M&A Activity of Major Tech Companies

In the venture world, there are typically two ways VCs successfully exit the companies they invest in: (1) via IPO or (2) through acquisition by a larger tech company (think Google, Microsoft, etc.,). Of these two methods, an M&A exit has historically been more common. Nonetheless the literature within the venture community about why large tech firms acquire the specific targets they snap up is sparse. It seems odd that while ‘the acquisition’ is the main goal for most of the venture community, many VCs spend little to no time thinking about investing from the perspective of the firms doing all the acquiring.

This semester, I took Columbia Business School Professor Raul Katz‘s course on Developing Strategies for High Tech firms. In the process, I wrote my final paper on this very subject. The focus of the paper was to understand the recent (last 3 years) M&A activity of four of the largest global tech companies: Apple, Facebook, Google and Microsoft. Specifically the paper analyzed the implications the M&A activity of these four companies (and others like them) has for early stage VCs focused on investing in tech companies.

In building towards a hypothesis around the motivations for M&A activity, I examined the 7 motivational variables displayed in the table below. I focused solely on operational motivators and excluded non-value maximizing motivators such as management hubris or financial synergies like the desire to reduce the weighted average cost of capital (WACC). The rationale behind this focus is that operational synergies are the most relevant and identifiable variables for VCs to focus on as they think about M&A as an exit option. Operational synergies are also: specific, repetitive (allowing for pattern recognition), have predictive power and can be used to build an investment thesis.

The shaded rows represent new variables previously not looked at in the existing literature. I used S&P Capital IQ as well as a variety of analyst reports and news articles (VentureBeat, TechCrunch, etc.,) to populate the data used in the regression model.

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The results of the regression analysis are displayed below:

Premium Paid = -$5,500 + $2,950(β1) + $324(β2) + $3,780(β3) + $109(β4) + $2,168(β5) + $4,193(β6) + $1301(β7)

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There are several characteristics of the regression worth pointing out. First, the intercept (β0) is negative, which limits the full application of the regression equation. This is likely due to a small sample size and data that is not normally distributed. Because of this negative intercept, we cannot make a direct dollar connection between each M&A motivation variable and the premium paid by the acquiring firm. That being said, we can make some relative observations based on the size of each beta coefficient. Additionally we can make some important observations regarding statistical significance. As seen in the exhibit above the four M&A motivation variables that were statistically significant include: economies of scale, value chain integration, growth in new and existing markets and large network effects. The remaining three variables are not statistically significant according to our model.

The results can be broadly bucketed into B2C variables and B2B variables—although there is certainly some overlap. On the B2C front, unsurprisingly, tech firms like Apple, Facebook, Google and Microsoft place the largest premiums on startups with large network effects. Acquiring companies like Instagram, WhatsApp and Skype allows these firms to essentially acquire a massive customer base with a large customer life-time value. Because of the large network effects, these customers are unlikely to switch to substitutes. Big tech firms can then monetize these acquired customers over a long period of time as well as cross-sell products and services on their existing platforms.

According to our regression output, these big tech firms also place an important (though not nearly as large) premium on B2C companies that allow them to grow in new and existing markets. B2C companies like Snaptu (a mobile platform for feature phones in developing nations acquired for $70 million) and Oculus VR (a virtual reality and gaming device company acquired for $2.3 billion) allow big companies like Facebook to enter new markets—whether geographic, customer-segment specific or newly emerging industries.

When it comes to B2B acquisitions, the M&A model provides evidence that large tech companies place a heavy premium on value chain integration and economies of scale—both means to maintain a competitive advantage. Apple’s acquisition of semiconductor company Anobit Technologies for $400 million is a great example of value chain integration. Apple has slowly been moving away from hard drives to flash memory beginning with the iPod and most recently its MacBook Air. Flash memory allows Apple’s products to be thinner and run on less power. Acquiring Anobit allowed the firm to acquire the hardware component needed to complete value chain integration and transition fully from hard drives to flash memory chips.

Though not as important as value chain integration from a relative perspective, large tech companies also consider economies of scale when acquiring B2B companies. Within that realm, companies that provide a service or toolkit that enable a bigger tech company to take advantage of scale economies are also often worth acquiring. Microsoft’s acquisition of Pando, a file-sharing technology that works peer-to-peer like bit-torrent, is a great example of this. Pando’s technology can be applied to Microsoft products like Xbox and Windows Phone App Store, to reduce costs in these divisions and enable Microsoft to take advantage of its economies of scale.

For full analysis of the results of this study as well as a discussion of the implications for VCs, please email the author.

Google Glass Investment Thesis

About a year ago, I wrote a post about Google Glass and the possibility that Glass (and other wearable tech hardware platforms) would eventually give rise to the next generation of startups. It seems like the jury is still out on whether Glass will be the next iPhone, but it is certainly an area worth exploring further. This semester while interning with DFJ Gotham Ventures, I was charged with building out an investment thesis around the Glass ecosystem.

As a result, I did a deep dive analysis on the eyeware itself, the wearable tech industry more broadly speaking and the opportunities and challenges that currently exist for venture investors. In the process, I went as granular as focusing on specific industries and identifying companies within those industries. I was fortunate to speak with a wide range of VCs, entrepreneurs and industry experts – all of whom greatly contributed to the end product. Special thanks to Zak and Lucas on the Gotham team and Professor R.A. Farrokhnia for their guidance. Enjoy and feel free to drop me a line if you have any comments or suggestions. 

CareCloud: A Good Investment?

This past week, while applying for the InSITE Fellows program, I had to prepare a quick analysis of CareCloud (a healthcare IT company) based on a venture beat article that can be found here. Now that the application cycle is over, I thought I’d share my response and some general thoughts on the company. Admittedly, I know very little about healthcare companies but the industry is intriguing and very much ripe for disruption. Here is a first attempt at evaluating the company from an investment perspective.

In assessing CareCloud as a potential investment, I examined three core areas: the market, the technology and the team. While the technology is very sound and the team is promising, I would likely not invest in the company due to several significant issues in the electronic medical record (EMR) market.

The Technology

CareCloud’s medical practice management software is a great solution to a clear pain point in the market—namely that legacy vendor’s provide systems that are too bulky, inefficient and costly. Built on a nimble Ruby on Rails platform, CareCloud’s elegant design and user-friendly interface has been well received by physicians and other users. The product is completely cloud based making it easy for physicians to update and stay on top of complex regulations and compliance mandates. It also focuses on providing users with the flexibility to pick and choose components of the software rather than being forced to adopt an entire platform and abandon existing software. All these features result in a lowered cost to the physician and a better way to manage their practices.

The Team

The management team at CareCloud is also very strong—comprised of industry veterans and individuals who are experts at the given function they lead. This of course starts at the top with Albert Santalo—the founder and CEO of the company. Santalo has spent the last 12 years working in healthcare. He is a successful serial entrepreneur having co-founded and grown Avisena into one of the largest providers of revenue cycle management software and services for physician practices in the world. The rest of the team is likewise very strong and experienced. This is a team that has experienced a lot of success prior to starting CareCloud and in the first 4 years of the company have continued to be successful.

The Market

The biggest challenge with CareCloud is the market. At a high level, things look pretty good. Healthcare is the largest sector in the U.S. economy and set to grow from a $2 trillion dollar market to a $4 trillion dollar market in the next 10 years. In particular there are mounting cost pressures stemming from an aging U.S. population that will grow from 12% who are 65+ to 17% who are 65+ in the next 10 years. Those over the age of 65 tend to spend 4X as much on healthcare as the rest of the population. Against this backdrop, the EMR market is estimated to be a $6-10 billion dollar market—which would appear to be large enough to invest in.

However, the big problems with the market are the regulatory environment in the industry and the plethora of competition CareCloud faces. Regulations and mandates imposed by the federal government could easily destroy the industry and put CareCloud out of business—particularly since so much data is stored in the cloud where it is more susceptible to compromise. In terms of the competition, legacy vendors like Allscripts, Epic, GE and Siemens already control at least 75% of the market and almost all large hospitals use them because of the subsidies from the government—CareCloud is unlikely to take any of this market share away. The remaining niche of 25% or $1.5-2.5 billion of the original market is comprised of pysichians operating in small clinics with over 300 electronic vendors, including well established companies like Practice Fusion and AthenaHealth, competing for their business. Even if we assumed that CareCloud could capture 25% of that market (which it almost assuredly won’t), that would only be a total share of $375-$625m, which is too small to invest in especially since the company has already taken in $54 million in total venture funding and we are only at the Series B level. There is a lot of pressure to have a very high exit in situations like this. Because of these challenges in the market, I would be very hesitant to invest in CareCloud.

Additional Questions

Some additional questions I have that would be useful to know when investing include:

  • What was the pre-money valuation before the Series B round of financing?
  • What do the actual revenue and customer acquisition numbers look like?
  • What are the terms of the deal—what sort of exit size do we need to make a good return?

 

Market Sizing: How big is online video advertising?

Television advertising still dominates the scene when it comes to advertising revenue. Yet in the last 5 years, Internet advertising has nearly doubled proving that there is little doubt that advertising is increasingly going online. Within Internet advertising, the video advertising component, while still relatively small, has been growing steadily resulting in a tremendous opportunity for innovative entrepreneurs disrupting this emerging market.

But exactly how big is the online video advertising market? Applying a bottoms-up approach yields the following results:

Total # of Video Ad Views = U.S. Pop. X Average # of Video Ads viewed per person
Total # of Unique Video Ad Views = 315mm X *840
Total # of Unique Video Ad Views = 265B

Average Price per View =  CPM / 1000
Average Price per View =  $15 / 1000
Average Price per View = .015

Central Equation
Video Ad Market Size = Total # of Unique Video Ad Views X Average $ per View
Video Ad Market Size = 265,000,000,000 X .015
Video Ad Market Size = $4B

U.S. Market Size = ~$4B
**Global Market Size = ~$16B

*Based on ComScore 2012 U.S. data, market sizing estimates
**Applied a multiplier of 4 to get the global market size.

Doing a quick search through the Wall Street Journal – it appears that they agree with this market size of $4B for the U.S. market.

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It is important to note two trends in the video ad market that matter and will significantly impact the size of the market.

1)   Contraction Force: The average price per video ad is decreasing. In 2011 at top tier sites ads were in the $17-$25 range. In 2012 that range fell to $15-$20. The WSJ argued that this price will only decrease further from here.

2)   Expansion Force: Video advertising may only be a $4B market as of 2012, but it is an increasing segment of the overall $42.5B digital media market—a market which is growing in size itself.

The net effect of these two forces is hard to determine as they act in opposite directions, but the overall affect will likely be an increase in the market size in the next 5 years, especially as the internet plays an increasingly important role vis a vis the television.

Google Glass

Since the beginning of the computing industry, it has been the case that hardware platforms produce software innovation. A single innovation in hardware can provide the base for a multitude of software applications. In the process, thousands of companies are created, millions of customers are acquired and billions of dollars in revenues are generated.

Hardware innovation in the 1970s and 1980s by IBM around the personal computer led to software innovation by now Fortune 500 companies like Microsoft, Oracle, Adobe, Symantec and SAP. In the mid 2000s, hardware innovation by Apple on the iPhone led to many of today’s rising stars: Twitter, Instagram, Flipboard and Waze are all built on mobile platforms.

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It is still too early to tell whether Google Glass will be the next ubiquitously used hardware platform spurring software innovation. It looks like the product development teams have a ways to go to iron out some of the kinks and lower production costs to get the price down to what consumers would be willing to pay In fact, last week Forrester Report published survey results showing that only 12% or approximately 21.6 million U.S. online consumer would use Google Glass on an everyday basis.

Yet, if we looked back in time, I don’t think the early adoption numbers for the personal computer or iPhone would be all that different, especially pre-launch. Nonetheless here we are in 2013 and I can count on one hand how many people I know who don’t have a smartphone or a personal computer.

If Glass is able to capture broad consumer appeal, you can count on another big wave of software innovation. Already, Google has released parts of its developer API and the applications are limitless—everything from education to health to advertising. Smart entrepreneurs and VCs will already start thinking about software applications Glass could enable. It’s a great time for innovation.

Metamorphic Ventures

This past week, I started a pre-MBA internship at Metamorphic Ventures—an early stage venture capital firm that focuses on investing in transactional media companies. More specifically MV likes to invest in companies with the potential to disrupt the digital media and commerce space.

The full list of portfolio companies, which includes companies as diverse as IndieGoGo, Songza, Tapad and Moveable Ink, can be found here. But broadly speaking, MV is looking for companies that are going for a seed or Series A round, focused on B2B products/services and have the ability to use a small injection of capital to scale quickly.

In my first week as a Summer Associate with the firm I have been able to get a quick glimpse of the world of VC. Admittedly I haven’t even scratched the surface here, but what I have seen has impressed upon me the uniqueness of the business. It’s been said by many before that you really can’t learn about VC by reading a textbook or taking a class—not that those aren’t perfectly acceptable foundations from which to build. But in order to really learn the industry and get good at identifying promising companies, you need to view any junior level role as an apprenticeship. Find people who know what they’re doing, who have been in the business for a while and try to learn as much as possible from them.

My hope is that as the summer progresses, I’ll have the opportunity to write more about this experience and what I’ve learned about early stage tech investing from the leadership at MV. For now, however, here’s a glimpse at some of the projects I’m working on.

1)   Deal Flow: MV gets a large volume of deals each week coming through the pipeline. Part of what I’ve been working on is creating an internal system to best manage the deal flow and track companies that come our way. Along with this, I’ve been helping write initial memos of companies based on preliminary research, conversations the partners have had with the entrepreneurs and any company materials they’ve sent our way.

2)   Portfolio Company Support: Several of MV’s companies have projects that they would love to pursue but simply don’t have the time for this summer. One of my hopes is to get involved in more of an operational role with some of these companies. To start off with, I’ll be sitting down with Songza next week to discuss a competitor analysis project that they need some help with. More on that as the summer progresses.

3)   Internal Projects: There are a number of research projects and industry analysis reports that need to be done this summer. The goal here is to collect and analyze data that will help the firm make better investment decisions as well as grow the amount of shared knowledge for the MV community.

All in all, it’s shaping up to be a pretty interesting summer experience that will definitely provide valuable insight into the VC/Tech world. Looking forward to writing more soon.

Customer Acquisition Challenges for Location-based Startups

Location-based startups seem to be pretty popular these days. Some of the most successful location based startups (i.e. Foursquare, Shopkick, Yelp, etc.,) have received multiple rounds of funding, achieved nice exits and set a high bar for others to follow. Nonetheless, many location-based start-ups still face a number of challenges when it comes to growth – particularly in the area of customer acquisition. This post seeks to dig a little further into the issue of customer acquisition for location-based apps. Here are some steps startups can take to address challenges they face in acquiring new customers. 

  • Performance Measurement: It’s important to first take a step back and reflect on the existing product and existing customers. Some questions to ask include: Who are the customers? Are there different segments? How are the current customers using the product? Are there differences in the ways various segments use the product? How is the product performing among various customer segments? An understanding of these questions will allow the portfolio company to better target its strategy—whether that is to strengthen its position in a current market or pivot a little and go after a different set of customers.
  • Product Differentiation: Startups looking to acquire customers should differentiate their product from the competition and make the value-add very clear. That way, from a customer’s perspective, there is a clear reason for switching to the new product. Product differentiation can build customer loyalty and allow the startup to monetize its partnerships with advertisers or other 3rd party vendors. Mobile represents a huge opportunity to creatively differentiate across a range of platforms. Startups should find unique ways to combine location-based data with mobile platforms to provide users with useful information. Foursquare’s check-in rewards system seems to have championed this strategy.    
  • Personalization/Segmentation: Location-based startups should also focus on personalizing as much as possible when trying to acquire new customers. This means offering a different type of service for different customer segments. LinkedIn has done a great job of this. There is a free service for the 80% of customers who only use the platform a few times a year. Another 15% of the customer segment, who use the product monthly or weekly, pay for a slight business upgrade. The final 5% who use the service daily pay for the most expensive “executive” version—with expanded product features. But personalization should move beyond product lines to also include targeted marketing and sales campaigns so that potential users are finding out about the product through channels that appeal to them most.   
  • Focus on Branding: Location-based startups can also attract customers by building a really strong brand. Brand loyalty seems to be mostly based on three things: differentiation, relevance and emotion. Some examples: Apple has built an incredible brand around the concept of aesthetics and beautiful design. Etsy has built a brand around homemade/vintage goods.  Focusing on the above 3 keys to build a really strong brand can, in turn, attract customers.
  • Customer Service: One way to really attract customers (and to also differentiate from the competition) is to provide strong customer service. This entails providing a high quality service or product experience, showing support for customers during and after the sales process, developing customer loyalty programs and creating a customer service team with a 100% focus on customer satisfaction.

2013: Startups on the Rise

This is definitely a bit over due, but here are my thoughts on the up-and-coming start-ups to keep an eye on in 2013. Some of these have already built quite a bit of traction, others have been lurking for a while waiting for the right time and others were started less than a year ago. I’ll have to do a follow up post at the end of the year to see how they end up doing.

Uber: This mobile app takes much of the hassle out of finding a cab to get around town in. The app allows you to request a cab at any time, let’s you know how far away the cab is, texts you when your cab has arrived and then allows you to pay for the cab using the app. It’s a very convenient way of getting around. I’m hoping the Uber team can work out some of the product kinks (in NYC for example there are many restriction around the black cabs that Uber works with), so that the service can go more mainstream as it’s currently a much-needed service. Once these challenges are resolved, I think this app can have much success in most major metropolitan hubs.

MoviePass: As a movie theater subscription service, MoviePass is building something very new to the movie industry—the ability for viewers to go see an unlimited amount of movies each month for a flat fee rather than paying for each individual movie. It’s kind of like the concept of having season tickets to a sporting event. This will be particularly useful for avid moviegoers who see multiple movies each month. Many of my friends who are movie fanatics have already signed up for beta access to MoviePass.

Fab: Many thought that e-commerce was in decline but Etsy and Fab seem to be proving that theory wrong. Of particular importance Fab, with its focus on “everyday design”, has been an innovator in social commerce—seamlessly integrating with facebook and twitter. Fab also has created better mobile apps than any other e-commerce platform making it easier to make purchases regardless of location.

2U (formerly 2tor): 2U is disrupting education by providing high quality online learning environments. 2U partners with top-tier universities to deliver rigorous, and selective graduate degree and undergraduate for-credit programs online. Some of the universities currently using the 2U platform include: USC, UNC, Georgetown and Washington University in St. Louis. As a recent college grad, former teacher and soon-to-be graduate student, 2U’s approach seems to be the future of education and is already disrupting the way in which many universities think about education technology.

Stamped: Stamped is already becoming popular in several of my various friend circles. Now acquired by Yahoo, Stamp is a mobile app that lets you recommend and share your favorite things like: movies, books and restaurants. One of the best features is the ability to receive recommendations from friends and other reliable sources (rather than anonymous online reviews). The ideas behind this could disrupt the way online reviews and recommendation systems currently operate.

Media Cause

The Product

Media Cause is a marketing company that focuses on helping non-profits increase awareness for their programs, raise more money online, and better engage with their supporters. The startup provides marketing and social media advertising support to non-profits of a wide range of sizes and budgets.

This is accomplished primarily through the creation of a large and engaged volunteer community. Non-profits start the process by signing up for Media Cause and requesting services from volunteers that match their specific needs. SEO requests, Google Grants, digital advertising campaigns and social media initiatives are separated into smaller projects called “challenges” that are then completed by anyone in the volunteer community. In exchange for the marketing and advertising support they provide, volunteers are then recognized publicly through facebook posts, tweets, blog posts and LinkedIn recommendations.

The Market

With 1.8 million 501(c)3 non-profits in the US and many more non-profits around the world there is a large, yet predominantly untapped market for the marketing and advertising of all these non-profit organizations. Most non-profit organizations run on tight budgets and focus the vast majority of their efforts on their organization’s mission. They often have little time and few resources to advertise themselves, raise money or increase their online presence. Yet the need to engage in these activities is critical for non-profits to grow and strengthen their impacts. Thus, there is a clear need in the marketing and advertising industry for services that target non-profit organizations. Media Cause is an interesting startup in that it seeks to close the marketing and advertising gap between non-profit organizations and their for-profit peers.

Media Cause is also a particularly attractive company given recent trends in marketing and advertising that seem to be making it easier for non-profits to launch and garner support. To begin with, fundraising has been democratized through crowd funding platforms like Kickstarter. The spread of the Internet from computers to mobile devices has also offered non-profits with the ability to reach more users via different mediums. And finally the availability of large, ease to use social networks like Facebook, Twitter and LinkedIn, has enabled the deployment of cheap, yet effective marketing campaigns—campaigns which once harnessed by expert volunteers through Media Cause’s platform can result in a high payoff for non-profits looking to raise money or spread awareness.

The Profit Potential

Media Cause is an early entrant into the non-profit marketing and advertising space. And while it is true that many of the advertising and marketing mechanisms that exist for for-profit companies are also available to non-profit companies, Media Cause is the only company that is entirely focused on affordable and efficient services for the non-profit niche market. Thus, the startup currently has few competitors and is way ahead of any would-be-competitors.

Interestingly, enough, at the moment, Media Cause is itself a non-profit organization. However, the startup has experimented with a few small revenue models including offering premium online marketing services to larger non-profits. It is entirely feasible for Media Cause to be run as a for-profit company by developing a whole line of services that scale all the way down to smaller non-profits and take more of a strategic consulting role in the marketing and advertising of non-profits rather than simply crowd sourcing much of the work to volunteers. In terms of exit opportunities, Media Cause could very easily be acquired by a larger advertising or marketing company (such as Pulse 360) or become the marketing/advertising arm of a non-profit strategic consulting firm (like Bridgespan).

To sum, Media Cause possesses all of the ingredients of a potentially very successful startup: an innovative product, the right market timing, growing demand, a clear competitive advantage, and feasible exit opportunities. I would love to be a shareholder in the company.

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Multi-weather Energy Generators

Each year millions of people are affected by weather related events like storms, blizzards and hurricanes. Among other challenges, these weather events result in wide spread power outages and damages to electrical infrastructure—requiring repair that often takes weeks to restore. It is estimated that nearly 8 million people on the east coast lost power during Hurricane Sandy and another million people faced power outages this past weekend during Winter Storm Nemo. Many of these people went days if not weeks without power.

To address this I propose the creation of multi-weather energy generators (MEGs). Similar to traditional back-up generators, MEGs would provide an alternative form of energy to power homes and commercial businesses during and in the aftermath of major storms. However, these devices would be multi-faceted and would work throughout the year to continually store and synthesize various forms of energy into some sort of battery format that could then be used on an as needed basis. During the Summer/Spring for example, MEGs would use solar panels to continually convert solar energy into stored electrical energy. During the Fall/Winter, MEGs would use wind turbines to convert and store mechanical energy into electrical energy.

For most of the year the energy created by MEGs would simply sit as stored energy in a battery format. However, during the 2-3 weeks of the year when weather sours and households faced major power outages, MEGs could be drawn on to provide much needed power until the power grid is restored. In designing these devices the focus would be on making them light-weight, low-maintenance and affordable to ensure that consumers would not incur a large cost in terms of money spent and time needed to maintain the devices.