Greek Complexity

Spotify revisited

I thought I'd revisit my somewhat snarky, dismissive post on Spotify's rumoured current valuation from a few days ago because of the latest news that they recently hit 1 million paying users. They also have more than 10 million free users.

Spotify charges anywhere from GBP 5 to GBP 10 per month for their paying subscribers, putting their current revenue run-rate at anywhere from GBP 60 million to GBP 120 million. In addition, they make some money from advertising. Let's be charitable and assume that their revenue run-rate is at the upper end of my estimate, i.e., GBP 120 million or, in round numbers, USD 200 million.

Now, it's not clear to me whether the rumoured USD 1 billion valuation is pre-money or post-money, but let's say it's post-money. Digital Sky Technologies has invested (or is in talks to invest) USD 100 million at this valuation.

A pre-money valuation of USD 900 million for a company with a USD 200 million revenue run-rate gives us a P/S ratio of 4.5x. Even if my revenue estimate earlier was too charitable, the P/S ratio is at most about 9x. On the face of it, not really that expensive when compared to the universe of Internet and new media companies. Is it?

Let's peel the onion.

The massive price multiples that Internet companies generally trade at usually have a few assumptions baked in: vast market potential, network effects enabling a virtuous cycle of continued growth and very high margins. How does Spotify fare on each of these?

Market potential

Funnily enough, even though I come across as a sceptic on the valuation of the company, as a consumer, I would love to use the service. ("Would love" because it's only available in Europe for now.) I really couldn't care less whether music resided on my local machine or on a server farm somewhere as long as it was accessible to me whenever I wanted it. In fact, I think I prefer it being hosted by someone else -- no hassles around organising and maintaining libraries, having sufficient disk space, ease of navigation, discovery of new content, etc etc. I've never bought a CD in my life. Yes, never. I much prefer services like Grooveshark.

However, I recognise that I might be a bit of a freak. Most people, it appears, still want to have music physically available to them. Streaming services have been available to people for a long time, long before Spotify came along, but they're not as common as buy-and-download services or CD sales. Streaming video and renting movies online has become quite common over the past couple of years (where bandwidth is available) but music hasn't quite followed the same path. I suspect this is because people generally watch any given film once at most whereas music is listened to again and again. Spotify's premium users can download music but I believe the files self-destruct once they stop paying their subscriptions. So, given that Spotify doesn't let its customers buy and keep music forever, will it appeal to the broader market as much as rival services? I suspect not. The implication is that, once it gets past the early adopter crowd, revenue growth is going to plateau.

Network effects

I'll keep this short. There are no network effects in Spotify's business model. The model is pure B2C with no social elements to it.

Margins

Spotify is currently loss-making. Can it make money?

Though I don't have any information regarding their cost structure I imagine what Spotify pays for music licences must be a significant cost. Is this going to go decrease in future (as a percentage of revenue)? I doubt it. If anything, I'd expect it to go up as the labels get greedier. Even if this doesn't happen though, Spotify has no leverage in the model. As subscriptions and revenues increase, I expect -- not having the benefit of reviewing Spotify's contracts with music labels -- that licensing costs will rise in lock-step. How can Spotify make the transition to profitability then? Only by keeping other expenses under control as it grows, such as staff costs, marketing, hosting, bandwidth, etc. I can't imagine the leverage on these expenses is that substantial though. Moreover, if you accept my logic above, I don't see considerable revenue upside from here either, so there's limited scope to play the spread-costs-over-a-larger-revenue-base game.

Based on this brief analysis, does Spotify meet the requirements for being valued as a high-growth, potentially very profitable business? No. It's only about as attractive as a traditional radio station.

The only remaining niggling thought is why DST would agree to these terms then. I don't know. Anyone who wants to enlighten me is welcome to add a comment here.

 

Bicycles and the economy

How bicycling will save the economy (if we let it) | Grist

from www.grist.org via mrbrown

Imagine getting a $3,000 to $12,000 tax rebate this year. Now imagine it coming again and again. Every year it grows by around a thousand dollars. Imagine how this would change your daily life.

Yes, but, but... if I ditch my car in favour of a bicycle, how can I show people I have too much money than I know what to do with?

Book slobs

via www.newyorker.com

I'm a bit like this except for the food stains! Not that I have that many books. The guilt means that I prefer not to buy books to begin with. Either read on-screen or borrow from the library. Click through to see two interestingly different points of view.

Blood on their hands

Those of you who read this post of mine the other day may be interested to know that the Straits Times chose not to publish my letter, never mind apologising for publishing inflammatory letters as I pointed out. Not that I expected any more. They would rather publish letters from, to take an example at random, someone complaining that he didn't get to participate in a lucky draw while shopping. One person's $ over the lives of thousands? Welcome to Singapore!

I'll give them this: they did publish brief letters from other cyclists but no major rebuttal of the arguments in the original letter and, of course, no explanation for why such an irrational letter was printed to begin with. One of the letter-writers told me privately that his letter was heavily edited before publishing.

The next time there is a casualty on the roads because of road rage or a plain ol' sense of entitlement, the Straits Times and Dr Terence Teoh will have blood on their hands.

In slightly more positive news, this saga has caught the attention of readers outside Singapore too. See this and this, both websites with large followings in the cycling world.

Inside the VC's mind

A few days ago, someone I met wanted to pick my mind regarding a business idea she had. Not that I'm an expert on what she wanted to do but she simply wanted to know what a venture capitalist thinks about when evaluating a potential investment opportunity.

Let's put the standard stuff around size of market, product differentiation, entrepreneur quality, valuation and all the rest to one side for the nonce. What I'd like to do in this post is set some context around how VC firms are organised and how this affects the kinds of decisions they (we) make.

A few disclaimers: I am not an expert. This is not investment advice. This is not start-up advice. What I am saying is based on my personal experience and observations of the world, and may not be representative of either my employer's views or those of the VC industry as a whole. Heck, my own thinking may change in future when faced with new data. In short: caveat emptor. These disclaimers hold for all posts on this blog.

First of all, VCs are money managers. They invest other people's money on their behalf. This means that they themselves have investors (called LPs) to answer to. (It also means, by the way, that investments I make aren't from some pot of gold I myself possess. I've been surprised how often people assume this! I'm just a salaryman like most other people.)

Second, returns are generally measured in terms of multiples of cash invested not IRRs

• Money is committed to funds by LPs for long periods, generally about eight to ten years. Given that the time period is fixed, it's just easier to think about returns in terms of multiples.
• VC investments are higher risk and dependent on several qualitative factors (including luck), more so than the typical stock punt. Detailed IRR calculations are just not meaningful when evaluating an opportunity. Is something a 4x or an 8x is more important to know than whether it will yield 30% or 35%.
• VCs do not want dividends! Dividend payouts imply that the company is not growing quickly enough to justify reinvesting cash in the business. (Warren Buffett has the same philosophy.) If you don't have dividends, again IRR calculations are unnecessary.

Third, unlike buying and selling publicly listed stocks, an individual VC generally can't manage investments in more than perhaps half a dozen companies at a time. Limited "bandwidth" (as we say in the trade) requires us to pick and choose companies with the biggest bang for the buck. By "buck", I mean, of course, not just the literal dollars invested but also the time and effort that goes into making any investment a successful one.

Why does all this matter? It matters because it affects the kinds of investments a VC will or won't do.

• No income-generating companies. Capital-appreciation is the goal.
• VCs want a team running the company. They don't want majority control or having to run companies themselves.
• Companies that don't just grow capital but have the possibility of growing that capital in j-curve fashion (meaning growing it by large amounts quickly). Because there are LPs looking to make a return on their money, the time horizon for returns is limited.
• Cannot make small investments even if each individual investment looks like returning large multiples.
• Every prospective investment opportunity needs to show the potential for being a superstar going in even though every VC knows that, because of the high risk involved, only a few companies in the portfolio will achieve that dream. The point is that it's (usually) no use trying to get a VC to invest in a "safe", decent-return company.

Of course, investment styles and philosophies will vary from one firm to another and one individual to another so treat the above as rough guideposts.

I'll try to post more such articles in future.

Anti-anti-cycling

[Update 6 March 2017: I made a few corrections to the post below.]

Anti-cycling sentiment in Singapore scaled new heights yesterday with the publishing of this letter by the Straits Times, Singapore's largest daily.

One wonders why the sentiment. After all, as a friend of mine said:

There seems to be some misconception that cyclists cause congestions. Next time you are stuck in a jam look for the cyclist causing the jam. You won't be able to. Cars cause jams.

There also seems to be a sense that since cyclists don't pay road taxes, their right to use the roads is somehow diminished. I've heard this point being made ad nauseam but hang on a second: the purpose of road taxes is to fund road investment and maintenance disincentivise the use of vehicles while taking into account their horsepower, specified use (commercial or personal use), engine displacement, fuel type, and so on. (Road investment and maintenance are funded by general tax collections paid by everyone: individual income-earners, businesses, property owners, and so on. Road tax collections would not be adequate for this.) Paying road taxes doesn't confer any road use rights on the tax payer. The roads are public property. Bicycles are used by far fewer people and don't cause the wear and tear on roads that other vehicles do to begin with. This is the same reason pedestrians don't pay road tax every time they cross the road or use the footpath (which I imagine are maintained using the same taxes).

I wrote the following letter to the Straits Times today in response to yesterday's letter.

Dear Sir,

I refer to the letter, “Curb recreational cycling on roads” dated March 1, 2011.

Even as a motorist myself, I fail to understand Dr Teoh’s argument.

• Is he saying that all road users not proceeding to work or back home must be banned from the roads, presumably including himself?
• If I were to commute to work by MRT instead of by road, would I have the right to order joyriders off the train for my personal comfort?
• The bicycle was invented before the motorcar and cyclists were on the roads before drivers —this right was not accorded recently, as Dr Teoh seems to say— so where would we be if cyclists reversed the argument and began ordering cars off the road?

The logic is unappealing. The roads are public property and no one person has any larger claim on them than any other.

If Dr Teoh were to recognise that he, like all other road users, is part of a system and equally responsible for traffic (or arguably more, since four cyclists occupy less space than a car), and if he were to suggest improvements for the system as a whole, I would support him completely. For example, he could agitate for wider roads, higher ERP charges, more flyovers, public transport improvements, higher fuel surcharges, etc. Targeting just one group is unfair and sets a precedent — tomorrow he may be the target of the next “improvement”.

Even if no such systematic changes are made, when faced with slower traffic of any kind, all road users have choices: overtake safely at an appropriate distance (1.5m is the legal requirement taught at driving schools for all traffic, not just cyclists), wait a few seconds to allow the route to clear, take a different route, commute at a different time, use a different form of transport, etc. I’m sure Dr Teoh exercises one or more of these choices when faced with large vehicles and taxis stopping for passengers — why not cyclists too?

I would thank the Straits Times not to print such inflammatory letters. We have enough accidental deaths on our roads not to add to them by inflaming people’s passions with misguided arguments.

Murli Ravi

Let's see whether they publish it. I do question their judgement in publishing the original letter to begin with. It's not like we have a paucity of road rage in Singapore. We could learn a lot from Malaysian drivers.

If you would like to express your own views without going to the trouble of writing a letter, please take this Straits Times survey and choose what you think is the best way forward.

If I were to choose just one, my least-worst choice would be "Fund and create a self-governance culture..." but adding drivers to the mix: neither the problem nor the solution lies with cyclists alone surely? Along these lines, one notes with a sigh that the starting assumption of every survey response is that cyclists need to do something to remedy the situation, not road users as a whole (the usual ST survey full of leading questions). Even so, something is better than nothing, I suppose.

Sign of the times

From eBay:

Own half of a house for $16,000 and receive Income

This is how it works;

You put up the $16,000

We go in halves on a house in the Palm Springs Ca. Area using yours and my income to qualify for the mortgage.

1. I pay the down payment and closing costs out of the $16,000.
2. I make ready the house to rent.
3. Until rented I pay the mortgage.  
4. I rent the property to a third party
5. The rents go into a joint account.
6. The joint account pays the mortgage, Property Taxes, Insurance and any other expense we may have.  Anything over that amount is profit and can be paid out to us.  The monthly payment will be around $550 a month.  We will be able to rent the property for $950 a month.   And that is how you can own half a house and get a second income at the same time for $16,000.
7. But in this case there is more; you see these properties sold for over $300,000 in 2006 before the housing crash.  We will buy for under $100,000 if we act now.  So there is a good chance the value of the property could double in around five or ten years for a really nice profit when we sell.
8. There is no other legitimate investment that is this safe and pays this much over time.
9. For best results Act Now while the newest houses (built between 2003-2007) are still available.

Interesting. And what makes this joker think anyone who is willing to put up $16,000 while he puts up zero will be willing to give up half the rental income and capital appreciation?

To the pedants out there: I know he says he will pay the mortgage until the property is rented out, but there's nothing preventing him from renting it to a passing hobo for a dollar a day. Also, note the fine print about how the initial $16,000 is used.