"Too Big to Fail" & Charlie Rose

A recent issue of Fortune Magazine included a nice piece about Charlie Rose - "Why business loves Charlie Rose." I'm thankful for the article because it reminded me how much I enjoy his program so I've now set my DVR to record these episodes. Heck, if Warren Buffet watches it, I probably should.

Mr. Rose interviewed Andrew Ross Sorkin this week, author of "Too Big to Fail" - a book about the events and people surrounding the financial market crash, and I found myself completely engrossed with the conversation between Rose & Sorkin on the program. Lots of intricate details about Hank Paulson, Richard Fuld, Tim Geithner, and others. I just ordered a copy of the book from Amazon...

The discussion quickly reminded me of "Barbarians at the Gate" by Bryan Burrough and John Hely on the leveraged buyout of RJR Nabisco in a previous decade. I finally got around to reading this book over the summer.

While it's hard to believe how Wall Street deals sometimes go down, it's really not when you read about the people behind the deals. In the interview with Rose, Sorkin described his book as a recounting of people and their personalities as much as it is a book about the events themselves.

Acquisition Price - FriendFeed/Facebook

I wish I was always this good... I guessed somewhere around $50 mln in an earlier post today about Facebook's acquisition of FriendFeed.

Turns out I was pretty close according to this post in the WSJOnline late today.

So it didn't take linear algebra to make the guess, but what the heck...

"No Thanks!" in 140 Characters or less

Maybe the message was something like:

Twitter: @Facebook "No can do. Thx 4 the offer."

It's common knowledge now that Twitter declined Facebook's "$500 million" offer. Running some numbers yields some interesting results on the offer and valuations of both companies. (We'll come back to the quotes around the $500 million shortly...)

Back in April, Michael Arrington wrote that Twitter was worth between $60-$150 million just before it closed it’s $15 million venture round at the end of May.

TwitDir shows that there are “3,328,420 twitterers we know!” as of the time of this article. Using the $500 million offered by Facebook for Twitter and some simple math, this would equate to a valuation of approximately $150 per twitterer. Not sure if I’m buying that (pun intended….).

Henry Blodget did some interesting analysis on the real value of the Facebook offer, since the $500 million is “overvalued Facebook stock” based on the $15 billion valuation. There are lots of ways to slice and dice Facebook's valuation (including my own perspective based on the "Facebook Multiplier"). Blodget estimates that Facebook’s correct valuation is closer to $5 billion, thus decreasing the real value of Facebook’s offer down to $150 million, or $45 per twitterer.

At $45 per twitterer, which is probably a more realistic number to use, two questions:

1. How would Facebook earn back the $45 per twitterer in future value terms?
2. What does Twitter have planned that makes them think they can do better than $150 million.

Just my opinion, but:

1. I'd guess that Facebook isn't quite sure what it'd do - sort of feels like Yahoo! in a way. Good on eyeballs and users, not so good with the whole revenue thing.
2. Twitter isn't so sure either, but knows that there's a better deal out there than $500 million in monopoly money. Just because they turned down this deal doesn't mean they turn down the same amount or less from another enterprise.

Learn How to Sell

Spent the evening in the office getting some odds and ends worked out. I often listen the the podcasts on the Entrepreneurial Thought Leader Lectures to help make the time more productive.

This evening, I listened to this podcast from Steve Blank, who fastidiously suggested that company founders that can't sell their product will never be successful entrepreneurs. He talked about how founders need to know how and why customers make purchasing decisions, how to process information, and how customers think about the problems that you think you have.

He also suggested that lead engineers should spend 20% of their time in front of customers. Doesn't sound like much, but that's one day every week. Think about that.

The complete podcast is certainly an hour of time well-invested.

Writing for the Real Estate Market

Just a quick note to let you know that I'm also managing a blog now on ActiveRain specifically focusing on real estate market data and marketing strategy for real estate agents. Check it out here.

AllAdvantage.com - One Last Hurrah...

Back in late 1990s, I travelled frequently to the Bay Area for work, and during that time, was convinced that I belonged in Silicon Valley working with one of the great new start-ups. It took me until 2001 to finally get here, just a bit past the prime years of gluttony for many-a-startups.

One of those companies that was particularly interesting to me was AllAdvantage.com - a company that paid its users to surf the Internet. A close friend of mine (who shall remain nameless), worked as an analyst there and still tells stories about how the company would announce how many millions of dollars they paid out to its users (generally denominated in millions); followed by an employe cheer on at the recital of how much money was lost that month. Even as a analyst working on the AllAdvantage.com version of TPS reports, something didn't seem right to my friend.

Now in the lore of Silicon Valley start-ups long gone, AllAdvantage.com managed to resurface in a recent piece on The Industry Standard.

Quite ironic how The Industry Standard is doing pieces on failed Internet start-ups. I attended one of their rooftop parties many years ago - they weren't exactly the frugal type themselves....

Google's Employee Retention & Entrepreneurship

About a year ago, I explored Google’s investment per employee during their growth phase, noting that the Google’s employee retention might suffer in the long term as a result of simple mathematics. As Google continues to grow its revenue and employee numbers, maintaining the investment rate per employee to pay for its innovation and development would become increasingly more difficult.

As is well-known, Google inherently breeds entrepreneurialism by allowing its employees to spend 20% of their time on self-developed projects. Projects are presented to Google's product councils for further internal funding and support. Once the “true entrepreneurs" (which I am defining in this case as individuals that would actually leave their corporate binds to strike out on their own) learn the skills necessary to develop and incubate a new innovation, it is a natural progression to expect that they will move on to work on their own.

The brightest minds that have been with Google since the early days have little monetary incentive to stay now that their share options have vested. Those that came aboard Google after their successful IPO and subsequent share price growth have even less upside to sticking around in the near term. Why give up self-developed intellectual property to the “mothership” when you can add the Google brand name to your resume, retain ownership of your idea for a few years, and pursue your own interests afterward. This raises an interesting management question – is it possible that current Google employees are sand-bagging? Could they be working on only a part of their own ideas while working with Google, but saving their very best for a planned departure in the near future?

Adam Lashinsky’s article a recent issue of Fortune Magazine – “Where Does Google Go Next?” – examines the departure of key personnel at Google leaving to create their own start-ups. Some of the individuals and examples that Lashinky cites are Paul Buchheit who co-founded of FriendFeed (with three other former Googlers), Yanda Erlich who founded Mogad, and Nathan Stoll who founded Mechanical Zoo (with other ex-Google engineers). Which of these companies (if any) and their core ideas where actually developed during employment at Google?

The natural metamorphosis of many start-ups is to create a product model legitimized through a rapidly growing user base (and sometimes even paying customers!), and then an exit via acquisition to a larger firm seeking new technologies and products not otherwise developed in-house – companies like Yahoo! and, of course, Google.

Following this line of thinking, Google’s growth creates a reduced incentive system for the true entrepreneurs, but the corporate culture formalizes their employees’ entrepreneurship skills and strengthens their ability to develop and build their own businesses. During this employment period, the true entrepreneurs may sandbag on their ideas, then leave to start their own technology companies that conceivably end up as an eventual acquisition target for Google and its competitors.

This presents an interesting moral hazard for Google. While they deliberately strive to hire people with a penchant for entrepreneurialism, they may not know which employees are “true entrepreneurs” and which simply have an entrepreneurial spirit willing to share their best ideas with Google. This places even more emphasis on the recruiting and hiring process to vet out which applicants are entrepreneurial, but are not necessarily true entrepreneurs.

While each of these thoughts require additional analysis and research, Lashinsky’s article and listening to Paul Buchheit at a recent SVASE Panel Speaker event got me thinking about the Google-employee incentive relationship. More to come on this idea....

Getting Started with Bootstrapping Your Business

Traditionally, angel capital became known as “angel capital” because they were the first investors – the “pre-seed” funding, but with deals becoming more numerous and requiring more stringent expected ROI requirements, the entrepreneur in need of $50K or $100K in seed capital is left to bootstrap their business. If you are looking for that first installment of seed capital, here are some concrete ideas to consider.

1. Attend local start-up events. Get out and meet people. Yes, you’ve heard this time and again. Check you calendar. When was the last time you attended an industry event? If it’s been more than a month ago, that’s too long.
   
   Here in Silicon Valley, I’ve been a huge fan of the Silicon Valley Association of Start-up Entrepreneurs (SVASE). You probably won’t find funding at one their events, but you will surely uncover great ideas from their guests, panelists, and speakers.



2. Keep a regular blog. You don’t need to divulge company secrets, but keeping a regular blog provides you with some very tangible outcomes. First, a blog provides a written history of your idea’s development, so if you meet a potential investor or partner, you can show them your progress over time, not just where you are at the moment. It shows the outsider that you can keep a commitment to yourself and are able to communicate effectively with the outside world. Or perhaps a potential investor will find you when they are out searching for projects.
   
   Second, this helps you to see your own progress. As an entrepreneur, it’s easy to feel discouraged when you’re developing a new technology or innovation. You can’t always look back at the end of a weekend grinding away in your garage to see your progress. A blog enables you to see your accomplishments over time – everything from setting up an LLC to installing and understanding some new project management software to jotting down thoughts or ideas you’ve recounted from meetings and events you’ve attended.
   


3. Ask for advice and then listen. At a recent SVASE event, one of the panelists mentioned (to paraphrase) – “If you ask for money, you’ll get advice. If you ask for advice, you might get some money.” As an entrepreneur, you need to learn how to take constructive criticism and listen. Listening skills are the foundation of good sales skills, and enables you to improve your idea without taking the criticism personally. Remember Dale Carnegie’s book – “How to Win Friends and Influence People.” And if you haven’t read this book at least once in the last three years, then good back and read it again.



4. Ask for referrals. Memorize this line – “Thank you for your time and your advice. Do you know 2 or 3 other people that I can talk to for their advice as well?”



5. Carry a 5” x 3” Memo Book. These are about $1 at the local Walgreen’s and fit in your back pocket or jacket pocket. Great for writing down ideas that you get at the spur of the moment, or for jotting names and phone numbers of people you meet.



6. Stay positive. “It's supposed to be hard. If it wasn't hard, everyone would do it. The hard is what makes it great.” (Jimmy Dugan, played by Tom Hanks, in "A League of their Own" in response to Dottie (Geena Davis) saying she's quitting the team because "it just got too hard.")

CBS - The CNET Acquisition

The acquisition of CNET by CBS – let’s take a quick look at the numbers.

I began by checking out the Balance Sheet, and as a content and media company, one would expect what I saw – relatively low base of assets and liabilities. Pretty tough to determine the value of CNET based on assets on the books.

Then moving to the Income Statement, annual Revenues have been growing modestly each of the last three years (from Yahoo! Finance):

2005 = $354 mln.
2006 = $387 mln.
2007 = $406 mln

But the bottom line income tally reveals the results of some interesting accounting activity:

Total Income 2005 = $19.6 mln
Total Income 2006 = $6.8 mln
Total Income 2007 = $176 mln

The jump in 2007 looks impressive, until you see that CNET accounts for a $178.8 mln “Income Tax Expense,” thus propping up the overall bottom line income for the year.

Looking at the Cash Flow Statement, nothing here seems terribly appealing.

Change in Cash Flow 2005 = $26.3 mln
Change in Cash Flow 2006 = ($24.5) mln (CNET paid off $125 mln from convertible notes issued in 2004.)
Change in Cash Flow 2007 = $57.3 mln

Aside from debt retirement, it seems that cash flow situation seems is fairly stable as you look at cash flow from operations. But, nothing seems particularly compelling or attractice here from an acquisition standpoint.

So what does all of this mean in terms of the $1.8 billion price paid by CBS for CNET? The $1.8 billion represents a premium price per share of $3+. It also represents about 4 times revenue, slightly less than the price Microsoft offered for Yahoo! (which was 6 times revenue). CBS isn't in a situation where top line revenues really matter, so to acquire CNET simply to add to top-line revenues probably isn't a valid reason for the acquisition.

Total annual income is unimpressive, and the annual changes in cash flow are appealing but don't provide the case for the acquisition either. Overall, as seems to be the case when old media companies are attempting to keep with consumer demand for innovative content, the $1.8 seems to be an overpayment. CBS is obviously buying the CNET brands in hopes (yes, hopes) in evoling these brand names to consumer mindshare.

The bigger question is whether or not CBS can convert and integrate the acquisition into a positive gain to justify the price. I’m guessing not.

Is Yahoo! acquiring assets or problems?

Over the last couple of years, Yahoo! has been on a perpetual shopping spree in recent years – acquiring social media and social networking companies to boost its status in the Web 2.0 world.

18 months ago, a Business Week article by Catherine Holahan – “Yahoo’s Strategy: Growth By Acquisition” – supported Yahoo’s strategy, promoting the relatively low cost of these acquisitions. In 2006 for example, Yahoo! acquired Del.icio.us for about $20 million. Smaller acquisitions of maturing start-ups put Yahoo! in the position of a late-stage venture capitalist – pick a portfolio of seemingly good bets and expect that a couple of them will pop. Not a bad idea if you're flush with cash and need some new products.

That was then, this is now. More recent acquisitions are well above venture capital money - Blue Lithium for $300 mln, Zimbra for $350 mln, Maven Networks for $150 mln, and Right Media for $680 mln. As I wrote in a previous article, it seems that Yahoo! gave up cash for a goodwill asset on the balance sheet. More importantly, Yahoo! appears to have become a quilt of media companies, Web 2.0 technologies, and social networking tools that hardly generate revenue.

Back in January on TheDeal.com, David Shabelman suggested that Yahoo! consider more acquisitions - possibly of Monster.com, Expedia, and Shutterfly (among others). At some point, Yahoo! seems almost addicted to acquisitions as if the next one will be their saving grace or missing piece to the puzzle.

Shabelman also suggested that Yahoo! might combine Right Media and BlueLithium and spin out the combined company as an IPO. To break even on the acquisition costs of these two companies, the IPO proceeds would have to exceed $1 billion. To provide some perspective, Vision China’s (VSIN) IPO hit the market at about $544 mln in late 2007 and Digital Domain (DTWO) is scheduled to hit the market at $72-84 mln. This isn’t exactly a thriving IPO market for technology companies.

Corporate finance maneuvers of acquisitions, spin-offs, and juggling won't save the future of Yahoo! I have more thoughts on this, especially when compared to Google’s ability to grow its business more organically through innovation and development. Stay tuned for more….

Yahoo!'s Valuation - Goodwill leads to Goodwill

Recent word is that Microsoft has no plans to raise its $44.6 billion bid for Yahoo! Inc. $44.6 billion got me wondering how this matched up to Yahoo's value based on its balance sheet. I found one item to be particularly interesting - "goodwill" - which seems to be indicative of Yahoo! Inc.'s problems, and could be leading the company to Goodwill Industries very soon. How about a new logo?

As defined on Investopedia - "goodwill appears on the balance sheet of the acquirer in the amount by which the purchase price exceeds the net tangible assets of the acquired company." In other words, goodwill is the extra that you pay for after accounting for the actual company assets.

Keep in mind that I don't know what the media industry norms are with regard to the goodwill-to-acquisition price ratios, but looking at the Yahoo! Inc.'s 2007 Annual Report, it seems to me that they're pretty good at throwing cash into the goodwill bucket for acquisitions without getting much of a tangible return.

A few examples from Yahoo! Inc.'s 2007 10-K to illustrate (this info is found around page 70-85 of the report...):

1. Purchase of SOFTBANK, a firm with which Yahoo! had a couple of joint ventures (2005)

Total purchase price = $500 million in cash
Amount of purchase price allocated to Goodwill = $388 million

2. Purchase of Right Media (2007):

Price = $526 million ($246 in cash, $237 in equity)
Amount of purchase price allocated to Goodwill = $440 million

3. Purchase of Zimbra (2007):

Price = $302 million ($290 in cash)
Amount of purchase price allocated to Goodwill = $241 million

4. Purchase of Blue Lithium (2007):

Price = $255 million ($245 in cash)
Amount of purchase price allocated to Goodwill = $221 million

5. Alibaba (2005):

Price of 46% of shares = $1 billion in cash
Amount of purchase price allocated to Goodwill in 2007 = $443 million

Like I said, I don't know what the normal allocation to goodwill as a percentage of total purchase prices in the media business, but when I look at these transactions, I see a significant trend -

Yahoo! likes to take cash from its pockets and exchange it for an accounting asset called "goodwill" that you can't touch or see. These investments are not all-inclusive of all of the deals on Yahoo! Inc.'s books, but just up the cash spent on these five examples and you get nearly $2.3 billion.

I'd like to think that the brain trust at Yahoo! Inc. would like to have that $2.3 billion to spend on projects developed internally to produce organic company and product growth. Perhaps these actions are a microcosm of what's happened to the Yahoo! brand. A company that led the Web 1.0 revolution is now becoming a sideline watcher in the Web 2.0 and Web 3.0 evolution.

To put some perspective Microsoft's $44 billion offer - Yahoo! generated $6.9 billion in revenue in 2007, putting Microsoft's offer at a bit more than 6x revenues. Compare that to Microsoft's valuation of Facebook at $15 billion, estimated to be 500x revenues.

More on the Bear Stearns Valuation

At market close on Thursday, Bear Stearns was trading at nearly $6/share, yielding a market capitalization of just over $800 million, nearly a tripling of the publicly-announced offer of $2/share ($236 million) from last weekend.

The general consensus indicates that the real estate owned by Bear Stearns in New York City is worth about $1 - 1.3 billion. On March 16, Paul Kedrosky wrote that that this real estate asset would account for a large portion of the sale price.

If this is the case, some things still don't add up to -

1. At the original sale price of $2/share ($236 million), it seems that JP Morgan was buying a $1 billion real estate asset for about 25% of market value. There are proponents of the $236 million price tag that argue that JP Morgan is "buying the stock, not the assets." In the simplest terms however, when you own a stock, you own a share of the company. When you own a share of a company, you own a share of all of its assets. This is the basis of intrinsic valuation.

This is my fundamental position againt the low valuation. I agree that Bear Stearns is not worth the $20+ billion when BSC share traded at $170, but their largest underlying real estate asset is worth more than $236 million.

2. What about the human capital at Bear Stearns? The company paid $3.4 billion in compensation in 2007 (according to their 10K). Assuming that anyone worth their salt has left the company by now, you can probably estimate that the remaining human capital still with the firm by the time this shakes out is worth some value of what they were paid in 2007. Let's call it 10%, which provides a current human capital value of about $340 million.

By these estimates, assuming all other assets in the company are worthless:

Real Estate + Remaining Human Capital = Total Current Value of Bear Stearns

So:

$1 bln + $0.340 bln = $1.340 billion, which calculates to $11.35/share. Given the risk profile of BSC right now, JP Morgan could justify a discount, a "risk incentive" to take the shares at a price slightly below this level.

So with a share price at the $6/share area and a secondary market valuation of about $800 million, we're getting warmer. But it's not surprising to see current shareholders balk at the $2/share originally proposed.

Bear Stearns, Portfolios, and Waldo

Where's Waldo?

Courtesy of the Bear Stearns 10-K for the year ending November 30, 2007:

Some basic math indicates that 33.4% of Bear Stearns' portfolio was held in Mortgages, mortgage- and asset-backed securities. Add the Derivatives line item and you come to 47.5% of their portfolio is relatively risky assets. So how does this compare to a few of the other bulge bracket investment banks?

Hard to say in some ways with the numerous write-downs recently - $8 billion by Merrill Lynch, $9.4 by Morgan Stanley, $17.4 billion by Citigroup. But, some digging reveals how Bear Stearns is certainly outside of all of these firms regarding their risk exposure.

According to some recent 10Ks/Annual Reports:

Goldman Sachs - 11.9% of their portfolio is held in Mortgage-related. Add Derivatives, and 35% is in these two security types.

Merrill Lynch - 11.9% of their portfolio is held in Mortgage-related (no, that's not a typo - it's also 11.9%....). Add Derivatives, you get 43% in these two securities.

Lehman Brothers - 28.4% of their portfolio is held in Mortgage-related. Add Derivatives, and you get 42.7% of their portfolio.

This is a fairly cursory analysis, but looking at the most recent and pending results of the firms above, perhaps there's a linkage in there somewhere? There are many-a-bankers asking themselves what sort of business strategy that Bear Stearns was undertaking, and certainly comparing results might yield some cause and effect in retrospect.

Or maybe Bear Stearns just missed the memo....

Short-term Project Financing: Case Study

This question (paraphrased) was submitted by one of my readers:

"Hi Scott - I have been reading some of your financial blogs. I have a question for you, yes is a needle in a haystack... I am looking for capital - short term - to announce a local sporting event with internationally-recognized sports figures. My original funding source was delayed out of by 30 days and I need some immediate cash for expenses related to the event. Do any of your contacts have access to immediate funds with ticket sales as collateral?"

Funding of this sort doesn't fall into the normal "venture capital" funding out there, but I see a couple of potential options for you:

1. Talk with your event partners, such as the arena hosting the event about providing a short-term loan in exhange for a return on ticket sales. In the arena is booked, they might find it difficult to re-book their location with another event, and thus both of you would be losing money if the event does not happen. Take a partnership approach.

2. Approach your local vendors that stand to lose planned revenues if the event is postponed - same principle applies as with the arena hosting the event. Agin, take a partnership approach and leverage the fact that you're bringing this event to your city - they'll be buying into you and your ability to make the event happen.

3. Talk with a leading local bank about some derivative of Accounts Receivable Financing (sometimes called "factoring"). This type of financing is normally reserved for firms that have revenues booked as Accounts Receivables, but have not yet collected. Because the terms extended to customers may include net-30, net-45, net-60, net-90, etc., some lenders provide financing based on these future revenues, with some risk premium charged to you in exchange. While this doesn't match your situation exactly, a local lender or credit union may be willing to provide a loan in exchange for the aforementioned risk premium and some hefty sponsorship recognition from your organization at the event.

A search in Google for "accounts receivable financing" yields thousands of results where you can learn more.

Because of the short-term nature of your capital requirements, you'll need to approach private banking institutions and lenders, and avoid SBA (Small Business Association) loans. SBA loans take months to get cleared and its likely that your situation doesn't fit their lending criteria.

I'm suggesting a local bank because they may have more autonomy to make a quick decision locally, instead of the probable "up-the-ladder" decision process with a large regional or national ban. Plus, the local banker will have more implicit interest in receiving sponsorship status in exchange for providing an event loan.

4. Meet with the local Chamber of Commerce to discuss business contacts of private business leaders that can help you out of your situation. From what I know about your city, there are bound to be a couple local business leaders that might be willing to take a risk in working with your event. They may have some lenders in mind for your as well.

5. Contact your previous sponsors and VIP ticketholders and offer a significant pre-pay discount for sponsorships and tickets if you've had this event in the past. This would provide you with some quick cash flow for promoting the event.

In short, I'd consider any and all options if you're in that much of a bind. Take the win-win approach that everyone that gets involved with the event and leverage your existing work with previous events and your foundation. Hope this helps.