the economics of my life

I, for one, am excited about the upcoming market challenges facing start-ups.  Yes, less money will be invested.  Yes, valuations will be lower.  And yes, start-ups will have to run leaner even if at the expense of growth.  Good.

As a fan of technology and innovation, I’m bored.  I’ve been bored.  The past few years have been littered with over-hyped, over-funded “companies” (please note the quotations) that are much better suited as plug-ins or features than real businesses. Everyone knows this, but the tech community prides itself on building “the next big thing”.  So it’s compelled to throw catchy language around in an attempt to convince itself that we are continually entering new stages of development.  Web 2.0.  No, Web 3.0.  No, cloud computing!

But no matter how or how often you say it, the fact is innovation has stalled. Rather than building disruptive technologies that can transform an industry, entrepreneurs have focused on the race to be the latest [insert hyped trend here] company featured on Techcrunch.  Why? Because Techcrunch = hype, hype = VC money, VC money = more hype, and more hype = a quick flip.  It’s a beautiful equation, but one that only works with excess VC money, growing budgets, and dying incumbents that are scared shitless.

Even if you exclude the “me-too” noise, what we’ve been experiencing for the last several years is, at best, simply the natural evolution of previous innovation: adding a new feature, designing a better UI, expanding into new markets…making current technologies incrementally better or more useful.  Necessary? Of course.  Exciting? Not the slightest.  I’m bored of incremental.

[Enter the current economic crisis]

The climate has changed.  There is a cautious attitude among investors (if not an actual strain on VC money), budgets are declining and exits of any kind are years away (at least for money losing start-ups).

Now this? This has the potential to be exciting.  With funding hard to come by and quick exits but a memory, the noise will fade.  Only real business models with true long-term value creation potential will get funded.  And only smart, passionate (yet prudent) entrepreneurs—those willing to risk it all for something they truly believe in—will survive.   Long-term perspective and passionate minds is a beautiful combination, one that leads to the creation of disruptive technologies and ideas.

I, for one, am excited.

Almost exactly three years ago, when I was but just a small town kid from California trying out life in the big city, I posted to my blog:

…what a great setting: a beautiful, sunny Saturday afternoon in New York City with The Shore providing my real life soundtrack. I’ve literally been sitting here for the last couple of hours relaxing, listening to music with a smile on my face because I can’t get over how much I love New York City.

It’s funny: somehow when you live here you are able to forgive, let go unnoticed even, all the obnoxious horn-honking, uncomfortable 8×8 boxes we call apartments, garbage-lined sidewalks, 8mm+ suits/hipsters/tourists constantly rushing toward their destinations (with no interest in seeming friendly), unbearable humidity, and lack of direct contact to sunlight. Instead, we relax listening to music on sunny Saturday afternoons with smiles on our faces, because we know that never before or ever again will we have as much fun as we are having right now.

Well I’ve decided I’m not quite done with the city just yet. So I’m back!

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It was one and a half years ago that I left New York to join a small start-up I had invested in at my previous firm.  The transition from NYC to a tiny suburb of Sacramento was tough (read as: unbearable), but being involved with MaxPreps was a privilege and an experience that I feel very fortunate to have… well… umm… experienced.

In 2005, while I was at a NYC-based venture capital firm, I developed the thesis that the Internet was not only enabling a dramatic shift in local media, but that shift was going to be largely realized in the coming one to three years. The infrastructure had been in place, but the timing of the market was beginning to feel right. Historically, traditional local media (newspapers and television) owned “the local”. They had built huge brands over the years and had a lock on distribution…but the Internet had/was changing that, especially with regard to the lock on distribution. Readers/users were simply finding their information sources elsewhere.

I wasn’t revolutionary in this belief by any means. Craigslist was already well established and there was a crop of early stage companies in the hyperlocal community space being funded: Judy’s Book, Insider Pages, Yelp, etc. Further, Google and Yahoo! had even begun working on their local strategies. In fact, many verticals once dominated by local media were being attacked by new media: classifieds, weather, traffic, business reviews, etc.

Generally, the model was to leverage the community to provide low-cost content and a centralized database to publish the data in a local manner. The geo-targeted content created a huge value proposition to local advertisers…and by aggregating the hyperlocal communities you also created an audience large enough to attract national advertisers. All of this (including the instant, on-demand information access aspect) at a cost structure that completely disrupted the traditional print and broadcast models.

However, most verticals already had a dominant leader or were crowded with well-funded start-ups. Further, it wasn’t clear to me how to pick a winner; most companies didn’t have any real tech differentiation and there was no clear home-run marketing strategy.

In the process of researching the different verticals, I came across high school sports. It was a large and established market: there are over 20,000 high schools across the country (each with a built-in, passionate fan base) and hs sports are not a trend, but rather a tradition, an institution. Also, it was clear that both local and national advertisers were interested because they had been spending money on local hs sports for years: it is a great way to reach a young demographic that has large spending power, especially in combination with the influence teens have over their parents’ spending. Further, it was a relatively untapped market. There were only a few players that had any real traction in the space and most players were still focused on the pro and college sports markets. Finally, there were obvious exits when you looked at traditional media because they needed properties to grow their younger audiences and/or extend their sports brands down market.

I had found my niche, vertical market.

MaxPreps, even in its infancy, had already attracted a decent sized audience and some major brand advertisers. More appealing was that MaxPreps had a real technology differentiation: they provided a free web-based platform to high school coaches allowing them to quickly and easily input their information (schedules, scores, stats, rosters, etc.). An important aspect of this model was that they didn’t have to try and dramatically change coach behavior…coaches have always kept records of this information, MaxPreps just provided a more efficient way of doing it. The service also provided other value added features (such as content syndication to local media, text-to-mobile messaging to players, etc.) that appealed to coaches and gave them incentive to participate. With over 25% of every high school football coach already inputting data into their system, MaxPreps had already built a large user base of semi-professional content creators/providers. And there was a clear marketing strategy to grow the coach network by acquiring coaches geographically and across new sports (there was actually a known cost per coach acquisition and a direct correlation between an incremental coach and traffic growth). Once you built the network of coaches you owned the market.

Meeting Andy Beal, the company’s founder/CEO, and the rest of the MaxPreps employees only solidified my interest. It was a team of coaches and tech professionals that truly understood their customer, market and technology. I found this to be of great importance because I knew a) the traditional leaders in the space, local newspapers, were not going to move fast enough, and b) even if a new group of savvy Silicon Valley developers, executives and investors ultimately saw the opportunity, they would not understand the market well enough to succeed. MaxPreps had all the right pieces.

Once we made the investment, I was able to observe the company much more closely and I just fell more in love with the team and the vision. Cut to a few months later and, after talking with Andy, I decided to re-locate to Cameron Park (CA) and join the company full-time to help execute on some new initiatives.

A year and a half—and a highly successful exit to CBS—later, I had had one of the best professional experiences in my career. It was my first entry into operations and I was lucky enough to do it with an amazing group of people. I truly am thankful for the opportunity.

However, now I’m ready for my next new adventure. So I’m back in the city ready to listen to music on sunny Saturday afternoons with a smile on my face, knowing that never before or ever again will I have as much fun as I am right now.

Anonymous commenter (in 2006):

The reason Akamai stock has done so well is that they have taken out their competitors. As soon as a new one emerges they either 1) sue them to try to stop their growth (Speedera, Limelight, Digital Island) or 2) buy them to constrain the market [Speedera, Netli, Nine Systems, Red Swoosh].

Today:

CAMBRIDGE, Mass. (AP) — Akamai Technologies Inc., which provides technology for the distribution of digital media, said Friday a jury ruled in its favor in a patent suit against Limelight Networks Inc., sending its stock higher in afternoon trading.

Like with Speedera, Akamai may come in now and acquire Limelight at a depressed price (assuming its can get approval).  I own shares in both as I’m bullish on the cdn market (see my earlier post–I guess I was right that Limelight’s a buyout candidate, although this isn’t exactly what I had in mind).  I guess the best I can hope for is a [now generous] $7/share offer (50% premium over current price) which would still net me a 20% return on LLNW and let Akamai take out its main competitor at a very cheap price (about 4x 2008 revenue, while Akamai is currently trading at 7x).  From there I ride Akamai’s dominance for a few more years.

Anyway, this provides a great opportunity for other cdn start-ups, specifically low cost providers such as Panther (which just raised a big $15.75mm round from Index Ventures and Greylock Partners).

Today’s filing has some interesting information about Yahoo!’s acquisitions:

–> The acquisitions of Right Media, BlueLithium and Zimbra totaled $1,083mm (at $526mm including its original $40mm investment, $255mm and $302mm, respectively).  This is about 20% less than what was reported by all of the blogs at the time of the announcements.

–> Yahoo! invested $40mm into Right Media in October 2006 for a 20% stake, implying a valuation of $200mm.  Yahoo! then acquired the company in July 2007 at a valuation of $526mm.  That’s a 2.6x return (ignoring any potential preferred or participating prfd cap structures) on Redpoint Ventures‘ $5mm Series B investment in about nine months.  I can only imagine the return on Redpoint’s $7mm Series A investment made way back in 2005.  Stepping outside the 10-K for a sec, Redpoint also co-led (with Benchmark) the Series A investment in Zimbra, and participated in follow-on rounds, resulting in about 25% ownership.  The acquisition by Yahoo! produced a 10x return on their $9mm total investment.  Two monster deals (likely returning well over $150mm total to the fund)…both acquired by the same company…less than four months apart.  Not bad.

–> While no specific revenue numbers for the three acquired companies were given, Yahoo! did provide the combined revenue of the Company and the 2007 acquisitions as if the acquisitions had occurred at the beginning of 2006.  This data showed that Right Media, BlueLithium and Zimbra combined for $97.28mm in 2006 revenue.  So Yahoo! paid 11.1x combined 2006 revenue.  However, all three companies are assumed to be in high growth mode, so it would be much more interesting to see what that multiple would be on combined 2008 revenue.

To get there, I’m going to make the, presumably reasonable, assumption that the three companies average 50% year-over-year growth in 2007 and 2008.  That gets you to combined 2008 revenue of about $220mm*, and implies a 2008 revenue multiple of 4.9x.

If this is the case, not only were the acquisitions great strategic moves, but financially make a lot of sense as well.

* I did a much deeper analysis based on the combined 2006 and 2007 revenue of Yahoo! and three acquisitions.  First, I tried to break out the 2006 revenue numbers.  Based on this article in 2006, the BlueLithium CEO expected to break $100mm in 2007 revenues.  Assuming he was applying typical entrepreneur growth rates, I’d place actual 2006 revenue around $20mm.  Further, based on this article, Zimbra had 2006 revenues south of $20mm…I assumed $15mm.  Knowing the combined number was $97mm, I assumed Right Media had 2006 revenue of $62mm.  Making some further assumptions on the individual companies growth rates, based on their market and 2006 scale, I estimated Right Media, BlueLithium and Zimbra 2008 revenues of $104mm, $70mm and $53mm, respectively. In the end, this process required quite a few more assumptions (and you are more likely to be off the mark with each additional assumption you use) and ultimately landed me combined 2008 revenue of $226mm and a 4.8x multiple.  They’re pretty close, so I just went with the more broad 50% growth assumption.

From late November through January, I had slowly been building a position in Yahoo!, starting in the mid-20s all the way down to the high teens.  And I was looking forward to continuing buying up shares as it dipped into the mid-teens.  Why?

Here is what I like about the business:

1) Great consumer web services: Yahoo! is the market leader here.  Between its homepage, email, news, finance, sports, maps, messenger, flickr, delicious, go/mobile, etc., Yahoo! has a lot of great properties and still draws the largest audience.  Integration hasn’t been great and they haven’t monetized the properties through advertising as well as you’d hope…but they are still very valuable assets.

2) Great international assets: I didn’t think the market was properly valuing Yahoo! considering its stakes in Yahoo! Japan and Alibaba.

3) Great recent acquisitions: I love the Right Media (online ad exchange), BlueLithium (behavioral targeting ad network) and Zimbra (email) acquisitions.  The first two help solve the core challenge of monetization of its assets through advertising—and Zimbra is another great service, provides some interesting opportunities for integration with Yahoo! Mail, and provides an entry point into the enterprise (and a subscription-based revenue stream to diversify and hedge against the risk of an ad downturn).

However, as a stand-alone business there still needs to be some major restructurings to ultimately realize the full long-term value.  First, cut the fat (much more than the hundreds laid-off in early January) by eliminating non-revenue generating businesses (opposed to broad, blind layoffs across the entire company).  Second, re-create an engineer/developer culture.  Third, once the non-revenue generating products are cut, focus on integration across core products with an emphasis on user experience.  Four, leverage the recent acquisitions and work on accelerating the ad revenue growth across Yahoo! properties, in addition to the publishing partners’ properties.

That said, the announcement by Microsoft provided me a 30% return in less than two months.  As much as I like some of the long-term potential in the business…30% in two months?  Sold at $28.51.