Paul Wallbank – Brilliant Communications

Tag: investment

  • Bubble values

    Bubble values

    The argument continues about Facebook’s purchase of photo sharing site Instagram.

    One side claims a billion dollars for a business with barely any revenue and 13 employees is clear evidence of a bubble while the other side say its a strategic purchase that is only 1% of Facebook’s estimated $100 billion market value.

    The latter argument is deeply flawed, comparing the purchase price against the value of other assets is always risky – particularly in a market where those underlying assets are being valued at the same inflated rates.

    We could think of it in terms of a Dutch farmer in early 1637 claiming that paying a thousand Florins for a tulip is fine when he has a warehouse containing hundreds of them.

    In reality, that farmer during the Dutch Tulip mania of the 17th Century held contracts for delivery; just as modern day investors held Collateral Debt Obligations.

    Measuring value against other inflated assets is always dangerous and only fuels a bubble.

    A much more concerning way of judging the wisdom of Facebook’s investment is against profit and revenue.

    If we compare the purchase of Instagram against Facebook’s revenue, then the investment has cost them three months income.

    Should we compare the acquisition against profit, Instagram has cost Facebook five years of profit at current rates.

    Both of those numbers are very high and it indicates how big a gamble the Instagram acquisition is for Facebook.

    It can be argued there is a lot of blue sky ahead for Facebook and that future profits and revenues will justify the Instagram purchase.

    There’s also a very compelling argument that Facebook has to get into mobile services and Instagram does that.

    Whether Instagram is worth three months income or five years profit to Facebook remains to be seen, but we should have no doubt it indicates we are well into Tech Boom 2.0.

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  • Distorted priorities

    Distorted priorities

    Every year the bureaucrats of the world’s movie production industry make their way to the Locations Show where governments compete to attract movie producers to their states with fat subsidies.

    This year, the preparations for the Locations Show conference are overshadowed by the US government’s struggling with continued subsidies to the Export Import Bank, an organisation going by the wonderfully Soviet name of the ExIm Bank.

    While ExIm and screen subisidies aren’t directly linked in the US – the bank being a Federally funded body that finances American manufacturing sales to foreign market while state governments compete for productions – both though illustrate the zero sum game of corporate welfare that leaves citizens poorer in the process.

    Delta Airline’s law suit over Exim subsidies to Boeing gives us a real life illustration of how business loses in these battles for government largess.

    When Delta Airlines goes to buy or lease a Boeing 777, they have to find funds at a commercial rate of interest. Air India on the other hand gets a subsidised rate courtesy of ExIm bank.

    However if Delta chooses to buy an Airbus A330, European governments will offer similar subsidies to the American carrier.

    So the subsidy system actually encourages American carriers to buys European jets rather than the US products. Nice work.

    This distortion is something we see too in film subsidies, as government funds are siphoned off to support large corporate movie productions.

    Nowhere is this truer than in Louisiana where the state embarked in 2009 to capture the so-called “runaway production” market of footloose movie projects that shop around the world for the most lucrative subsidies.

    This has worked, with Louisiana based movie production expected to total 1.4 billion dollars in 2011 on the back of $180 million in subsidies.

    One of the productions Louisiana grabbed in 2010 was The Green Lantern which came as a surprise to the government of the Australian state of New South Wales who thought Sydney had secured the project.

    The Green Lantern loss was the nadir for the Australian film industry that ten years earlier had been overwhelmed with productions like The Matrix Trilogy.

    At the time of the Green Lantern loss the industry appeared to be in its death throes, crippled by a high Australian dollar and disadvantaged by relatively lower government subsidies.

    You’d have thought that riches to rags story had taught Australian politicians that dumb subsidies don’t work and may have actually damaged the local film industry more than it helped.

    Unfortunately not.

    Last week the Australian Federal government announced $13 million in support for production of Wolverine. The Prime Minister’s office gushed;

    To attract The Wolverine to Australia, the Gillard Government granted the producers a one-off payment of $12.8 million which will result in over $80 million of investment in Australia and create more than 2000 jobs.

    The payment effectively provided The Wolverine a one-off investment package equivalent to an increase in the existing Location Offset to 30 per cent.

    Without this effective tax offset incentive, the producers of The Wolverine would not have chosen Australia as the location.

    In the 1950s, it made sense to invest in the industries of the future such as aviation, movie and car manufacturing industries.

    Unfortunately for our politicians in Washington, Canberra, Sydney and Baton Rouge, we don’t live in the 1950s.

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  • Bubble economics

    Bubble economics

    You know you’re in an investment bubble when the pundits declare “we’re not in a bubble”.

    A good example of this is Andy Baio’s defence of Facebook’s billion dollar purchase of Instagram.

    Justifying the price, Andy compares the Facebook purchase with a number of notorious Silicon Valley buyouts using two metrics; cost per employee and cost per user.

    Which proves the old saw of “lies, damn lies and statistics”.

    The use of esoteric and barely relevant statistics is one of the characteristics of a bubble; all of a sudden the old metrics don’t apply and, because of the never ending blue sky ahead, valuations can only go up.

    Andy’s statistics are good example of this and ignore the three things that really matter when a business is bought.

    Current earnings

    The simplest test of a business’ viability is how much money is it making? For the vast majority of businesses bought and sold in the world economy, this is the measure.

    Whether you’re buying a local newsagency outright or shares in a multinational manufacturer, this is the simplest and most effective measure of a sensible investment.

    Future earnings

    More complex, but more important, are the prospects of future earnings. That local newsagency or multinational manufacturer might look like a good investment on today’s figures, but it may be in a declining market.

    Similarly a business incurring losses at the moment may be profitable under better management. This was the basis of the buyout boom of the 1980s and much of the 1990s.

    Most profitable of all is buying into a high growth business, if you can find the next Google or Apple you can retire to the coast. The hope of finding these is what drives much of the current venture capital gold rush.

    Strategic reasons

    For corporations, there may be good strategic reasons for buying out a business that on paper doesn’t appear to be a good investment.

    There’s a whole host of reasons why an organisation would do that, one variation of the Silicon Valley business model is to buy in talented developers who are running their own startups. Google and Facebook have made many acquisitions of small software development companies for that reason.

    Fear Of Missing Out

    In the Silicon Valley model, the biggest strategic reason for paying over the odds for a business is FOMO – Fear Of Missing Out.

    To be fair to the valley, this is true in any bubble – whether it’s for Dutch tulips in the 17th Century or Florida property in the 20th. If you don’t buy now, you’ll miss out on big profits.

    When we look at Andy Baio’s charts in Wired, this is what leaps out. Most of the purchases were driven by managements’ fear they were going to miss The Next Big Thing.

    The most notorious of all in Andy’s chart is News Corp’s 580 million dollar purchase of MySpace, although there were good strategic reasons for the transaction which Rupert Murdoch’s management team were unable to realise.

    eBay’s $2.6 billion acquisition of Skype is probably the best example of Fear Of Missing Out, particularly given they sold it back to the original founders who promptly flicked it to Microsoft. eBay redeems itself though with the strategic purchase of PayPal.

    Probably the worst track record goes to Yahoo! who have six of the thirty purchases listed on Andy’s list and not one of them has delivered for Yahoo!’s long suffering shareholders.

    The term “greater fools” probably doesn’t come close to describe Yahoo!’s management over the last decade or so.

    While Andy Baio’s article seeks to disprove the idea of a Silicon Valley bubble, what he shows is the bubble is alive, big and growing.

    One of the exciting things about bubbles is they have a habit of growing bigger than most rational outsiders expect before they burst spectacularly.

    We live in exciting times.

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  • Hyping start ups for pleasure and profit

    Hyping start ups for pleasure and profit

    Monday’s announcement that Facebook would buy photo sharing website Instagram shows the power of Silicon Valley investor networks and how they operate, we should be careful about trying to emulate that model too closely.

    Intagram has been operating for 18 months, has 13 employees, has no prospects of making a profit and is worth a billion dollars to the social media giant. Pretty impressive.

    A look at the employees and investors in Instagram shows the pedigree of the founders and their connections; all the regular Silicon Valley names appear – people connected with Google, Sequoia Capital, Twitter, Andreessen Horowitz.

    The network is the key to the sale, just as groups of entrepreneurs, investors, workers and innovators came together to build manufacturing hubs like the English Midlands in the 18th Century, the US midwest in the 19th Century and the Pearl River Delta at the end of the 20th Century, so too have they come together in Silicon Valley for the internet economy.

    It’s tempting for governments to try to ape the perceived successes of Silicon Valley through subsidies and industry support programs but real success is to build networks around the strengths of the local economy, this is what drove those manufacturing hubs and today’s successful technology centres.

    What’s dangerous in the current dot com mania in Silicon Valley is the rest of the world is learning the wrong lessons; we’re glamourising a specific, narrow business model that’s built around a small group of insiders.

    The Greater Fool business model is only applicable to a tiny sub set of well connected entrepreneurs in a very narrow ecosystem.

    For most businesses the Greater Fool business model isn’t valid.

    Even in Silicon Valley the great, successful business like Apple, Google and Facebook – and those not in Silicon Valley like Microsoft and Amazon – built real revenues and profits and didn’t grow by selling out to the dominant corporations of the day.

    The Instagrams and other high profile startup buy outs are the exception, not the rule.

    If we define “success” by finding someone willing to spend shareholders’ equity on a business without profits then these businesses are insanely successful.

    Should we define business success by creating profits, jobs or shareholder value then the Silicon Valley VC model isn’t the one we want to follow.

    We need to also keep in mind that Silicon Valley is a historical accident that owes as much to government spending on military technology as it does to entrepreneurs and well connected venture capital funds.

    It’s unlikely any country – even the United States – could today replicate the Cold War defense spending that drove Silicon Valley’s development and much of California’s post World War II growth.

    One thing the United States government has done is pump the world economy full of money to avoid a global depression after the crisis of 2008.

    Some of that money has bubbled up in Silicon Valley and that’s where the money comes to buy companies like Instagram.

    Rather than try to replicate the historical good fortune of others, we need to make our own luck by building the structures that work for our strengths and advantages.

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  • What if Bill Gates had been born in Australia?

    What if Bill Gates had been born in Australia?

    Microsoft founder Bill Gates is today one of the world’s biggest philanthropists having built his business from an obscure traffic management software company to what was at one stage the world’s biggest technology corporation.

    But what if he’d been born in Sutherland, New South Wales rather than Seattle, Washington? How different would things have been for an Australian Bill Gates?

    The first thing is he would have been encouraged to study law; just like his dad. In the 1970s lawyers had far more status and career prospects than software developers in Australia.

    Causing more concern for his parents and career counselor would have been his determination to run his own business. It’s far safer to get a safe job, buy a house then start buying investment properties to fund your retirement.

    The Funding Drought

    If Bill still persisted with his ideas, he’d have hit a funding problem. No bank wouldn’t be interested in lending and his other alternatives would restricted.

    In the Australia of the 1970s and 80s they’d be few alternatives for a business like Micro Soft. Even today, getting funding from angel groups and venture capital funds depend upon luck and connections rather than viable business ideas.

    Bill Gates’ big break came when IBM knocked on his door to solve their problem of finding a personal computer operating system; the likelihood of any Australian company seeking help from a small operator – let alone one run by a a couple of twenty somethings – is so unlikely even today it’s difficult to comprehend that happening.

    Eventually an antipodean Bill Gates would have probably admitted defeat, wound up his business and gone to work for dad’s law firm.

    Invest in property, young man

    Over time a smart, hard working young lawyer like Bill would have done well and today he’d be the partner of a big law firm with a dozen investment properties – although some of the coastal holiday properties wouldn’t be going well.

    While some things have changed in the last thirty years – funding is a little easier to find in the current angel and venture capital mania – most Australians couldn’t think about following in Bill Gates’ path.

    Part of the reason is conservatism but a much more important reason are our taxation and social security systems.

    Favoring property speculators over entrepreneurs

    Under our government policies an inventor, innovator or entrepreneur is penalised for taking risks. The ATO starts with the assumption all small or new businesses are tax dodges while ASIC is a thinly disguised small business tax agency and assets tests punish anyone with the temerity to consider building an business rather than buying investment properties.

    At the same time a wage earner is allowed to offset losses made in property or shares against their income taxes, something that those building the businesses or inventing the tools of the future are expressly forbidden from doing.

    Coupled with exemptions on taxing the capital gains on homes, Australian households – and society – is vastly over invested in property.

    Making matters worse, the ramping up of property prices over the last thirty years has allowed generations of Australians to believe that property is risk free and doubles in value every decade.

    That perception is reinforced by banks reluctant to lend to anyone who doesn’t have real estate equity to secure their loans.

    So we have a society that favours property speculation over invention and innovation.

    Every year in the run up to Federal budget time tax reform becomes an issue, the real effects of negative gearing and other subsidies for housing speculation – the distortion of our economy and societies investment attitudes – are never discussed.

    In Australia there are thousands of smart young kids today who could be the Bill Gates’ of the 21st Century.

    The question is do we want to encourage them to lead their generation or steer them towards a safe job and an investment property just like grandpa?

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