There’s been plenty of talk about another bubble lately and comparisons to the dot com bubble have been made. I’ve been reading the autobiography of Henry Ford, “My Life and Work,” and found some interesting observations about the automobile bubble at the beginning of the century when hundreds of auto startups were launched in Detroit and around the world.
Here are some excerpts and my comments:
”The automobile business was not on what I would all an honest basis…That was the period, it may be remembered, in which many corporations were being floated and financed. The bankers, who before then had confined themselves to the railroads, got into the industry.”
Henry Ford was referring to the railroad bubble and crash in the 1870s in the US (before that, there were railroad bubbles in the UK and other parts of Europe).
“A business ought to start small and build itself up and out of its earnings. If there are no earnings then that is a signal to the owner that he is wasting his time and does not belong in that business.”
What an old fashioned idea. Ford goes on to say…
“I have never found it necessary to change those ideas, but I discovered that this simple formula of doing good work and getting paid for it was supposed to be slow for modern business. That plan at that time most in favor was to start off with the largest possible capitalization and then sell all the stock and all the bonds that could be sold.”
Interesting observation about “modern business.” Those wonderful visionaries that pioneer the new era of “modern business” always talk about how things are different this time around. Unprecedented.
“A good business was not one that did good work and earned a fair profit. A good business was one that would give the opportunity for the floating of a large amount of stocks and bonds at high prices. It was the stocks and bonds, not the work, that mattered.”
All the talk these days are about IPOs and mega financings of private companies at billion dollar+ valuations. There is very little talk of profits and even revenue is starting to go out the door as a proxy for value as people marvel at the valuations of companies such as Instagram, Pinterest and AirBnB.
A new era of the “fat startup” is upon us. There are now more private companies with billion dollar valuations than during the peak of the dot com bubble. Most of the billion dollar companies during the late 1990s blew up, some in spectacular fashion. How will this latest crop fare?
The history of record breaking companies to $100B market cap shows that keeping up an impressive growth in valuation is hard to do.
Microsoft was the fastest to $100B in its day. It took them 25 years to reach the staggering figure. After being flat for years, their market cap has lingered around $260B. That is about a 6% gain in market cap per year over 16 years (although returns to shareholders have been higher due to dividends).
Cisco completely shattered Microsoft’s record and got to $100B in only 12 1/2 years and kept going to $500B in record time, briefly overtaking Microsoft and GE to be the most valuable company on the planet. After the doctom crash, Cisco has been languishing for more than a decade and is below $100B ($88B as of last Friday and an enterprise value less than $70B).
Google shattered Cisco’s record, getting to $100B in only 8 years. The company has grown by leaps and bounds since 2005 but is less than 2x higher in market cap after 7 years and accumulating tens of billions in profits and cash.
I always thought the next great company would break Google’s record of 8 years.
Now we know Facebook will be the next great company to $100B market cap. But it won’t shatter Google’s record. It’ll get there around the same time. Maybe a bit slower.
It’ll be interesting to see how Facebook will hold up in 10 years.
Doing quarterly reviews of our companies tonight, one key lesson has emerged. Budget cuts and headcount reductions forced one of our companies to focus exclusively on the quality of the product as a means of attracting users rather than spending on unproven marketing channels. This has led to increases in activity and new user registrations to record levels - with zero marketing spend. How ironic. We should have made cuts earlier.
At another company, far more successful than the first, we are seeing acceleration in growth rates even though the VP Marketing was let go for being ineffective. With less marketing activity, growth has accelerated. We attribute the growth to continued, relentless improvements to the product, especially on performance/scalability improving response time and user experience.
One of the highlights of this year’s NVCA meeting was seeing Mike Markkula interview Arthur Rock.
Rock’s “most fun deal” was Scientific Data Systems, his first big exit. He didn’t get into details about this spectacular investment so I did a bit of research.
SDS was founded in 1961, the same year that Arthur Rock moved to California to start Davis & Rock. In 1969, SDS was acquired by Xerox for $1B. The founder, Max Palevsky invested $60,000 and got back $100M and joined the board of Xerox. According to the book “Venture Capital at the Crossroads” published in 1992, Rock, the Chairman of the board, also netted $100M for his fund, on a $257,000 investment for a 389x return.
$1B was pretty serious money back then ($6.3B in 2012 dollars).
Two of Arthur Rock’s more famous investments were in Apple and Intel. He served on Intel’s board for 31 years (1968-1999), including a stint as Chairman. He resigned from Apple’s board after 10 years due to competitive conflict with Intel. Can you imagine what those investments would be worth today (if held)? The combined market cap of Apple and Intel is nearly $700B.
In this 1984 article, written by Mike Moritz, Tom Perkins is quoted as saying that Arthur Rock is “the best long ball hitter around.”
http://www.time.com/time/magazine/article/0,9171,949965,00.html
His least fun deal was Diasonics. The company went public and ran into lots of trouble. According to Rock, GE and Siemens took the market away. Told hospitals to “just try it out.” Also, “the CEO promised too much. Got in trouble.”
Rock looked for investments that were “open ended with no limits to their success.” He said he had no idea how big some companies would get. He just looked for people he could work with “and seeing what would happen.”
The only company he knew 100% would be successful was Intel. He got to see what Noyce and Moore could do at Fairchild. They were very entrepreneurial. They were good leaders. Peopled liked working for them. After 8 years of success at Fairchild he believed they knew what they were doing.
Rock stated that VC firms have gotten too big to make small investments. Davis & Rock started with $5M. We couldn’t invest more than $300K. In today’s dollars, that would be like starting a $38M fund and limiting investments to $2.3M (1961 to 2012 dollars).
Other countries have a hard time replicating VC because they don’t deal with failure as well. Change in psyche needed. As that happens they will find more success.
Rock also talked about philanthropy. He focuses on on K-12 education.
Someone asked what did he look for in people (his most important criteria):
He looked for
1) Smart people.
2) Honest people. “I mean intellectual honesty. Will they admit their mistakes?”
3) Hard workers.
4) “Do they get along with others of their ilk?”
Then repeated…most of it is intellectual honesty.
It was interesting to read Ben Horwitz’s blog post about Instagram.
http://bhorowitz.com/2012/04/22/instagram/
312x is certainly a spectacular return in 2 years. Now, compare that against $2.7B raised so far.
http://bhorowitz.com/2012/01/31/why-has-andreessen-horowitz-raised-2-7b-in-3-years/
Simple math says, after netting $78M on $250K, the funds of Andreesen Horowitz will need 34 more Instagrams to return capital. Just 103 more to achieve the typical target of 3x return.
Does that seem likely to you?
History shows that, at most, 10-15 deals per year create almost all of the value in the tech industry. So they would need a very large percentage of the big hits in the venture industry, each and every year, for the next 10 years to have a shot.
Does the math make sense?
“People are never alone now… We make them hate solitude, and we arrange their lives so that it’s impossible for them to ever to have it.” — Brave New World by Aldous Huxley, published in 1932 (72 years before the launch of Facebook!)
“A great institution is the lengthening shadow of a man” — Ralph Waldo Emerson
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During a time when people are selling stocks in near panic mode due to economic and political concerns, this Warren Buffett quote should serve as a reminder of what is important in assessing stocks:
“We will continue to ignore political and economic forecasts which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%. But surprise - none of these blockbuster events made even the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.
” — Warren Buffett, Berkshire Hathaway 1994 Annual Report“A contrarian approach is just as foolish as a follow-the-crowd strategy. What’s required is thinking rather than polling.” — Warren Buffett, 1990 Berkshire Hathaway Annual Report
“Ben Franklin said that an ounce of prevention is worth a pound of cure. That grossly understates things. It’s worth a TON of cure At Berkshire we didn’t learn how to solve problems. We learned how to avoid them.” — Charlie Munger, Morning with Munger in Pasadena, California, July 2011