Yahoo! (Market Capitalization as of 25/05/13: $28.5bn)
Tumblr (Market Capitalization: N/A)
On May 20th, Yahoo! continued its aggressive strategy since Marissa Mayer took over as CEO by announcing the takeover of New York-based blogging platform Tumblr for $1.1bn, all in cash. Tumblr was founded in 2007 and has more than 108mln blogs and nearly 117mln active monthly users. The transaction adds Yahoo! to the list of established Internet companies, including Google and Facebook, that have spent at least $1bn apiece to buy start-up companies in the hope of stimulating growth. Yahoo!’s stock, which has been on a +70% bull run in the year to date, was up 0.8% on the news.
The news comes about a year after Facebook snapped up the start-up photo sharing service Instagram for $1bn, the most closely comparable transaction to the Tumblr acquisition. In both cases, the target firms had little to no revenue compared to the size of the deal. However, it is worth noting that the Instagram deal was worth only 1% of Facebook’s market cap, whereas Tumblr is valued at almost 3.9% of Yahoo!’s market cap. Yahoo! seems to have paid a chunky premium of $200mln over a precedent valuation of $800mln in a round of VC financing in 2011. The peculiarity of this deal is that it paves the way for a renaissance of the east coast, and New York City’s Flatiron district in particular, as a technology start-up and venture capital hub. The first round of seed financing for Tumblr came from Union Square Ventures (NY), Spark Capital (Boston) and Betaworks (NY). These early backers have netted a 100-fold return on investment from the acquisition. The second major capital injection was carried out in 2011 and totalled $85mln from Greylock Partners, Sequoia Capital and Peter Chernin, among others. However, it is not clear that these later investors have obtained a satisfactory return over the implied valuation of $800mln at the time.
Tumblr’s growth potential, particularly on smartphones, is the rationale being provided for the valuation, backed by the fact that the site has 300mln users. This means Yahoo! paid around $3 per user, while Facebook paid around $30 per user. The acquisition was carried out entirely in cash from Yahoo!’s $5.4bn reserves. This was also made possible by the fact that the firm has no debt on its balance sheet.
The acquisition is Yahoo!’s ninth this year, which highlights Ms. Mayer’s strategic focus on returning the Sunnyvale-based firm to growth: one of the most advertised previous transactions is the purchase of Summly for $30mln, which made its 17 year old founder a millionaire. Nonetheless, the valuation has raised a few eyebrows in the industry given that Tumblr had revenues of only $13mln in 2012, which must be compared to estimated operating costs for the year of $25mln. Tumblr’s management forecast revenues of $100mln in 2013, which would allow it to turn a positive profit but represent almost 800% growth YoY. The monetization of its customer activity is achieved through targeted advertising, even though the firm’s track record is too limited to assess how it will perform in terms of revenue per user and clickthrough rates with respect to comparable social networks such as Twitter and Instagram.
With Yahoo!’s advertising revenue falling every quarter since 2011, the company will seek to utilize the untapped advertising revenue potential of Tumblr and Ms. Mayer has already hinted that she might create an ad exchange for Tumblr. Furthermore, Yahoo! can exploit the 100,000+ daily new users of Tumblr to stimulate its stagnating growth. Even though the double aim of Yahoo!’s acquisition is both to integrate Tumblr’s user base into its own, and to offer a larger audience to its advertising partners, there are challenges to the smooth implementation of this plan. On the one hand Tumblr’s young and independent core users do not show appetite for being “adopted” by Yahoo!: the stream of blog posts migrating to the competing WordPress platform reached a staggering 72,000 per hour on the night the deal was announced. On the other hand, Yahoo! might have trouble selling ad space to corporate image-sensitive advertisers on a website where one in six blogs contains adult material. Tumblr will keep operating independently with incumbent CEO and founder David Karp retaining his role to ensure “the same Tumblr irreverence, wit, and commitment to empower creators”. His cash payoff from the acquisition is estimated at around $220mln from his 20% stake.
The deal illustrates that, despite a decline in its core customer base, a veteran like Yahoo still has the muscle – and cash – to take on its competitors and reposition itself in the current social networking-centred internet landscape. If Ms. Mayer can live up to her word of “We promise not to screw it up” one could see Yahoo! reaping the benefits of a larger and younger user base. On the other hand, the social networking landscape is intrinsically volatile in terms of customer preferences (as the fast migration has just shown) and feasibility of monetization schemes.
Ms. Mayer’s bet may be an expensive and risky one, but it is one that in our opinion she has been right to make in the best interest of her firm and shareholders, in the search for a growth that has been missing for far too long at Yahoo!.
Yahoo! didn’t hire external advisors for the transaction and relied on its internal M&A team, suggesting they have been accumulating expertise to be used in future deals. Tumblr was advised by Frank Quattrone and Jonathan Turner from specialised boutique Qatalyst Partners.