temper expectations, people assume that the valley believes the same valuation numbers. The result is long-term damage to the credibility of SV and a contraction of the investment supply. After all, if someone comes up next year and describes DuckDuckGo as a $100B company, why would anyone believe the valuation? Everyone would point to Facebook and give it a much lower valuation even if it probably deserves a much higher one.

To make it clear, I think that this type of chicanery from wall street is scorned yet expected in the eyes of most people. We have all accepted the fact that they will pump stocks, especially at the top (http://www.scribd.com/doc/86194691/Long-Good-Buy was Goldman's paper which essentially gave a bullish case for equities at the top). But there is still some credibility lent to silicon valley, which people should not squander in the interest of one investment.

AznHisoka2• 14 years ago

Build something people want and will pay for. Stop worrying about Facebook and IPO's. Waste of time.

dxbydt2• 14 years ago

I see this attitude all the time in SV techies - lets just ignore the finance because its all chatter anyway. Frankly, this line of thinking is counter-productive and quite dangerous. Macro matters much more than slapping together some code to build widgets people will want & will pay for. For one thing, most of those people who want & will pay are getting their dough from boring non-tech ventures affected entirely by macro. When things head south, people will batten down the hatches. They will neither want nor pay for, because they simply can't afford to. All of this wanting and paying for is mostly discretionary spending driven by a upbeat macro signalled by IPO markets & especially FB. Once those signals flash red, the wallet stays shut. No more app store purchases, cloud drive subscriptions, ipads, servers, what-have-you. Huge giants ( Sun, SGI, Cray...) fell by the wayside because they collectively put their head down & built what they thought people would want & would pay for. People did want those things initially, but once the economy went into a tailspin, the dot in dotcom became the dot in dot-bomb. I still have those Sun tshirts proudly proclaiming our red hot dotness. I wear them on the weekends when I take out the trash. The kids snigger and say "dot in dot com...wtf ?" and I realize...yeah, wtf were we thinking.

rexreed• 14 years ago

What's wrong with building stuff people want and selling it for a price they want to pay? That seems to work in all non-tech industries, especially ones that are not used to raising any money or going public. Indeed, isn't that how most business works?

AznHisoka2• 14 years ago

Well our country and economy is already over inflated with debt, so it wouldn't be such a bad thing if discretionary spending halted.

really, would that be such a bad thing to the overall economy? People tightening their spending, instead of recklessly borrowing debt, and buying nice things that ultimately aren't necessary? I guess if you're a company that targets discretionary spenders, you're doomed.

philwelch• 14 years ago

Counter example: Apple. Got through the last recession very well, exactly by focusing on building what people wanted.

smnl• 14 years ago

From the article: "That means that Facebook's enterprise value is greater than 10x current revenue run rate and greater than 25x EBITDA. These are big multiples folks. I am happy to take those numbers for any company out there."

The bigger those multiples are, the more "overpriced" a company is, so it should actually be less attractive of an investment.

jtbigwoo• 14 years ago

The bigger those multiples are, the more "overpriced" a company is, so it should actually be less attractive of an investment.

Right. The OP is considering the situation as a seller, not a buyer. He would be overjoyed if everything he sells is overpriced similarly.

startupfounder4• 14 years ago

"...the Facebook IPO will hurt the funding market for earlier stage startups. But no one knows yet how much. Possibly only a little. Possibly a lot, if it becomes a vicious circle." - PG [1]

"I think it will be particularly impactful on the late stage and secondary markets where most of the IPO valuation speculation is happening." - AVC [2]

We are now in a contracting market where funding for earlier stage startups, late stage and secondary markets is drying up.

AVC referenced PG's letter, but didn't address the letter. Now that we are in a post-frothy market and the froth is drying up, where does this leave early stage startups that are feeding the late stage startups with talent? It would be nice for AVC to address PG's letter directly and not just provide financial analysis to the Facebook valuation.

[1] http://news.ycombinator.com/item?id=4067297

[2] http://www.avc.com/a_vc/2012/06/some-perspective.html

samstave2• 14 years ago

So are you saying that the bubble did not burst with the FB IPO, but rather the FB IPO has caused a leak in the bubble which is (still rather rapidly) deflating?

While i feel this is (mostly) true, I also think that we are in so much of a stronger position than the last time the bubble burst that the tech market is not going anywhere any time soon.

Valuations will be lower (which is a good thing) but investment will still be strong.

startupfounder4• 14 years ago

I am saying that the bubble saw its reflection in the mirror with the Facebook IPO and is contracting to "reflect" that understanding of self.

What this means for early stage startups is that they will have to be built upon solid small business cash flow business models while the market is contracting.

If they do this and are dependent of investment they will likely attract the attention of investors.

This contracting will filter out the startups that lack a business model that works in the "real world" (aka small business).

rgrieselhuber2• 14 years ago

> We are now in a contracting market where funding for earlier stage startups, late stage and secondary markets is drying up.

Have some data for that assertion? PG's letter never said that. He just identified sentiment and provided warning advice. I think it's still too early to see if there is a material impact.

startupfounder4• 14 years ago

"Jessica and I had dinner recently with a prominent investor. He seemed sure the bad performance of the Facebook IPO will hurt the funding market for earlier stage startups." - PG

What part of this is unclear? PG was sure enough to write a letter to the startups warning of the oncoming contraction. I am guessing the VC was someone of the caliber of Ron Conway.

I do not have data as data is a historical record (in this context), not a prediction of the future. This is why it is a warning of thing will come, but the question is HOW MUCH will the market contract, not IF if will contract.

"I think it's still too early to see if there is a material impact."

I believe this should read, "I think it's still too early to know the extent of the impact."

EDIT: I don't have any hard data, I am using PG and AVC to assert that what they say is true based on the information they know.

pnathan• 14 years ago

It's also important to think of the market outside of tech: it's been intensely downsliding in the last month or two. The "European Question" is kind of a Big Deal.

A draining tide sinks all ships.

startupfounder4• 14 years ago

Very true, but the Facebook IPO was the signal for the tech industry of the coming contraction for early stage startups regardless of the "outside tech" market.

DennisP• 14 years ago

I don't see why FB's IPO should be considered a failure, from the perspective of earlier investors. They sold stock at an IPO price even higher than the market could support. What's not to like?

Of course institutional IPO investors don't like it, because they want to buy stock at a discount and sell it with a big bump the next day. But the early investors are the losers in that scenario.

I guess you could argue that the IPO investors just won't play ball if they can't get their free money, but I think more likely they'll just be more careful about pricing next time.

EternalLight• 14 years ago

I agree completely with your view, can someone explain to me why this is a bad thing?

dcaranda2• 14 years ago

Despite market fluctuations, pundits and haters - there is an objective truth that Facebook's financial performance is exceptional.

Facebook full year 2011 EBITDA was roughly 55%, demolishing google's 37% and apple's 42%. Wilson approximates a 40% margin in Q1, but ad businesses tend to be Q4 heavy due to holiday shopping. Facebook has demonstrated exceptional leverage in its model.

Facebook has growing pains for sure, but that is likely a result of being the first to scale in its market.

Who knows what the market will do, the general sentiment here and in other places seems to be largely emotional and indicate that it will go down further. But even if you strip away Facebook's brand name and sexy market, the numbers are impressive and the business performs very very well.

bad_user• 14 years ago

The problem isn't that Facebook doesn't have earnings, but rather their incredible P/E ratio.

Also, the profit margin doesn't say much about a company that doesn't do much other than its core product, while Google and Apple have their hands in other products as well. If anything the chances for long-term survival look better for companies that diversify successfully and Facebook hasn't demonstrated an ability for that.

mrshoe• 14 years ago

Personally I love to see Facebook's stock languish. Not because I dislike Facebook, but because it's great to see the market react rationally to an over-hyped tech stock.

FB is arguably the most hyped IPO in history. There was a blockbuster movie made about it. If ever there was a positive sign that we are not in a bubble, the poor performance of FB on the open market is it.

It's great to not be in a bubble. That means we won't wake up one day to discover it has popped. But to see the lack of a bubble on display so publicly has more important benefits. All the sub-par investors and entrepreneurs who flood the valley just to cash in on bubbles will be repelled.

heretohelp• 14 years ago

I said the exact same thing to a friend of mine yesterday, when we were discussing the news surrounding their IPO.

So as long as the market punishes this kind of hubris and rationally prices companies relative to real revenue and potential, I feel better about us not having a bubble.

larrys• 14 years ago

"If ever there was a positive sign that we are not in a bubble, the poor performance of FB on the open market is it."

The poor performance on the open market is in comparison to the offering price. If the offering price had been considerably different (for whatever reason) the performance would be in comparison to a much lower number potentially. Since the pricing decision was made by people (who have all sorts of motives) not sure that this is (although it maybe of course) representative of a positive sign of a bubble.

brandall10• 14 years ago

True, but it's a good sign that irrational exuberance is not taking hold of the open market, which was a cornerstone of the .com bubble.

I find it somewhat refreshing that with the number of people who use Facebook and feel it has significantly impacted their lives, that there wasn't a upwards pop on this.

taligent• 14 years ago

Wait so were we in a bubble or weren't we ? And what about now has the bubble burst or not ? All of this bubble talk has been shown for what it is.

Complete nonsense. One or two companies != Bubble.

advocate1• 14 years ago

Internet VC's like bubbles.

I agree this trend the investor posited to pg is a good one. It will force startups to focus on profits not hype and VC. That will make for better startups that can perhaps become longlasting companies.

Facebook is all hype. That is not the formula for a longlasting company. As long as the hype is high, they are in good shape. How long does hype last? Our society is more deficient in sustained attention than ever thanks to the internet. Facebook needs to acquire any Facebook alternatives early and often. People are more than ready for the next new thing.

There is no value in data itself. You have to do something with it to produce income. You need a plan. Facebook lacks a plan. Facebook will stand as a good historical example for those who wantonly collect personal data and dream of its value. The amount of personal data Facebook has collected is unparalled. But that does not magicaly create a business. Unless the business is cold calling or some similarly annoying tactic to generate sales.

Facebook's business is running on hype, not data. If the hype slows. It traffic dies down, it's game over.

The idea that the sucess of Facebook is just a matter of flipping the switch and asking Facebook's users to buy things is unsupported by any evidence. However we have the dot com bubble as an example that just acquiring users without a solid business plan is not enough. Grow big, fast, is not enough. Facebook dreamers still think it is.

As investors see that the general public understands that Facebook has no plan, as reflected in the media, and that only have lots of users and personal data, investors will be more cautious. Investors read newspapers. And they believe what they read.

The hype wears off. People see that these companies are smoke and mirrors. And suddenly you can't pull another Groupon so easily.

michaelochurch2• 14 years ago

The bubble isn't in valuations, which are reasonable. Rather, the bubble is in the high value that some very talented people are giving to subordinate positions in startups that "seem" cool, not based on business or career considerations, but irrelevancies like whether there's an XBox on site. They're doing themselves a disservice by taking positions that tout themselves as the "startup experience" but involve none of the investor contact, mentoring, or career development that they'd actually need in order to become founders for real (I.e. with enough contacts and resources to do it right and without risking personal financial ruin). They'd be better served if they took technical positions at more established and traditional companies, whether these be larger corporations or "lifestyle" businesses.

Of course, there are a lot of great startups out there, where a person can learn a lot very quickly, but those are not all of them and joining a company because "it's a startup!" is, without more knowledge, a bad idea.

That's the bubble I see: people taking jobs in dodgy startups for ridiculously low equity slices based on information that's either biased or only validated by the ridiculous echo chamber, thinking that their position as Employee #57 is going to make them real founder material in 8 months (because the CEO will just give them investor contact). It don't work that way.

temphn• 14 years ago

> in order to become founders for real

The first 1000 people at Facebook are millionaires. http://www.washingtonpost.com/business/technology/facebook-1...

Any early Facebook employee has both the money and the name brand to be a credible founder.

By contrast, have you founded a successful startup? Have you raised money from investors? If not, why would you feel qualified to offer advice on the matter?

georgemcbay• 14 years ago

"But even at half those numbers there are fantastic returns for investors and entreprenuers to be had."

What about at 0.1% of those numbers?

Facebook (while it obviously has a ways to go on direct customer monetization), is an extreme outlier whose numbers across virtually any metric are far more extreme than most startups will ever come close to. IMO it is their outlier status combined with the lackluster performance relative to that status that is the killer.

Trying to anchor other startups to Facebook's numbers at something like "half" or even a "quarter" is kind of handwavey because a startup would have to be improbably, insanely successful just to get a small fraction of the userbase Facebook enjoys.

badusername• 14 years ago

Did he just say, in very nice terms, that Facebook stock is still overvalued?

lifeisstillgood• 14 years ago

The Articles argument seems to be that FB got 10x revenues and if new startups got just half that it would be great

sadly that's a common fallacy on any business plan - the Market is x million and we could get 10% of that then ...

So what's a better argument?

FredBrach• 14 years ago

I don't really see the relation with the pg's letter unless facebook' ipo and valuation. It's interresting anyway.

mathattack• 14 years ago

Great perspective on price. It is still a success, but perhaps also still overpriced.

salimmadjd• 14 years ago

I'm glad to see FB come down, just so I can invest on FB at reasonable price. As for FW he is right. FB used the hype to raise money at great valuation. If anything, there is now a lot of liquidity among potential investors.

Fred Wilson's response to "Paul Graham's Letter to YC Companies"

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