Mark Zuckerburg announced that Facebook was acquiring Instagram for $1 billion yesterday, which set off a firestorm of blog posts, tweets, and news articles debating whether this was a sign of a bubble or if Instagram sold out too soon. I think Facebook needed to pay $1 billion to make the deal happen, so I thought I would offer my 2 cents on how Facebook could try to justify the $1 billion figure.
I’ve never really valued a company without any revenues before. Since I’m a restructuring banker, I have valued several companies that are massively cash flow negative, but they (or at least their management teams) all generally have rosy projections that increase their revenues higher than their costs within 3 to 5 years which give me something to work with when performing valuation analyses.
3 Traditional Methods to Value a Company Don’t Justify $1 Billion Price
However, the fact remains that the 3 traditional ways to value a company (DCF, Precedent Transactions, and Market Multiples) won’t help us justify the $1 billion sale price.
Great. So, if I’m trying to use traditional valuation methods to quickly value Instagram, I can’t really make any significant conclusions due to the lack of available information.
Since Early-stage, high-growth start-ups often have little to no revenue, they routinely need to raise funding to support operations. These fundraising rounds come with a negotiated valuation of the company at the time of the financing so that the company (i.e. founders) can issue shares to the investors at a set price they both agree on.
Instagram Raised $50 Million at a $500 Million Valuation Last Week
In a surprising move, Instagram reportedly raised $50 million of additional funding late last week at a $500 million valuation from a group of several top venture capital firms. So, it should be simple, right? If Instagram was worth $500 million on April 5th, shouldn’t it probably also be worth $500 million on April 9th, just 4 days later?
Well, it depends (shocker!). There is a major difference between financial investors (a VC fund, hedge fund, Private equity firm, etc) and strategic acquirers (other companies, usually in a similar industry). The subject company is more valuable to the strategic acquirer for 2 key reasons:
Giving up 1% of your market cap to take out biggest threat is a savvy move.
Okay, So Why $1 Billion?
Instagram had all the leverage. They just raised a massive round of funding and the founders were perfectly willing to use the money to build a bigger business that could challenge Facebook. I’m sure Google has expressed interest over the past few months and Apple may be sniffing around to get a hit in something social, so there were likely no shortage of suitors. Anything less than a massive premium to the $500 million valuation and the co-founders would have said “Hell No” and gotten back to grinding to build a multi-billion dollar business.
Also, Facebook didn’t want to make the mistake that Yahoo repeatedly made in failing to close deals with Google (in 2002) and Facebook (in 2006).
While the $1 billion may seem excessive, it was the price needed to get a crucial deal done and I believe Facebook made the right decision in making this acquisition.
(Note: Thanks to Hamza for pointing out a typo in an earlier version)
If you own an IPhone, an IPad, or play games on Facebook, you’ve probably heard of the popular new app “Draw Something”. It’s only the #1 free and paid app in over 80 countries, has been downloaded 35 million of times, and is (apparently*) insanely addicting.
*For some reason I’m the only idiot not to have played it yet. I’m going to blame it on the fact that I just got the new IPad (which is amazing) and haven’t had time to explore all the apps I want to yet.
What you may not know is that OMGPOP, the company that created and owns “Draw Something”, was just sold to Zynga this week for up to $210 million. This is an incredible success story for a company that was considering shutting down as recently as 7 or 8 weeks ago.
Here are 6 takeaways from OMGPOP’s sale to Zynga:
1. Don’t Give Up
Most people see the success of Facebook, Google, Pinterest, etc. and probably assume that transitioning from a startup to a successul company with millions of users is relatively easy.
OMGPOP started in 2006 under a different name and created over 35 games before hitting it big with “Draw Something”. Similarly, Angry Birds was Rovio’s 52nd game and Twitter only had 500k users after 1 year.
OMGPOP had several chances to fold over the past few years, but the team had confidence in their products and persevered through years of unspectacular growth.
2. Know When to Cash In Your Chips
Some tech writers/bloggers are criticizing OMGPOP for selling too soon and not taking the time to capitalize on “Draw Something’s” initial success to build a bigger stand-alone business.
Everyone has their own risk-reward ratio, and I’d argue that selling to Zynga offers the OMGPOP employees (and investors) a fantastic opportunity to cash in on their years of grueling work while still having the ability to create great games working at Zynga. They have taken a massive amount of risk off the table, and after some of the struggles they endured these past few years, I don’t see any problem with that.
Even the VC investors, who put in about $16 million of equity, should be thrilled with this result as they have gotten a great return on their investment. If OMGPOP had decided not to sell itself and instead tried to leverage the success of “Draw Something,” raise further VC capital, and scale into a larger company like Rovio, there would be no guarantee (especially in a relatively hit-or-miss market like gaming) that OMGPOP would be able to create meaningful growth after “Draw Something”.
3. You Need to Diversify Your
Bonds Revenue , _***** (link NSFW)
From Zynga’s perspective, this acquisition also makes a lot of strategic sense. Zynga has become the market leader in social gaming and “Draw Something” clearly complements Zynga’s existing portfolio of popular social games as Farmville, Words With Friends, and Zynga Bingo.
More importantly, OMGPOP, and especially “Draw Something,” represent a fantastic opportunity for Zynga to accomplish its strategic goal of diversifying from an online gaming company to a mobile gaming company. While Zynga has been extremely successful online in web browsers, it has become overly reliant on Facebook. If something were to ruin the Zynga-Facebook relationship it would be quite damaging for both companies, but Zynga would be hit hardest as approximately 90% of its revenues come from Facebook. Relying on one company for such a high percentage of revenue is extremely risky as it gives Facebook far too much leverage over Zynga.
As Wu Tang Financial so aptly advise their clients in this brilliant (NSFW) Chappelle Show sketch, you gotta diversify. Zynga needs to pursue further avenues of growth beyond online gaming, and the “Draw Something” acquisition will help Zynga further expand its mobile revenues by adding millions of mobile customers who love playing the game. Additionally, OMGPOP’s employees will provide 50+ highly talented programmers and engineers who can develop Zynga’s future mobile games and help diversify its revenue base.
4. Silicon Valley Tech Giants Continue to Establish Engineering in NYC
While the success of Foursquare, Etsy, Tumblr, etc. have proven that the tech startup scene in NYC has been very succesful, only recently have the “Big Boys” from Silicon Valley actually placed engineering talent in our fine city. Twitter opened up its NYC office in October 2011, Facebook announced in December 2011 that it was opening a new Engineering Office, but Zynga previously had no engineering presence in NYC.
This acquisition allows OMGPOP’s employees to remain in NYC, which gives Zynga an established base to recruit future engineering talent in the City.
5. Keep it Simple, Stupid
“Draw Something” is delightfully simple. It has a catchy name that is clear, concise, and easy to find in the App Store. Also, from what I’ve read, it is ridiculously simple and intuitive to use - anyone from a 5-year old kid to a 85 year old grandpa can immediately figure out how to play the game. There are plenty other, older apps that have similar features as “Draw Something” but they either are harder to find or harder for customers to use. As my 7th grade math teacher used to preach to us, Keep it Simple, Stupid.
6. Apps Can Be a Popularity Contest
The App Store isn’t always the ultimate meritocracy in that the best products don’t always win. What seems to matter as much as quality is momentum. If people love your app, it will skyrocket up the rankings and likely stay there while it’s hot. The problem is that there is no set formula for figuring out what app people will love. It is extremely difficult to break into the iTunes Store’s Top 25 list, but “Draw Something” was able to go all the way to #1 in just about 1 month.
The CEO of OMGPOP tweeted this incredible statistic yesterday:
It took AOL 9 years to hit 1 million users It took Facebook 9 months It took Draw Something ~9 days
From what I’ve read, “Draw Something” isn’t really that unique of a game, but it really resonated with its users and has become an overnight success.
Congratulations to the OMGPOP team on all their success. Now I need to play this damn game to see what all the hype is about.
(Photo from http://brohamnation.com/surge-we-hardly-knew-ye/)
Note: This post is a special request from my friend Michelle who wanted to see “Suraj on Surge”. Thanks for the inspiration - the subject is very near and dear to my heart.
1996 = Fate
In first grade all of my classmates really struggled with how to pronounce my name correctly (the correct way is “Sue-rudge”, where the “rudge” is pronounced like “budge”). In a desperate attempt to make it easier for them, I started pronouncing it “Sir-idge”.
My friends found this much easier to say, but little did I know that my name was about to get much easier for them to pronounce in 1996 when I entered 3rd grade, which was when I first experienced the soda Surge.
The delicious taste (and high caffeine levels) immediately won it a treasured place in my heart. Forget about Red Bull or 5 Hour Energy, in the 2nd half of the 90’s, Surge was all we needed to stay awake and go nuts. For people in my age group, Surge was the fuel for endless after school hangouts and late night sleepovers.
It also had the unintentional side effect of changing the way my name was pronounced forever as over time it turned from “Sir-idge” to simply “Surge” - not that I minded, of course. In fact, I embraced it as several of my student government campaigns in middle and high school revolved heavily around Surge related advertisements and posters.
By 2000, Surge was by far my favorite soda and I was drinking it multiple times a week.
2001 = Tragedy
It started off innocently enough. It was some time in 2001 and mom came back from the store without any of my favorite soda. No big deal - I didn’t think much of it at the time; I obviously I figured that Surge was too popular and the local Farm Fresh or Food Lion was overrun by caffeine-crazed teenagers who couldn’t get enough of the best soda in the world.
Next week, it happens again. I start to get worried. Finally, after a few months reality sunk in and I was crushed. The worst part was that they didn’t give us any warning! I would’ve stocked up on Surge cans for months if I had known my favorite soda was going out of existence.
Despite a fantastic name, delicious flavor, and a loyal, passionate fan base, Surge was discontinued - and at the tie I had no idea why.
So If It Was So Good Why Did It Fail?
Now that I’ve had 11 years to cope with the loss of Surge, let’s take a look at some potential reasons why Surge failed as a product:
*The high caffeine may or may not have been partly responsible for the massive upswing in ADHD diagnoses that began in the late 90s
**As an addict of Surge from 1996-2001 I really hope this was a rumor
It’s been a rough few years for us Surge fans. Right away there were several websites that popped up, including SaveSurge. However, despite repeated attempts to contact Coke management, Surge has remained discontinued.
Every once in a while when I’m in the soda aisle at the supermarket, I’ll see a green 2-liter and get excited. But alas, it normally is just something stupid like Vault.
However, in 2011 some glimmers of hope appeared for us fans as a new Facebook Group called SurgeMovement was created to try and bring back Surge.
I wonder what would happen if Surge were released as a new product in 2012. Granted, people are even more health conscious and concerned about sugar/caffeine than ever before, but Surge seems like a product that could thrive with the help of social media. I can easily imagine several clever, high-energy, cost-effective advertising campaigns that could quickly gain traction (especially on Youtube and twitter).
Plus, it fits right in with our Red Bull / Monster / 5-Hour Energy culture, and I’m sure it would be a great mixer if you’re trying to rage. I think Coca-Cola should definitely bring Surge back, especially as it doesn’t seem they have any real answer to Mountain Dew. I mean, when was the last time anyone saw anyone drink Mello Yello? And check this out, people are still tweeting pictures about it here and clamoring for it here - we can’t get enough of it!
In any case, I definitely have some nostalgia about Surge. I don’t often drink sodas, but when I do...I prefer drinking a Surge.
Are there any other products from your childhood that you think would succeed if they were re-introduced today?