Tumblr says Google is worth $4.2 trillion

Barron’s story about Yahoo’s acquisition of tumblr fuels fears

and reservations about Silicon Valley valuations, especially

compared to ones that are grounded in reality.

To be clear, this is not meant as a knock against Barron’s reporting.

It’s outstanding, as usual.

What’s disturbing is the $1.1 billion price Yahoo paid for tumblr,

a company that received more than $125 million in venture funding

but has only produced $13 million in revenue, Barron’s reported.

The metric used for valuating Yahoo’s price for tumblr is about 84.62

times the micro-blogging website’s annual revenue. 

While tumblr may bring a unique advantage to Yahoo, what hasn’t

been made clear in any of the reporting is whether tumblr’s

technology is so proprietary it can’t be duplicated.

Tumblr, then, in many ways, is a glimpse of how venture capitalists

value website start-ups; but this euphoria or, if you prefer, valuations

far beyond reality, cannot last.

At some point, Silicon Valley industry directors and executives will

sober up, realizing Wall Street values these start-ups for far less than

the venture capitalists searching for the next greatest fool to pay

a price that's far beyond reasonable for the company they’ve invested

in and helped build.

The tumblr acquisition shows that venture capitalists, their investors

and the start-up’s employees are the winners.  The shareholders

of the acquiring company, based on what happened to Yahoo’s

stock last week, are the losers. 

If the metrics for valuating tumblr are used with Yahoo or with the

Silicon Valley’s standard-bearer of the health of the technology

industry, Google, then these two companies are worth far more,

at least by venture capitalist standards, than Wall Street says.

For example, Yahoo, during 2012, produced about $4.9 billion

in revenue; its market capitalization is about $30 billion, which is

just over six times the company’s annual revenue, a metric far

less than what it paid for tumblr.

But if tumblr’s recent value – based on the price for which it was

just purchased – is applied to Yahoo, then Yahoo should be worth

about $422 billion. 

For that matter, Google, which produced about $50 billion in 2012,

should be worth about $4.2 trillion and yet the search engine’s market

capitalization is but a humble $290 billion, just under six times

annual revenue.

Facebook, the most recent Silicon Valley player to go public,

produced $5 billion in revenue in 2012 and has a market

capitalization of $60 billion, or 12 times revenue; applying the

tumblr valuation, the social media website should be worth $422 billion.

Based on the reality of Wall Street – around six times annual

revenue – Yahoo shouldn’t have bid more than $80 million for tumblr.

How long venture capitalists can secure the kind of valuations that

tumblr just received is hard to say.  How long Silicon Valley executives

want to be the fools of venture capitalists is also difficult to predict.

But anyone who’s ever followed valuations and traditional 

economics knows prices cannot remain this high forever.  At some

point, the rubber meets the road.

The worries of Tumblr

You can’t help but wonder what Yahoo’s top corporate executives

are doing.  Sure buying blogging site Tumblr appears, at least on the

surface, to be a fine idea but what about that price?

According to newspaper reports, Yahoo paid $1.1 billion for Tumblr,

a company that generated only $13 million last year. 

Apparently making the deal irresistible was that Tumblr, according

to published reports, has between 117 and 300 million unique monthly

visitors, many of them younger – perhaps even slimmer – than the

average Yahoo user, described, in a blog at the Los Angeles Times,

and another, in Digital Trends, as “Overweight women ages 18 to 49,

who tend to be in relationships of only one to five years with children, 

residing in the suburbs or rural areas.”

The pending acquisition raises many questions and points that, perhaps,

weren’t vetted as closely as possible, including whether Tumblr’s

hipsters will want to be part of a web portal that fat, middle aged women

find attractive?

There are also other questions, too, including the following:

The information about the number of unique monthly visitors isn’t clear.

According to The Wall Street Journal, Tumblr has about 117 million

but according to Tuesday’s Investor’s Business Daily, it’s around

300 million. 

For the sake of shareholders, can Yahoo provide a unique monthly

user number that holds up to what ComScore reports, 117 million?

While apparently it’s difficult but not impossible to sell ads on Tumblr,

a more worrisome issue for Yahoo is Tumblr’s users, who, based

on what’s been reported, have no reason to remain with Tumblr.

In other words, they can flee to other micro blogging websites or

start one of their own.  If that’s true, what’s the value of Tumblr to

Yahoo?  Is this really a technology play?

Did Yahoo consider the possibility that if Tumblr’s revenues never

move north of $13 million, it could take it close to 86 years to earn

what it paid for the site?

If it can generate, as one former Google executive said on his blog,

about $100 million a year, it will only take Yahoo about 10 years

to have Tumblr paid off.  Does that number hold up if the users flee?

If there really are only 117 million unique monthly users for Tumblr,

then Yahoo paid about $9.40 for each of them.  Do they have a plan

in place to keep them?  What will it cost?

While Yahoo’s Tumblr acquisition might make sense – let’s assume

CEO Marissa Mayer knows what she’s doing – what’s not certain

is how this acquisition will move Yahoo’s stock price.

Based on what’s happened this week, so far, the stock market

appears to have welcomed Yahoo’s acquisition, modestly moving

its stock price up from where it had been on Monday, meaning that

while Wall Street approves the deal, it’s far from excited about it,

and, quite possibly, doesn’t understand it.

The larger, overriding issue is that economics catches up with

every industry.  It might not happen for a decade or 20, possibly,

even 30 years but, in time, economics determines how industries

mature, prosper, fall apart and work.

Right now, we appear to be seeing the maturing of the Internet

industry as it consolidates.

When an industry is new, entrepreneurs and companies of all shapes

and sizes often step in because they see an opportunity to thrive.

Only a very limited few will succeed but, as with PowerBall gambling,

if the winnings are viewed as being high enough, many will throw

their hat into the ring.

But eventually there’s a contraction as investors cash out, taking their

earnings and banking them for another future opportunity while

others shut down, not always able to sell the assets they once

used in the new industry.

This activity – of one company buying another – usually leaves

fewer players, making the new industry look like an oligarchy,

with a few dominant companies keeping a close eye on one another.

While it’s hard to believe today, the U.S. automotive

industry back in the late 19^th and early 20^th centuries, was

composed of about 2,800 companies.  They included mom

and pop shops to long established companies in the horse-drawn

wagon business trying their hand on a new idea – mechanized

transportation.

The automotive industry’s new technology was so successful,

disruptive even, that it killed off horse draw wagons.

Today, there are three automotive companies headquartered in

the United States, Chrysler, Ford and General Motors, but only

two are U.S.-owned, Ford and General Motors. Italian carmaker

Fiat owns Chrysler.

The U.S. daily newspaper industry suffered a similar fate, from

being an industry once composed of more than 5,000 titles, back

in the late 19^th century, according to About.com, to one that publishes

just over 1,400 different papers today.

Little deals like Tumblr, at a shocking price of $1.1 billion, are

small.  Tumblr will become a division of Yahoo – not something

that fundamentally alters Yahoo.

Deals like Tumblr – where the company was valued at nearly 85

times more than its annual revenues – can’t continue.  If Tumblr

never brings in $800 million, or even $1 billion – and it’s hard to

see how it will – Internet executives will hesitate, and likely refuse,

to pay such extraordinary multiples for the next company whose

revenues don’t come close to backing up the valuation its

investors claim.

The wild-eyed optimism of the Internet -- $1 billion for Tumblr

or Facebook’s recent valuation at $500 billion (when it’s only

doing over $5 billion a year) – will end. 

As the Internet industry matures, the question that needs to be

answered is what’s the future for Yahoo, Google and Bing?

Which one of these players will buy the other to provide it

with the long-term competitive advantage it needs?

Growing up is hard to do, says the adage, and anyone

who’s been in an industry’s infantile stage knows excitement

dims as the adults move in to make sure it lives up to its claims.

So, David Karp, for your sake, let’s hope you’ve cashed out

handsomely and stashed the money where it’s safe because

you’re about to be upbraided by Marissa Mayer as she holds

your feet to the fire.