Going Social, Valuation Crazy II

December 4, 2011

In an update last week we referenced the potential for a shortable upside move in our long time poster child for inflated late stage/social networking/clean tech (which incidentally saw yet another climate change summit marred by Climategate 2.0 email releases last week) GSV Capital. The driver at the time was $100B valuation chatter for Facebook, despite losses in the company's investment in GRPN. After a lengthy and positive story in Barron's this weekend highlighting GSVC as the vehicle for "the little guy to get in on the action", we look for a sharp move upward on Monday and would like to be able to establish short positions over $16 joining the likes of P and Z on the short side arrayed against a still very sizable GOOG long.   As we will discuss in detail below, if we are going to pay $7B for a social networking company we would vastly prefer LNKD, which in our view has some real fundamental and business model positives, than a Zynga in the public market or amazingly a Twitter in the private market.

What is truly ironic about the timing of the Barron's story, is that it sits beside headlines talking to a dramatic reduction in valuation expectations for Zynga and it plans to start its IPO roadshow this week.  Likewise, while the article mentions GSVs investment in Groupon and that the company had gotten public, it somehow failed to mention to price at which GSV invested.  Like late stage investors in Zynga, that price is higher than the current price, in GSVs case a $25 cost for GRPN.  From the outset we have viewed the mere existence of a vehicle such as GSVC, and indeed the existence of the unregulated secondary markets that in part enables it, as clear signals of a bubble in social networking valuation in particular.  As we expect it to end badly, very badly, given the fact that (1) the company made substantially all of its investments over the Summer at peak valuation levels and (2) as its investments come public, besides losing money the impetus to invest in a vehicle such as GSVC will be less as investors will be able to directly invest in the Zynga's and Groupon's of the world, likely driving a deep discount to a declining NAV that will also be pressured by ridiculous fees.

As for Zynga, GSV's investment is in the form of rather bizarre $4M on year note that pays rates of interest based on the valuation of the company, 10-20% in a range of $6-$14B, with participation above that level an loss of principal below.  It is perhaps a sign of the efficiency of the late stage private markets that the last Zynga trade on SharesPost, in which GSVC also has an investment and on whose board GSV principal Michael Moe serves, is valued at $20 per share or more than twice the current IPO range.   It is also notable that fully diluted shares increase by 100M for Zynga for a total of 800M out post deal and hence an $8B valuation at the top of the range, which again I currently see crawling by on the Sharespost website at $12B at $20 per share, indicating that in addition to a bad price they have a bad sharecount.

Like many of its social networking peers, growth has slowed dramatically for Zynga this year, though unlike GRPN P Z and others Zynga is however solidly profitable.  The company's bookings have stalled at just over a $1.1B annual run rate the last three quarters, with EBITDA declining precipitously to around a $250M run rate from closer to $400M last year at far lower revenue levels.  And this speaks to the fundamental notion that social models are somehow different or more profitable than traditional internet models or in this case traditional video game models.  At some distance, it sure looks like Zynga hasn't had a big hit in a while and is investing heavily to try and produce one, much like its console based peers.   Thus with revenue growth slowing to 10% sequential last quarter and bookings growth flat, its hard to see paying 30X EBITDA plus for Zynga.  And in sort of a reversal of the Groupon question (eg if GRPN is worth $20B what is X worth) much of the unprofitable highly valued recent IPO crop may suffer comparison poorly relative to a single digit revenue multiple and double digit EBITDA multiple for Zynga, including the likes of GRPN and Z.  Which is to say, should we really be paying a higher revenue multiple for Zillow than we are for Zynga?  Finally, given the significance of Zynga's revenue contribution to Facebook there are clear implications for GSVs valuation here, where they added another $3M plus a few weeks ago to bring the total investment to about $10M at a $70B valuation.

Having seen how well the whole GRPN process went, apparently Twitter executives are looking to emulate that, with recent commentary to the effect that Twitter is going to be a "massive business" from its Chief Revenue Officer.  This sounds much like the "wildly profitable" comment from GRPN Chairman Lefkofsky during the GRPN quite period.  One might thing that investors currently paying around $19 per share for Twitter or about $10B according the Sharepost already  believe the business is massive.  That level is about the same as GSVCs cost on its $9M investment in Twitter, its second largest.