Soaring on Ridgelift

Thoughts on iPhone apps

Blogging some thoughts live from MobileBeat 2008 at the PlugandPlay tech center in Sunnyvale, CA...

It's been an interesting couple of weeks looking at the first set of iPhone applications. Already we've seen a similar dynamic to apps on Facebook - a small number of popular apps with download numbers orders of magnitude higher than the rest.

In common with FB apps, the average price for an IPhone app is close to free - begging the question "how does anyone beside the device manufacturer or the wireless carrier make money?"

For sure we're early in the mass adoption of mobile apps but I see some interesting veins of value to pursue.

1. Applications that deliver their real value via a service. The app is free and provides the portal to the service leveraging portable peripherals (GPS, camera etc.) plus compute and storage resources.

2. Applications that collapse the function of other devices onto the phone. For example, I got an email today from one of my blog readers who had purchased a $2 app for recording voice notes rather than carrying yet another device (and paying someone else yet another $40+). But you still need to think of the back end service...

3. Apps that bind the manufacturer closer to their user - think of the relationship that you can build... Some examples, Microsoft XBox and XBox Live, Amazon with Kindle and Apple with iPod/iPhone with ITunes.

This last vein is applicable beyond mobile as it creates a more durable link to the end user for selling the next device and delivering up-sell or cross-sell revenue.

That's a significant margin improvement opportunity in a space where price/feature wars prevail.

Withering M&A?

Just in case you needed more reinforcement of my point from yesterday…

"…the emphasis is on results and driving hard to self-sufficiency. In other words, spend each dollar like it's your last and place all your attention on getting to break even. "

This month has been marked with a heavy ration of venture capital "doom and gloom"… It's hard to miss between the NVCA press release announcing

"…for the first time since 1978, there were no venture-backed IPOs in the second quarter of 2008…"

or…

"VC's a glum bunch over economy, lack of exits."

Indeed, the NVCA press release shows not only a drought of IPOs but a substantial drop in the number of M&A events as well. If the second half of 2008 is anything like the first, we're on track for the worst M&A year since 1999 as far as I can tell.

The cause of the drop-off in M&A activity can be partially laid on the economy – public companies don't acquire when…

• They are really concerned about their own expenses and profit – in this kind of market the target company better be break even or profitable otherwise the acquirer's own earnings are going to be negatively impacted and their stock will get hit.
• They believe their own stock is seriously undervalued.

But I think there is another root cause that needs to be considered…

Take a look at the number of M&A deals in each year compared with the number of deals where the M&A VALUE WAS DISCLOSED:

I took the numbers from the different reports linked above and then annualized the 2008 number as an estimate for the total year. The percentage of deals with disclosed values has dropped to 35% based on the first half of 2008 after running at a rough average of 50% over the rest of the data. I believe that in general, M&A values get disclosed unless either the buyer or the seller have a reason to want to keep the number private – generally because either the buyer paid too much (not likely here!) or the seller was embarrassed at the price paid (usually where paid in capital is >> than the exit value!).

The precipitous drop in disclosed values suggests a significant number of the M&A events this year were less than happy results.

Like any other sale, M&A only occurs when a buyer and seller agree on the same price - so I think there are a couple of other points to consider when thinking about the current decline in M&A events:

• M&A events don't take place when the seller is very unhappy with the sale price and they either have more capital to invest in the company or the company is self-sufficient (enough cash in the bank to give a long runway or breakeven/profitable).
• The would-be seller believes their company is undervalued and a better exit can be achieved with more time.

To me this just places even more of a premium on results and execution. Be in control of your own destiny or life will be unhappy.

Food for thought and the last flogging of this point for a while…

Global Surplus

Remember the story about King Midas? Everything he touched turned to gold… even his food and then to his ultimate misery, his beloved daughter. It's always struck me as ironic that Forbes Magazine calls their annual VC ratings "The Midas List" as a testimony to the wealth creation effect. The real Midas story was about the realization of life's true riches – I guess Forbes only read the first part of the story!

In a modern day echo of the story of King Midas, the global economy can't produce enough food to feed everyone, demand for oil seemingly outstrips supply leading to higher and higher oil prices but we have been able to create one resource in abundant excess…

CAPITAL.

Seemingly endless tsunamis of capital slosh around the global bath tub seeking opportunities to invest and generate a return. I first blogged about the impacts of excess capital in January of last year – re-reading that post makes me pause for thought - $6/gallon for gasoline doesn't seem so farfetched as it did 18 months ago!

The impact of too much capital can be as devastating as too little…

2000	$100B flows into venture capital funds. ~50% of every dollar was eventually written off. Excess capital continues to flow into venture funds resulting in reduced returns and unhappy investors who now question whether venture capital is still meaningful as an investment category.
2006/7	Capital pours into LBO funds - $255B in 2006, $302B in 2007 – mega-deals abounded until the credit crunch began in mid 2007.
2007/8/…	Sub-prime mortgage disaster. Near-death experience for the banks, huge write-downs, failing confidence in the financial industry.

 

Yet despite the destruction of so much wealth, capital continues to pour in. Why? As one limited partner summed it up to me in a conversation the other week:

"There are numerous challenges facing both LPs and GPs, but they are generally the same recurring themes of the past in different form. The real challenge this time is the massive excess of dollars seeking returns without the requisite increase in opportunities."

Increase in the number of opportunities? I'm not so sure that it's a lack of opportunities as it is about investor confidence being positive about the future. With falling stock prices, the loss of consumer confidence, soaring oil prices and a closed exit environment, its dark and gloomy and hardly conducive to optimism.

Conventional wisdom has it that Bear markets end when everyone capitulates and throws in the towel. That same wisdom says that you can only spot the end AFTER it happens – through hindsight. The bottom line... No one can predict the point at which optimism returns.

A lack of investor confidence has a direct impact on the startup world – initial capital is harder to get, the bar to raise follow-on capital gets pushed even higher – the emphasis is on results and driving hard to self-sufficiency. In other words, spend each dollar like it's your last and place all your attention on getting to break even.

Above all, don't succumb to the gloom and doom – every Bear market has an end (eventually!) and investor confidence will return. Just make sure that you're around to benefit from the return of optimism!