They call me Old School, a has-been, move with the times Ol’Man. Yet I cannot really understand all these Unicorns that have lately popped up with such frequency that even the name might be a misnomer.
Unicorns in the slang of Finance, is a company whose valuation reached the mythical status of 1 billion in either EUR/USD/GBP. Finance loves animal slangs… the bulls, the bears, and now the unicorns.
The biggest cheerleader of these Unicorns has been none other than Peter Thiel, author of Zero to One, extremely successful investor, and a Unicorn maker himself is a keen proponent of finding these types of investments.
I confess that I have dabbled in these types of investments too. It all starts with an Investment Pitch by the Founder and it’s Management Team pitching an idea of a market need and how they will provide it: A Business Model. Famous Unicorns have been yesteryears’ eBay’s, PayPal, and more recently Uber, Airbnb, Pinterest, and so on.
All the above companies went through this cycle of fund raising. The first round is called Seed, as the name might suggest why… but then goes through series A, B, C…
But how would you value such a business?
In Zero to One, Thiel utilised the Discounted Cash Flow (DCF) analogy to compare and contrast two companies that utilise advertising as their business model – Twitter and New York Times Co. (NYT)
Before we dive into these two companies what is DCF exactly? Well, it follows two simple concepts:
1. A company is worth it’s accumulated profits generated over it’s lifetime. Greediness and charity aside, when we pay for something we hope to get more out of it than we paid.
2.Discounted, because some genius realised that money loses it’s purchasing power over time. Who here does not remember when a bottle of coke was a nickel? Never mind I’m too old…
If this is all too confusing, remember Aesop’s fable: a bird in the hand is worth two in the bush.
Let’s see Thiel’s thesis on Twitter & NYT:
“Compare the value of the New York Times Company with Twitter. Each employs a few thousand people, each gives millions of people a way to get news. But when Twitter went public in 2013, it was valued at $24 billion – more than 12 times the Time’s market capitalization – even though the Times earned $133million in 2012 wile Twitter lost money. What explains the huge premium for Twitter?
The answer is cash flow. This sounds bizarre at first, since the Times was profitable while Twitter wasn’t. But a great business is defined by it’s ability to generate cash flows in the future. Investors expect Twitter will be able to capture monopoly profits over the next decade, while newspapers’ monopoly days are over.”
“… comparing discounted cash flows shows the difference between low-growth businesses and high growth start-ups at its starkest. Most of the value of low-growth businesses in the near term. An Old economy business (like a newspaper) might hold its value it can maintain its current cash flows for five or six years. However, any firm with close substitutes will see its profits competed away. Nightclubs or restaurants are extreme examples: successful ones might collect healthy amounts today but their cash-flows will probably dwindle over the next few years when customers move on to newer and trendier alternatives.
Technology companies follow the opposite trajectory. They often lose money for the first few years: it takes time to build valuable things, and that means delayed revenue. Most of a technology company’s value will come at least 10 to 15 years in the future.”
Zero to One, Chapter 5 Last Mover Advantage
The key takeaways from this excerpt are:
Great Business is one that has the ability to generate future cash-flows.
Cash-Flow of a loss making High-Growth company is in the distant future, so long as it monopolises its space, profits will be maximised in the future.
Cash-Flow of a Low-Growth business is in the near term, where the monopoly is expected to shrink, and hence profits disappear.
I am a great proponent of delayed gratification, sacrifice today for a better tomorrow. But in investing rarely being a Hero – trying to find the next Facebook, the next blockbuster – pays. There is a thin line between Speculation and Investment, and being a Hero you are in the speculative territory.
Let’s analyse properly Twitter & NYT with our plunger mindset.
The Rise of a Unicorn
In order to understand a unicorn, let’s understand their beginnings back to when they were still little ponies and no one knew a horn would pop out.
I think we should follow Peter Thiel’s analysis and compare the Old Economy NYT and New Economy Twitter. In some sense they are both fighting for the same thing: advertising dollars.
The market is massive:
Globally in 2019, more than $595bn will have been spent on advertising, and you can see the breakdown. What interests us is the Newspaper (NYT) and Social (Twitter) ad $’s. Thiel was right – Twitter is the riding a massive wave of growth to Social Ad’s platform:
So naturally Twitter has better prospects.
Now let’s consider their Financial Statements
Social Media is the biggest disrupter in the Advertising Industry.
Advertising follows our Attention Span – Social Media has trounced Newspapers in terms of time used in each platform.
Investment Tip: Always breakdown Earnings into Economic Cycles – gives you perspective and context of the results. Low Earnings in a recession are expected.
NYT Earnings matched the decline in global newspaper advertising spend.
Twitter revenue grew with Social Media advertising spend. No Profits.
Let’s Pretend We are in 2013 -
Investors were willing to pay 55x sales for Twitter but only 1.4x for NYT – Twitter was bound to have massive growth – as we saw on the table above on social media ad $.
Let’s be clear here: No one lost money investing in Twitter in Private Placements (Series A to G). A total of $ 760 million was invested in Twitter, at an average weighted valuation of 7bn and you had a chance to participate at 18B valuation if you were not of the lucky few who had access to private placements. That’s a compounded return annually of 14% annually for 7 years, up until IPO.
Where Would You Put Your Money?
Twitter It raised and burnt 760Million, it never made a profit, but sales and market conditions predicated a massive increase and a tectonic shift on advertising dollars to the detriment of Old Media, most significantly to Newspapers. It never made a profit, but Twitter has an ingrained space in the Social Media industry with over 300 million active users.
OR, you could have invested in NYT – a company with a proven track record, but suffering from falling newspaper circulation, but monopoly positions in their inherent market (something that Thiel touts in his book as crucial for investment).
From 2010 to 2013 it made on average $55M in the start of major revenue declines, but if a successful transition to digital would mean lower fixed costs and higher profitability.
In both scenarios nothing was guaranteed, and in a Valuation you always make assumptions.
We can cut it to the core:
Could Twitter utilise its massive user base to one day achieve profitability in it’s monopolised niche space? Cost: $36bn
Could NYT, albeit profitable in newspapers, successfully mount a challenge to add subscribers to its online offerings? Cost: $2.3bn
Certainty vs. Uncertainty – what pay’s off?
So this seems to be the debate of Us, old economy investors and new economy investors. We are all using the same tool – the DCF – gauging how many flipping birds are on the tree, before I let go of my precious one in my hand.
The main difference between Us and Them is that they place greater emphasis on the Terminal Value of the firm – i.e. the present cash-flows are irrelevant as the big money will be earned down the line – in Thiel’s emphasis “10-15 years in the future”.
Sort of like a lottery ticket – big money in the future, negative cash injections now. Give me uncertainty today, because I assume that in a Monopoly I will have great profits, and it may pay off, or falter.
Whereas Team Plunger believes that the Future is Uncertain, and we can’t forecast the development of certain industries and future profitability. However, what we can is use common sense in analysis past data that we believe might give us some insights into the future. Give me certainty today, and I let speculation add any future benefits that may arise.
Twitter to the left, NYT to the right. Starting date for both is Twitter’s IPO date of 29th of November 2013.
The difference is astounding. In terms of price appreciation alone – the Old Economy trounced the New Economy stock by a 14x or more than doubled.
Twitter’s private valuation and eventual IPO did not match the eventual Public Valuation.
A company that is valuable is one that has its distinctive capabilities turn into competitive advantages, allowing the outsized earning potential over their immediate competitors.
In the competition for our Time and our “Eyeballs”, an advertising medium works best when it is monopolised – where the circulation is highest. And the truth of the matter is that Newspapers and Social media have those inherent network effects within them that can create outsized returns.
The question is, when will Twitter prove it’s worth? The longer it takes the bigger the profits it must have to compensate for the years of sustained losses (12 years in a row).
The truth of the matter is that had we taken the advice from Thiel and discarded NYT as an investment due to Twitters growth potential – we would have taken a huge loss, in one of the longest bull markets in the world.
Twitter may or may not eventually earn a respectable return on your capital. All I know is my plunger prefers certainty regardless of what story is spinned by loss-generating companies
Sustaining the Madness – Unicorns Distinctive Capability = CASH
What is sustaining many Unicorns is the unprecedent Cash that is backing them – a major difference from the Dot Com burst. This capital started from founders that made successful exits on their investments and have deployed their know how and experience in launching more start-ups – Peter Thiel is a legend in this.
In Game Theory this is the classic game of Chicken. Many of the Unicorns investment thesis is the Winner Takes all, and therefore whoever can outlast without blinking, will take the investments home. Playing chicken games in Investment can prove costly.
Along came other Private Equity houses, Big Tech. Co.’s, Founders are spewing capital everywhere that moves and the capital all of a sudden become a Competitive Advantage… the locker-room equivalent of who has the biggest… plunger.
And the amounts are staggering, Softbank’s with the $100 billion Vision Fund, Tencent of China (owners of WeChat platform) have deployed over $100 billion in 300+ deals in 10 years, Alibaba has deployed over $80 billion all vying to outsmart each other in their Monopolistic mindset of conquering it all.
Whoever gets invested by them, has a natural advantage – they can be irrational to returns and expand at any cost. And that they have done.
Unicorns have the peculiarity that they have a very good narrative, and never underestimate the power of the narrative – how many times have we been duped by wonderful stories. Today we have an avalanche of narratives over the new companies that will come and conquer the world in their specific segments.
And that narrative really sells when the select club of Private Investors hype their own stuff and believe their own narrative. Hence I have never seen a capital raising that the value of the company was less than the previous
When Will We Learn?
Here is the latest Private Unicorn going Public:
One plunge in 9 made outsized returns. That’s a lottery.
WeWork is preparing for its IPO at a valuation of $48bn (as of this writing), we have an uncanny similar story happening to Thiel’s Old Economy vs. New Economy. Both are in the industry of Office rentals – one is profitable the other is highly unprofitable. One has massive cash backed by Softank, the other has been in public domain since 2003.
Before you invest, remember the Twitter vs. NYT.
 Preference Shares, liquidation preferences – Legal technicalities to ensure that if the valuation is not higher at least we get paid first. Madness.