Episode 28: The Amazon IPO with original Amazon Board Member Tom Alberg

Episode 28: The Amazon IPO with original Amazon Board Member Tom Alberg

Ben & David welcome very special guest Tom Alberg, board member and first lead investor in Amazon.com, to cover the IPO of "earth’s most customer-centric company". From longterm thinking to flywheels to riding big waves, this episode is chock full of lessons and stories from the journey of building one of tech’s most iconic franchises. We hope you enjoy listening as much as we did recording it! 

Topics covered include:

  • Tom’s “prolific” bio from the Amazon S-1
  • Jeff Bezos’s journey from a Vice President at the New York hedge fund D. E. Shaw to founding Amazon in a Bellevue, WA garage in the summer of 1994
  • Jeff’s longterm thinking as evident in the early days of Amazon, and his approach that "failure is ok, but not trying things is not ok” 
  • Raising the seed money for Amazon before product launch, how Tom met Jeff and decided to invest despite the “high” valuation
  • Tom's (and Jeff’s) focus on the power of targeting large and growing markets 
  • Amazon’s actual overnight success after launching the website: according to Tom at the time, "By the second or third week… It was clear there was a trend here.”
  • How Amazon’s venture round, led by John Doerr of Kleiner Perkins, came together in the spring of 1996 
  • Amazon’s torrid growth through 1996, Jeff’s mantra of “get big fast” to win the land grab of online book selling, and the board’s decision to prepare for a public offering in the spring of 1997 
  • How Frank Quattrone and Bill Gurley, then of Deutsche Bank, won the lead position for the Amazon IPO, beating out more storied firms such as Goldman Sachs and Morgan Stanley 
  • Development of the flywheel concept within Amazon, as an outgrowth of maniacal focus on creating superior customer experience
  • Amazon's public offering on May 15, 1997 at $18 per share (effectively $1.50 relative to today’s stock price after splits), raising $54M at a market capitalization of $438M — and subsequently trading down during the first few months following the IPO  
  • Amazon and Jeff’s management of investor perceptions of the company, and ability to sell the longterm vision over short term profits — “you get the investors you ask for” 
  • The creation of the first annual letter to Amazon shareholders included in the company’s 1997 annual report (and republished every year since), and then-CFO Joy Covey’s role and contributions to it 
  • Raising convertible debt just before the peak of the dotcom bubble and subsequent ability to survive the burst, and the impact of the downturn on Amazon culture

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 27: Special—A Conversation with Microsoft's Head of Strategic Investments Brian Schultz

Episode 27: Special—A Conversation with Microsoft's Head of Strategic Investments Brian Schultz

Ben & David chat with Brian Schultz, the Managing Director of Strategic Investments & Corporate Development at Microsoft, about Microsoft’s approach to M&A, investing, and partnering with startups — and his journey from acquirer to acquiree and back again! 

Topics covered include:

  • Brian’s history working across “both sides of the aisle” as both a startup founder and corporate development leader at a big company, how perspective from each informs the other, and the importance of learning “customer empathy” 
  • How Microsoft approaches M&A from an organizational perspective, and the importance of fit with the company’s product roadmap 
  • How Brian approaches strategic investments at Microsoft, and the evolution over time of the Microsoft (and large technology companies as a whole) perspective on investing in other companies
  • Balancing the tension between partnering and investing, and what criteria Brian thinks about when evaluating companies 
  • Microsoft’s investment in Facebook in 2007 (at a then-crazy-seeming $15B valuation), and more recently Foursquare, Mesosphere, CloudFlare and others
  • The current state of the tech M&A landscape, and the emergence of private equity as tech company acquirers 
  • Potentially changing corporate and foreign tax structures and how they impact acquirers’ thinking around deals (or not!) 
  • How Microsoft tracks and evaluates success of acquisitions over time, and lessons learned from successes and failures 
  • The increasing number of operating companies (technology and otherwise) looking to invest in startups, and how that landscape has evolved over time 

Followups:

  • Snap Inc.’s rumored IPO filing — and bonus discussion of how VC’s and other investors think about “exiting” their investments in companies that have gone public

Hot Takes:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 26: Marvel

Episode 26: Marvel

Ben and David complete the Disney acquisition trilogy, covering the "house that Mickey built"'s 2009 acquisition of Marvel Entertainment. Will our own superheroes save the day for shareholders, or perish at the hands of villainous corporate raiders? Tune in to find out!

Topics covered include:

  • Marvel’s corporate origins as "Timely Publications”, created in 1939 by pulp magazine publisher Martin Goodman in NYC, with the publication of Marvel Comics #1
  • Creation of enduring characters such as Captain America, the Fantastic 4, Spider Man, The X-Men, Iron Man, Thor, The Hulk and more
  • Adoption in 1961 of the "Marvel Comics” brand, and writer-editor Stan Lee’s transition of the company towards focusing on edgier characters and stories targeted at older audiences 
  • Marvel’s first sale in 1968 to the Perfect Film and Chemical Corporation (later Cadence Industries)
  • The company’s “turbulent” corporate history through the 1980’s and associated mergers, acquisitions and lawsuits
  • Marvel’s reinvention as a film-focused media company in the late 1990’s and early 2000’s with the launch of Marvel Studios
  • Disney’s ultimate acquisition of the company for $4.2 billion in August 2009, during the depth of the great recession 
  • Marvel's—and in particular Marvel Studios’—performance since the acquisition 

Followups:

Hot Takes:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 25: The Facebook IPO

Episode 25: The Facebook IPO

Hey Acquired listeners. A note about this show: we recorded this episode the night before the 2016 Election Day in the US. At the time, the biggest change we saw coming was adding a new type of content to Acquired in analyzing IPO’s, which we introduce in this episode. Two days later, we woke up to a very different world than the one we were expecting.

Reflecting on what’s happened, and the past few months of our show, we wanted to say two things:

First, we want to apologize for our cavalier attitude toward this election cycle, and our glossing over the clearly very real problems and deep divide in America that it represented. In the Skype episode, David pretty glibly compared the AT&T - Time Warner merger to "Make America Great Again", arguing that any reactionary force is “on the wrong side of history” and cannot be relevant in a changing world. That was wrong, the sentiment behind it was wrong, and it was insensitive to the very real pain a lot of people are feeling out there on both sides. 

Second, looking back on this particular episode about the Facebook IPO, we think it actually might present a relevant parable for our country right now and--we hope--some important lessons for the technology industry going forward. For all the wonderful aspects of the tech industry that we celebrate on this show, there is no doubt that it also bears a great deal of responsibility for the current divide in America, and especially in its contribution to wealth inequality. Likewise, for all the wonderful aspects to the Facebook IPO story, as told in this episode, there is a very dark side as well: Facebook shareholders, investment banks and institutional investors raked in billions of dollars at the expense of individual retail investors who lost their shirts. 

At the same time, Facebook’s perseverance through their “broken IPO", and their determination in overcoming with incredible speed the massive, existential challenge to their business model posed by mobile, is something we think *can be* an inspiration to us all on how to move forward even when that seems hard. We hope you’ll listen to this episode with that in mind and think about how you, we, and the technology industry as a whole can do better in serving everyone in this country and in the world. 

Thanks for being on this journey with us. We’re sorry for our shortcomings, and we’re going to keep working hard to do better. 

-Ben & David

Topics covered include:

Followups:

Hot Takes:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 24: Skype

Episode 24: Skype

An acquisition so wild and crazy, they had to do it again. And again. Ben & David cover tech’s perhaps most-traded asset, Skype (which also happens to be a fantastic business). How do we even know which deal to grade? Tune in to find out… 

Topics covered include:

Followups:

Hot Takes:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 23: NeXT (Live show at the GeekWire Summit)

Episode 23: NeXT (Live show at the GeekWire Summit)

Ben & David broadcast live from the 2016 GeekWire Summit covering one of the all-time greats, Apple’s 1996 acquisition of NeXT. This episode has it all: the Steve Jobs hero story, Apple, I.M. Pei, Ross Perot, Aaron Sorkin, Nobel Laureates and… Gil Amelio? Does NeXT rank atop the best acquisitions ever? Our own heroes cast their votes. 

Topics covered include:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 22: Zillow + Trulia with Zillow Group CFO Kathleen Philips

Episode 22: Zillow + Trulia with Zillow Group CFO Kathleen Philips

CFO of Zillow Group Kathleen Philips joins Ben and David to cover the show’s first true “merger” versus “acquisition" (only took 22 episodes!), Zillow’s 2015 combination with Trulia to form Zillow Group. 

Note: our audio glitches unfortunately continued on this episode, and quality is rough. We recommend listening on speakers vs headphones if you’re able. We apologize and will be back to normal quality next time!

Topics covered include:

  • Zillow and Trulia’s beginnings during the “Web 2.0” era in the mid-2000’s 
  • Zillow, Trulia and other online players’ place within the massive US real estate market
  • The lengthy “dance" between Zillow and Trulia and earlier aborted merger talks between the two
  • The difficulty of "true mergers” among private companies and why the path is easier for public companies 
  • Public company shareholders’ influence and role in M&A transactions 
  • Details of the blazingly fast negotiations (27 days start to finish!) per disclosures in the SEC filings (scroll down to "Background of the Mergers”)
  • Structuring the deal and incentivizing Trulia and Zillow mangers to stay and continue growing as separate brands
  • Trulia cofounder Sami Inkinen’s whereabouts during the merger negotiations 
  • The experience going through a lengthy FTC review of the merger, and defining what the relevant “market” is the FTC should be considering
  • Introducing our new acquisition category: a “time machine acquisition” ;) (h/t Kathleen)
  • Zillow Group’s overall approach to acquisitions, folding into its broader HR strategy 
  • Zillow founder Rich Barton’s startup thesis of searching for "What piece of marketplace information do people crave and don’t have?"

Followups:

Hot Takes:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 21: Inside the M&A Press with Bloomberg's Alex Sherman

Episode 21: Inside the M&A Press with Bloomberg's Alex Sherman

Ben and David go inside the M&A press with Bloomberg’s technology M&A reporter and host of the Deal of the Week PodcastAlex Sherman. If you’ve ever wondered how stories about big deals get broken or what “according to people familiar with the matter” really means, tune in for the behind-the-scenes scoop! 

Note: A technical glitch with our recording setup created occasional short silences between Alex’s comments and Ben & David’s. It shouldn’t impact listenability, but we apologize for the awkward pauses!

Topics covered include:

  • Bloomberg’s own fascinating “history & facts” and origins following the acquisition of storied Wall Street firm Salomon Brothers 
  • Bloomberg’s core as a highly profitable technology business (selling terminals to Wall Street firms), with a large media empire built on top of it
  • The tradable value of breaking M&A news & information to Bloomberg’s terminal customers, and competing on speed
  • How “sources" work — and industry standard that sources be directly within the companies involved in a deal
  • The coded language of M&A reporting and gleaning where information is coming from based on a story’s structure and phrasing
  • The lifecycle of a story—steps from sourcing to writing to release, and reasons (or lack thereof) for why stories run when they do
  • Internal & external PR resources companies use for M&A 
  • How Alex prioritizes his time researching and creating stories, and who he’s meeting with to hear about what deals are in the works 
  • The difference between ‘news' and ‘analysis', and why news dominates the majority of stories versus deeper analysis
  • Media and social media business models, their evolution in the messenger world, and speculation on Twitter’s future
  • How entrepreneurs can think about interacting with the press and building relationships with the right reporters for their stage and space
  • Apple’s ‘unique’ approach to press relations 

Followups:

Hot Takes:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 20: Android

Episode 20: Android

Ben & David examine Google’s 2005 purchase of Android for a rumored $50M, undeniably one of the best technology acquisitions of all time. But will it top the list of these tough graders? Tune in to find out.

Topics covered include:

  • Welcome new listeners! We quickly review the show format for newbies. 
  • Community spotlight: Patagonia on a Budget from community member Matt Morgante (@mattm on Slack)
  • Andy Rubin’s career trajectory and what made him “born to start Android"
  • The undeniable “cool factor” of the Danger Sidekick in the early/mid-2000’s, including fans such as Larry Page, Sergey Brin and… Turtle from Entourage 
  • Android’s original ambition to build an operating system for… digital cameras
  • WebTV founder Steve Perlman is pretty much the best friend ever 
  • Google’s own perspective on Android as their “best deal ever"
  • The Android team’s reaction to Steve Jobs unveiling the iPhone in January 2007, and redesigning the initial launch hardware
  • Announcing Android and—equally importantly—the Open Handset Alliance (“OHA”)
  • The much-talked-about "mobile holy wars", between Android’s “open” platform and Apple’s “closed” platform
  • The less-talked-about US carrier wars with the iPhone + AT&T in one camp, and everyone else in the Google / OHA camp (including “Droid Does”)
  • A quirk of history: HTC at one point acquires a majority share in Beats, resulting a short-lived period of Beats-branded Android phones (still available on Amazon!)
  • The real battleground for Google in the mobile platform wars: the economics of “default search” (briefly known thanks to the Oracle/Java lawsuit against Google
  • Google’s detour into smartphone hardware with the acquisition (and subsequent divestiture) of Motorola
  • The “fork-ability” of Android via the Android Open Source Project (versus “Google Android”), and the rise of Xiaomi, Cyanogen, Kindle Fire and other platforms
  • The ecosystem economics of the Android business for Google
  • “Defensive” versus “offensive” acquisitions, and protecting Google’s core search business
  • Could (or would) Google have built an Android-like platform without acquiring Android the company (or having Andy Rubin)?
  • Framing the technology world’s shift to mobile within (surprise) Ben Thompson’s Aggregation Theory
  • The current “moving up the stack” of the competitive playing field as the mobile landscape matures
  • Grading: Android versus Instagram?

Followups:

Hot Takes:

  • The iPhone 7 (and AirPods) announcement

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 19: Jet

Episode 19: Jet

Ben & David break down Jet.com’s meteoric rise, culminating in Walmart’s blockbuster $3B+ acquisition of the company just two years after its founding. Will we look back on this deal as an ‘Instagram-like’ bargain or a ‘Pets.com'-sized blunder? And most importantly, can *anyone* compete with Amazon going forward? We speculate wildly.

Topics covered include:

Followups:

New section: Hot Takes! (thank you @cteitzel on Slack for the idea)

The Carve Out

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 18: Special—An Acquirer’s View into M&A with Taylor Barada, head of Corp Dev at Adobe

Episode 18: Special—An Acquirer’s View into M&A with Taylor Barada, head of Corp Dev at Adobe

Ben & David are joined by special guest Taylor Barada, VP and Head of Corporate Development & Strategic Partnerships at Adobe, to discuss how large tech acquirers approach buying companies. This episode is full of great insights for startups & entrepreneurs who might find themselves navigating the M&A process, as well as anyone curious about the craft of dealmaking and the strategic approach of large acquirers. 

Topics covered include:

  • How conversations begin between startups and acquirers
  • The importance of building a relationship with acquirers over time and "investing in lines, not dots” (just like raising VC)
  • The often under-appreciated role of culture fit between acquirers and acquisition targets
  • How entrepreneurs should evaluate acquirers throughout the M&A process
  • Two examples of successful acquisitions Taylor completed at Yahoo in Citizen Sports and IntoNow
  • The M&A process at large technology acquirers, from initial conversations to LOI, due diligence and the definitive merger agreement
  • The relative roles of Corp Dev, business/product owners and executive sponsors in the M&A process
  • Common mistakes startups (and VC’s) often make in the M&A process
  • Different “categories” of M&A that acquirers think about, and the relative risks & opportunities of “core" acquisitions vs transformative new businesses
  • What percentage of deals Adobe looks at actually happen, and the importance of being willing to say no
  • M&A as a tool for strategy, and the different M&A cultures & approaches at different companies
  • Tech themes Taylor and Adobe think about as part of their M&A strategy
  • Evaluating the longterm success of deals and the importance of the M&A integration function

Followups:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 17: Waze

Episode 17: Waze

Ben and David navigate the mobile platform wars of 2012-13, avoiding speed traps en route to Waze’s destination as a $1B+ acquisition by Google.

Topics covered include:

The Carve Out

Followups:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

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Episode 16: Midroll + Stitcher (acquired by Scripps)

Episode 16: Midroll + Stitcher (acquired by Scripps)

The meta show: Ben and David turn their gaze inward and examine the podcasting industry through E. W. Scripps’ recent acquisitions of the Midroll podcast advertising network and Stitcher podcast client. Featuring discussion of our own product process and metrics at Acquired. 

Announcements:

  • We’re pivoting! (not really) Our new show description: A Podcast About Technology Acquisitions That Actually Went Well
  • But we are launching a new feature! Since so many of you, our listeners, are also tech and startup folks and/or other builders, we wanted to create a space to feature cool products, companies and side projects you’re working on. Thus we’re adding a "Community Showcase” section to the show. If you’d like to be included just send us a Slack message or email, and we’ll choose one submission to feature on each show. This episode we’re highlighting BESTR, from community member David Resnick (aka @the_rezonator in Slack), which is an online platform to share lists of great things. Check it out and let David know what you think. 

Topics covered include:

  • Top Google search results for “acquired podcast"
  • Midroll’s origins in the comedy podcast Comedy Bang Bang (now an tv show on IFC) and exit last year to Scripps
  • The structural challenges inherent to podcasting as a medium and the gap between audience size/engagement and industry revenues
  • Opportunities for independent podcasters and our own audience and business metrics at Acquired
  • Stitcher’s long corporate history as a venture backed company, first acquisition by French music company Deezer, and now second acquisition from Deezer by Scripps
  • Problems with Stitcher as a product and industry reaction to the acquisition including John Gruber's responseBen Thompson’s article on Stratechery, and Ben & James Allworth's discussion on their excellent podcast Exponent
  • Handicapping Stitcher+Midroll’s chances for success within Scripps, and opportunities for new startups & innovation in the podcasting space
  • Pioneer Square Labs’ own past efforts in the podcasting space and their process for evaluating potential new company ideas
  • Shoutout to Pocket Casts and our listeners down under

Followups:

The Carve Out

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or just-plain-hilarious transcription errors)

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Episode 15: ExactTarget (acquired by Salesforce) with Scott Dorsey

Episode 15: ExactTarget (acquired by Salesforce) with Scott Dorsey

Ben and David return to make their first foray into enterprise software, covering Salesforce’s $2.5B acquisition of ExactTarget in 2013 with the help of special guest and ExactTarget cofounder & CEO, Scott Dorsey

Technical note: due to an issue we didn’t catch during recording, audio quality is significantly lower than usual for this episode (especially David’s voice). We apologize but hope you’ll give it a chance anyway— Scott offers great wisdom & insights, and the ExactTarget success story is a inspiring one underdog entrepreneurs, especially (but not limited to!) anyone located in the Midwest or elsewhere outside of traditional "Silicon Valley-style” tech hubs.

Topics covered include:

  • The decision to start ExactTarget post-internet bubble and in Indianapolis, with zero software experience between Scott and cofounders Chris Baggott & Peter McCormick
  • Raising initial money from friends & family, followed by early investment and mentoring from Indianapolis venture pioneer Bob Compton
  • Building and scaling a great sales organization within a technology company
  • The importance of focusing early on a clearly defined target market (SMBs in the case of ExactTarget), and then “stair-stepping” up as the product and business scale grow over time
  • ExactTarget’s unsuccessful first IPO filing during the financial crisis
  • Building a "capital-efficient” early stage company, and the value of raising growth capital at the right time to step on the accelerator
  • The value of “secondary” investments allowing founders, employees & early investors to “stay hungry” by achieving some liquidity along the way
  • When and how to expand internationally and the importance of strategic resellers
  • ExactTarget’s second successful IPO filing and life as a public company with quarterly financial reporting to Wall Street
  • How the acquisition process played out with Salesforce and other bidders (including reference to ExactTarget’s incredible SEC filing detailing the entire negotiation—scroll down to "Background and Reasons for the ExactTarget Board’s Recommendation”, starting at the bottom of page 13)
  • Approaching the difficult task of integrating a major acquisition involving thousands of people
  • The fun story of ExactTarget’s winning Microsoft as a large customer—including actual sledgehammers
  • Scott’s new Indianapolis-based venture studio, High Alpha
  • Plus as always the "hard hitting" analysis across acquisition category, what would have happened otherwise, tech themes—and final grading

The Carve Out

Followups:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or just-plain-hilarious transcription errors)

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Episode 14: LinkedIn

Episode 14: LinkedIn

Ben and David cover the 3-day-old acquisition of LinkedIn by Microsoft for $26.2 billion. They cover LinkedIn’s founding story by Reid Hoffman, break down their core businesses, analyze recent stock behavior, and speculate on the future of the company inside Microsoft. The big question - were they worth the price tag?

Items Mentioned On The Show:

The Carve Out:

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or just-plain-hilarious transcription errors)

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Episode 13: Push Pop Press (Facebook Instant Articles) with Todd Bishop

Episode 13: Push Pop Press (Facebook Instant Articles) with Todd Bishop

Ben and David are joined by Todd Bishop, technology reporter and co-founder of GeekWire, to discuss Facebook's 2011 acquisition of Push Pop Press. Highlights include:

  • The founding story of Push Pop Press by Kimon Tsinteris and Mike Matas.
  • The evolution of Facebook Creative Labs, Facebook Paper, and eventually, Facebook Instant Articles.
  • Facebook's role in the changing media landscape today.
  • GeekWire's experiments with Facebook Instant Articles, Google Accelerated Mobile Pages, and live video.

The Carve Out

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or just-plain-hilarious transcription errors)

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Episode 12: Snapchat (?!)

Episode 12: Snapchat (?!)

Ben and David tackle their first failed acquisition: Facebook's 2013 offer to buy Snapchat. They cover the fascinating story of Snapchat's creation and growth, their blossoming business model, how it would be different inside of Facebook, and what the future holds.

Items mentioned in the show:

The Inside Story Of Snapchat: The World's Hottest App Or A $3 Billion Disappearing Act?

Inside Evan Spiegel's very private Snapchat Story

Join the Acquired Slack Community at http://acquired.fm

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or just-plain-hilarious transcription errors)

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Episode 11: PayPal

Episode 11: PayPal

Ben and David return to technology acquisitions by examining a classic: eBay's 2002 purchase of PayPal. 

Items mentioned in the show: 

How the 'PayPal Mafia' redefined success in Silicon Valley  - Tech Republic

Instagram Will Be a $3 Billion Business This Year: Analyst

President Obama and Bill Simmons: The GQ Interview

"The Carve Out":

Antifragile: Things That Gain from Disorder

The Bill Simmons Podcast - Chris Sacca

 

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or just-plain-hilarious transcription errors)

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Episode 10: Virgin America

Ben and David deviate entirely from the stated purpose of the show, tackling this non-technology acquisition that is so recent, we have no idea if it went well yet. But, the April 2016 acquisition of Virgin America by Alaska Airlines was so fascinating, we had to do it! 

Items mentioned in the show: 

Louis C.K. - Everything is Amazing and Nobody is Happy

Alaska Acquires Virgin America Investor Deck

“Measuring The Moat” Paper - Michael J. Mauboussin

Business Adventures - Twelve Classic Tales from the World of Wall Street

"The Carve Out":

Michael Mauboussin: "The Success Equation:Untangling Skill and Luck" | Talks at Google

 

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or just-plain-hilarious transcription errors)

Ben:                 I should see what episode this is going to be.

David:              Ten.

Ben:                 Ten. Easy.

                        Welcome to Episode 10 of Acquired, the podcast where we talk about technology acquisitions that actually went well. I am Ben Gilbert.

David:              I’m David Rosenthal.

Ben:                 And we are your hosts. Today, we come to you with an acquisition that is actually not a technology acquisition, but something that David and I were inclined to talk about anyway because we both sort of have a little romantic fascination with anything involving airplanes, and this is particularly interesting.

                        Today we’re going to be talking about Alaska Airlines acquiring Virgin America right here in our own backyard in Seattle. Before we get into the acquisition history and facts, I wanted to remind you that you can sign up now at Acquired.fm to get our episodes delivered via email. We also would really, really, really appreciate it if you could rate us on iTunes. It will help us grow the show and expand what we can do with it from productions to new topics and guests.

                        Now, with that out of the way, David, you want to dive into acquisition history and facts?

David:              Indeed, yeah. This will be a fun one. Listeners, let us know what you think. Don’t worry, we’re not changing the topic of the show, but we thought we’d have some fun and analyze a very different industry than technology.

Ben:                 Yeah, and not to mention the fact that it’s not a tech acquisition. There is technology involved, but the way we’re kind of breaking the mold into this one too is this just happened last month.

David:              Yeah.

Ben:                 Or this month actually.

David:              A couple of weeks ago.

Ben:                 Yeah. So this is something where it’s going to be highly speculative, but I think it’s going to be a fun ride.

David:              All right, with that. So, Virgin America was actually founded in 2004 by Richard Branson and then had to go through a whole series of machinations to end up finally launching their airline service in the US not until 2007. Over those three years, a whole bunch of things happened. So one, it turns out that due to some crazy laws, US domestic airlines cannot have foreign ownership greater than 25 percent of the company.

Ben:                 Crazy.

David:              Crazy. So, Branson and Virgin had to basically sell off 75 percent of the company before they could even have a hope of operating.

Ben:                 It’s wild. I think at that point, when they were first starting, it was Virgin USA even and they rebranded.

David:              It was later that they rebranded to Virgin America. So, Branson sells 75 percent of the company to a couple of hedge funds.

Ben:                 And licenses the Virgin Brand to Virgin America, so that Virgin America doesn’t even own Virgin that’s painted on their own airplanes.

David:              Yup. There was talk at various points in time about ditching Virgin, the name, would that help get regulatory approval earlier, faster. Craziness. Anyway, they finally clear all the regulatory hurdles, they buy some aircraft, and they start operations in San Francisco with SFO as their hub. They launched in 2007. Things go fairly well. They don’t die at least like a lot of startup airlines, and they actually have some major technology-related innovations. So, in 2009, Virgin actually becomes the first airline to offer Gogo in-flight wireless, in-flight Wi-Fi, which is that’s hard to imagine now.

Ben:                 As Louis C.K. says, “It’s magic and it’s the newest thing I know that exists.”

David:              I still hate it now – the random, you know, rare times when you end up on a plane without Wi-Fi.

Ben:                 Sorry.

David:              They also are the first airline, I believe, to install in-flight seat back interactive touch screens for everybody all throughout the whole plane.

Ben:                 Not to mention purple afterglow light.

David:              Not to mention nightclub-inspired lighting. For our listeners who haven’t flown Virgin America, they probably have no idea what we’re talking about.

Ben:                 Yeah, I guess it’s pretty West Coast, and anybody listening in the Bay Area has definitely flown it since they’re hubbed out at SFO.

David:              So, Virgin actually ends up going public having an IPO in November 2014 and then not that long later where about 18 months since then, a bidding war erupts for the company between Alaska which ended up buying them and had rumored to be interested in the company, in Virgin, for a long time and JetBlue. Then Monday morning, April 4, Alaska announces that they have agreed to acquire Virgin for $2.6 billion, which was a 47 percent premium to the Virgin stocks closing price, the previous price at about an 80 percent premium to where the stock was before rumors came out that a bidding war was happening.

Ben:                 Yeah, this is the first red flag for me. I mean, I think that…

David:              Basically, a massive premium.

Ben:                 Yeah, yeah. Anytime you see a spike like that, you start to dig in to why, and I think we’ll talk a little bit more about kind of the way that industry has shifted. But with all the consolidation, the only way that an airline can really compete with the big guys is to be big themselves, and the big guys being United, Delta, American, and Southwest.

David:              Which itself started as a little guy.

Ben:                 Very true. I think that’s like the typical low end disruption case study. That’s a great business and a really interesting story on its own. But, I mean, clearly, Alaska in trying to compete, there’s a limited number of airlines that it could buy. JetBlue clearly identified the same opportunity and the result is this very, very inflated purchase.

David:              Yeah. So when the dust clears and all is said and done, basically the total enterprise value of the deal ends up being about $4 billion, if you include the debt and the aircraft leases that Virgin had.

Ben:                 Which is fascinating because normally when we talk about these acquisitions, we would say a $2.6 billion purchase in cash and stock or maybe an all stock deal, this was an all-cash $2.6 billion purchase plus taking on that $1.4 billion of leases on your planes and debt. What a ridiculous capital-intensive, high fixed cost industry air travel is.

David:              That’s four Instagrams, Ben.

Ben:                 Wild.

David:              Then perhaps the craziest part about this deal is, again, relative to the technology sector, so it was announced a couple of weeks ago on April 4, 2016, not expected to close until early 2017 at the latest. Huge amount of regulatory review that still has to happen here.

Ben:                 We’ve actually precedent I think in the American Airlines – US Air merger where there was regulatory troubles and it almost didn’t go through.

David:              Yeah. The government extracted huge concessions from those two airlines when they merged.

Ben:                 So, we may be doing a follow-up at some point in the future if by 2017 we don’t see a joint airline here.

David:              And our listeners don’t revolt against us, we’re talking about airlines.

Ben:                 It’s true.

David:              Okay.

Ben:                 Well, the other really interesting thing here is in just talking about the deal price, Alaska Airlines does not have $2.6 billion in cash to make this purchase. If I have my numbers right, as of November 2015 according to their earnings, they had $88 million in cash and $1.1 billion in marketable securities. So, I believe what happened here is in the bidding war with JetBlue, Alaska has incredibly clean books. They’re one of the few airlines that actually is investment grade debt.

David:              Very low debt load. Actually, investment grade debt, which for listeners who aren’t in the… come from the investment banking world basically means that the amount of debt that Alaska has is small enough relative to its earnings power that people think it’s very, very unlikely they’ll go bankrupt especially for an airline. No other airline is rated as highly, basically which means that people who don’t think there’s a good chance they’ll go bankrupt.

Ben:                 Yeah. So, is there a chance then, that the way I sort of understand it is JetBlue sort of had to cry uncle because they didn’t have the amount of debt available to them.

David:              Didn’t have the borrowing power to be able to…

Ben:                 Make the purchase.

David:              Yeah, reach this price. But now, this is going to totally transform Alaska, like they’re going to take out another $1.5 billion, perhaps plus with debt.

Ben:                 To make the, well, yeah, I mean to make the purchase and then to take on the debt and leases that…

David:              Virgin was also a fairly low debt load airline as far as airlines go. But still, it’s changing the capital structure of the combined company, pretty significant.

Ben:                 Yeah.

David:              Great. So, we move on to acquisition category.

Ben:                 Yeah, it sounds good to me. Why don’t I start with that?

                        Moving on to the acquisition category, this, to me, doesn’t fit our mold necessarily of people, technology, product, business line or other, and I guess if everything fits in other. In some ways, it’s a business line. They picked up a brand that people have tremendous affinity for and access different customers with…

David:              That’s assuming they keep the brand.

Ben:                 Well, yeah, and that’s something we should talk about. Ultimately, though, what I think they’re acquiring here is capacity. They identified the opportunity that they wanted to be the West Coast airline and right now, they don’t have a meaningful presence in California. They’re hubbed out of Seattle, they have very little in San Francisco, and even less LAX presence. This gives them major, major capacity to be the West Coast airline.

David:              Yeah, basically, if you look at it, if you think about airline route maps that you see on the back of the cards and the back of your seats.

Ben:                 It makes your head spin, but it’s super cool.

David:              It makes your head spin but it’s usually, you know, it’s like the spider web that emanates from a few major cities. The Alaska hub at Seattle and there’s a huge spider web coming out of Seattle to every city in America and in several international destinations and then very few route pairs from other cities. Virgin is the same thing but just from SFO.

Ben:                 So, in your opinion then, well, before we get into that, how would you categorize?

David:              So, yeah, actually we hadn’t discussed this beforehand, but I was going down the same path you are and say in our framework, this would fit closest to a business line, like buying the local San Francisco airline and the local Seattle airline.

                        But I actually think the best categorization is this is industry consolidation, which is in a super mature old school industry like the airline industry, very different from technology, you get these periods of consolidation where players merge with each other because they feel like they need greater scale to compete. And I think that’s what we’re seeing happen here.

Ben:                 Yeah, and this is an interesting time to go into how Alaska makes the case to their investors for this. There’s this great investor deck that they have on their website where they talk about why their investors should feel comfortable with this purchase. And they say that “we’re bullish on the industry.” From 1977 to 2009, the industry lost $52 billion.

David:              The airline industry is notorious for…

Ben:                 Oh, yeah.

David:              I mean, we should talk about there’s a great, great… I almost included this as my carve-out for the week, but I’m going to do something else because I knew we’d talk about it on the episode.

                        There’s a great paper that was written by Michael Mauboussin and his team who’s a great investor. He was head of Legg Mason which is a large mutual fund and at Credit Suisse for a long time. I believe he’s now back at Credit Suisse. He’s written a number of great books. He’s also a professor at Columbia Business School, I believe. He wrote this great paper called Measuring the Moat. It’s all about the concept of the moat, you know, as an investor is sort of the most important thing. Warren Buffet emphasized it in Berkshire Hathaway and Charlie Munger emphasized the moat as sort of the most important thing they look for. And it uses the airline industry as an example of a terrible industry that has destroyed so much economic value and has no moat.

Ben:                 Yeah, and this is… I’m not sure if this… I think this is still true. It was at least true a couple of years ago. If you look at the airline industry since its inception and you look at basically a profit loss statement for an aggregate of every single airline, it’s lost value, like it’s actually not been profitable if you look at every single.

David:              The entire industry, yeah, yeah. And not just lost value but lost a huge amount – a huge amount of capital has been destroyed in this industry.

Ben:                 So, they said that 1977 to 2009, they’ve lost $52 billion as an industry. It is interesting that people continue to invest in it, yet from 2010 to 2015 over the last six years, it generated…

David:              It’s been good times in the airline.

Ben:                 Yes, $45 billion of value.

David:              We’ll get into that.

Ben:                 So some of the things they cite are… or Alaska cites to their investors are “a fundamentally changed industry structure.” That, I think, is largely… I mean, when you look at the consolidation that’s going on they’re basically saying, “Okay, the fragmentation is gone and right now the industry structure is that there’s four relatively perfect substitutes and these big ones that are all, you know, you’re going to get treated sort of like cattle when you’re in coach.”

David:              And you’ve seen in the past few years, I believe the first was United and Continental merged. You’ve seen all the major legacy domestic airlines consolidate and merge, and then US Air and American merged. So you’ve got this consolidating power structure of the industry that actually represents, between the top four airlines, 80 percent of all US domestic airline traffic.

Ben:                 Yes, so it’s interesting. I went and grabbed all their market caps today. Highest right now is Southwest, is a $30 billion company. Delta is higher at $36 billion, Southwest at 30, American at 25, United at 21. Then if you look at… Alaska is $10 billion without Virgin. Virgin is 2.5 and JetBlue at 7. So if you just look at those players, $132 billion effectively market cap for the industry, and when you think about Apple as a $590 billion market cap company, you start to understand like, “Wow!” The whole industry here is, you know, if we’re looking at this any given airline and comparing it against one of these mega technology companies that we usually talk about on the show, the airline companies just don’t create that much value.

David:              Yeah.

Ben:                 Or maybe more accurately, they don’t capture that much value.

David:              Yeah, and it’s super interesting. I’m sure we’ll get into throughout the show the supply chain of the airline industry is fascinating. You’ve got basically a duopoly that are direct suppliers to the airlines in Boeing and Airbus that make the big passenger jets. They have a huge amount of power over the airlines because while there is two of them, you could go from one to the other, it’s not like you can say it’s not like the airlines can be like a Google and be like, “Oh, we’re going to become a full stack company and we’re just going to obsolete you and we’re going to make our own cloud,” or whatever, like, the airlines can’t make their own airplanes.

Ben:                 Yeah. Getting good at servers is different than getting good at airplanes.

David:              Yeah.

Ben:                 Yeah. So getting back to the Alaska, reasons they’re bullish on the industry, the industry structure is consolidated. This is sort of a BS bullet point, I think, but returns focused leadership teams, that’s like tuning your own horn and claiming competency.

                        Constrained airport real estate – this one’s sort of interesting. I guess they’re saying like we reached a saturation point right now where we’re not building more airports, the airports aren’t getting bigger, and over the last since 1960, that’s been the case. Now, it’s all about vying for space at the existing airports that we have, and then the capacity acquisitions starts to make a lot of sense.

David:              Yeah. There are only so many gates.

Ben:                 Right, right. Growth in leisure travel, which is interesting to pick apart and think about why that might be, and then new revenue sources. I think we can all grape about how we are well aware of all the revenue sources that airlines can…

David:              Charging for bags.

Ben:                 Food and entertainment.

David:              I mean, some of these are new services they’ve added. Virgin and Alaska have both been kind of the leading edge here. The in-flight Wi-Fi and entertainment and movies and snacks that are actually edible.

Ben:                 And co-branded with Tom Douglas. It’s always so funny to get on those planes and see how far – for those of you not from Seattle, he’s like the big restaurateur in town – to see how far he’s leveraged that brand. Now that I open the little snack pamphlet in American Airlines, there’s Tom smiling at me on the front of it.

David:              I love it.

Ben:                 So artisanal. So, yeah, from a category perspective, I think absolutely I would chalk it up to capacity.

David:              Yup. The other point I want to explore here a little bit is there’s a really interesting context for this deal that people in Seattle might be aware of, but I doubt anyone not here is, and that’s that Delta actually has been putting a huge amount of pressure on Alaska here in Seattle in their hub. Delta has been growing over the last few years their presence in Seattle a lot. For a long time I think Alaska was probably either concerned or expecting that Delta was going to make an offer to buy them, and they haven’t. Instead, they have just organically grown and taken more and more gates here in Seattle. It’s really interesting.

                        I was talking to somebody who was far more of an airline industry expert than we are and he was making the point that the frame of reference is really different for these two companies, Delta and Alaska. Alaska is a domestic carrier and it’s a West Coast focused carrier. Delta is an international carrier. Delta coming in to Seattle was part about competing with Alaska domestically because Alaska has built a really nice business here. But also, an even bigger part probably for Delta is using Seattle as a gateway for international flights to Asia because gate real estate, as you were saying Ben, is so scarce and the other big cities on the West Coast at SFO and in LAX is so competitive and impossible to get more real estate there. I think Delta really viewed Seattle as their gateway so that they could send people from all over the US on flights to Seattle and then hop over to Japan, to Korea, to China, to what-have-you.

Ben:                 Makes sense.

David:              Whereas for Alaska, that’s not even an accessible market to them right now.

Ben:                 Right, right. In looking at this acquisition category in kind of the way we’ve both defined it, in a $2.6 billion sale that it seems inflated for two reasons. One, kind of the bidding war because it was scarcity of good airlines to buy that would compliment JetBlue or Alaska well. But two, a lot of the value, the intrinsic value that was given to Virgin even before rumors of a sale was brand value. They have tremendous customer affinity, they do things a little bit differently.

David:              People who love Virgin love Virgin.

Ben:                 I always have a better experience.

David:              And people who love Alaska love Alaska, too.

Ben:                 It’s true. Actually, those are two of my favorite airlines to fly. But Virgin is notoriously different and better and feels premium, and that had to be factored in to their market cap. When you think about what they are going to be used for, I mean, Alaska announced that by 2018 they hope to be fully rebranded as Alaska. Hopefully, they can learn some things from Virgin, and they’ve been watching them very carefully. But if they obliterate that brand, what was the point of paying a markup on a markup for capacity?

David:              Yup. It’s a great point. The Alaska brand, again, it was very good especially in the airline industry on its own. I think really was kind of like very professional. They had either the best in the industry or the best on the West Coast on time percentage, lots of great… very, very business commuter-friendly. Virgin was, like we joked earlier, like a nightclub on a plane. It was the favorite airline of all of my classmates when we were in business school. We can leave it at that.

Ben:                 So then one other thing that I want to bring up in that realm is payback period. So Alaska cites that they’ll have $225 million of total net synergies at full integration. So what we can pull from that is that there will be $225 million of cost savings after they’re fully integrated, so let’s call that 2018-ish, and that means that there’s probably other value that they can create on top of that like ability to create more revenue because they have these economies of scale, new things just on top of that. But that means that they have on this, if we look at the $4 billion as the figure, that’s a 17-year payback period on this acquisition just on the synergies.

David:              Now, Virgin had earnings as well that would contribute to that, but two points I want to make, but go ahead.

Ben:                 No, no, go for it. I’ve pretty much made the point there. It seems like it’s going to take a while to…

David:              Yeah. Any way you slice it, it’s going to take a while and I think there are two really head-scratching things about this merger that are really important, that certainly industry experts are questioning, but Alaska hasn’t talked a lot about, one, the primary reason for the sort f economic renaissance of airlines in the last couple of years has been falling fuel prices.

Ben:                 Yeah, which are not only passed on to consumers and everyone’s getting a little…

David:              Right, right. So airlines as a whole, across the whole industry, have gone from call it spending X on fuel which was a huge amount of their operating budget and kept their budgets low to negative to spending X divided by two on fuel. Thus, they are enjoying as an industry much greater profits than they used to.

                        Now the question is, like, is that the new normal or is our oil prices going to go back up at some point. We could do another show on the oil and gas industry. This is a major existential question for that whole industry, but, if you were to take the viewpoint that this is a temporary thing and prices will go back up, which historically they have fluctuated throughout history. Gosh, it seems like you’re buying at the top of the market here where profits are artificially inflated. So, that’s one.

                        Two, synergies as you rightly mentioned, Ben, are often about the combined revenue potential and being able to extract more money from consumers and routes and whatnot, but they’re also really about cost savings.

Ben:                 Yeah. And consolidating the back office.

David:              Consolidating and economies of scale and all that front. But there’s kind of a problem here with this acquisition and that’s that Alaska flies Boeing planes and Virgin flies Airbus planes.

Ben:                 Exclusively Airbus, their entire fleet.

David:              Yeah. Alaska only flies Boeing and Virgin only flies Airbus. You might say as a naïve consumer, as I did before I started looking into this, like no big deal. I mean, they look like… it’s a plane. A plane is a plane, right? I get on it and it looks the same. Well, it turns out that actually they have completely different control systems and pilots who fly Boeing planes can’t fly Airbus planes, and pilots who fly Airbus planes can’t fly Boeing planes.

Ben:                 So it’s not like they’re going to be able to share pilots at all between these fleets.

David:              Not going to be able to share pilots and, of course, all the maintenance and all the parts are completely different.

                        Now, the other major airlines do use a mixed fleet of both.

Ben:                 Except for Southwest.

David:              Except for Southwest, yes.

Ben:                 So Southwest is entirely Boeing 737’s because they realized that a part of their business model was going to be staying as lean as possible and keeping everything totally interchangeable and swappable.

David:              That’s actually been a big part of their story to Wall Street and investors about why they’re a great company. That’s been kind of a pillar of it. Alaska had the same playbook. Now all of a sudden, they’re like a 50-50 shop of Airbus and Boeing.

Ben:                 Yeah. From a heartstrings perspective too, how dare a Seattle company buy a company that’s entirely Airbus planes? That’s just not patriotic.

David:              That’s much sorted in history on Seattle and Boeing and perhaps for another show.

Ben:                 Yeah, yeah.

David:              So yeah, and I think that actually segues into what usually is a short segment for us and I think we’ll probably be short here of what would have happened otherwise. Here, clearly, the otherwise… I mean, Virgin was going to be acquired and the otherwise was JetBlue had acquired them. Now, JetBlue is also an Airbus company, so it would have been a lot easier for them to realize cost synergies.

Ben:                 Yeah. There’s two points I want to make here. One, Virgin is sort of only recently profitable, I think. So they launched in 2007, took them three years to have their first profitable quarter. They’re struggling as pitching themselves as both a low-cost airline and an airline that has a really premium service.

David:              Yup.

Ben:                 I think that they were better at adhering to the premium service than they were to the low cost, but that’s a tough story to sell to consumers. I think they were struggling with how to be both because you can’t both be a Volvo and a Cadillac, and have that story be sustainable and enduring. So I think that Virgin didn’t necessarily need to sell. They were definitely in the right place, right time where they had exactly what…

David:              They got an 80 percent premium to the pre-acquisition share price. That’s pretty good.

Ben:                 Yeah, yeah. Good on them for their M&A positioning, but that seems like a little bit of a precarious position. At prior scrap labs, a lot were thinking about starting these companies, I think I would get a lot of crazy looks if I was like, “Well, we’re going to be a low cost premium company.”

David:              It reminds me of, I’ve been reading… another could have potentially been my carve-out, but won’t be, I’ve been listening on audiobook to a great book called Business Adventures. It’s a classic. I believe it was written in either the ‘70s perhaps. It was recommended to me by a good friend and I’ve been listening to it, and it’s just 10 vignettes of more and more aptly titled Business Misadventures. The first one is about a stock market crash in the ‘60s. But the second one that I’m listening to now is about the Edsel, the car that Ford launched that’s widely considered the worst product launch in history.

                        One of the key lessons from it is that Ford wanted the Edsel to be everything to everyone. They say like “daringly adventurous with a dash of conservative.” It’s like, “What? Are you kidding me?” “It’s an elegant luxury for the aspiring young executive and affordable for the middle market,” and it’s like, “What?” And it failed spectacularly.

Ben:                 Yeah, yeah. I’m not over here preaching that that was going to be Virgin’s path, but that was always sort of a head scratcher maybe about that company.

                        Now, the question that I want to pose to you is: What would have happened to Alaska with all the consolidation in the market going on and kind of moving four major players?

David:              And the pressure from Delta.

Ben:                 The pressure from Delta on the home front. What if they don’t expand?

David:              Yup. I think to give some credit to Alaska, I feel like we’ve been taking potshots of this deal, we’re in a tough position I think. Doing well in the moment but facing this pressure from Delta, this consolidation across the whole industry and they had developed a really, really nice niche here in Seattle as by far the best routes and customer service for people who live in Seattle and flying in and out of Sea-Tac with great business routes. But they had nowhere to go. They were getting pressure from Delta here. It was super hard for them. What are they going to do, expand internationally? Are they going to go to other cities?

                        And that’s what they did with this. They said, “We need to grow. It’s going to be super hard to do organically. We have a great balance sheet and for an airline, a lot of cash. We know we’re relative to the industry pretty well run. Here’s an opportunity to buy Virgin and basically double our size and run the same playbook again.” Or they could have just stayed in a steady state where they are.

Ben:                 Well, it’s funny. You would hope that they double their market size because the acquisition is so expensive, but when you look at the numbers of what Alaska is doing and what Virgin is doing, Alaska has 32 million total passengers a year, Virgin has 7. Alaska has a thousand departures a day, Virgin has 200. There’s 112 destinations served by Alaska, Virgin has 24. Pre-tax profit from Alaska is at $1.3 billion, Virgin $200 million. So, that is an expensive purchase for a much, much smaller operation.

David:              Yeah. And a much smaller operation with no room to grow in San Francisco.

Ben:                 Yeah.

David:              Not just SFO but the other airports in the Bay Area, too – Oakland and San Jose, which they’re really commuter airports, although pro tip for Seattle to Bay area commuters: never fly to SFO. You always got to do Oakland or San Jose because if you do SFO, there’s so much fog and fog delays, and they always delay the Seattle flights because they want the cross-country flights to land on time. Got to do Oakland or San Jose.

Ben:                 Pro tip.

David:              Pro tip. Anyway, but there’s no room to expand with any of these airports.

Ben:                 Yeah. All right, let’s move on to our next section. What tech themes does this illustrate for you?

David:              Yeah, this is a really interesting one. I debated a lot of ideas here and it’s ironic because this is not a technology acquisition. But actually, I’m going to go with niche marketing and again, even though we’ve been taking potshots against this deal, both Virgin and Alaska before the merger really succeeded at this. In a crowded marketplace with lots of big platform players and the big national carriers, they found a niche – Alaska here in Seattle and with business travelers, and Virgin in San Francisco with quality of service and style-minded customers. They served it really, really well. The group, very big businesses out of that. I mean, combined obviously the price for Virgin at $2.6 billion and… I can’t remember, what was Alaska’s market cap before?

Ben:                 Oh, their stock actually went down on announcing acquisition, it’s about $10 billion now.

David:              About $10 billion. These are great businesses and I think that same principle totally applies in technology and people, especially startups, often overlook it. They try and go after the Delta or the United or the Southwest on day one. They try and go after Google on day one. You’re not going to be Google on day one. The way you’re going to be Google down the road is you start with a small audience, a small niche of people who love you passionately and then you grow from there. Then you knock down, in crossing the chasm speak, the next bowling pin and the next bowling pin and the next bowling pin. That’s much easier to do in technology than it is in airlines.

                        But the great thing about it is that you probably not going to become the next Facebook or Google. But if you knock down a couple of bowling pins along the way, you’re still going to become a really great value company and then maybe you got a chance to knock them all down and you will be Snapchat and become the next Facebook, calling it here.

Ben:                 There you go. That’s a good point.

David:              Does that analogy also apply to the brand loyalty aspect of airlines? Which they have huge innovation…

Ben:                 Yeah, invented loyalty.

David:              In the inventing the loyalty and the airline miles and status.

Ben:                 So you’re postulating that in order to capitalize…

David:              Are there other technology companies that have – probably not enough, there should be more – but that have taken that loyalty aspect where the more I use a platform, the deeper I get locked in because the more airline miles I have on it, for lack of a better word.

Ben:                 Yes, totally. I think that everybody that has done well at loyalty in the last 50 years has taken it from airlines. The question is do you need to…

David:              OpenTable definitely did.

Ben:                 Yeah.

David:              Quite successfully.

Ben:                 I guess I’m wondering do you need to…

David:              That will be a great acquisition to cover at some point.

Ben:                 OpenTable?

David:              Yeah.

Ben:                 Yeah. I’ll add it to the list. Yeah, I’m trying to think about is it necessary? Has something changed in the world where it’s necessary to consolidate to keep loyalty? Does something exist now that didn’t exist before where people only ever want to use one airline?

David:              That’s definitely the case in technology. I think about the power of network effects like HipChat, right? Two years ago, a bunch of our portfolio companies used HipChat and some of them used Slack and some of them used HipChat. I talked to people using HipChat and I’ll be like, “You should really check out Slack.” They’d be like, “We use HipChat, it’s good enough.” But then as their friends and other companies got on Slack and then Slack channel started popping up for industry groups and whatnot, then it was like, “Well, we should really think about moving to Slack.” Then this parallel takes over and being on…even if I think Slack has done a lot of great product innovations, but even if it hadn’t, you would be pushed to move towards it even if you’re on HipChat because the rest of the world is on it.

Ben:                 Yeah. It was Slack I think that the network effect was because people were starting inter-company Slacks so you would end up with like, “Oh, I’m in this Slack,” that’s like a social thing or an industry thing. Then it was like, “I’m not going to keep using two separate applications.” So, does that apply here where, “Oh, I’m not going to maintain points in two separate loyalty programs,” because that was always super annoying. There were a few startups that I was trying out that we’re trying to aggregate my loyalty programs for me or at least help me keep track. That was total pain.

                        To segue off of aggregator onto another technology trend, let me think through this and see if this logic follows. So, sites like Kayak and Hipmunk and all these Travelocity and Priceline, travel aggregators pop up.

David:              Yup.

Ben:                 That’s 15-20 years ago. That effectively commoditizes airlines and compresses their margins because people’s loyalty to those airlines is shaken because they have an easy way to find cheaper prices. So therefore, margins are driven down because airlines get more commoditized and when they’remore commoditized and there’s less profits that you’ve had even though they weren’t making a lot of profit before, they need to consolidate to create a cheaper back office, taking economies of scale. Now, if you’re a smaller airline, the inefficiencies from you having a smaller operation could kill you.

                        So if you follow it all the way back to the online travel aggregators, does that create the environment in which you need to have a bidding war for this acquisition so that you could be a more major player in a consolidate market?

David:              Yeah. That’s interesting. It’s different because it hasn’t fully become a digitized industry, but it’s reminiscent of Ben Thompson’s aggregation theory where aggregating a consumer endpoint and experience, he argues, in the digital 21st Century post-internet world, is where all the value is. Then you can aggregate all the difficult content creation behind that… content creation but in this case, airlines like point to point travel, and own that relationship with the customer at the front end. Then you commoditize everything on the backend. That’s completely happened.

                        Interesting, Southwest has refused to participate in the aggregators to let themselves be aggregated and probably has some of the most loyal customers. I mean, their ticker symbol is LUV and they always talk about how much everybody loves each other at Southwest. Yeah, they’ve fought that actively and it probably and they’ve probably had the most success on the branding front.

Ben:                 Yeah, yeah. Why don’t we move on to rendering our conclusions?

David:              I think it’s that time.

Ben:                 Yeah. I think we’ve expressed our opinions laced in a bunch of comments throughout this. For me, I think the value has inflated both by the bidding war and by the fact that they bought something that had brand built into the market cap when they’re not necessarily a leverage and in fact have announced they’re not going to leverage that brand.

                        But, I think they needed to. I don’t think they had a lot of options and I think they both picked the time right when this was an available purchase. They put themselves in a really good position to make that purchase – I’m probably the wrong person to talk about this – but by putting their books in a great position over the last 5 years and being really intentional about being an investment grade or having investment grade credit. I think that JetBlue didn’t prioritize that as much and neither did any of the smaller airlines and in a world where they need to consolidate, they had put themselves in the position where they’re able to do so.

                        So, I’ll give it a B minus.

David:              Yup. It’s hard to separate out just, at least for me, coming from the tech industry this sort of shock looking at the terrible economics of the airline industry as a whole in dynamics versus the actual quality of decision-making in this acquisition. So I think a lot of what you said, I agree with. But I’m going to go lower. I’m going to go C minus because what you said is right, but they paid so much money. They paid so much money! I don’t think it’s public and I don’t know that anybody except the executives involved know what Alaska’s initial bid for Virgin was, but it got bid up so many times and that’s a large price for something that your pilots can’t fly.

Ben:                 Can an airline make a good purchase?

David:              Yeah. Good point, good point.

Ben:                 Yeah.

David:              All right. Should we move on to the carve-out?

Ben:                 Yeah. So this is wild. I was stopping myself from laughing and my jaw dropped and I think it almost ruined David’s train of thought earlier when he started talking about how it wasn’t going to be his carve-out but it was a paper that Michael Mauboussin wrote about this. I picked my carve-out as a Michael Mauboussin talk that he gave at Google.

David:              Oh, this is so good. Everybody should watch this talk, it’s really good.

Ben:                 David, this is so weird. I haven’t watched this in probably two years and it was something that I’ve recommended to friends very often and so I was sitting here before the episode thinking I didn’t see anything particularly interesting this week that I wanted to recommend, but I have an oldie but goodie. It is absolutely wild.

David:              This talk is great and it’s based on a book. I’ve read the book too which is worth reading, too, called Untangling Luck and Skill.

Ben:                 Yup. Untangling Skill and Luck: The Success Equation, and it is so, so fascinating. He gives so many great examples that will make you both follow it logically and nod your head and sort of scared about how much of your own success has been out of your control or how much the world is out of our control. So how much of your own success cannot be attributed to you and how much of your own failure cannot be attributed to you, and trying to figure out what are things that you have perfected.

David:              Attributed to your own skill.

Ben:                 Yes, yes. And what are things that you actually should be focusing on and what are things that you should know that there’s going to be redness in the world.

David:              If you only have an hour, listen to the talk. If you really want to go deep on this, get the book. It’s so good. I will restrain myself, I could go in so many directions. But one real quick vignette I want to throw out is one of my favorite themes from this talk and book is the paradox of skill, which is such a cool thing that in a given activity… the whole premise of the talk and the book is that any activity, the results of which are going to be based somewhat on the skill of the participants in the activity and somewhat online. There’s a spectrum and some things go more towards the luck and some towards the skill. The paradox of skill is that even in things that are highly skill-based, as the level of play gets higher, so imagine the example, Mauboussin uses basketball, as basketball which is very skill-based. As the level of play gets higher and higher and the parody of skill amongst the players gets more and more uniformed, then luck plays an increasing role in the outcome, even though it’s a skill-based game.

Ben:                 Particularly due to globalization because the only people who are even considered for this are the best in the world. So then it’s like, well, among the people that are all the best that look very similar to each other in skill level…

David:              Yeah, the variation in skill gets so minute.

Ben:                 Then luck is magnified.

David:              Then luck is magnified, yeah. And the exact same dynamic holds true in investing in startups and lots of things.

Ben:                 When the world is the pool, you always are the cream of the crop and then it’s all about all the crazy dynamics that play off of there. So, can’t recommend it enough. It’s on YouTube. We’ll link it in the show notes. Definitely check out The Success Equation: Untangling Skill and Luck.

David:              I’ve taken enough time. I’m going to save mine for another time. It wasn’t super interesting anyway. I’m going to doubly recommend this. It’s so good.

Ben:                 All right. Well, there you have it. Thanks for listening today. Again, if you have the time, please, please, please leave us a review on iTunes. Can’t say enough how much it’s important to the success of the show and we love your feedback.

David:              And if you want to receive episodes by email going forward, just sign up on Acquired.fm and we’re also now going to start publishing the show by email updates as well, if you prefer that channel.

Ben:                 It’s true. You can give us feedback on the website or Acquiredfm@gmail.com. See you later, everyone.

 

Episode 9: Writely (Google Docs)

Episode 9: Writely (Google Docs)

Ben and David continue the cloud productivity saga with Google Docs. They examine the suite of acquisitions made by Google with a focus on Writely in 2006. They tackle:

  • The nuts and bolts of the Upstartle (company behind Writely) acquisition, founded by Sam Schillace, Steve Newman and Claudia Carpenter.
  • SaaS offerings in cloud productivity today.
  • Was this a good idea for Google?
  • Google's future bets.
  • A new section: The Carve Out!

Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or just-plain-hilarious transcription errors)

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