What would \$100 Billion Valuation for @Evernote Look Like?

In a recent article in Inc magazine, Evernote CEO, Mr. Phil Libin, wrote

” there is a good chance that it will be worth \$100 billion in a few years”

You likely want to ask what “good chance mean”.

Mr. Libin wrote this in the context of  Evernote’s current one billion valuation and comparing it valuation of The New York Times. Mr. Libin’s makes a very valid point that such comparisons are point less and valuations are based on future expected value from a business’ growth.

I agree.

Most public companies have relatively predictable levels of growth, so their valuations are heavily based on the current values of their businesses. In other words, few investors expect The New York Times‘s profits to grow tenfold in the next few years.

Such valuations on future growth are valid as long as they are computed by taking into account all possible future scenarios and not just the most optimistic outcomes. In many cases, and I don’t mean it is the case with Evernote, we not only overestimate the size of positive outcomes but also overestimate the chances of such outcomes. In such cases the valuations become segregated from reality.

Back to the \$100 billion valuation for Evernote. What would it look like?

Let us say it gets the same revenue multiple of 5.51 (say 5 for ease of math) as Google. That would mean \$20 billion in yearly revenue. Where would that come from?

From its current sources I estimate that Evernote makes \$63 to \$84 million a year from 34 million users (1.4 million paying subscribers). If the current business model is the only option that would mean one of following (or combination)

1. Every customer generates \$45 a year, meaning 444 million paying customers (13 times current user numbers and 31 times current paying subscribers)
2. 50% paying customers, meaning  888 million users
3. 100 million customers (not users), meaning \$200 a year revenue per customer – that means either their subscription price goes up or they found other ways to monetize customer. \$200 a year just from subscription does not make sense (NYTimes yearly subscription costs \$195 and it did not find 100 million subscribers). Regarding other revenue sources even Google and Facebook have not found a way to get \$200.

Even if Evernote does deals like Moleskine tie-up that generate \$4-\$6 million a year, that is a larger number of deals to get to \$20 billion a year sales.

That leaves other sources of revenue that are not yet known from its current strategy. Which means one must consider higher uncertainty in such large outcomes given insufficient information.

Mr. Libin said, “there is a good chance”. Given what is known today and the uncertainties I am not sure what “good chance” means.  But given the current valuation of \$1 billion, investors seem to think the expected value of the valuation (considering all good and bad chances) is \$1 billion. Or in other words, the numeric value of good chance is much less than 1%.

A question you must ask is,

Is there also ‘good chance’ of \$200 million valuation? (See: Zynga)

Finally  I am not going to run a complete scenario analysis here as I have done for other valuations before. That is left as a homework for you.

When I wrote the valuation model for Pinterest, many people wrote to me to point out that Pinterest stopped using SkimLinks and hence stopped making any revenue. Making revenue it turns out is not good for your startup (don’t quote this line out of context).

How do you value an investment? Any investment, be it a farm , shares of an established enterprise or a tech startup?

Simple answer is, you look for profits they generate now and how it is expected to grow.

But that level of transparency and simplicity is a problem for venture capitalists investing in Silicon Valley’s startups. The New York Times Bits blog says why VCs don’t want the startups to show any viable business model let alone profits,

“It serves the interest of the investors who can come up with whatever valuation they want when there are no revenues,” explained Paul Kedrosky, a venture investor and entrepreneur. “Once there is no revenue, there is no science, and it all just becomes finger in the wind valuations.”

With any hint about business model one can come up reasonable valuation models for any business. Granted one has to make assumptions to get there but we can quantify the uncertainties in the assumptions and state our valuation in terms of probabilities which can be used to place bets (I mean investment).

That is not good because

they’re interested in pumping up enough hype and valuation to find a quick exit through an acquisition at an eye-popping premium.

How else can you justify \$200 million valuation for Pinterest when its chances of making revenue that justifies such a valuation is less than 0.25 percent?

This seems to explain why VCs advice startups to give their product away for free and why VCs don’t advice startups about customer segments and filling an urgent need. As Stanford’s Pfeffer says,

These companies are simply being founded to be bought.

Not to fill an urgent need and to take their fair share of value created.

Surely you are not surprised by Groupon woes?

Update 11/1/2012: Groupon valuation is back in news because of its rival LivingSocial’s woes.

In Amazon’s 10-Q filing late Friday afternoon, it disclosed that Living Social saw revenue of \$372 million for the nine-month period ended Sept. 30. While that is up 120% from the same period last year, it reflects third-quarter revenue of just \$124 million – down 10% from the June period.

If that sequential drop reflects an overall weakness in the daily deals business for the third quarter, then it implies potentially disappointing results for Groupon when it posts its own results for the period next week,

When valuing a company’s stock it pays to understand what pressing customer needs it serves and what unique value it adds. That is assuming you are Benjamin Graham, Warren Buffett type investor who takes the time to understand the business before investing.

Business model is value-creation and value share. A business that creates net new value for its customers gets to share in it. A business cannot get its share of value it did not help create, let alone grow exponentially.

If you are such an investor then Groupon’s announcements about lax controls should not come as a surprise to you. I am not referring to the \$2 drop in its stock today but the news that led to it.

It is hard to describe Groupon’s business. In fact even Groupon is not clear about what it is.

For starters, it is a two sided market. It essentially brings together small businesses on one side and end consumers on the other side.

In general a two sided market adds value by unlocking value, creating new value or removing inefficiencies. It then gets its fair share of the net new value added. A two sided market must be consistent in its positioning – it must serve as the enabler for the jobs the two sides are seeking to do. There should be no asymmetry.

Take for example, eBay. It positions itself as the market place for buyers and sellers to find each other. No asymmetry here. EBay adds value by enabling transactions that otherwise would not have been possible.

What about Groupon’s role as two sided market?

What is its positioning to deal seekers? It tells them about, “one ridiculously huge coupon everyday” and its tag line is, “Collective Buying Power”. In other words it wants the deal seekers to hire it as a sales channel to buy products at steep discounts.

What about its positioning to small businesses? It tells them about, “guaranteed new customers”, “big exposure”, and “measurable marketing”. The story line goes, “these customers fall in love with your service and visit you again and again, paying full price”. In other words it wants the businesses to hire it as a marketing channel.

That is asymmetry (to put it mildly) in its messaging. Groupon cannot be a sales channel to acquire ridiculously huge discount and a marketing channel to acquire valuable customers at the same time.

Businesses bring value to the table in the form of 50% off discount. Deal seekers add no value but get 50% off. Groupon gets its share of 25% from the businesses.

You bring a full pie.
Give half of it to my email subscribers.
Give half of what is left to me.
Take home the rest and wait.
It will not only grow to become a full pie, it will multiply into many full pies.

To repurpose Omar Khayyam, “the deal seekers having scored a deal, move on. No level of customer service will bring them back to pay full price for your cupcake they can get for 50% with their next coupon in the bakery next door”.

There is no net new value add. Just value distribution – from businesses to deal seekers and Groupon.  Groupon cannot take its share of value it did not help create.

So we have a business that most do not understand, even it does not have clarity on the needs it serves and adds no new value. How can you place a valuation on such a business?

Surely you are not surprised that such a confused business finds itself again in the accounting hot water?

There is a WSJ report that SEC may investigate Groupon. I see no reason for such an investigation at the expense of taxpayers. If irrational investors want to bet their money on a business they do not understand or chose not to understand, why should they be protected?

Reversal of Irrational Consumption

Have we been buying things that are worth less to us that the price we paid for them? If we all are rational we should not pay more than our willingness to pay which is a function of  what the product is worth and our reference price.  A recent Financial Times article on changing consumer preferences in recessionary times had quotes from several marketing professionals and academics. One of the quote was from Mr. Seth Godin, author of several marketing books,

Seth Godin, a marketing trendspotter, calls this the “affordable premium” product, which, like a McDonald’s coffee, is deemed to be worth more than it costs.

If we are rational (left image) we should only be buying products that leaves us a positive consumer surplus. What Mr.Godin suggests (or to be specific the FT’s quote states) is that we have been behaving like the right image.

Does that mean we have been buying goods that are not worth the price  we paid for them? Perhaps. There are two possible explanations:

1. Our consumptions were hedonistic and we convinced ourselves that the products are really worth more than the price we paid for them.
2. Our consumptions were conspicuous – that is we have been doing them for keeping up with appearances and with the Joneses.

Availability of easy credit and high home prices drove us to behave like the right image and buy things that we were not getting the value for the price we paid. Now with bad economy we see the reversal to the expected rational behavior.

The bigger question is how do consumers value the products they buy? Even consumers do not know the exact dollar figure of value. A marketer can tease out this value and make a reasonable estimate of the relative weights we assign to the components of a product like is utility, hedonistic value, brand and luxury. Next up I will discuss the factors that go into the valuation and the current shift in consumer valuation.