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Netflix's Journey, Building TCV, and Investing Through Downturns (with TCV co-founder Jay Hoag)

Limited Partner Episode

November 10, 2022
November 10, 2022

We had the rare opportunity to interview Jay Hoag, cofounder of the first tech crossover investing firm, TCV, at TCV’s Engage Summit in Half Moon Bay earlier this fall. Jay and Rick Kimball started TCV back in 1995 and have been part of the private-to-public journeys of storied companies like Netflix (which Jay shares some great war stories about on this episode), Spotify, Zillow, Expedia, Facebook, Airbnb, Peloton and many others. Jay and TCV were kind enough to let us release the conversation as an Acquired LP episode, and we’re excited to share it with all of you. We cover the firm’s history, how companies should calibrate the magnitude of their future-looking product investments (a topic we didn’t realize would end up being so timely) and perhaps most importantly, pivotal moments where now seemingly unstoppable companies almost died amidst big macroeconomic changes. We hope you enjoy!

Links:


Sponsor:

Thank you to the Solana Foundation for being our presenting sponsor for the LP Show this season. Solana is the world’s most performant blockchain, the BEST place for developers to build Web3 applications, and of course very near & dear to the Acquired community’s heart. You get in touch with them here (just tell them them at Ben and David sent you), and you can find and listen to Solana's own podcast here, hosted by the Acquired community's very own Austin Federa!

Note: Acquired hosts and guests may hold assets discussed in this episode. This podcast is not investment advice, and is intended for informational and entertainment purposes only. You should do your own research and make your own independent decisions when considering any financial transactions.

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!

10. Marvel

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…

Marvel
Season 1, Episode 26
LP Show
1/5/2016
November 10, 2022

9. Google Maps (Where2, Keyhole, ZipDash)

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!

Google Maps
Season 5, Episode 3
LP Show
8/28/2019
November 10, 2022

8. ESPN

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.”

ESPN
Season 4, Episode 1
LP Show
1/28/2019
November 10, 2022

7. PayPal

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.

PayPal
Season 1, Episode 11
LP Show
5/8/2016
November 10, 2022

6. Booking.com

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.

Booking.com (with Jetsetter & Room 77 CEO Drew Patterson)
Season 1, Episode 41
LP Show
6/25/2017
November 10, 2022

5. NeXT

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.

NeXT
Season 1, Episode 23
LP Show
10/23/2016
November 10, 2022

4. Android

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.

Android
Season 1, Episode 20
LP Show
9/16/2016
November 10, 2022

3. YouTube

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.

YouTube
Season 1, Episode 7
LP Show
2/3/2016
November 10, 2022

2. DoubleClick

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...

1. Instagram

Purchase Price: $1 billion, 2012

Estimated Current Contribution to Market Cap: $153 billion

Absolute Dollar Return: $152 billion

Source: SportsNation

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.

Instagram
Season 1, Episode 2
LP Show
10/31/2015
November 10, 2022

The Acquired Top Ten data, in full.

Methodology and Notes:

  • In order to count for our list, acquisitions must be at least a majority stake in the target company (otherwise it’s just an investment). Naspers’ investment in Tencent and Softbank/Yahoo’s investment in Alibaba are disqualified for this reason.
  • We considered all historical acquisitions — not just technology companies — but may have overlooked some in areas that we know less well. If you have any examples you think we missed ping us on Slack or email at: acquiredfm@gmail.com
  • We used revenue multiples to estimate the current value of the acquired company, multiplying its current estimated revenue by the market cap-to-revenue multiple of the parent company’s stock. We recognize this analysis is flawed (cashflow/profit multiples are better, at least for mature companies), but given the opacity of most companies’ business unit reporting, this was the only way to apply a consistent and straightforward approach to each deal.
  • All underlying assumptions are based on public financial disclosures unless stated otherwise. If we made an assumption not disclosed by the parent company, we linked to the source of the reported assumption.
  • This ranking represents a point in time in history, March 2, 2020. It is obviously subject to change going forward from both future and past acquisition performance, as well as fluctuating stock prices.
  • We have five honorable mentions that didn’t make our Top Ten list. Tune into the full episode to hear them!

Sponsor:

  • Thanks to Silicon Valley Bank for being our banner sponsor for Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

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

Ben: Hello, Acquired LPs. We had the rare opportunity to interview Jay Hoag, who is the founder of TCV, the firm originally known as Technology Crossover Ventures.

David: This was so cool. Back on our Altimeter episode, Brad Gerstner referenced Jay and TCV as the original crossover investors and still among the very very best out there.

TCV was founded back in 1995 and they were the first firm that invested in both public and private companies at the same time from the same fund. Jay has some awesome war stories that we get into with companies like Netflix, which we talk a whole lot about with him. Spotify, Zillow, Expedia, Facebook, Airbnb, Peloton, and many, many others.

Ben: The firm obviously looks much bigger today and very different than it did in 1995. They have over $20 billion in assets under management, 50 people on the investment team, 140 employees total. We recorded this episode live at a private summit that TCV had for their portfolio with all their chief product officers and we asked them if we could release it as an acquired LP episode and they were kind enough to let us.

This interview covers a little bit of firm history, some pivotal moments where important companies in our world today almost died amidst big macro economic changes, which is what's that like? We also touched on the topic of how to think about the magnitude of future-looking product investments that a company should make. Now with that, this is not investment advice, do your own research, and onto our interview with Jay.

David: It's a rare chance that we get to interview the legendary founder of TVC.

Ben: I know we're in a closed room here, but this doesn't happen very often. You tend not to be on stage despite having an unbelievable amount of experience to share.

David: Literally, the magnitude of your impact goes to our hotel rooms tonight. Ben texted me a photo when you checked in.

Ben: It is wild walking into the hotel and of course the TV's on because it's a hotel and they always have the TV on with some promotional something when you walk in. The first thing you do is grab the remote, you're like shh and you go to turn it off. I went to push the power button, but the most prominent button on the remote is not a power button, but a Netflix button. A standard button on a remote control shipped by an OEM who makes a television. That had to be the investment thesis?

Jay: Totally. That’s the idea.

Ben: It has to be unfathomable based on where that company started and slowly inched its way to literally be the one brand on many TV remote controls today. It's wild.

Before we get into Netflix and a lot of companies that you've worked closely with, and built TCV in your own entrepreneurial journey, we wanted to start back with your upbringing. Over to you.

David: Tell us a little bit about where you grew up, what your family was like, and we'll see some of the threads come through with that.

Jay: Well, it's great being here. Thank you for having me. I'll try not to bore you too much. I guess I'm the least likely person to ultimately be a technology investor for now 40+ years. To date myself, I grew up in the Midwest. I was in high school in the ’70s and graduated from college in the ’80s. There was no technology. If you think back, not only was the Internet not commercialized and there were no mobile phones.

David: There was no Internet.

Jay: It wasn't until 1980 that the fax machine was invented and the VCR. Not only do we not have email, as an example, we didn't have voicemail. I grew up outside Chicago and then went to a high school in a little town in Wisconsin with 5000 people. The technology we had was a stoplight. Halfway through high school they installed a second stoplight. It totally blew people's minds. People were just cruising through and just ignoring it.

Ben: A hundred percent year over year growth.

Jay: Exactly. Didn't know what to do about it. In college there were no PCs and even in business school, just to again date myself. I went straight on from undergrad to business school so it was 1981 and 1982 in University of Michigan Business School, the University of Michigan.

David: We won't talk about that.

Jay: We'll get to the Ohio State Michigan rivalry in a minute.

Ben: I'm a Buckeye.

Jay: We learned to program on punch cards. These were mainframes. It's an arcane thing. There was no first computer so it was a very strange time before most of the technology.

David: How did you end up going from that environment to first to Wall Street? You joined Citi right after business school?

Jay: I describe it as a sequence of very fortunate events as opposed to the books of unfortunate events and a series of lucky moves/choices. I'll try to do it briefly. Actually, the first luck was I grew up in a middle class midwestern family, and for whatever reason I had a good work ethic. Middle class being, I was going to go to college, which is born on second base as opposed to hitting a double. That was the first bit of luck. Meandered through my college life and had one single offer coming out of college which was to sell insurance, and decided maybe that's not the thing.

I applied then to business school and law school. I got into a better business school than law school. At the time, the rankings were parents wanting to be a doctor, a lawyer, and then a business person, in that order. So, didn’t go on a long one, business school.

I was meandering through that and I had a professor named Dave Brophy who taught an investment class that got me interested. He got me off my full college and business school experience to start to focus. Then I applied to 102 jobs coming out of business school, had three offers and one of which was being a research analyst at Citi, which became Chancellor Capital over time, so 1982, and an equity research analyst, an old fashioned analyst, which ultimately gives you a lot of fundamental grounding.

The additional piece of luck was I wasn't assigned when I started in any industry. They just showed up and they offered that I could cover Paper & Forest Products. This was covering public stocks, paper forest products. At that time, I don't even remember who it was, the publishing companies at the time were McGraw Hill and Standard & Poors. I like to say I knew all equal amounts of all three which is to say nothing.

Ben: It was not sexy to pick technology. It was not like an obvious oh, I should go do that.

Jay: No, it wasn't sexy. It also wasn't necessarily sexy to go into the investment business. One of my old bosses said his biggest professional accomplishment was keeping his job between 1974 and 1982 because generally the markets moved sideways. 1982 was a bear market.

David: If I remember right, these are the days of like mid-teens interest rates, right?

Jay: Yeah.

David: People are freaking out about the world going to 4.5%.

Jay: At the time Ronald Reagan was President and my first office job was the summer of ’81 between business school years at an investment firm and I vividly remember that short term interest rates were 18%.

David: My god.

Ben: That'll keep home prices down.

Jay: That'll keep a lot of things down.

David: That will make the investment management business a lot less sexy. How did you start first investing in private companies? Was that just natural of technology being such a young industry?

Jay: Again, I started as a research analyst at Citi. My clients were portfolio managers on the institutional side and on the high net worth side, and did that for three years. Then in 1985, I joined the venture group at the time, which invested in venture funds, directly invested in companies, and then had a small cap public effort. Then over the years I ended up running the technology portion of that. That was the business model.

At the time, the prominent venture funds included Kleiner Perkins. My contemporaries were folks like John Doer and Brook Byers were older, so it was more Kevin Compton and Doug Mackenzie at Kleiner. Benchmark had not started, Andy Rachleff at Merrill/Pickard, Bruce Dunleavie there as well, Bob Kagle came from TVI.

Ben: As a side note, it is amazing how many of these are no longer brands. We think about a lot of venture firms as these big enduring things, but the venture landscape is just littered with people that raise fund one and fund two. Even the enduring firms stopped and new firms were born.

Jay: I have respect for Sequoia who's done multi-generational shifts over a very long period of time. When the internet bubble burst and subsequent the fact that we survived, one of the biggest professional accomplishments sometimes it's literally just surviving. Here we are in our 27th year.

It sounds maybe overly dramatic, but it's not always clear because there are a lot of funds that either perish firms or peak and then have a long gestation period of less than stellar.

David: We're going to just talk about a company or two that had some of that journey in a minute.

Ben: What was the first time that you saw success in doing public and private investing at the same time and you thought I might be onto something. There really could be a durable future here because I'm learning things from doing this that I wouldn't learn by doing just one or the other.

Jay: I'd say if you think about the late '80s probably, which actually was when I met Reed Hastings of Pure Softwares, it was Pure Software at the time.

Ben: Was it Chancellor investment? Reed's first company?

Jay: Yes. It's really important to be lucky early on and then just keep following great entrepreneurs around.

David: One of the big themes on Acquired and even to this day—it's still true today but must have been so much more back then—was it's a small number of people who create a huge amount of value in this world. Most people don't know that Reed had a company before Netflix. Getting to know him then gave you a great seat for later.

Jay: We had plenty of not great investments, some of way back in the '80s investment. We invested in Sybase, which was the original online transaction processing relational database, Ingres, which was a successful but less successful than Oracle relational database, and Intuit which is crazy. Intuit's business at the time ultimately sold off and totally transformed the company.

The reason I go through some of those is because those ended up being successful private companies and then successful companies in the public markets as well. The companies that are able to sustain rapid growth over a long period of time, including in the public market, can generate substantial returns.

David: Was it partially because you were within a large Wall Street investment bank that there wasn't this pressure from the LP base and the funds to distribute stock from private companies as they went public and you were able to keep going with them?

Jay: If you're spending all this time identifying what the most promising trends are within technology, identifying the best companies, investing in a bunch of them privately. Their growth prospects don't end when they become public so maybe you should be patient and be long-term partners with those companies. But also, all that work can lead in periods of dislocation to an opportunity where you might deploy capital publicly via pipe, or just taking a stake, or taking a stake and becoming an active board member.

It's so economically rational in part because markets are volatile and things go in and out of investor favor, so it makes total sense. The receptivity on the part of the USM community varies because it's well-liked and understood in bull markets, and it's generally not liked in bears like right now where everything's under intense pressure.

Ben: Anytime you're doing anything that's a little bit divergent or disruptive, you get lots of rope and bull runs. Then if you take a risk, then that's the opportunity to get penalized during those down periods. I think it's so interesting to study the down periods, the moves people make, and the risks people think are worth taking in those down periods.

I want to zoom in on 2000. Netflix is getting ready to go public, but they're not going to be cash flow positive before they go public and the market's falling apart. If my history is right, you put together a financing for Netflix that it might be fair to say it saved the company and the company wouldn't exist today without this financing coming together.

I'm curious. When you think about those moments where tens of billions of dollars of value is created in the future, but of course you don't know that, but you're willing to take a bet that even though everyone's looking at me with the most scrutiny that they ever could, I'm still going to take this risk. How do you analyze a situation like that?

Jay: Of course, we wish they all worked out the way Netflix did. Experience does have some benefits and I was less experienced then. But the ability to be balanced in one's view, which often can mean contrarian not consensus, and ignore conventional wisdom or ignore the headlines because right now it is an example as was true then.

The press headlines were just horrific around all things technology, and just to set the stage for it, my old firm back with Reed Hastings when he was at Pure Software, which was a very successful software company back in the day. They did error checking software for programmers. They acquired another company and went public and they ultimately got, I think it's still part of IBM's software efforts.

Netflix did ever increasing financings from 1998, 1999, 2000, and raised a lot of money and filed to go public in March of 2000 on the heels of 300+ tech IPOs in 1999—it's crazy. Then the nuclear winter hit for all things internet-related, which is a little crazy to think about today because you have Amazon and those businesses weren't bad. They were just subject to investor psychology swings.

Ben: Which is important. The dogs were eating the dog food. People were loving these services and yet everything was overvalued, so you had this weird situation where as long as you could survive, people kept wanting your product, but you had to survive.

Jay: Now there were a lot of companies from that era that didn't. There were some bad ideas funded. There were some good ideas funded that their order book just went away. We were invested in a couple companies that help people build websites, which sounds arcane, and then a lot of the world didn't need websites built short term.

I do think it's one of the benefits of and for all people focused on the consumer and focused on products. If you have a compelling value prop that is quite evident, then it is worth funding even if the world doesn't think it's worth funding.

The story I tell, which is true, they pulled the IPO. Netflix was pretty close to breaking even from a free cash flow standpoint, which is the really important measure of breaking even, but needed additional capital. Our conversations with Reed are that we said we will provide that capital, but you may not love the valuation, so please go out and do a market check on what others might value Netflix at. The psychology was so negative that the answer was nobody would provide any capital.

We did a recap financing where we and others who participated were able to increase our ownership. Ironically, the company never really needed the capital. They turned free cash flow positive pretty quickly, so I'm glad their forecasts were off. Then they went public in 2002. Even there, the stock traded down on the IPO.

David: How long did it take before that investment became clear that it was truly a great investment?

Jay: Eight years, probably. It wasn't until 2009 or 2010. Investment originally went on the DVD model, which I'm happy to go into, and then the company started investing in streaming in 2005. Although originally it was actually digital delivery because it wasn't clear whether a download model or a streaming model was going to be for choice.

Ben: I remember installing Silverlight so that I could download the digital delivery of the Netflix movies.

Jay: It doesn't get a lot of headlines now, but we started investing in streaming in 2005 and part of it was Reed is a student of technology history and things like Innovator's Dilemma from Clayton Christensen if you've read the book, and had to observe and not to pick on AOL, which was original online service and it was dial up. As broadband occurred, they didn't forward invest. They just harvested the dial up.

David: They also sent a lot of discs through the mail.

Jay: Netflix, we chose to forward invest early and it wasn't clear how big streaming was going to be, but the cost of missing it and underinvesting was potentially fatal.

Ben: The sin of mission.

Jay: Yeah. Streaming was launched in 2007, maybe this is when you downloaded Silverlight. It was PC-only, not even Mac. It was about a thousand titles that nobody cared about. In contrast, for some arcane legal reasons, the DVD service was every movie and TV show ever made.

David: Was that the first sale doctrine?

Jay: Yeah, because video stores like Blockbuster, way back in the day, could buy every DVD so therefore so could Netflix. Streaming was a pretty limited content offering, but they stayed at it and it was free. It was added onto your DVD subscription. But it really wasn't until 2010 and 2011 that it was clear it was going to be successful. Then the company hit the gas from a content spend standpoint.

Ben: Bet the company moves are very common when a company is in a terrible position. Apple betting the company on the iPod, or the iMac or the iPhone. The MacOS 9 was a dead-end platform and it was going nowhere, so it didn't actually cost much to bet the company. This costs a lot because you're reinvesting a lot of what otherwise could be free cash flow into something that would be very difficult to try and understand the TAM.

What do you think about, at that time an investor in Netflix, but now as a prospective investor in new companies, not only does this have product/market fit, but I believe that this thing could be huge. What's your calculus around that?

Jay: Well, I also say, it is also as a sometimes current public board member with companies who are going through the same calculation, which is how much do I forward invest in the future thing or expanding the product roadmap, so that the value prop in 3–5 years is quite different than it is today and much bigger compared to moats.

I do think it's really hard for most companies, but particularly for most public companies to do that. I think Netflix is an extremely positive example. There are others as well. It is mandatory, but I think many companies, once they get public, start playing defense, playing a little safe, with such an emphasis obviously on quarterly earnings. The thought of reinvesting half of your profits into some unknown future thing is pretty daunting.

David: Do you remember either for you and TCV at that moment or within the company for Netflix, what was the work that you did to get conviction, that this new whole paradigm with a whole different business model that the prize was big enough, that this would be so much bigger than our current market in DVD streaming, that it was worth this risk to the company?

Jay: You'll probably be disappointed in the answer because the question implies a level of detailed quantitative analysis, maybe not in evidence. That to me is what makes great founding entrepreneurs CEOs. They envision a day when they would be not shipping DVDs. Actually, they still are today looking at the bandwidth expansion and iPhone was also introduced in 2007, but obviously there were cell phones before that with consumption on handheld devices.

It took a lot of guts to do that. They recently talked about, particularly with the original effort, that they're competing with studios that have been around for a hundred years. In the last decade, effectively they, in the original side, built up a catalog to rival that.

You talk about huge forward investments. Everybody who's a Netflix subscriber, in fact benefited from that value being delivered because it was forward investing to provide great customer delight and then more subs allows you to spend more on content. More content allows you to get more subs, and so on.

David: Which is so interesting because that was so different from the Blockbuster model. With the doctrine of first sale, Blockbuster and the first iteration of Netflix could just ride along with whatever Hollywood produced and not have to worry about investing all of that money, all that dynamic that you then later learned of more subs and investing in more content. You could be a small DVD rental business and have access to everything, but the minute you've moved to streaming, all of that changed.

Jay: Early DVD days, it was not always totally clear that Netflix could be a runaway success. If you think way back when it was requiring changing consumer behavior, something that a lot of companies contemplate. Yes, you could get all the DVDs in the world. The advantage of the online model was you don't have physical stores, so you don't have the burden. You have an infinite supply, so you're not limited. I think a typical Blockbuster had like 800 titles or something.

The downside though was people for years got in their car and went down to Blockbuster, or on the way home from work, Bob or Mary went by a Blockbuster to get something to watch that night. The idea of the Netflix queue, which was to list all the movies you want to watch, and then when we rolled out a subscription service, three at any time you watch one, you return it, the next one shows up. That took a while to actually take in the consumer's minds. What do you mean? What is this all about?

Ben: Because you're asking them to shift their behavior, their model for how I think about what movie I'm getting.

Jay: Yeah, it's going to be a spur of the moment. The online [00:22:56] so you weren't spending hours and hours doing it. Blockbuster is considered a very intimidating company to compete against, but they were not consumer-friendly. Their north star was not delighting the customer including the late fees.

They also maybe strangely were quite profitable at one point. It's that same issue of do you invest a massive piece of your physical store profit into this DVD online business or do you milk those economics? It took them a while. They ended up being a significant competitor for some period of time.

Ben: And having a real advantage in the fact that if you want to go get another movie right away, instead of waiting four days to mail it back in and to get it back, you could just go to a store and swap it instead.

Jay: Yes, but that load was a whole nother set of issues that I think constrained their ability to forward invest. They had a series of different CEOs who maybe pursued different strategies. Then some of the stuff they did was in hindsight, to me at least, was just hair brain. At one point, their solution to digital delivery was you would go into the store and download a movie onto your USB.

You're like what? That's not consumer convenience. The other thing I'd say, even about the streaming business on Netflix, is that it surprised me to this day, because it was not a secret. It took probably four years to really become a much more compelling value prop. But the company, we're doing that in the public eye, and we can talk about the financing in 2011 was due to a dislocating event.

David: We go into that next.

Jay: But I still am surprised. We did have an activist investor in Netflix at one point, Carl Icahn.

Ben: Who was the same activist investor in Blockbuster around the time they were competing with Netflix?

Jay: I don't know if it was around the same time.

David: I think he was part of the Blockbuster.

Jay: I think the fact that a strategic acquirer did not try to come after Netflix. It still surprises me to this day because once it was pretty clearly successful…

Ben: You just wait for it to become cheap enough, then try and take it out.

Jay: You would think. There was that opportunity in 2011.

David: We're building out the Acquired merch store, and right now we just have t-shirts that say Acquired.

Ben: This is not a commercial.

David: This is not a commercial.

Ben: It’s just an opportunity for us.

David: But we really want to add t-shirts that have our favorite quotes from the years we've done the show on it. One of our favorite quotes is Barry McCarthy’s quote from this time. What happened for folks who don't remember is that the Quickster, the spinoff of the DVD business, that Wall Street was not very receptive to.

Ben: Public backlash, strategically made sense but received very poorly, and the company had to like very quickly recover and figure out how do we not abandon all these customers.

David: I believed this story. You can correct us if it's wrong. Barry McCarthy, the CFO, was set to retire and then this happened. He said on an earnings call, when asked why he wasn't retiring, he said you don't leave your friends in the middle of a knife fight. Is that true?

Jay: I think so, yeah. Just to broaden out the time. In 2011, so long streaming ’07, built the content catalog, supported more devices including partnering with Microsoft on the Xbox as a delivery mechanism at one point, then Sony, and Nintendo, and then ultimately having Netflix everywhere on all devices including a remote control in your hotel room. Then forward investing in content for streaming without charging for it. It was bundled in with your DVD subscription.

In 2011, two important strategic decisions. One to start charging for streaming. In the consumer's mind, read that as a big price increase. Then rebrand the DVD service as Quickster and spin it out. That decision was changed and remained as part of the company.

The price increase, to your point, I think was the right strategic decision because it would allow the company to forward invest more in content and get that flywheel even going further, but there was a great human cry. I think consumers often respond emotionally to price increases.

Ben: Or redesigns.

Jay: Actually, the irony there is that when prices increased in Netflix's history, folks were grandfathered for a year or two, and some of those people canceled. It wasn't happening to them. The stock was down 70%.

Ben: It's uncorrelated with the public markets.

Jay: It was a benign time.

Ben: Right now, when you say the stock was down 70%, you're like yeah, so is everyone else.

Jay: That's true. Also, from a business standpoint, I think 22 million subs went to 19 million. It was a nervous point in time. The company was just about to launch in the UK to pull back on that. It ended up pretty quickly stabilizing and then subs group fairly soon thereafter. If you think back, it's super easy to say that was an easy decision.

David: This is when you let a public investment in the company.

Jay: But you think about from a business model standpoint, big fixed content obligations, shrinking subscriber base. Oops.

Ben: That's what operating leverage goes wrong. You want operating leverage when you're a high growth business, but as soon as that's not true, oh my God, this is a big problem.

Jay: The underlying analysis of well, streaming is the future. We’re clear leaders. We're clearly providing tremendous value to the consumer. Some of them are canceling right now, but we'll be through that. At the time, Netflix was US and had just launched in Latin America. There were big growth vectors across the globe. You couldn't extrapolate data points because we weren't in Europe or various parts of Asia Pacific, but you could envision this value prop being applicable there.

David: That subsequent international growth story for Netflix is I think one of the not as well known and told growth stories, but it's one of the greatest of all time. How many countries is Netflix in now?

Jay: One hundred ninety-five, I believe.

David: There are not many more countries than that in the world.

Jay: It has been everywhere other than China because China has some constraints. I figure now also excludes Russia.

Ben: Can I generalize a little bit? We've got the leaders of the incredible products and growth teams in the room. How would you generalize some learnings around when it makes sense to continue to forward invest in something that's not yet proven and when the experiment is showing enough data where you're like let's focus on the core business?

Jay: There's a bias. I don't think great technology companies cannot forward invest in both the current product roadmap as well as you can't run the risk that this is true of Facebook when they had no mobile ad unit. It just went public. Can you afford not to invest there?

I have a dinosaur story in a company called Ascend Communications, which was one of the original building blocks of the Internet. There was an Ascend box in every point of presence across the country as it was being built out. But that was a technology called Inverse Multiplexing, whose first application was in data networking and sold a million dollars. They forward invested specific features for points of presence in building out the internet service provider network and that was hundreds of millions of dollars.

To me, it's a matter of degree, how much can you experiment with new things? Obviously, today as appears to back then, you can iterate and test a lot. I also do think using the consumer as the north star, everything you do, even if it's short-term financial, should be with keeping that consumer in mind as opposed to nickel and dime them along the way. It was counterintuitive at the time, but if you think back to the current cable model and AOL and others, it was or is almost impossible to cancel. You had to call the help desk and they would try to bait and switch you.

David: John Malone famously used to say something like he would look at the percentage of revenue that was spent on customer support or customer service and he would fire people if it was too high. He was like I want it to be as low as possible because I don’t want to have the worst customer support possible.

Jay: Obviously, that's one strategy.

Ben: That's why we all love cable companies.

Jay: The short-term maximization, but I was going to say when Netflix first rolled out the DVD offering and then streaming, it was one click cancel online, which is viewed as insane by Wall Street because you're going to make it easy for your consumers to churn? The answer was in your term, yes, but they'll come back.

Ben: I've probably churned as a Netflix customer 50 times and I'm currently a Netflix customer.

David: 50?

Jay: I thought this was a successful podcast?

Ben: To me, the only economically rational thing to do is always cancel all of your subscriptions all the time and then always feel free to restart whatever you want to watch a piece of content. I don't know if that's okay.

Jay: As a board member, I probably can't do that. It would be viewed as disloyal.

Ben: You could imagine Netflix making that call enabling this weird consumer behavior that I have where I don't even think, and yet I've paid thousands and thousands and thousands of dollars to Netflix because I trust them as a brand that I have a good deal with.

Jay: And to your point, if it was a herculean effort every time you went to cancel, once you successfully cancel, you may not come back.

Ben: You should see my tweets about the New York Times. Anyone ever tried to cancel your time subscription? That is a nightmare.

David: Yeah, it is very difficult.

Jay: Again, public companies, another modern day example on Netflix in two things, analysts can't seem to get through the fact that are you going to release things in the theaters? That's where people want to see movies. They'll occasionally do a limited window, but it's not where people want to go.

People want to go to the movie theater, great, but the vast majority of consumers see it at their home. I think it's because Hollywood has the year of a lot of analysts and they can't seem to get through that. It's not actually a major issue at all, it's a minor issue.

The other thing is the binging model. Company articulates that some of the biggest hits like Squid Games would be hard to envision unless there was a lot of talk in the zeitgeist. A South Korean drama being successful across many of those 195 countries if it was one episode every week. Binging allows massive awareness hit, a positive hit, and of course, somebody could binge through it and cancel if they so desire. It's a legacy question.

If you're an ad-supported model—maybe like Game of Thrones—you do want to appointment TV once a week, but I think most of the world is moving beyond that. But they still get questions as to why not release one episode a week.

David: I want to maybe ask Ben's question in a slightly different way. Ben's question of when should you forward invest for growth as a tech company? When should you not? We have an audience of product and growth folks in the room. I want to ask you maybe in a more native to TCV as an investor way that I think might also shed light as operators for companies.

Many, if not most of TCVs legendary investments have followed this Netflix-like path. I’m thinking about Peloton now. I'm thinking about Airbnb during the pandemic. I'm thinking of Zillow through all this. You are as a firm and personally as an investor, not at all shy about making a call when the chips are down for a company that this company is going to persevere and continue to be a fast grower in the long run. I'm sure you don't always make the call to do that.

What are the key factors as you think about whether you're going to double down on some of those situations versus not?

Jay: This will sound like motherhood and apple pie. It starts with the CEO and the team. I think particularly public markets swing wildly from genius to idiot. Folks, it's the same team.

Ben: You were telling me before, it's always funny that you can see whatever the story, the narrative, the press wants to perpetrate by what picture they pick. It depends what cycle we're currently in. If it's the frowning picture or the smiling picture of the genius CEO, but it's the same CEO.

Jay: I haven't tried to prove that scientifically, but I'm pretty convinced it's accurate. The same person but a different picture. We start as a private investor. Often the teams aren't complete, and then over multiple years there's change if you read Reed's book on No Rules Rules.

But the visionary CEO who hires superb people sounds simple. Then when you work with them over a long period of time, you're gaining confidence. They may actually make the whole decision, where it starts and ends.

It's also really trying to reassess the product, customer delight, competitive moats maybe would be the second big variable, and the team gets into the ability to execute. There are many companies across technology history who had equal opportunities. Some execute superly, some don't. Market cap difference is quite dramatic. I say you have to, particularly if you're buying more of a public situation that is under severe pressure, you have to be comfortable being viewed as an idiot for some period of time.

Ben: Which is wholly counter to everything that evolutionarily has led humans to where we are. We’re the people who were the descendants of people who were not viewed as idiots, so it's really hard to rewire your brain to be like I'm super comfortable being ostracized.

Jay: It isn't always easy.

David: You don't say it's fun.

Jay: It obviously derives from you need to have really high conviction and you can't be viewed as an idiot forever.

Ben: Eventually if you're non-consensus, you need to become consensus, but you need to place that in the background.

Jay: Or most importantly, in that quadrant of concensus or not consensus, right or wrong, you have to be right no matter what you do.

Davd: Ben talked about this in a recent episode. I love it. I think it's true. You have to be non-consensus and right, but can't be in the non-consensus part of it for too long or else that becomes wrong, even if you're right.

Jay: That's the other angle and hopefully the current environment is an example. When you look back at market dislocating events like the global financial crisis or the Netflix history in 2011 as an example, when you look back at them, they're actually pretty short. When you're in the middle of it and the clouds are rolling in the thunder and lightning can seem really daunting. But I can't think of a single great technology company that didn't struggle at some point. I refer to it as desert disillusionment.

They were in this nice plush forest. They went in and I was in the desert and there were scary animals and there's no water. Some might die, but I think Netflix went through that. Expedia, on 9/11, there were negative booking days. Think about that. It's not like revenue slowed down. Airbnb, negative booking days. Again, not all coming up.

David: Now we look back at that now and that was like a month, but it probably felt like 10 years.

Jay: Facebook, no mobile hand units.

David: The Facebook example is a great one.

Jay: Zillow went through a global financial crisis, COVID shutdown down. Reed is a veteran of many crises in his 25 years. As an investor you can say, I'm going to be dispassionately reanalyzing the whole situation. As a CEO leader, you have to be a leader.

I'd say maybe at TCV and other investment firms now, you also have to try to lead and hold hands a little bit because this is generally a young person's business and that means most investment professionals may not have lived through the global financial crisis. They got here after that. They don't know whether the world is really going to come to an end or it just seems like it.

David: I think that's where we would love to end with you and to spend a few minutes off. We got a chance to chat with Howard Marks recently and his son Andrew. Other than Howard, I can't think of anybody else we've talked to who's had a four decades–long investing career. Here we are at the end of 2022, you've seen times like this probably at least 4 times in your career.

Ben: And every one of these downturns is different and idiosyncratic in its own way. Of course, it's not like oh, this is exactly like it was last time, so it'll be over in 3½ months. They're all special, different.

Jay: I'd say there are some that are tech-specific. Internet boom bust. Global financial crisis I describe as a tech got sideswiped a little bit, but didn't get run over. Current thing after many years of uniformly positive investor psychology. It's a little bit more front and center, the truck.

David: Got hit by the bus.

Jay: Yeah, but then also, I started during a bear market for small caps. There was the crash of 1987. The markets were crushed in 1990 when it was the first Gulf War. I forget one long-term capital management, when people thought that was the end of the financial system, global financial crisis. The pandemic, there's no playbook on how to invest during a pandemic. That was a first.

Ben: Then it did the opposite of what we all thought.

Jay: I'm old, but I wasn't there.

Davud: During the last pandemic.

Jay: During 1917 or whatever it was.

David: I'm curious especially for the folks in the room who are operating at companies. What advice would you have for, say you're working at a small cap public tech company right now and your stock's down 70%?

Jay: I'd say don't take it personally. By the way, somebody will say it doesn't mean that XYZ is not going to go down another 70%, because the old joke of stock down 90% is down 70%, down 70%, but it's short-term. Again, assuming the company's well-funded. It's a basic, critical assumption. Just focus on the business. Ignore the press.

Assume that the vast majority of what the press writes is inaccurate. That's been my experience, stay passionate about the roadmap and delivering value to consumers, and all will be well. It may take three months, it may take two years. I don't know.

David: I love that point, too. I hadn't focused on that, but the very beginning of my career was, I started in 2007 after college at the peak and then the global financial crisis. It wasn't that long.

Jay: It was your fault.

David: Yeah, it was my fault. It was exactly my fault, but it wasn't that long. It felt like forever at the time.

Jay: I'm not trying to say it doesn't weigh heavily upon the psyche when it happens. Actually the best business, that's one of the things you have to guard against. Okay, you seem to be getting beat up every day. It can make you defensive when actually now is the time. Every crisis has been a good period of time to invest. Not across all companies.

Google started in 2000 and people thought it was an insane valuation at 70 pre. That was the chatter. Tesla almost died in 2008 when the auto industry was being bailed out. Just as you look back, there are failures, but it's proven to be a good period of time.

Ben: Amazon, absent the Joy Covey vehicle of putting together the convert while they were a public company, they would've gone out of business.

Jay: You think about Amazon going public in 1996, $190 million in revenues or something like that. The scale is insane. It is hard to separate the negative psychic aspect, but it's really important, too.

Ben: It's a great place to leave it.

David: That is a great place to leave it. Well, Jay, thank you so much.

Jay: Thank you.

David: Thank you, TCV.

Ben: Thanks everyone.

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