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:
The Carve Out:
Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)
Ben: Welcome back to Episode 25 of Acquired, the podcast about technology acquisitions. Today’s episode, we’re trying something new. We’re piloting a new idea, analyzing IPO’s, in addition to our normal acquisition format. When we started the show, our goal was to understand what made an acquisition go spectacularly well. And over the past 24 episodes, we started zooming out and asking ourselves exactly why that is. Both David and I are really trying to understand how to create big enduring companies, and we know that’s why a good chunk of our audience listens to the show. Oftentimes you can have these huge, successful acquisitions but that’s not the only goal. The goal, for us and for many entrepreneurs, is to create lasting value. As we thought about what direction we wanted to take the show, it became more and more clear to us that we should be looking at companies that don’t get acquired but go all the way to going public. And really, these are even a better example of building hugely valuable companies. So today, we’re starting with a monumental IPO in recent history: Facebook.
David: Dun, dun, dun…
Ben: Oh yes.
David: I’m really excited for this and I hope you guys are, too. Not that we’re going to stop doing acquisitions, but we thought this was, as Ben said, just a great direction to take the show. So, let us know what you think in the Slack channel, by email, on Twitter. We love feedback here at Acquired.
Ben: Very true. And in typical… I mean, both of us are very involved with early stage companies and in different facets, and in kind of typical customer validation, customer development format, be harsh. We love all your criticism, and we want to make Acquired the best show possible for you, guys.
David: Yes. It helps us make the show better.
Ben: True that. All right, you want to go into with IPO history and facts?
David: With that, this is an epic one to start with. So, I’m going to assume that most of our audience is familiar with the Facebook founding story. You know, if you’re not, we highly recommend you go watch The Social Network.
Ben: Or if you’d like a less fabricated version, the David Kirkpatrick book, or there’s a variety of good resources and we would do a much worse job telling that story here than you could get elsewhere.
David: Yes. Much ink has been spilled on that front. But suffice to say, that Facebook was founded in 2004 by Mark Zuckerberg, Eduardo Saverin, Andrew McCollum (the forgotten Facebook founder), Dustin Moskovitz, and Chris Hughes. A whole bunch of stuff happened, including turning down several acquisition offers along the way. Most notably, a $1 billion acquisition offer by Yahoo in 2006, just when the company was 2 years old, sort of foreshadowing Instagram in years to come. I think Mark has talked about turning down that acquisition being one of the pivotal moments in the history of the company.
Ben: And that’s the kind of like crisis moment in the bathroom. I think there was a point there where he… I’ll have to check my facts on this and we can do it in followup. But I think this is the one where it was over dinner and he ended up in the bathroom looking at himself in the mirror and having this emotional crisis of “Oh my God, am I actually turning down a billion dollar offer?”
David: Yeah, crazy. But he did, and Facebook went on to much more than a billion dollars in value, so much so that if you Google the Facebook IPO and you find yourself on the Wikipedia page. There’s a whole Wikipedia page dedicated to the Facebook IPO. And right in the beginning, it refers to it as a “cultural touchstone”.
Ben: Yeah, and that’s no joke. I mean, it’s one of the largest IPO’s of all time.
David: Indeed, the third largest behind Visa and General Motors, but probably happier than those two since those were… at least General Motors was posed to financial crisis when the US government was re-IPOing it after the bailout.
Ben: Huh, but talk about enduring companies.
David: Yeah. So, let’s dive into it. In the late days of Facebook as a private company, which it’s been 8 years from 2004 until 2012 as a private company, it was a frenzy not just inside the company but outside the company. Everybody and their mother, literally, their mother wanted to be an investor in Facebook. And at the time, there were actually two ways, two sites that had popped up that would let you do that. There were these vehicles called SecondMarket and SharesPost, and these were startups themselves that facilitated trading private company stock. You had to be an accredited investor to do this. This was before the JOBS Act and before a lot of the new equity crowdfunding laws and regulations.
Ben: Did you have to be an accredited investor to sell or just to buy?
David: Just to buy. But employees could sell on these sites, and the vast majority of all volume of being traded on these sites was Facebook shares in 2010-2011. And this was starting to be a really big problem because now all of a sudden Facebook and other companies whose shares were trading on these sites, it sort of lost control of these shares, and they had all these shareholders out there who didn’t know who they were. And at the time, pre JOBS Act, the laws were that you had to have less than 500 shareholders as a private company. Once you had more than 500 shareholders, you had to go public. And so this was happening in Facebook more than any other company at the time.
In an effort to sort of try and also get under this 500 shareholder rule, in January 2011, Facebook separately did a rather infamous deal with Goldman Sachs that didn’t go so well. The first part of the deal went fine, and that was that Goldman invested $450 million itself in Facebook. That happened. But the second part of the deal, and that was at a $50 billion valuation, the second part of the deal was that Goldman was going to create a special purpose vehicle that was going to be one single entity, and then it was going to market to its private wealth management clients the ability to invest in this special purpose vehicle that was going to be a $1.5 billion in total, and then that vehicle would invest in Facebook. And so they sent this email out to select private wealth management clients of Goldman saying, you know, “opportunity of a lifetime”. It was like a Nigerian cash scam email that Goldman was sending out to their clients. They couldn’t even say the company by name. It was an unnamed high growth private company that they were offering the opportunity, once in a lifetime opportunity to invest in.
Ben: Wow. But you throw the Goldman brand behind that, and it seems like, yeah, sure.
David: Seemed like a good idea at the time and to Facebook too. Well, the SEC didn’t think of it as such a good idea. So the New York Times DealBook actually leaked/scooped that this was happening, and after that, the SEC started investigating and Goldman ended up… they still ended up doing the deal but they did it will all foreign clients, so they decided that it was too risky to have US investors invest in the deal. This was a huge, huge moment. Big egg on Goldman’s face and on Facebook’s face for what came across as really trying to skirt US securities laws. Up until that point, Goldman had been sort of top billing the running to be the bank that would take Facebook public.
David: And this basically killed their chances of being lead-left on the “IPO”.
Ben: For those of us kind of not from the industry, what is “lead-left”?
David: So when investment bankers take a – speaking as a reformed investment banker myself – when investment bankers take a company public, there’s usually a consortium of banks that underwrite the IPO. But there’s one bank that’s the leader and that’s referred to be as being “lead-left” which is on the cover of the prospectus of the IPO. The bank that’s at the top and on the left, is lead-left. They get the biggest allocation of the IPO. And it’s always a huge battle amongst the big bulge bracket banks for hot IPOs and there was never going to be any IPO hotter than Facebook to be the lead left. Not only because they’d make a lot of money from it but the prestige associated with that. Well, in theory we’ll see what really happened, live on for a long time. So because of these two things that were happening, there was immense pressure on Facebook to finally go public in the 2012 timeframe.
So, late 2011, they start preparing. They actually select Morgan Stanley, Goldman’s long-time rival, to be lead-left. They’re deep preparing for the IPO, and business is going great. For the year of 2011, they ended the year with 845 million monthly active users, 483 million daily active users. So doing the math on that, that’s over 50% DAU to MAU ratio, which means over half of Facebook’s users used it every single day, which is just incredible.
David: And still to this day, there are so few products that are like that. And not just usage but engagement. So, they were seeing at the end of 2011, over 2.7 billion likes and comments per day, which is crazy. By the time they actually went public in 2012, they amended their S-1 filing to include Q1 numbers, and in Q1 2012, they saw 3.2 billion likes and comments every single day.
Ben: Which those likes and comments numbers, they like to put that in there. It’s like almost an unfathomable, ridiculous vanity metric, right? Because there’s nothing to compare it to and really, it’s hard to wrap your head around what that even means.
David: Well, but it’s engagement, right? People aren’t just opening the app. They are actually doing stuff in the app.
Ben: Right. Great point.
David: And in these days – we’ll get to this in a second – it wasn’t so much the app as it was the website on desktop. Not only, you know, things are going really well for Facebook at this point. Not only do they have these huge, unprecedented user base, unprecedented engagement, but they are making real money too.
Ben: Yeah, they were profitable by their IPO.
David: Very profitable. So, in 2011, they did $3.7 billion in revenue and over $1.7 billion in operating income, which is really incredible. You think of a private startup at that point in time. People had never seen a private company at kind of this scale of both revenue and profitability.
Ben: Right. Let’s see. That’s a 45.9% operating margin.
David: Yeah. As we were talking about it before the show, hiring Sheryl Sandberg to build advertising at Facebook was one of, if not the best, decision that Mark Zuckerberg ever made.
Ben: Yeah. This is worth a quick little story, but before March of 2008, Facebook didn’t have Sheryl Sandberg kind of at the helm as COO. And they had no ad product.
David: Yeah, they’re just running banner ads.
Ben: They cut some deal with Microsoft. Mark was totally allergic to cannibalizing the purity of the site with advertising. In March of 2008, Sheryl Sandberg came in, and her goal and her charter was make the company profitable. So before she joined, “the company was primarily interested in building a really cool site.” Profits, they assumed, would follow. In late spring, Facebook’s leadership team finally agreed that they were going to rely on advertising with the ads “discretely presented” and then it was kind of her charter over the next 3 years to actually build an in-house competency coming from Google of a real ad platform.
David: Of a real advertising platform. And in 3 years to go from, you know, essentially nothing. Like they were making plenty of revenue but it was low quality revenue from banner ads. To go from essentially nothing to almost 4 billion in revenue and almost 2 billion in profit?
David: Totally wild. Interestingly, this is a fun side fact, this was the days of the Facebook platform and games on Facebook and particularly FarmVille. They noted in their S-1filing that Zynga alone represented 15% of Facebook revenue at the time of the IPO.
Ben: That’s a huge risk.
David: Yeah! That was in the risk factors. So as we’re alluding to, things are going great. February 1, the big day, the day that everybody in tech has been waiting for, Facebook files its S-1 which happens– Now it happens before you go public, you file your registration statement, the prospectus for going public. In those days it happened even longer before the actual IPO happens. Now it’s a fairly short time period after some of the changes made in the JOBS Act.
So February 1, they file. Morgan Stanley is lead-left banker. Then showing how far Goldman had fallen just a year earlier, they were in the poll position to be lead-left. They actually get demoted to third. So JP Morgan is second and Goldman is third. So this was a big, big demotion for Goldman. But as we shall see, Morgan being lead-left on the Facebook IPO, wasn’t necessarily the golden egg that the banks thought it was.
So things are great, but there’s one problem with Facebook right now.
Ben: What’s that?
David: And that problem is mobile.
Ben: Yeah. So fascinatingly enough, in their S-1, when they’re listing the summary risk factors to the business – this one’s incredible – one of the risk factors is growth in use of Facebook through our mobile products, where we do not currently display ads as a substitute for use on personal computers may negatively affect our revenue and financial results. So, the risk factor they’re identifying here is not that we don’t know how we’re going to monetize the phone, we haven’t rolled out phone ads yet. The risk is that people start using mobile products more than desktop products, and we don’t have a revenue model there.
David: Yeah. They literally had no revenue model. So, two aspects to this very huge problem for Facebook right now, the mobile problem. One is a usage and engagement problem. And we just talked about this incredible usage and engagement metrics that they had, but that’s all on desktop. On mobile, they have mobile apps for Facebook, but these are the dark ages of HTML5, and the misery of the HTML5 mobile Facebook app which was so slow, basically impossible to use. And as a result, only about half to slightly less than half of Facebook’s users were active on mobile.
Ben: And like fascinating to think about all the implications to mobile being an afterthought. When you open the app, the newsfeed as we know it today, was not one unified newsfeed where you would see the same thing on the mobile app that you would on desktop. It was like you would see a completely different set of information, like a different algorithm determining what you would see, served down to you a different way, cached in a different way, obviously not nearly as responsive. Philosophically, they wanted to be able to move faster by dynamically controlling the HTML that was served down without having to resend it to the app store.
David: Right. And not making a bet on, you know, this was as we’ve talked about on the show, the age of the mobile platform wars; and is iOS going to win or Android, and they thought they could be really flexible by having this HTML5 app that was one app that would get put in a wrapper and shipped to both app stores. But yeah, it was not working.
David: And it’s funny even doing the research for this episode. I read a bunch of articles about this and I remember doing this. A lot of people, rather than installing or using the app on their phone for Facebook, they would go to m.facebook.com and use the mobile web because it was better than the crappy app that they had.
Ben: Yeah. Shocking.
David: I mean, this was in tech years, 4 plus years ago, 4 ½ years ago, a long time, but it’s not like the mobile ecosystem was undeveloped at this point in time. There were apps like Uber existed. There was no excuse for not having…
Ben: I think Twitter had already bought Tweetie, so the iOS client for Twitter was exceptional at the time. Tweetie became the native app. To put this in perspective, where they had no ability to monetize on mobile at this point and they –
David: So one-half of the huge gaping chest wound that Facebook had at this point was the app sucked. Then the other half was they had no monetization. They made no money from mobile.
Ben: Right. To put that in perspective today, David will tell us the story of kind of everything along the way. Facebook’s earnings came out a couple of weeks ago and mobile advertising revenue represented 84% of ad revenue for the quarter.
David: So that was the third quarter of 2016, as we’re recording this today.
David: And it’s basically the entire business today. So the story of how we got there is massively tied up in the Facebook IPO. And actually even just a couple months later after the IPO in September 2012, Zuckerberg was onstage at TechCrunch Disrupt that year and he said “the biggest mistake we’ve made as a company is betting on HTML5 over native in mobile. That’s how much over a few short months he realized what a big problem he had.
Ben: Wow. It’s probably worth before diving back into the story to set some context on the numbers here. So, IPO, biggest in technology history, you know, third largest of all time. The market cap for Facebook was 104 billion.
David: Which we’ll get into in a sec.
Ben: Okay, cool. Yeah, why don’t you just dive in then.
David: Okay. So we’re still on the road to IPO and it’s now April. Facebook has been working on its roadshow and presenting to investors, large institutions who will buy into the IPO. And on April 9, 2012, they come out with a rather shocking announcement at the time that we’ve already covered on this show in one of early episodes, and that is in fact our benchmark of what a great acquisition is. They announced that they’re acquiring Instagram. And we talked about this a little bit on the episode. But just to step back again here and put this into context of how crazy this was, that Facebook had filed their S-1. They’re in the process of going public and they acquire a company that has 13 employees for a billion dollars. This was just crazy. But, underscores how much, how Mark and Sheryl and the team were coming to realize how big of a problem mobile was for them. And the entire rationale for the Instagram acquisition was around bolstering their story and their user base in mobile.
Ben: I remember trying to rationalize this at the time and talking to friends. I think we even talked about this on the Instagram episode that there were a few things that Facebook held near and dear, one of which was being the source of platform andidentity, and that was quickly becoming really important to them to get a foothold in, that everybody sort of needed a Facebook as infrastructure on the internet. But the killer app for Facebook was photos.
David: It was photo sharing, yup.
Ben: It’s what got by far the most engagement, it was nostalgic.
David: All those comments and likes, billions every day.
Ben: Yeah. And so, for them, to lose that foothold where that’s really their core strength, is this is where people share and engage and photos. That’s a total existential threat, especially when everyone’s attention shifting to mobile and they don’t have a credible offering there.
David: In this time leading up to the actual IPO, Facebook was, and most companies do amend their S-1, their registration statement quite frequently as new information comes up, and they’re working through feedback from investors and whatnot. Of course, they amend it for this acquisition that they announced. And it’s interesting, they say in the S-1 that they intend to continue operating Instagram as a standalone entity and product, which we talked about on our show. But, interesting that they actually put that in the S-1 for Facebook’s IPO.
But then they also say, this is after they talk about Instagram but in the same paragraph, “We believe that mobile usage of Facebook is critical to maintaining user growth and engagement over the long term, and we are actively seeking to grow mobile usage, although such usage does not currently directly generate any meaningful revenue.” This is how important they’re realizing it’s becoming.
Also, interesting side note that I found while I was doing research here. There was a breakup fee on the Instagram acquisition of $200 million. So if for whatever reason the acquisition didn’t go through, Facebook would have paid Instagram $200 million.
Ben: Wow! That’s enormous. Because Instagram, like a lot of that time, you’re going to have a breakup fee like that because of the incredible cost that you incur by, you know – opportunity cost, negotiation, and like the time.
David: Usually, you see those things often when it’s like a public company acquiring another public company, it’s impacting the stock price… But this was a 13-person startup.
Ben: Right. And it’s not like when we were talking to Zillow’s CEO, Kathleen Philipps, how like the negative signal that it could send to the market to Trulia’s shareholders and to Trulia’s incredible number of stakeholders from the advertisers to all the people that depended on them. Like, Instagram didn’t have a lot of stakeholders. Instagram didn’t have a high opportunity cost through other things they could be doing at the tune of $200 million. It’s not like they even had more than a few people working on the acquisition. It was Kevin and Mike talking.
David: And some very excited VCs on their board.
Ben: Yeah! No kidding. Wild that it's that high.
David: So, things keep moving along in the process. On May 9, Facebook files the sixth amendment to its S-1. We’re going to come back to that in a minute. Things keep going along. And mid-May, they decide that they’re going to set Friday, May 18 as the day that Facebook goes public.
So the start of that week, though, there’s an inauspicious start and that’s at the beginning of the week, GM (General Motors) – that we’ve already talked about on this episode – announces that they’re going to stop all advertising on Facebook because it’s not actually working that well for them. They’ve been spending $10 million a year with Facebook.
Ben: And they wanted flashier ad units. I mean, their major complaint was, “look, on all these blogs they are letting us take over the whole back page, we can slide stuff in from the sides, we can get this big header that pushes all the content down, and all we get are these crummy, little static ads on Facebook on the side.” And I don’t know if they had started newsfeed ads at that point, but either way, the ad formats on Facebook have historically been so much more limiting than the kind of arguably user-hostile things that you get across the advertising ecosystem on the web.
David: Yup. But, you know, no matter. Ten million dollars? That’s a big account. But Facebook made $3.7 billion the past year. So a drop in the bucket, things proceed. The night before the IPO, Thursday night, Facebook holds an all-night hackathon leading up to the IPO and then in the morning, everybody’s been up all night and the whole company rings the bell for the NASDAQ remotely from California, and Zuckerberg pushes the button. Big fanfare. Then, the company is supposed to start trading. So they price the IPO the night before; they price at $38 per share, which gives Facebook a market capitalization of $104 billion at IPO. Again, unprecedented in technology history.
Ben: They sell enough shares to consist of how much value?
David: They sell 421million shares at $38 a share, raising $16 billion in the IPO and about half of that, the company keeps and about half of that is selling shareholders that are monetizing their shares.
So, Zuckerberg presses the button. In the morning, everything is supposed to begin trading and actually, when companies go public on the NASDAQ, they actually delay trading a little bit so that at the open, the stock do start trading right away, they have a little time to make it orderly because usually there’s a lot of interest in IPOs and a lot of trades are happening.
Facebook was supposed to start trading at 11:05 AM EST on Friday, May 18. 11:05 comes, people are placing trades, no trades are happening. The NASDAQ is broken. Facebook has literally broken the NASDAQ. Everything is functioning for all other stocks. But what NASDAQ would later describe as a “technical error” occurs and this just unleashes mayhem on the Facebook stock. Traders are placing orders and they don’t know if they’re going to get filled at all. Plenty of orders placed during this time period aren’t filled.
Ben: Or if they’re going to get filled with the wrong price.
David: Or if they’re going to get filled with the wrong price, so a lot of orders actually get filled at the wrong price, at a higher price than what people were placing them at. This is a disaster of epic proportions on NASDAQ’s part. And actually ends up contributing… this really hurts NASDAQ.I mean up until this point, NASDAQ had always been the place for technology companies, and all the tech companies were on the NASDAQ and the old school companies were on the New York Stock Exchange. After this, I mean NASDAQ still has plenty of tech IPOs but the New York Stock Exchange really makes a push.
So when Twitter ends up going public, they do it on the New York stock exchange; Fitbit, Grubhub, Zendesk. Lots of tech companies are now using the NYSE, and a lot of it is because of this. So it’s pretty bad and eventually, NASDAQ actually settles two lawsuits. The SEC files a suit against them. They pay $10 million to the SEC and then a shareholder class action lawsuit against them because of this, for people who lost money in the Facebook IPO. And NASDAQ ends up paying $26.5 million to shareholders as a result.
David: So once it all gets sorted out though later in the day, Facebook does begin trading. And it’s pretty clear that things are not going well. The stock ends the day at $38.23, so up 23 cents from offering price. But that’s a really bad sign because that means they didn’t get a pop from lots of excess demand and people wanting to buy the stock. And what that usually means and this is what happened in this case, that the underwriting banks ended up supporting the stock because they’ve staked their reputation on this IPO, they don’t want to let the price fall below the offering price, and so Morgan Stanley, JP Morgan, Goldman Sachs end up buying a lot of shares to support the price on this first day of trading.
Ben: Well, that doesn’t sound sustainable.
David: No, and it doesn’t because the next trading day, which is the following Monday, it’s a blood bath. So, market opens on Monday and within 15 minutes of trading starts, Facebook is down almost 14%, which doesn’t sound like a lot, but stocks don’t move 14% in one day.
Ben: Also, if you think about it, that means that like $15 billion of market cap was destroyed.
David: Just erased immediately. I mean, that would be like if the whole market moved that much, that would be like the Dow losing 2000 points in one day. And this is the second day, Facebook’s second day as a public company.
Ben: That’s like destroying 14 Instagram’s.
David: Yeah! Immediately. So, not good. It’s so not good that it actually trips what’s called a circuit breaker that stock exchanges have built into them that if a stock starts really getting pummeled like this, they’ll stop trading in it, so that’s short selling –
Ben: Just for that stock?
David: Just for that stock, yeah. So that short sellers can’t aggressively bash the price down. So this is really bad, and ends up closing that day at about $34 a share, which is down 11%.
The next day on, I guess, Wednesday, two days later, the stock opens, closes down another– Or sorry, Tuesday, closes down another 9% at $31 a share. Wednesday, the stock opens and news hits that Facebook is getting slammed with a shareholder lawsuit because news has leaked that that sixth revision that Imentioned to the S-1 prospectus a couple of weeks before the IPO, well, it turns out that there was actually a little more to that story than just revising the S-1 and what happens is that, that was the first day of the official roadshow for Facebook on May 9. And Mark, Sheryl, and the executive team were doing the roadshow and at the end of the day, David Ebersman who was the CFO of Facebook at the time, takes Morgan Stanley aside and says to them, “Hey, we’re actually going to lower our guidance for what we expect revenue and earnings to be for the second quarter.”
David: And you don’t do this when you’re on your IPO roadshow.
Ben: That’s private information.
David: Well, it's private information but (A) you don’t… so they were giving guidance as part of the roadshow to institutional investors, sort of like, you could think of it like practicing your earnings calls but investors are going to want to know what management’s outlook is for the future.
Ben: It’s practicing your earnings call but to one shareholder and not all the other people who are –
David: Well, right. Given the first part of a roadshow with the old estimates and so now they have to figure out what to do. But the other thing is you don’t lower your guidance during the roadshow. You lower it before you go out on the roadshow. Once you started –
Ben: What would you do in this situation if you've gotten news that it’s going to come in lower if you were in the middle of your roadshow? How do you fix that?
David: Well, you probably don’t do what Facebook and Morgan Stanley did, which is that they decide that they’re going to call the equity researching analyst that are going to cover Facebook and they’re going to disclose this news. The reason for this, by the way, is that mobile was really hurting them. So they were terrified that they were going to come in below expectations because they were behind on mobile, and people were switching over to mobile faster than they could get products out the door and get monetization done.
So they call up their research analyst, but they called the research analyst of the underwriting banks, and they tell them that they’re going to revise earnings down. And so, the underwriting banks – Morgan Stanley, JP Morgan, and Goldman – they all call their clients, their institutional investors which are mutual funds and hedge funds, and they tell them “Hey. Facebook, you know, this IPO that’s going to be the IPO of the century next week, they actually just revised their forecast down.” So you've now got this situation where the public has no idea that any of this is happening.
Ben: But all the big institutions know.
David: But all the big institutions know, all the clients of the banks that are doing the underwriting for the deal. And so, we find out much later but there was a huge amount of short selling pressure on the Facebook stock at the IPO because all these banks are, like, well now there’s information asymmetry, like I know something you don’t know.
Ben: They should capitalize that on behalf of their clients.
David: I mean, that’s what they do.
Ben: So is what they did a securities violation? Is that legal?
David: Well, it’s very much a gray area. And, actually Facebook never gets in any trouble for this, but Morgan Stanley takes a big reputational hit and ends up settling a lawsuit actually with the Massachusetts state regulators. I’m not sure it was Massachusetts and not the federal SEC. But the only lawsuit that ends up getting settled… and it's not that much money, Morgan Stanley pays $5 million in the settlement to Massachusetts for this. But they tacitly admit wrongdoing here, and this is a big oopsy for them.
Ben: Yeah. It’s crazy thinking about it in these like highly controlled environments like this that a side conversation like the two of them had can create ripples of that magnitude.
David: Well, when you’re talking about a $16 billion IPO that is literally the biggest in technology history, and you’ve just created this information asymmetry and that’s going to be the most watched by all parties, including the SEC, of all time.
Ben: Well, when you phrase it that way, David.
David: Yeah. Not an auspicious beginning. So, all told, when all this is done, the first 2 weeks of Facebook as a public company are terrible. The stock goes down during 9 of the first 13 trading days. And by the end of May, so 2 weeks after the IPO, Facebook had lost a quarter of its value. And remember, an IPO at a $100 billion market cap. So, $25 billion in value just wiped out.
David: The Wall Street Journal calls the IPO a “fiasco”. And so then, what do you do? So now you’re the company, you’re Mark, you’re Sheryl, you go from being the most hyped IPO in history to literally a “fiasco” with all these shareholder lawsuits flying around.
David: You've got this “gaping chest wound” of not figuring out mobile.
Ben: Yeah. So to me, there’s 2 things going on here. One is the PR thing that you have to manage, and the entire financial ecosystem that you’re now a part of and you really have to, weave carefully here on, you know, your next few quarters are going to be watched so carefully, you've taken a huge reputational hit, people are afraid of buying your stock, other people are opportunistic in getting in and feeling like it’s maybe a little risky. But then the other thing that’s kind of going on here is, you know, Facebook just needs to inwardly look at their product and this is really what they do, is say, “look, all of these symptoms that are happening in the financial market are because of the problem that, one, we don’t have a credible, like a great mobile experience; and two, everyone is shifting to mobile anyway, even with our crummy experience and we don’t have an ability to monetize there.”
The interesting thing is it doesn’t take them too much longer to actually launch, which I’m sure you’ll tell us about in a moment, to launch their mobile ads product, but like, it is so interesting that as a management team, they kind of took a step back, focused on the fundamentals, focused on improving the product, focused on serving their customers, and actually rebounded from this with very strong step into mobile.
David: For me, and we’ll get into grading in a minute here, this is the defining moment for at least the public company part of Facebook’s journey. This is why they are a great company and why Mark and Sheryl are great leaders. I mean, it would have been so easy to hit the panic button with everything going on here. The amount of pressure was just immense. But, they do exactly what you said. They spend the rest of the summer completely focused on mobile, and this is when you hear about Facebook has a very unique corporate culture, they have essentially like a propaganda department that makes posters and puts them up around campus in Menlo Park, and posters all of a sudden went up all over campus like “mobile is our future” and they get the whole company in the period of just one summer basically completely focused on mobile. They spend all summer working on native apps.
August 23, they release their native iOS app. The native Android app comes a little later. Then shortly thereafter, it’s not like they release that and the market is like, “Oh, great. Problems are solved.” On September 4, Facebook hits its all-time low at $17.73 a share, which puts their market cap at about $49 billion. So, they just lost $50 billion of market cap. This is really the depth here.
David: But they release a product, it’s a great product, people love the iOS app, and more importantly, it has the ability to insert ads into the feed. And now, the age of the native ad and advertising into Facebook feed on mobile is born and kind of like a Phoenix rising from the ashes, it’s just incredible. So, they don’t turn on advertising in Q3. But Q4 of 2012, they do turn on advertising on mobile and they go from literally $0 to 23% of the entire ad revenue for the whole company comes in via mobile in Q4.
Ben: Wow. Which is amazing because when you think about where they have transformed to today, they basically have cracked advertising on mobile. I mean, the newsfeed ad unit is like the best ad unit. I think that when we shifted to mobile, everybody tried to move their banners down to tiny little banners, and that didn’t work very well.
David: Yeah. I remember like Millennial Media and iAd.
Ben: Oh, yeah.
David: The AdMob and all that stuff.
Ben: Oh my God. iAd launched my career. Did I ever tell you that story?
David: That’s right!
Ben: Yeah. In Seize the Day, we benefited from Apple.
David: Which is an app that you build while you’re in college, right?
Ben: Yeah. It’s kind of one of the early To-Do List in the store. We launched and we’re one of the first partners to have iAd in there.
David: What a crappy ad format.
Ben: We had ridiculous CPMs and Apple featured us. I think Nissan Leaf was one of three advertisers that actually bought– Anyway, so banner ads didn’t work very well. Apple since iAd, a lot of publishers are moving to just putting their square desktop ads in the middle of articles. People are getting closer with these sort of like native ads embedded into publisher formats.
David: But what really works on mobile is Facebook ads.
Ben: Is a native Facebook ad. When you’re scrolling through that newsfeed, well, you scroll sort of or you stop at every story to pause and look at what it is, and for that brief moment, the advertiser has the opportunity to take over your entire captive attention in a way that they never could on desktop. And Facebook cracked it. The fact that 84% of their revenue today and as a hugely successful company comes from mobile advertising, is a huge testament to them turning it around.
David: They cracked it. I mean, in a period of about 6 months, while going public, and while acquiring Instagram, they basically invented the mobile ad industry. I think a really nice way of putting a bow on and tying up the Facebook IPO story is that the next year, at TechCrunch Disrupt 2013, so in 2012, Zuckerberg said in an interview on stage that HTML5 was the biggest mistake that he had made in the history of the company.
In 2013 TechCrunch Disrupt, Michael Arrington asks Zuckerberg onstage, you know, “So how about that IPO?” And Zuck says, this is a quote he says, “I’m the person you would want to ask last on how to do a smooth IPO.” And this is a year later, he says, “But it’s actually a valuable process having gone through a terrible first year, as it made our company a lot stronger. You have to know everything about your company. It took us to the next level, and we run our company much better now.”
Ben: Pretty interesting.
David: Pretty interesting, yeah.
Ben: Should we go into ‘what would have happened otherwise’?
David: What would have happened otherwise?
Ben: Well, I think is kind of a natural point of segue because in one of the things that I was thinking about in ‘what would have happened otherwise’ is sort of three things that you get when you IPO. Three sort of like, advantageous components to it. The first is, an influx of cash. Obviously, Facebook is going to raise $6 to 7 billion in cash that goes directly to marketable securities or cash on hand for the company. The rest obviously goes to existing investors who are cashing out.
The second is the fact that if they’re going to do M&A transactions in the future, having public company stock way more valuable than difficult to value part of company stock.
David: Not necessarily more valuable, but the industry term is it’s a liquid currency in that you can assign value. You can say like one share of Facebook stock is worth X on the public market. I can tell you with certainty it is worth $17.73 on September 4, as opposed to, I don’t know… what’s a share in PSL worth, Ben?
Ben: It’s a little speculative at this point.
David: Yeah, exactly.
Ben: And that ties into our third too is, liquidity for shareholders. So, when you IPO, you've got all these employees that have been working for private company stock options for years, a lot of them having purchased them. And, you know, they can’t really get like where they can sort of use the SecondMarket.
David: Oh, using SharesPost in SecondMarket.
Ben: Yeah. So it's interesting that some of the trials and tribulations of the IPO can be attributed to the fact that there was sort of a value assigned to the company by the transactions that were going on in SecondMarket. But there were so few of them that it was a pretty illiquid marketplace. So you've got this very rough estimate of what the company is worth sort of setting and guiding what they’re going to IPO for and if they hadn’t IPO’d, you could have even more of this going on, and the longer they wait, the more difficult it gets because people are super anxious to get liquid on part of their compensation that they held for years. A lot of it, life-changing amounts of money.
David: Yeah. I think it’s a year that a lot of the clear bungling of the IPO was probably a result of just waiting too long and there was so much pent-up pressure there – pressure to perform, pressure to… the last round the Goldman had done, that they botched with letting private wealth management clients invest via the special purpose vehicle, that was at a $50 billion valuation. So, Facebook wanted to deliver a 2X return on that and wanted to hit the mythical $100 billion market cap. I think it was just a lot. Then they were forced to by SecondMarket and SharesPost and the lack of having the JOBS Act.
Ben: Which is funny, because you were saying that while they were on the roadshow is when the JOBS Act got signed.
David: Yeah. So the JOBS Act actually gets passed into law while they’re working on the IPO. So ironically, they could have avoided a lot of this pressure if they just waited a little bit. But, they didn’t know that at the time.
Ben: It really did seem like what would have happened otherwise. Like if they had stayed private, to their knowledge it wasn’t going to get passed and they shouldn’t count on it and they sort of were forced to IPO. If they had continued to wait longer, like actually we’re seeing a lot of companies do today, you run into these sort of issues where early investors need to get their money out and they’re going to, I don’t know, do big secondaries and you’re going to have the same sort of issues we’re having today with the super-unicorns which we should talk about in tech themes.
But, another big one that I think is worth talking about is the fact that they went under a tremendous amount of scrutiny by going public. Like this really forced management to understand every facet of the business and understand where their huge key risk factors were. I really think that the most interesting part of that S-1 is where they identify risk to the business because truly, they probably were working on some of the mobile advertising stuff beforehand, but it is a huge slap in the face and like a huge wakeup call to realize our business has an existential crisis on its hands. So many other companies got destroyed in the wake of mobile. It was interesting that Facebook was able to kind of like keep their head above water until they really kind of came out and thrived.
David: Yeah. I think it's such a testament to Mark and Sheryl leading this company to do that because it's kind of like a running joke in the industry that “risk factors” in S-1’s are like a joke. Like, “You have to put them in there so let’s make up some phony risk to our business that actually make us sound stronger.” But part of I think because of all this disaster that the IPO process became, they had to really answer to what this risk meant and they saw literally half of the value of the company evaporate before their eyes. And, what stronger wakeup call could there be to understanding that they had a big problem there to fix.
Ben: Right. I guess they could have priced lower and gotten the pop that they were looking for, maybe they just got ahead of their skeez a little bit and could have weathered this first year by pricing at 70%, getting a little pop up to like 75% and then over the next 18 months, then really kind of turning the gas on.
David: And it’s interesting. They definitely could have done that, but like to what would have happened otherwise, would they then have noticed with the magnifying lens have been shown as brightly on how big a problem mobile was. And would they have again fixed the product, fixed the ad model, fixed the monetization model, invented a new ad unit within six months.
Ben: Yeah. Pretty crazy.
David: Pretty crazy. All right, tech themes.
Ben: Yeah. Let’s do it. The biggest thing that I think we both really want to talk about here, we’ve chat a little bit before the episode, this totally changed the way that tech companies IPO.
David: It was the “cultural touchstone” according to Wikipedia.
Ben: Which is of course, according to something else because Wikipedia makes no claims to be correct, but rather referenceable.
David: Actually, it was referenced to, I forget what article labeled it a “cultural touchstone”.
Ben: Yeah. But I mean, companies that were IPO-ing before were averaging 3, 4, 5 years before they IPO’d. Facebook went 8, and had this total calamity on their hands. And, you know, we went through a pretty rough patch last year where there were just not a lot of tech IPOs and bleeding into early of this year. And, I think you can probably speak to this better than I can, but we’re definitely in a period where people are waiting longer now and that seems like you can kind of trace that back to Facebook.
David: It's so interesting. I think one of the lessons that Silicon Valley and the tech world seems to have absorbed from the Facebook IPO is “don’t go public, it’s terrible”. The IPO was indeed terrible as we’ve said. But what’s so interesting is Zuck would be the first one to refute that. In his quote a year later at TechCrunch Disrupt, like it was great for the company, it forced them to really step up and play with the big boys, play in big boy land and big girl land. But the lesson that’s been taken is totally opposite.
So, Ben, you were referencing this. I pulled some numbers on some well-known companies that went public before Facebook and how long between founding and when they went public. So, Zynga went public before Facebook, a couple months before, 4 ½ years from founding to IPO.
Ben: Which is crazy to think about. Zynga was built on the back of exploiting opportunities within Facebook.
Ben: Facebook may have been, whatever, 12% or something, or 16% –
David: Fifteen percent.
Ben: Fifteen percent reliant on Zynga, but Zynga was100% reliant on Facebook.
David: Yeah, exactly.
Ben: When they moved, ran into big troubles when they tried to move off of Facebook and kind of control their entire ecosystem with their own website.
David: Yeah. Realized they had no control. Another company, similarly, Groupon. Three years from founding to IPO.
Ben: I was at the TechCrunch Disrupt when Andrew Mason was onstage and said “never take your company public”.
David: Yeah. This was what entrepreneurs were internalizing from this. Zillow which we covered, 6 years. Pandora, 7 ½ years; people thought that was a really long time to go from founding to public. The VCs were dying to get out of that company. LinkedIn, that we covered, 6 ½ years. So that was kind of like the normal before Facebook. After Facebook, like you said, Ben, the really great companies haven’teven gone public but the ones that have, like Etsy, 10 years; Shopify, 11 years; Fitbit, 8 ½ years; Atlassian, 13 ½ years; Trulia, 9 years this year. People are staying private a really long time and not just staying private, but raising just absurd amounts of money. So, you know, Google, it’s so funny to see the evolution of the generations of tech companies and how they behave in the private markets.
Ben: Generations in the last 20 years.
David: Well, generations in tech companies are about 4 years. It’s like going to college.
David: Google raised $25 million before they went public. Facebook raised kind of $2 to $3 billion when you include that Goldman round before going public; without the Goldman round, somewhere around a billion or so. Uber has now raised $11.5 billion over the 8 years or so.
Ben: It's insane that you can raise $11 billion without having to be under the scrutiny of a public company. That’s totally the sighted advantage, is like we don’t have to disclose all these things, it’s better for competitive reasons, but really, for a lot of these companies, they don’t want to be part –
David: But the reality is it’s just worse for everybody.
David: It’s worse for the companies because you’re not accountable to these massive challenges that you’re facing. Like, let’s imagine, let’s do another ‘what would have happened otherwise’ for Uber. Let’s say instead of raising the last couple of billion dollars Uber had gone public and was staring down this DD situation in China as a public company and would have been forced to really fix it.
Ben: It turns out that hundreds of years of standard accounting principles and having to disclose in this very standard format, it’s actually quite good for keeping discipline for the business.
David: Actually good for the company, yeah. And it’s not good for investors because investors now, the reason, you know, what you've seen since the Facebook IPO is obviously like the age of the unicorn has existed and that’s two-fold. It’s one company staying private longer, not wanting to go public. But then related is that investors, all the people that were investing in these IPOs, their business model is predicated on getting cash into companies at this stage. So you've seen T. Rowe Price, you've seen Fidelity, you've seen Tiger Global (the hedge fund), you've seen Dragoneer and XYZ other public market investors start doing late stage private venture rounds.
David: Because that’s what they’ve always done. It’s just now those deals are happening in private instead of in public. It’s bad for the company, it’s bad for the investors because they don’t get the disclosure. And it’s terrible for the public because you can’t buy these stocks.
Ben: It’s really kind of anti-patriotic. Follow me on this, but the American prosperity is built on the fact that for hundreds of years, American corporations have innovated. The computer, the internet, all these things that we conceived of and brilliant innovators in the US often because of our great public education system and a lot of the shared values of our culture. Having public markets allows for the everyday person to, you know, now it’s more like through mutual funds and index funds, or if you want to take a flyer on a company, but like benefit from the aggregate innovation.
David: Wealth creation.
Ben: That comes out of the American corporation. And it really freezes those people out. Really, if you want to really carry it forward sort of contributes to wealth polarization.
David: Yeah, I think it absolutely does. I think there are two elements, as we’re seeing in this election cycle play out so viscerally, like income inequality and wealth inequality in America is more polarized than it’s ever been.
Ben: Here’s the crazy thing. We’re sitting here on Monday night, our listeners will know the outcome of this election, where we do not.
David: We’re literally the night before the election here, which is also crazy.
Ben: All that rioting outside that you hear, all the sirens and stuff is because of the Sea Hawks Monday night football game here in Pioneer Square, not because of the election.
David: Night before the election. Seattle has its priorities either straight or completely wrong depending on how you view things.
But yeah, part of that is that these entrepreneurs are creating these tech companies and they’re getting massively wealthy – Mark Zuckerberg, Travis, and Airbnb guys and whatever. But it's equally on the investor side too, like the people that are investing in these companies are so much more institutions now and for so much of the wealth creation period of these companies than they ever were so much more.
Ben: Yeah. When you restrict the access to invest to people that already have the information and means to do so and large enough amounts of money to deploy, it’s a “rich get richer” scenario. And, yeah, it’s pretty crazy.
Actually, to kind of continue this, thinking about tech trends or really like investment trends, with big institutionals coming down market and investing directly rather than deploying that capital into private equity and late-stage venture, it kind of puts the squeeze on those industries.
David: Oh yeah, absolutely.
Ben: There’s a few things sort of contributing to this trend. There’s this notion that we’ve been talking about that companies want to go public later, but their investment vehicle is where large amounts of money can be deployed. So, large amounts of money will be deployed. There’s that thing going on.
David: In the private markets.
Ben: Exactly. Simultaneously, you have this market force that’s fueling that which is over the sensitive element of the internet that the one thing that’s always been true and that is, more information will be more available to more people than previously existed. So now it’s so much easier to get information than it previously was that institutional investors, VCs, and private equity firms would make the case to their limited partners, their investors saying, “Look, I have information access and connections to these startups or these late-stage companies that I will deploy this capital into, and I have unique access to that.” Whereas, that’s becoming less and less true.
David: Yeah, absolutely.
Ben: There is much more visibility into what companies are performing well and people can kind of go find them directly. Obviously, that’s not entirely true. There’s still a very human element to all of this, but in general, it is easier to find out who is running a company and if that company is doing well, and reach out to them if you have an attractive offer to invest than ever has been before.
David: I mean, I think about this every day being a venture capitalist. At the early stage, we’re somewhat insulated from this, somewhat, but only somewhat. There’s sort of three things that a venture capitalist does, and I had to make this up, but lotsof people talk about this.
Ben: Principles of venture capital.
David: One, find companies, great companies. Two, pick them; decide if you’re going to invest or not, if you think the company has high potential or not. But then, three, win the deal if it’s a competitive deal. It used to be like those three disciplines where all really important and now, like at least the belief is that it’s all about winning the deal. It’s like oh, yeah, yeah, you can find companies easily; and yeah, yeah, you can tell what’s going to be successful and what’s not. I mean, there’s some judgement there but it’s kind of a commodity. But, it’s all about winning now.
Ben: If that’s the case and it’s really all about just getting the best deal, then it should be more entrepreneur-friendly and prices should go up, and it should be much more commoditized to the point where –
David: Which is exactly what’s happened.
Ben: Exactly. That investors effectively just get the minimum acceptable return that any of them are willing to deal with.
David: Yup. At the late stage venture, this is 100% what has happened over the last few years in the market, and it’s changing slightly on the margins. But, this has been a powerful force across all of venture and especially late-stage venture in the past few years. All because of the Facebook IPO. Thanks, Mark and Sheryl.
Ben: I don’t know if we’re saying that exactly.
David: All right. Should we bring it home?
David: Do you want to talk about how we thought about what our criteria would be for grading IPOs?
Ben: Yeah, absolutely. The way that we normally grade an acquisition is through the lens of was it a good way to deploy that capital for the acquirer. So, we kind of close our eyes and don’t really care about was it a good thing for the acquire because they’re getting a bunch of money, it was a great thing, and investors are cashing out, and almost every time that we analyze it, it was good.
David: Yup. And we think a little bit about like the financial returns to the acquirer but we’re not spreadsheet jockeys here.
David: We think strategically, was this a good move for the acquirer.
Ben: Yeah. And we think about did that acquisition both provide that financial return but sort of in a longer lead time scenario, was it something that made that a better, more lasting, more enduring, more valuable for longer company. And so, the way that we decided that we’re going to grade IPOs is through that same endurance lens. We want to assign this a grade based on the rubric of did it make this company a more lasting and enduring institution, a bigger competitive moat, make it a stronger, more viable, long-lasting company.
David: The way, we were talking about it before the show and I want to think about it, is like, was the IPO a springboard for the company, or a diving board. A lot of people thought the Facebook IPO was going to be a diving board.
Ben: Yeah. So what that allows us to do is sort of zoom out from that terrible plunge in the first week plus the ensuing months.
David: Really the whole year. For the first year, I mean, the stock below the IPO price.
Ben: Right. And it allows us to look at the company as it exists today and look at that moment of IPO and say was that the right move for the company or not.
David: With that rubric in mind, what’s your grade on this?
Ben: I am going to call this an A-. A lot of that is based on how bullish I am on Facebook today, how great their strategy has been since the IPO, correcting for a lot of those blunders. The minus is because I am not convinced that all of the tumultuous times that they went through contributed to the success that they are today. I think that they could have gotten here… they definitely needed the IPO. No doubt about it they needed to do that situation. But I think that they could have gotten to this point of hypergrowth and like kind of saturating the addressable human race with internet crux that they’re at today, I think they could have done that without such a bungled year.
David: No doubt it was a bungled year. I’m not so sure. I’m going to give this, probably unsurprisingly giving my enthusiasm during the history and facts, I’m going to give this an A+ because I think they wouldn’t have and I think had they not gone through that year and had this massive, you know, 20,000 megawatts spotlight shown on them, they wouldn’t have moved so fast to plug the mobile hole. And it wasn’t just a hole, like it was a chest wound, and built, like we said, not just the product but the whole business and advertising model and invented native advertising practically within six months.
I agree with you, I think they could have done it eventually, but had they not moved so fast because of this, with the heavy loss. And the other thing that’s in my mind here, clearly May was the pivotal moment for the Facebook IPO when things really started to go south. And these cracks started getting exposed. But I got to imagine that the whole process was really in Mark and Sheryl’s minds, starting to expose some of this stuff. And, what if they had not bought Instagram in April? If they had not bought Instagram and not moved so quickly to plug these holes, would there be a future or an alternate present today where Instagram had remained an independent company, had become the Facebook of mobile and figured out native advertising, and completely eaten Facebook’s lunch. I mean, so if you look at Facebook’s revenue over the last couple of years, essentially the desktop Facebook is completely flatted down over the last four years. What was their whole business, this meteoric rise that made them the most hyped IPO ever, the largest technology IPO ever, that business is essentially dead? And like you said, 84% of their advertising now is mobile. What if that were, you know, half, a third, a quarter, a fifth, or a tenth of what it is today, and Instagram were the gorilla in mobile advertising?
Ben: Yeah. I mean, there’s a whole lot of things they would need to go right there.
David: A whole lot of things, for sure.
Ben: They would need to have a Sheryl Sandberg who’s going to build this operational advertising sales business. You would need… well, it’s actually really interesting looking at… So Twitter didn’t have this crux, right?
David: Yeah. And Twitter was always, you know, if not mobile native, like it was built for mobile.
Ben: Yeah. It’s text messaging, right? Yeah. And you look at their transition to the smartphone world and, I mean, Twitter still doesn’t have a great ad unit. There’s a lot of problems going on there and we’re kind of seeing it all fall apart in front of our eyes. But a large part of it is it’s just never… Facebook ads are way more compelling particularly on mobile. And you raised this interesting point like if Facebook didn’t feel this existential crisis, could they wind up in a Twitter-like situation, maybe not with engagement but with monetization.
David: Yep. Or even maybe not Instagram, but I’ll throw it out there, you know it was February 2012 when Facebook filed its S-1. One year later, February 2013, Snapchat is founded. So you know, one of the greatest things I love the most about our industry is, it is so hyper competitive. I think this is just such a great case study of why you can’t rest on your heels even when you are the largest tech IPO in history because man, the next generation is coming right after you.
David: All right. Speaking of Twitter, followups. Twitter… lots going on on Twitter these days. But they’re shutting down Vine, potentially selling Vine.
Ben: Yeah, no surprise there. I mean, it’s shocking to me that they haven’t – and I think these will come – but they had like 9% layoffs. It seems like there’s a lot more of that to come. They got to streamline their products. It’s kind of shocking to me that they didn’t do Periscope too in one fell swoop. I think the reason that’s probably living on is because Facebook Live is proving so the future of Facebook that Twitter is really afraid to exit that race when Facebook is making such a big bet on it.
David: Total aside by the way, related to Facebook. It gets a lot of press but not in this context. Facebook is kind of trying to do this again, everything we’re just talking about, and that’s reinventing itself around video.
Ben: I think yeah, there’s an existential thing where they totally… and VR. They totally fear missing the next boat since they almost missed the mobile boat. So like, buy Oculus and be way ahead of the curve on that.
David: Try to buy Snapchat, yeah. And Snapchat is mobile and I just made that analogy like oh, could Snapchat have killed Facebook in mobile. But, Snapchat is also video.
Ben: Right. Yeah, so for me, tough to do. You never want to kill products that people love. But, I’m rooting for Twitter to survive at all here. And so, I think they need a lot more belt tightening to get there. To me, they’re in this very difficult situation where all the investors are super excited that they might sell, so that sort of pushes the price up, and then that price tag ends up being too expensive, so they’re in this like weird catch 22 where they were unsuccessful in finding a buyer and now they have to go figure it out.
David: And they’ve already gone public.
David: We need to a third category to the show, which is like, what happens if you've already gone public, you have no buyer. Plan C.
Ben: Yeah. It's an invaluable product to the world and I really want it to endure. And it’s actually a pretty good business, like they sell a lot of ads and there are reasons why people use Twitter ads and can’t necessarily satisfy that or any other platform. It’s a good business; it’s a Facebook sized business and they really need to reduce their cost to get it to a place where it can actually live on sustainably.
David: I agree. Quick followup on Skype, our last episode. We speculated on the show that Microsoft might have used foreign cash to buy Skype which was a non-US company, and it turns out that is indeed the case, was indeed the case. We were pointed in this direction by Nick Seguin, dear friend of Ben and the show, helped us a lot in the early days with feedback on the pilot.
Ben: Thanks, Nick.
David: Thanks, Nick. And he pointed us to an old blog post that he wrote after acquisition about talking with a friend about this. And yes, turns out Microsoft did use cash that it was holding overseas to buy Skype and so I got a massive… I was able to essentially repatriate that cash tax-free, thing got a massive tax benefit for it. So, definitely plays into how you should think about the Skype acquisition.
Ben: Yeah. If I recall, not only did they avoid paying approximately 33% to repatriate that capital, but then there’s that second advantage too.
David: Yes, there is that second advantage and that’s what is apparently referred to as “the deadly D” that they can repatriate apparently up to another $8.5 billion of cash tax-free, which at a 33% tax rate is worth $2.5 billion to them. So, in theory, perhaps Microsoft is getting about $5 billion in tax credits out of a value out of the Skype deal.
Ben: Pretty wild. And that’s eye-opening for me. If a US-based company uses overseas capital to make a purchase overseas, they can repatriate that same amount of capital back kind of in exchange for deploying that capital in an acquisition. It’s really interesting to start thinking about other companies that have huge amounts of cash overseas – Apple, Microsoft, and actually, most big tech companies at this point.
David: Google. Yeah, all of them. Facebook.
Ben: And what they could possibly do.
David: Interesting. Any corporate tax lawyers out there who know any more about this?
Ben: Truly we’d love to hear from you.
David: We’d love to hear from you. Let us know. All right, Carve Out.
Ben: Carve Out. So I was chatting with some of the listeners in Slack. If you like to join the Slack, go to Acquired.fm and you can sign up there. We were talking about the Internet History podcast.
David: Oh so good.
Ben: This is an awesome, awesome podcast where I believe it’s Brian McCullough, @brianmcc on Twitter. It’s like a hundred episodes or more. It’s super long.
David: Yeah, this is so good. If you like Acquired, you will love the Internet History podcast.
Ben: Yeah, particularly the story part. I started listening to the show a year ago and it’s sort of like long-form reading but just having it sort of read to you and he starts out with the story of the Netscape IPO dating all the way back to the founding and the Mosaic project and Marc Andreessen, and really, all the incredible drama in there. The episode that I just listened to, that I love, that had all sorts of interesting nuggets about the founding of Amazon, with Amazon’s technical co-founder and Employee #1, Shel Kaphan. It’s so interesting to get the engineer’s perspective on the founding of Amazon because in the ensuing years, you kind of get the version of it that’s in the “everything store”, you get Jeff talking about it on stage. It really is like not quite revisionist history, not quite sensationalized but definitely through the eyes of and through the lens of what Amazon is today. And Shel left Amazon a few years after they founded it and sort of he almost feels like his viewpoint is frozen in time. And you really get to hear not only the perspective of someone who remembers just that piece of Amazon history extremely vividly, but he’s also one of those just super endearing, old-school engineers, and the way that he talks about, “Oh well, we were using an Oracle database that had never seen these major transactions before, so it crashed that, and I wasn’t an Oracle guy, so we were just kind of making it work.” It’s awesome to hear about all of these really early stage Amazon stories about when they were kind of patching it altogether in the early days of the web.
So, whether you’re an engineer or not, I think anybody listening to the show will love that episode.
David: Totally. Like we said, let us know too if you like the IPO addition to the show. If you guys do, we go forward with it. We’re definitely going to have to do Amazon at some point.
David: No shortage of drama in that IPO either.
David: Okay, my Carve Out for the week, I thought it would be appropriate given that we covered Facebook today, is a relatively new book by Parag Khanna called Connectography: Mapping the Future of Global Civilization that I read. This is a really good book. And basically, it’s like a geopolitical, which usually is not what I’m into, but I had it recommend to me, and it’s great. Basically, the thesis of the book is that what the axis of power in the world, like geopolitically, are not nation states and borders and geography and land or even population that much anymore; it’s connectiveness/connectivity. And that the more connected a nation state is whether it’s physically with supply chains for industry or oil pipelines or water or electricity, the more connected they are to ideas and to trade, also very relevant to the election that is happening tomorrow, as we record this –
Ben: That happened in the past for all of you.
David: And happened in the past for all of you. Anyway, the argument is that the more connected a nation state is, the more powerful it will be and really, nobody gets this better right now than China. And if you look at a lot of China’s foreign policy, the Silk Road and the essentially trading block that they’re forming in Asia, it’s all kind of based on this and it’s delivering, creating massive power and influence for them. Anyway, great book. Totally related to Facebook connecting the world.
Ben: Yeah. All right. Well, that’s it for today. If you aren’t subscribed and you want to hear more, you can subscribe from your favorite podcast client. If you feel so inclined, we’d love a review on iTunes, maybe a Tweet, share on Facebook, it’s how we grow the show and it's how we make it even better. So, thank you so much and have a great day!
We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten. You can listen to the full episode (above, which includes honorable mentions), or read our quick blog post below.
Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!
Purchase Price: $4.2 billion, 2009
Estimated Current Contribution to Market Cap: $20.5 billion
Absolute Dollar Return: $16.3 billion
Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…
Total Purchase Price: $70 million (estimated), 2004
Estimated Current Contribution to Market Cap: $16.9 billion
Absolute Dollar Return: $16.8 billion
Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!
Total Purchase Price: $188 million (by ABC), 1984
Estimated Current Contribution to Market Cap: $31.2 billion
Absolute Dollar Return: $31.0 billion
ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”
Total Purchase Price: $1.5 billion, 2002
Value Realized at Spinoff: $47.1 billion
Absolute Dollar Return: $45.6 billion
Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.
Total Purchase Price: $135 million, 2005
Estimated Current Contribution to Market Cap: $49.9 billion
Absolute Dollar Return: $49.8 billion
Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.
Total Purchase Price: $429 million, 1997
Estimated Current Contribution to Market Cap: $63.0 billion
Absolute Dollar Return: $62.6 billion
How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.
Total Purchase Price: $50 million, 2005
Estimated Current Contribution to Market Cap: $72 billion
Absolute Dollar Return: $72 billion
Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.
Total Purchase Price: $1.65 billion, 2006
Estimated Current Contribution to Market Cap: $86.2 billion
Absolute Dollar Return: $84.5 billion
We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”. With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.
That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.
Total Purchase Price: $3.1 billion, 2007
Estimated Current Contribution to Market Cap: $126.4 billion
Absolute Dollar Return: $123.3 billion
A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...
Purchase Price: $1 billion, 2012
Estimated Current Contribution to Market Cap: $153 billion
Absolute Dollar Return: $152 billion
When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.
Methodology and Notes:
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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)
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