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Full Transcript below: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)
David: It can’t be turtles all the way down. There has to be a pool at the bottom.
Ben: Oh man, I’m using that as the teaser quote for this episode. [music] Welcome back to Episode 46 of Acquired, the podcast about technology acquisitions and IPOs. I’m Ben Gilbert.
David: I’m David Rosenthal.
Ben: And we are your hosts. Today we are covering an acquisition that the tech audience cares a lot about even though it’s not really a tech company: Nestle’s acquisition of Blue Bottle.
David: Shockwaves have gone through Silicon Valley.
Ben: Yes, yes. There have been lines around the block that are forming their own lines around the block just to hear the news.
David: So great. Where will the VCs and entrepreneurs congregate now?
Ben: Yeah. I mean, what’s the sort of like islandish one?
Ben: Phil’s. Fourth wave of coffee.
David: Fourth wave. We’ll get into it.
Ben: We will, we will. Our sponsor for this episode is Perkins Coie, the counsel to great companies. Today’s sponsorship is with Jeff Beuche, the firm-wide chair of Perkins’ M&A practice. So today’s question is a little bit of a deeper topic but super applicable if you're getting into sort of a serious state of mind about an upcoming M&A transaction. So Jeff, what are you seeing as the most disruptive trend in M&A right now?
Jeff Beuche: It's for sure representation and warranty insurance. That’s an insurance product that either a buyer or a seller can purchase to ensure losses associated with breaches of reps and warranties. The use of rep and warranty insurance is widespread in the private equity industry and has fundamentally changed the way that those parties approach purchase agreements, impose closing recourse negotiations generally. It's a really powerful tool for resolving some of the hardest risk allocation issues in a deal. We haven’t seen rep and warranty insurance widely adopted by strategic buyers or in the tech M&A world yet, but it's a revolutionary product that we do expect will be used in most deals in the coming years.
Ben: Thanks, Jeff. If you want to learn more about Perkins Coie or reach out to Jeff specifically, you can click the link in the show notes or in the Slack at Acquired.fm. All right. Well, David, that’s all I’ve got for pre-show.
David: All right. Well, before we dive in, I was thinking about this episode and it’s kind of funny. We’ve got this series of like miniseries here on Acquired. We did the Disney trifecta and then the fourth of course with BAMTech. We’ve done sports, we did the LA Clippers. That was out there but fun. We’ve done a bunch of gaming episodes. And now, we’ve got our second coffee episode on the heels of the Starbucks episode.
Ben: Well, this is a primarily Seattle dominant podcast, so we do have to do multiple coffee episodes.
David: The next one, we’ll have to do the Seahawks next.
Ben: Yeah, yeah.
David: So, coffee. We talked quite a bit in the Starbucks episode with Dan Levitan about waves of coffee and the parallels between the coffee world and the tech world. We alluded to Third Wave coffee which really is kind of the reaction to Starbucks, Starbucks being Second Wave. If the First Wave was kind of Folgers and Maxwell House and brew-at-home coffee, the Second Wave being Starbucks, an experience, a place you go to. The Third Wave is really all about the quality of the coffee. It is really the origin of hipsterdom. “Starbucks sucks. It’s super corporate. We're going to focus on the artisanal quality.”
Ben: And the coffee is burnt, it’s dark. No care put into it. It’s a factory. Everything is made exactly the same. Call it operationally efficient and praise their business model. Or, hate on it because it’s systematized. But it is definitely, definitely a reaction to the mass market success of Starbucks.
David: Yeah. And so, Third Wave places like counterculture was one of the first in Durham, North Carolina, Stumptown down in Portland, which is now owned by Pete’s, interestingly. Or Intelligentsia which I think started in Chicago is also now majority-owned by Pete’s. Caffé Vita in Seattle, all these folks. They really focus on the drink itself and probably, arguably, nobody focused more on the drink than Blue Bottle. So let’s dive into Blue Bottle.
So it was founded by a very interesting, interesting guy named James Freeman. And I highly recommend, we’ll link to this in the show notes but he did the Stanford Entrepreneurial Thought Leader talk; he gave a talk there last year. Really fun to listen to. Basically, let’s just say he starts it with an analogy to Merce Cunningham and John Cage, the sort avant-garde, modern dance choreographer Merce Cunningham and his partner John Cage who is an avant-garde musician. They worked together as an analogy for his whole talk and then he goes on to quote Sartre and Proust. Very philosophical.
Ben: Honestly, David, one of my favorite things about this show is learning about the insane and talented and driven people that start these companies. There are no normal people that start enormous companies.
David: No. And James is no exception. Unlike most of the founders we talk about, he is definitely not an engineer. Not even remotely connected with the tech world except for the fact that he lived in the Bay Area. He was a freelance clarinetist, a classical musician who played the clarinet, and he did that for until his mid-30s. Then he kind of woke up one day and he realized, “You know, I’m never going to be the best clarinetist and maybe I should find something else to do with my life.” And what else could he do? Turns out, he had this side hobby of roasting his own coffee beans in his oven at home. So he would buy beans and he would roast them at home in his kitchen in his oven. Apparently made lots of smoke and his wife at the time was not a fan of this hobby. But he made these beans and then he would drink the coffee himself and he would give it to his friends and people loved it, and he thought, “Well, maybe I’ll turn to coffee for my life.”
So he started in the early 2000s, he quits the music world and he lived in -- I don’t know if he actually lived in Oakland or if he started the company in Oakland. He was living in the Bay Area. Starts Blue Bottle in Oakland and the original business plan is that he’s going to keep doing what he’s doing and deliver beans to people’s houses, these great beans that he’s roasted in his kitchen the day before, will deliver them to his friend’s houses. So it kind of sounds like an on-demand startup.
Ben: Truly, truly. And hilariously part of the business, fast-forward a little bit that they operate now that’s a coffee delivery service, they acquired another company to do that called Tonx when they sort of moved into a bit of a different sector.
David: Yup. So the company is back to its origins now with that acquisition later but he does that for a little while and then kind of realize like probably not going to become a really large business if he’s roasting coffee in his own kitchen.
Ben: No. And it’s hilarious following the parallel to Starbucks. Like both started with this model of beans only and selling those and focusing exactly on that and then realizing, boy, there’s this whole other retail coffee experience to be created.
David: Yeah, exactly. And Freeman sort of similar to the Starbucks story where it wasn’t the Starbucks founders who realized that there was this retail opportunity. It was Howard Schultz. Freeman himself kind of stumbles into it. So in 2003, he signs a lease for a roastery so he can get it out of his kitchen and start roasting in a commercial space. It’s not until 2005 that he actually opens up his first retail location which is in Hayes Valley in San Francisco and it’s in a friend’s garage. So he has a friend who loves his coffee and his friend has this garage on a little side street in Hayes and says, “Why don’t you come open up a kiosk and actually instead of just selling beans, sell coffee there?” James is excited about this and his sort of approach to coffee, even though the name ‘Blue Bottle’ comes from Blue Bottle Coffee in Vienna which was one of Europe’s first coffee houses, he’s actually more influenced by the sort of Japanese style of coffee. Whereas Howard Schultz was influenced by his time in Italy and the Italian coffeehouses, the whole approach of Blue Bottle is very, very Japanese-centric and the Japanese approach to coffee is very Third Wave. It’s all about the very, very meticulously crafted, perfect cup of coffee. James talks about this in his ETL talk at Stanford that part of his inspiration is this coffeeshop in Japan where the first thing you do, the barista does when you order a cup of coffee is they have a wall with all these cups on it and the barista here, she will go look at the wall and decide which cup (they’re all different) is perfect for you.
David: And so that’s the inspiration for Blue Bottle. And listeners, if you've been to Blue Bottle, if you live in the Bay Area, I’m sure you have or travel there often, this is the anti-Starbucks. It’s very austere. There is very little in the locations except for the coffee. There’s no Wi-Fi. There are no power outlets. They do have some food but very little. It is truly all about the coffee. This idea of the cup James also talks about much later in the company’s history, they had cups specifically made for Blue Bottle. These are ceramic to-stay cups. They don’t like doing to-go cups. The cups are perfectly sized. They’re not perfectly round but they are sized exactly for the sized drink that you get a blue bottle. There are no sizes. You order whatever it is you order and it’s one size.
Ben: David, I can’t take it.
David: It's so hipster. The synergies with the tech community are just too perfect.
Ben: So you pay software engineers more money and more disposable income and they want to be better than everyone else and they want to buy more pretentious things. They love coffee, they need coffee to be productive. I know.
David: Sell them really expensive coffee that they don’t have to think about because they’re thinking about writing the code. So we do the thinking for them but it’s really good.
Ben: Exactly, exactly. It’s like the Steve Jobs one outfit reduce cognitive load thing.
David: Exactly, exactly. That is Blue Bottle. Which is very different from Phil’s which we’ll come back to in a minute. Phil’s is the competing Bay Area chain.
Ben: I should say like Blue Bottle is freaking amazingly good.
David: The coffee is really good.
Ben: I’ll rip on it for this whole episode but, you know, it’s an unbelievable product.
David: It really is. I mean, you can’t be from Seattle and not appreciate good coffee, and it is very good coffee. So after the kiosk, the first very little store in Hayes opens up. It really starts to take off and spreads kind of by word of mouth. They start to open more locations in the Bay Area, then they go to New York City. They go to Los Angeles and then they go to Tokyo, to Japan and the sort of inspiration for all of it. So there’s stores in all of these cities now. But they start to grow fairly rapidly and in 2008. So this is very early in kind of the rise of sort of the modern startup and VC industry. Arguably even maybe I would say before lots of capital, the sort of modern series A and beyond hyped startup, they raise a venture round and they raise $5 million from a firm called Kohlberg Ventures. And Chris Sacca and Lowercase Capital, this is just when Chris is getting going.
Ben: That dude gets into everything. Un-freaking-believable the nose on Chris Sacca to find those early-stage.
David: Amazing. It was a $4 million fund. So tiny by today’s standards but he was in everything. Blue Bottle, Uber, Twitter and many, many more.
Ben: And then bought up a bunch more of Twitter that he could on the second market.
David: So $5 million round from Kohlberg and Lowercase in 2008. Then a few years later in 2012 they raise a $20 million round led by Index Ventures and Google Ventures and then a whole bunch of other individuals. So Kevin Systrom, a number of other tech CEOs, Tony Hawk the skateboarding legend invests. I mean, this is the thing. We might have talked about this a little bit in the Starbucks episode. You’re literally selling drugs to your customers.
Ben: Yeah. Oh my God. One of my favorite things to do research for this podcast is to go look at all the quarter responses to reactions around the deal and sort of tease out what I think is a great point and things I want to bring up on the show. And there was one really great quote that I was going to wait to say later but I think it was worth bringing up now. From Daniel James on Quora and this $20 million round, the question was something around like why is Blue Bottle getting all this investment, whether the VCs see it. And he goes, “Coffee is a legal, addictive, unregulated psychoactive drug with cheap ingredients, premium pricing and a huge worldwide growth market. Blue Bottle is a quality brand with a good team and a strong history of well-managed growth To me, this seems much better than a VC bet with many consumer internet companies.”
David: I know. And it’s so funny. I actually think, I remember this round, the 2012 round. Nobody really paid attention to the 2008 one. But the 2012 round was like, you know, it was sort of simpler when we were starting Rover and people are like, “This is a sign of the apocalypse. It’s like Airbnb for dogs. Who’s going to use that?” And it was the same thing there. It’s like, what are these VCs thinking? They’re investing in a coffee company. And to be clear, there was never any even pretense that this was like going to be an internet company. It was like James and Blue Bottle. They’re like, “No, this is a coffee company.” We make coffee, we have stores. People come. They buy the coffee, they drink it. We have a website.
Ben: Reduce cogs and lower variable cost. Like, no, none of that.
David: No, no. This is a coffee company. And people are like, “Why are these VCs investing in this?” Turns out, they did well and particularly that round did very well. But we’ll come back to all that.
Ben: It is worth pointing out like the super interesting, near self-fulfilling prophecy of this. The sort of Twitter family and Blue Bottle was joined at the hip very early and they got a lot of sort of -- because they were both at least very early on incredibly product focused companies with sort of super tasteful visionary founders. Like they attracted the same sort of people and they magnified each other. So you look at Sightglass that was a couple of early Blue Bottle folks that left to start their own thing, like they co-founded that with Jack Dorsey. It was an early pilot for using Square at that location. And you see the types of people that were attracted to Blue Bottle as a product and as a lifestyle and put money into it. I mean, it is like they just won over the most valuable segment as customers and then brought them on as investors.
David: Yeah. We’ve talked about this on this show before but especially if you don’t live in the Bay Area or in Seattle or in LA, you're not kind of in the ecosystem, it’s easy to forget. You read about these companies in the press. They become so valuable. They’re almost like these celebrities. Like, these are real people and these companies exist in real locations. So I don’t know if it was the second but the first sort of canonical Blue Bottle store larger than the kiosk that was in Hayes was in Mint Plaza. And Mint Plaza is like two blocks away from the Twitter Plaza. So where do all the Twitter employees go when they want coffee? They go to the Blue Bottle in Mint Plaza. And it's just like these ecosystems, like everybody’s right there and that’s how these things sort of feed on one another.
Ben: I thought about this as like a customer acquisition strategy of if you have a company and you want people at another company to buy it for B2B purposes like buy all the Facebook Ads of the employees at that company so that you can get their attention even outside of typical channels. Like, if you aren’t right next to the Twitter building but you're interested in attracting Twitter people, could you target them all over the place digitally as well as having a physical location there because I feel like while Blue Bottle sort of pioneered that, I feel like that’s no longer novel to put something right outside of a company that, anyway, to put a physical location there.
David: Yeah, it's interesting. That growth hacking tactic doesn’t work anymore.
Ben: Could you be digitally close, yeah.
David: Yeah, seriously. But it definitely worked for Blue Bottle. And I think Biz Stone was an investor. I don’t know if Evan Williams was. Jack was obviously an investor in Sightglass, a competitor. But it worked. So 2014, they then raise another $25 million and then in 2015, they raise $75 million from Fidelity. And that was like, “wow.” This is like a lot of money from a real public markets investor and then they keep expanding within those cities that I mentioned before. But grow to over 30 stores throughout the country and in Japan and then, a surprise announcement, in the middle of September, on September 14, 2017, it is reported that Nestle comes in and the large conglomerate and buys out a majority stake in the company for a reported $425 million. We don't know the exact number but it’s been pretty widely reported that they paid about $425 million and that was for 68 percent of the company. So they bought out the investors and James and the rest of the management team are keeping their stake. So they keep 32 percent of the company, its own separate board. But all the investors are bought out, so the valuation on the company is $625 million, assuming that the $425 million figure is correct. And here we are.
Ben: Pretty amazing. I mean, I wonder, the first thing that comes to mind is did the founders keep all their shares, was there a little bit of secondary there where they took money off the table. They had have taken something, right?
David: I don't know for sure but they may not have. There had been some secondaries along the way. So I believe some of the money from some of the later rounds was secondary sales that the founders and management team were taking money off the table. So I actually don’t know in this case whether Nestle paid out anything to any of the employees.
Ben: Well, I will say, you know, as I for lots and lots of reasons believe that full acquisitions are better than these sort of majority buyouts, particularly for startups like this, I mean they’re 40-store retail location, but early-ish mid-stage company. But if you're going to do it in this manner where you're not acquiring the entire company, I love the idea of it running independently and the founders still having a ton of skin in the game to make this thing grow in valuation. There’s sort of an interesting thing of like it has to stay a separate company. Think about this. How if you're those founders do you think about how your shares get valued now? Like there’s not really a competitive market to do the next round. Like there’s not a market to value your company. And it’s certainly not anywhere near getting valued on a reasonable sort of price to earnings ratio. So are you hoping that at some point Nestle just decides to buy you out? Is it actually in their best interest to do that? I love the incentive. I’m curious on the mechanics of how that works.
David: I think you're hitting on all the right questions here, Ben. I think part of the reason this happened as it did is, I have to wonder. I don't know anybody at Blue Bottle personally, but Freeman and Bryan Meehan who’s the CEO, he came in and took over as CEO a number of years ago. But Freeman is still very, very involved. They both were very vocal about saying they never wanted to go public. They didn’t think being public made sense for Blue Bottle as a company and it also just was something they weren’t interested in. And yet, the company continued to grow but at the same time did raise all this money and in particular, in some of these later rounds, bringing in folks like Fidelity. Fidelity is a mutual fund. They’re a public company investor. They want to return. All the investors want to return but particularly them and they want liquidity. And so I can only imagine the tension that must have been building as they were making these decisions to take these partners on along the way, these partners as investors who just had sort of fundamentally different goals than what it sounds like James and the team did.
Ben: Yeah. Okay. So here’s the question is, did that dichotomy just continue to grow and grow and grow where they were diametrically opposed to going public, they were taking on investors that needed them to go public or needed to have a big liquidity event and in a reasonable timeframe and like they sort of were rocking a hard place.
David: Yeah. I mean, that is the question. And I think the question both for Blue Bottle and for us in terms of in this show like looking at what’s going on in the tech world, like Blue Bottle, we were joking in the beginning of the show that it is unapologetically not a tech company but this type of dynamic is rampant these days. I mean so many founders of tech companies have raised all this money and yet are adamant that they never want to be public and that a lot of them also say they don’t want to sell the company either. So, like, what are you going to do?
Ben: Yeah. I mean, it seems like that would have been a nice thing to be aware of upon investing.
David: It does seem that way. It does seem that way. And it’s so funny, it’s also so --
Ben: Is that lip service, David? Like, is it like how if you want to run for president you're supposed to say like “I’m not interested in being president” and then like you reluctantly do it so you don’t seem power hungry. Like, is it like, “Oh, you know, we never want to sell out” and then you inspire your employees and you're mission-driven forever and then until the day that it happens it’s never going to happen?
David: Yeah. I don't know. I mean, you could say so but then we’ve talked about this in so many episodes whether about Snap or about Facebook. These companies, the majority of them, obviously not Snap and Facebook, but have been private for so long now and they just keep staying so, like you know, Uber and Airbnb, all these companies and many, many others. Certainly could be public companies and probably should be. But the founders are for whatever reason either delaying or even saying they don’t want to. But I think also like there’s a tension here. I mean, on the one hand, I think we’ve been painting it for the last few minutes as bad or at least that this is a disconnect which it is. But on the other hand, if you go back to sort of what Blue Bottle is and this whole Third Wave of coffee which we’re using as an analogy for the state of the tech world right now, does it make sense for Blue Bottle to be a public company? I mean, it makes sense for Starbucks because Starbucks’ goal is to be everywhere and on every corner. But if Blue Bottle’s goal is to be about the cup of coffee and what is actually in the cup, does it make sense to be as big? I don't know.
Ben: Yeah. I mean, Blue Bottle has 40 locations, right? They have plenty of growth ahead of them if they want to. Starbucks has 24,000 locations. You don’t need to be a public company to be a 40-location coffee shop. I’m actually very curious too. They also have this online business selling directly to consumers I’m super curious what the revenue mix looks like. I would suspect a lot more of it is either buying coffee in the stores in liquid form or buying the beans in the stores and then the online subscription business is smaller. But interesting to think about that too because then you start to think about it, still not an internet company. I’m really sick of the fact that, like, oh, we sell it online and people subscribe to it. That’s a slight business model shift but ultimately at fixed cost, distribution cost, still not an internet business. But then you at least drift closer to something where you're like, “Okay,” this is different than all the brick and mortar stuff that exist today.
David: We’ve posed some questions here and I think James Freeman and the Blue Bottle team were very clear what side they came down on on those questions which was that Blue Bottle can’t be a public company and maintain its ideals and also that it’s not an internet company. But I do think in terms of where I come down on this, I’m not sure that that’s the dichotomy that makes sense. Like I think about Apple. An Apple store and a Blue Bottle store are eerily similar. And Apple is maintaining --
Ben: What Apple store used to be anyway. Like I think the days of believing that an Apple store is a far simple location is far over.
David: Well, no. But you walk into an Apple store and you can count on, well, you used to be able to count on both your hands the number of products they were selling there. It's more now but it’s certainly not relative to the number of square feet that they have. The number of products that they’re selling is way smaller. But that has been able to scale and touch just about everyone in the world. Whereas as you pointed out, Blue Bottle has 40 stores.
Ben: I’m curious to get into acquisition category because I’d love to get your take here. You want to dive into that now?
David: You know, let’s do it.
Ben: All right. So I’m curious what you think. The thing that I have bolded in my show notes of our categories (people, technology, product, business line, asset, or other) is product because it's really a fantastic product. A lot of care in every cup. Truly differentiated in terms of once you have it, you kind of want to go every day to that. You don’t want to go for anything less. Do I think Nestle could create that? Probably. Like, do I think they could create that for way less than they paid for Blue Bottle? Certainly. Would it be successful? Almost certainly not. Like I think ultimately what they have bought here is the brand and the prestige around the brand. And they’re going to try and leverage that into all sorts of, well, I think they’re going to try and leverage that into all sorts of interesting ways of using their supply chain to really amp up the growth rate of Blue Bottle to potentially sell other stuff in Blue Bottle, to sell Blue Bottle Coffee everywhere they have store space. But they bought brand here. They bought coolness.
David: Yes. I was going to go with business line because yes, there are all those things that Nestle could do with Blue Bottle. But they’re such a risk if they do, that they do that they destroy the brand, right? And I don’t know Nestle, the full ins and outs of their corporate structure but I don’t think the have anything quite like Blue Bottle which is like a physical retail experience. So this is something kind of new and different for them. But I think you also raise a great point that this is a business line but it's not one with a ton of crossover. There’s crossover potential but there are so many landmines in there.
Ben: Yeah. I don’t think I really considered that that much. The question is, I mean, if it’s a business line, then it should be freestanding and that means that you should believe that some are future cashflows on this thing are going to be $625 million. That’s a lot of growth.
David: Yeah, yeah. But on the other hand, so I’ll foreshadow, we’ll get into this more in tech themes. But this really is kind of like, it’s so interesting. Like this is a Facebook style acquisition being done by Nestle. They’re keeping the team’s effort. All the rhetoric is that they’re going to let Blue Bottle just keep doing its thing. It’s a separate board. The employees and James (the founder) still own a significant chunk of the company separate from Nestle. Yeah. But I don't know, what do you think? Is it going to work?
Ben: I mean, so what are they going to do? The question is like, what are they going to do with it? Are they going to try and put Blue Bottle in more places? Because I believe Nestle can probably do that. Like if that’s the goal and it’s really just to create a ton of the exact same Blue Bottle experience in more places, yeah, they can probably do that. And a big capital infusion is a really good idea to do that.
David: I mean, Nestle can be a much larger capital provider than even however much money Blue Bottle could raise as an independent company. You know, even an $875 million firm Fidelity, but Nestle could write that in a week.
Ben: Right, right. So I was reading this interesting Quora post that’s like it gives a good order of magnitude for what individual cafes sell. And I feel like I should have gotten the Starbucks comp because that would have been better. But this is in Australia, 60 percent of cafes sell between 200k and $2 million per year. So let’s say that the revenue side, that’s $2 million of revenue per store that Blue Bottle generates. That’s a lot of stores to get to $625 million.
David: Well, it’s not just revenue. Back to your point a little while ago, this is not a tech company. Let’s say they have 40 stores doing 2 million of revenue in each.
Ben: High-fixed cost.
David: Right. Like, okay, they had 80 million in revenue, let’s say. But the margins on that are not software margins.
Ben: Right, right, right. I did read one interesting piece that I thought was pretty interesting. That said that basically, Nestle had to do something in coffee because they have dominance in Europe with Nespressos. And by the way, having a Nespresso machine, we have one at work, these things are freaking awesome. Seventy percent of the single-serve market in Europe is Nespresso. And they tried to penetrate in the US and completely lost to Keurig and Tassimo and they have less than 5 percent penetration in the US on those single-serves. So the question is, if they came out with a Blue Bottle single-serve thing at home, would they be able to win some of that back. And the reason it’s important is because across Nestle’s businesses, their margins are about 15 percent and in their beverages it’s about 25 percent. So anyway that they can make more of their beverage business lines, they can generate much higher margins and this could be a huge missed opportunity if they have to forfeit the single-serve coffee market in the US as it just skyrockets in popularity.
David: Yeah. Interesting, interesting. So this is bad. But the right way to do the Juicero…
Ben: Yeah. Actually, David, I tried the other day just squeezing my Nespresso pod and they made amazing coffee on their own. I don’t know what I paid 100 bucks for this thing for.
David: Yeah. Well, you can’t do that with coffee.
Ben: No, no. So let’s paint this scenario. If it is a separate business line, like this is a totally new thing that may or may not work which is a leveraging of the brand into something that the brand may not be able to be leveraged into in the sort of single-serve home thing. Like would they pit Nespresso against Blue Bottle and have two divisions making similar things selling against each other? I mean, maybe it would be the same division and they would just sort of re-label the Nespresso stuff.
David: Well, if Nespresso, and I agree, they really do make good single-serve coffee much better than Keurig’s, but if they have such small market share here, maybe they just re-brand the whole thing in the US as Blue Bottle.
Ben: Yeah, I wonder. And how much of it, say, do the Blue Bottle folks have in that. I mean, presumably Nestle makes the decisions now and has the controlling interest.
David: Yeah. But again, remember, like they don’t 100 percent. The Blue Bottle team still has a large stake. There’s just a lot of complexity to this deal for so many reasons, as we’ve been talking about.
Ben: Yeah. I like your assessment of business line. I’m curious. It is that for now. I’m curious to see what sort of integration we start to see.
David: I feel like we’ve talked a bit about what would have happened otherwise. But I guess if Nestle hadn’t come in and acquired Blue Bottle and nobody else for a while, I mean, what happens? So like Fidelity is sitting there on their cap table at a very large stake and they’re not in the business of owning shares in private companies for 20 years. What happens?
Ben: Yeah. I mean, presumably another Nestle would have to come along in some amount of time. You can really see the dynamic here play out where the founders are like, “we don’t want to sell,” and they end up keeping all their shares. And the Fidelity’s are like we need to get out of this business. We’ve seen great growth but my God, we need a way to get out of this. You almost wonder did Fidelity tee this whole thing up with Nestle.
David: Well, and not just Fidelity too. I mean, don’t forget there have been VCs on the cap table here since 2008. So almost 10 years and venture capital funds have a life cycle. This is something that I think a lot of people don’t really understand unless you're an insider in the business. But the typical life of a venture capital fund partnership/limited partnership is 10 years. And what that means is that from the time the fund was raised until whatever that data is in typically 10 years, like you're supposed to wind up the whole fund and give all the money back to investors at that point. Now, in most cases there will be provisions to extend the life of the fund that almost always does happen but still then as the VC, you're having to go back to your investors every year and keep asking for an extension and eventually they’re going to get tired until you know.
Ben: And then what happens, David, this is a good little VC 101. Like what if the LPs say no and there’s still shares owned of these private companies that haven’t got liquidity yet.
David: Well, what would happen then is those shares would get distributed out to the investors in the VC fund, the limited partners, and that would be really bad for the company too because now all of a sudden instead of XYZ VC saying -- let’s say Index who led the Series B in Blue Bottle, so instead of Index as your investor and sitting on your board, now, ratably, all the unproportioned, those investors in Index, they all own little bits of your stock now and they’re in totally different businesses like they’re not in the business of sitting on your board, helping you grow. They may have different liquidity timeframes, return hurdles. It just turns into a nightmare.
Ben: And so then you could have 50,100, 200 new entrants on your cap table.
David: Yup, yup. And not just new entrants but new entrants with wildly divergent interests.
Ben: Right, right. And presumably at some point that starts to trigger some things that need to happen with the SEC because you have so many shareholders.
David: The rules have changed on that a little bit with the Jobs Act. But still.
Ben: No Bueno.
David: Yeah. No Bueno. So I kind of think, we talked about this before, but like, we’re going to see a bunch of this in the coming years. Like if some of these companies don’t get public or acquired, there’s going to have to be some sort of transaction that takes place. And maybe private equity is a path, so that might have been one thing that might have happened otherwise. You saw this with SurveyMonkey. So, similar situation. The company of Dave Goldberg, Sheryl Sandburg’s late husband, was the CEO and he was adamant, never wanted to go public but had raised all this money. And so actually several times the various private equity firms came in and bought out the existing investors in SurveyMonkey. And then even larger private equity firms came and bought out smaller private equity firms.
Ben: Right. There is a bigger fish for a while. At some point, they run out of big fish in the public markets where you need to go.
David: It can’t be turtles all the way down. There has to be a pool at the bottom.
Ben: Oh, man. I’m using that as the teaser quote for this episode.
David: Love it.
Ben: Okay, one other VC 101 moment. So of course every day is a day that goes by where it would be nice to have a return on your capital so that you can invest it elsewhere. But why don’t VCs more typically do an evergreen fund so they don’t have these sort of artificial fund vintage triggers to force this to happen?
David: Well, some VCs do. So like Sutter Hill is an evergreen fund. The thing about that though is that everybody has to be aligned in the partnership, both the VC partnership and then the limited partners about wanting. So all of the limited partners have to be able to say like, “Yup, we don’t care about timelines and liquidity.” But then even more importantly, the general partners in the VC fund have to also be willing to say like “I don’t care about liquidity either.” Most VCs, some are very wealthy independently or have been VCs for a long time and have gotten liquidity and aren’t as motivated. But really, if you look around the industry, especially in these multigenerational firms where the folks that are running the show or making investments now maybe aren’t necessarily the founders, they’re not in a position where they can just indefinitely go without liquidity either. And especially as a VC and investor in these types of companies, it's not like if the company is making and generating positive cash flow, it's not like they’ll dividend it out to you. So whereas if you are a founder of a company, you can start to pay yourself a lot more. If there is cashflow you can dividend it out or you can do bonuses or whatnot. None of that when it comes back to VCs.
Ben: Yeah. Great point. Well, thanks for sidetracking there with me.
David: All right. Should we dive into tech themes?
Ben: Yeah. Let’s do it. Let’s do it. Here’s one that I don’t know if it’s actually applicable but I’ve been thinking more and more about. And I think what I’m going to do here is walk myself into a corner where I say actually this is not a tech theme for this episode. But the return of brick and mortar in a different way than it was used before is really interesting to me where, you know, the story of the decade or the last two decades is Amazon taking 97% of retail growth, Walmart growing a little bit and everyone else shrinking and especially big-box stores shrinking. And this return of kind of boutique retail where even the online companies, Warby Parker, Bonobos, the sort of direct from internet to your doorstep companies are opening stores, and in many cases they’re doing the stores very differently. So like, you go to the Warby Parker store you don’t actually buy glasses there you buy them on the website in the store but you can kind of try it on. It’s almost like a marketing expense, like a brand awareness expense and a way to make the experience a little bit better. Now, as I said, I was walking myself into a corner. This isn’t quite the case with Blue Bottle. But it is sort of a part of this boutiquification of retail away from the man.
David: To invoke Ben Thompson a little bit, like it is a little bit aggregation theory in that what these new retail experiences do have in common, is they are a superior customer experience versus you are going to Warby Parker for one specific thing, you're going to Blue Bottle for one specific thing. You're going to an Apple Store for a one specific thing. Like there aren’t thousands of skews just lying around on the floor. And so as a result, you can have a much better, purer experience of that thing in that store and as a result, if you're able to get distribution, now this is where it breaks down a little bit in the physical world versus the aggregation theory on the internet. If you're able to have distribution wide enough and you have that superior customer experience, you will win every time. I mean, if there is a Blue Bottle next to a Starbucks like I’m going to the Blue Bottle, you know, but in the physical world and I think this is also, Ben, what you were talking about in the beginning of the episode like Blue Bottle has been valued like it is an internet company but it’s not. Like they need to have a store everywhere to do that and that’s going to require a ton of capital.
Ben: Yeah, it’s pretty interesting. I mean, the way I like to think about internet companies being differentiated is the super low, if not zero marginal cost. You can have super high fixed cost but low marginal cost especially not businesses like Apple that make hardware but like internet companies. As you sort of look around at those businesses they tend to be winner-take-all. Facebook is a winner-take-all business and Amazon will be a winner-take-all business, and Amazon doesn’t quite fit but maybe Amazon as the third-party seller group kind of fits. So the interesting thing here is like coffee stores are not actually winner-take-all. Like, despite the fact that Starbucks, you know, it's not just the internet that allows you to quickly saturate a global market. It’s many other factors of our world today too. It's our ability to do logistics at mass scale, our ability to do single advertising campaigns at large scale where you quickly make a brand understood by many, many people. So it’s slower than if it were just bits because it’s in the real, real world. But Starbucks, while expanding to a global market fairly quickly, I mean 24,000 stores, it turns out there actually are segments and it’s not a one-size-fits-all for everyone to create the best experience when you're in the real world and maybe even when you're in software too. You can’t create the thing that’s best for everyone under one single company.
David: Well, you can though if you're a marketplace. Right? And I think that’s why Amazon can be a winner-take-all business in retail because, like, you can buy the, I don't know, what’s some trivial example? Like an iPhone dock. Like, you can buy the $3 iPhone dock from China on there but you can also buy the like $500 artisanal, you know. You can get your Starbucks and your Blue Bottle on Amazon.
Ben: Well, that works on a product perspective but doesn’t work in a physical experience perspective.
David: Yeah, exactly.
Ben: Even if I could get exactly Blue Bottle coffee, like if I’m going to a Starbucks to get that, it’s not the same.
David: Yeah, right. So this is where the analogy breaks down in the physical world.
Ben: It's kind of interesting. Like if you go back to a traditional version of marketplace. Like before, it was this category of VC investable businesses, it was large square footage areas where multiple merchants were in a single place. And like Blue Bottle doesn’t want to exist in a marketplace either, much like Southwest doesn’t want to invest in a travel aggregator. Like I don’t want to be seen around all that cruft. I want to be in my own little thing and separated from all that. So, I guess the tech theme I’m going with here or the theme I’m going with here is like some things are un-crammable into these business models that are massive and winner-take-all and looks super shiny from an investment perspective, and I think coffee may be one of them. Like Starbucks is killing it, they’re doing great. But like, are they the answer for everyone? No.
David: I certainly agree with you in coffee as it exists today. But I’m thinking about like Airbnb though. Like a Holiday Inn was very different from a Ritz-Carlton, right? There were segments there for sure. But both of those experiences and both below a Holiday Inn and above a Ritz-Carlton exists on Airbnb. A platform like that actually can address if not the whole market, you know, many, many segments. Part of it is tied to maybe it’s just the nature of the coffee market, but I think it is also tied to this like physical nature of these businesses. Like you can’t do the same with coffee, right, because the experience of sitting in a Starbucks is very different from the experience of sitting in a Blue Bottle. They can’t kind of coexist.
Ben: Could Blue Bottle move down market at some point and open Starbucks competitors and like there’s Blue Bottle classics and then there is Blue Bottle something new?
David: What’s interesting, Starbucks is doing this with the roasteries. They’re moving --
Ben: They’re going to upmarket.
Ben: And like, can Starbucks actually win over the coffee snobs? I mean, that’s a tougher battle than like suddenly there being a $4 latte that’s available from Blue Bottle in a larger location that has Wi-Fi. Then I feel like I’m almost one of the cool kids and I have the product that I actually want.
David: Well, maybe the way they have to do it though is what we were saying earlier which was through the single-serve packaged coffee.
Ben: Go through the home instead.
Ben: Yeah, interesting. I mean, who knows what direction they’ll go but I’ll put the flag in the ground and say I just don’t think you can do a winner-take-all business and create a product for everyone when you have to think about the physical experience of it too.
David: I can’t think of an example that is not an internet business that can serve everyone. Like Google can serve everyone and Facebook can serve everyone and Instagram can serve everyone and Airbnb and Uber.
Ben: Even actually not Instagram and even not Facebook, like there’s so many people that want to select into their social network because Facebook is too public for me or Instagram is too limited.
David: Yeah. Good point.
Ben: I’d say we may be nearing… no, I’m not going to go there. Like the pushback of the one-size-fits-all but in some ways.
David: Well, okay, maybe Amazon can. Like who wouldn’t buy from Amazon?
David: Hmm, environmentalists, maybe. Yup.
Ben: I mean, I’m looking for corner cases in some ways. But do I believe that Amazon will be able to solve the problem of shipping products to environmentalists? Yes. Like that’s a bet I’d make.
David: Yeah. But I think you're on to something. Like it only works because you don’t have to go physically shop at Amazon. Because before Amazon, there was Walmart. But there were whole segments of people that would never shop at Walmart and likewise there was whatever high-end equivalent of Walmart you want to peak that doesn’t exist anymore.
David: Target. Right. Well, Target is sort of I think more mid-market or maybe slightly upmarket certainly from Walmart but I don’t think it’s the Neiman Marcus of big-box stores. Just about every demographic, unless as you point out, you have an environmental concern, would shop on Amazon, right?
David: Because again, you can get your $4 iPhone dock or your $500 iPhone dock there.
Ben: Yup. They’re getting there anyway.
David: Yup. All right.
Ben: You want to grade?
David: Let’s do it.
Ben: All right. You start because I don't know.
David: Well, this is tough. I mean, it’s kind of like everything worked out here. Investors got a nice return, especially the early investors. The management team and James certainly seems happy. I mean they’re leaving a ton of skin in the game so they must be bullish on the future. Nestle is getting potentially, well, they’re getting a growing brand and new business line to add but they’re also potentially getting something that could really be valuable to them in terms of rebranding their Nespresso single shot market and that’s a very big market. But it just feels like this whole thing wasn’t the right fit, you know, as we’ve had this discussion. I think I’d give it a B right now because this certainly was a good outcome for everyone but I just wonder if it was like the right path and what would have happened if maybe Blue Bottle had made some different decisions along the way.
Ben: I don’t disagree. It does feel like my biggest takeaway is with the real successful acquisitions we’ve seen, when you really dig in, you start to see like the one real reason this deal got done. And with Instagram it’s like “Oh my God,” Facebook can unlock even more supply, like even more add inventory and push all of their advertisers into a crapton more ad slots. Oh, that’s what that deal is about.
David: And they had an existential threat in losing mobile. It was very clear what it was about.
Ben: Right. And you know, there’s others. You see exactly what Disney wanted to do with Marvel. There’s their businesses turning super valuable IP into dollars in 11 different forms, and boy, are they firing out all cylinders of all 11 of those, pump them into the Disney machine. And what I can’t see here is like what’s the one reason they did this. Like I think it’s probably a good idea, like it seems like a good thing for Nestle to own. I can paint the story where the rebrand of the Nespresso makes lots of sense. I can paint a story where instead of growing 50% year over year and projected to grow 70% year over year next year, like they actually really turn it on and are able to open lots more stores very rapidly because they have all this capital. But like, do I see the one thing where this fits perfectly in and there’s internal alignment within Nestle of how they’re going to leverage this asset? Like, I don’t work there but probably not.
David: I think the only dark horse being the Nespresso, I mean that may just be a huge business and they needed a way to invigorate it.
Ben: Yeah. Thank you to the Quora commenter who suggested that. It's pretty interesting. So I’ll go B-, you know, maybe C+, but again, I’ve rated things that were way worse than the C’s, so I’ll go B+.
David: Carve out?
Ben: Carve out. So I was on a flight to Ohio this weekend and had lots of free time, I was clearing out my Instapaper. And this really interesting thing, I first heard about it like two years ago, that Tulip Mania story. There was a Dutch tulip bubble where people were going insane for buying tulips and it grew to religious fervor where people were paying unbelievable amounts for certain special types of tulips and highly speculative “I’m going to buy this bulb and it will be beautiful in some number of years from now.” Like total mania, right? The same way that we see bubbles that exist today and it’s kind of like the first macroeconomic bubble that people cite. And theoretically, like, crashed the Dutch economy and there was incredible despair and people lost fortunes and all this stuff. And the interesting thing was over the last few years, I’ve actually seen more and more of the story pop up in more places especially in the technocrats sphere where people loved to wax philosophically about it if we’re in a bubble or not. There’s even a movie coming out, I think it’s Tulip Mania or Tulip Fever or something this month, and the Smithsonian magazine published a really interesting piece called There was Never Really a Tulip Fever.
David: Oh, I’ve heard about this.
Ben: It was super interesting. Like this thing that’s gotten quoted and quoted and quoted and like referenced over and over again, like somebody wrote this book and did a bunch of research and tried to figure out like, okay, who were these people that lost their fortunes. And as they dug into it, they realized, like, of course there was over speculation here and the people, a lot of very wealthy people put lots of money in and lost that. But it never actually affected the working class and it never actually destabilized the whole economy and it didn’t throw anything into like a tailspin. It did not have these trickle-down effects that are so often quoted when wanting to compare a potential oncoming bubble or 2008 or 2002 to this Dutch tulip bubble. It’s like a totally fascinating analysis of why we wanted to believe that this mania created even more devastation than it actually did.
David: Hmm. Interesting. Relevant to today’s times.
Ben: Yeah, yeah. And there are some cool little takeaways in that and suggestions of why we do want to believe it but I’d say I’ll leave it to the author who’s way more eloquent at explaining that. So, click the link in the show notes if you want to check it out.
David: Cool. My carve out today is actually random-seeming, but is the iPhone SE classic. So I watched the Apple Keynote a couple of weeks ago. We talked about it a lot on the HTC episode. It was really great. And, you know, coming out of it, so for the last three years I’ve been a Plus model guy. I got the 6+ and then I got the 7+, and coming about it, I wasn’t that compelled by any of the hardware. Like I see where they’re going with the iPhone X. It's the future, it’s amazing but I was like, I’m not ready just yet because AR isn’t like really yet. It will be in the next generation or two. Then I realized, I was like, I was looking at the iPhone X and I was like, “Oh, it is smaller. It would be nice not to have such a big phone in my pocket anymore.” Then I just kept looking at my 7+ and I was like, ‘this thing is enormous.’ And like, I can’t sit down with it. I’m like, for the last three years every time I’ve had lunch or dinner or gone out, like I always put my phone on the table because I can’t have it on my body and so I was like, you know what, there’s such an active liquid secondary market for Apple products. I just sold it on eBay and I got an iPhone SE on eBay for way cheaper and I’m sure I will upgrade in the next generation. But I’m really happy to be back to having a small phone, I never thought I would say that.
Ben: This just in: Venture capitalist decides not to partake in new high-tech technology and rolls back to the Stone Ages.
David: That’s me. That is me. No, it’s such I’m always like all my whole life I’ve been a bleeding edge adopter but the form factor, I just kind of realized, yeah, maybe I’ll probably change in a couple of years but honestly it’s just nice to be back to being able to have my phone in my pocket.
Ben: I’m envious. I’m envious. You're so right on that. I think were it not for these cameras and sometimes when I want two-handed use of a larger keyboard, I’ve missed the crap out of that form factor.
David: Swipe-glide typing though on the G keyboard, the Google keyboard is pretty good. And I think this is it for me. Like I’m not much of a photographer. I don’t take that many pictures whereas I know you do. So I was like the appeal of the cameras for me is AR in the future and I just don’t think it’s there yet. So I’m going to enjoy my 1 or 2 years, probably 1 year with a phone in my pocket.
Ben: Well, David, enjoy your non-bionic phone.
David: I know. I’m going to miss the bionic. Are you going for a X?
Ben: If I can get one. I’m going to dual wield and have my browser open and try to order online and have my Apple Store app on my phone open and see if maybe I’ll end up with two, I don't know. But I bet I’m into Q4 or if not in early Q1 next year.
David: That’s the thing about Apple products, right? Like if you are an iOS person, the secondary market is so liquid. Like yeah, you have to pay some transaction costs but like not that much.
Ben: It's crazy. And they keep their value. Incredible.
David: They keep their value. You can swap out for really not much money in terms of economic impact. It’s kind of crazy.
Ben: It is. It is. Well, that’s all I’ve got. Do you have anything else?
David: That’s all I got.
Ben: All right, listeners, if you aren’t subscribed and want to hear more, you can subscribe from your favorite podcast client. If you feel so inclined we would love a review on iTunes. Other than that, join us at Acquired.fm. You can join the Slack and that’s all we’ve got. Have a great day!
David: See you guys soon. [music]