5 Jan 2015

Tech Valuations and The Year Ahead

Valuation of Consumer Tech Services Companies

Valuations are very useful tool to gain insight into a company's future (or at least what investors think that future might look like). As we begin 2015, let's look back at the some of the highest valuations in consumer tech services and attempt to understand their drivers.

The chart above compares valuations of leading consumer tech companies that have interests in the services space. Whatsapp's valuation was originally pegged at $19 billion, but the deal included a significant amount of Facebook stock that appreciated in value before the deal officially closed. Figures for Facebook and Twitter are equivalent to their market capitalization (number of outstanding shares x stock price) whereas the remaining are based on the last funding round or acquisition. The lone exception here is Instagram's latest valuation -- valuation estimates from Citi pegged this at $35 billion. While this may not be as reliable, it does give us another rough data point to work with. Finally, Xiaomi recently became the most valuable tech startup in the world when it was valued at $45 billion in its latest funding round. Interestingly, this funding round coincided with Xiaomi's announcement of 61 million smartphone sales in 2014 implying a sequential sales decline from Q3 2014 to Q4 2014.

This list isn't meant to be exhaustive and only includes companies where I could find a comparable MAU figure. Facebook and Twitter had 1.35 billion and 284 million MAUs as per their Q3 2014 results. The rest of the MAU figures, including Xiaomi's 70 million, are from company press statements. Based on this data, their per user valuation multiples are plotted in the following chart:

Valuation Per User

Value per user is usually based on the following factors -- (1) user engagement, (2) potential to expand user base, (3) current average revenue per user or ARPU, (4) growth potential of ARPU and (5) probability of fulfilling potential. Given Xiaomi's pricing model, its $45 billion valuation seems to be a function of monetization potential from services and e-commerce, not hardware. This makes their $600+ per user valuation figure very interesting. We have already seen that Xiaomi's current services ARPU is comparable to leading messaging apps like LINE. Based on this, it seems that investors expect an explosion in MIUI's user base and monetizable services. In other words, Xiaomi's valuation is based on user acquisition through aggressive overseas expansion and minimizing customer churn. It is therefore no surprise that Xiaomi has also been expanding into other product categories like TV and connected devices. Creating a layer of hardware interaction and services on top of the Android OS allows them to create a secondary ecosystem lock-in and attract new users without facing the problems associated with AOSP.

Facebook attracts the second highest valuation multiple, but this may be slightly misleading. Since this is valuation is at the company level, it also reflects expected user and revenue additions from other products owned by Facebook, including Instagram and Whatsapp. Twitter may be a better benchmark for comparing other products. As a standalone product already generating over $1 billion in revenue, Twitter's per user valuation reflects current users/revenue and modest growth expectations (and consequently, a pessimistic view on a profit). Instagram and Snapchat's valuation multiples overshoot the benchmark set by Twitter, and Whatsapp comes in below.

The value of an Instagram user has increased by 3-4x from 2012 to 2014, even though its user base has already seen tenfold growth (30 million to 300 million). This shows investor confidence in Facebook's ability to monetize Instagram. In comparison, Whatsapp users are valued at just $49 per user even though its user engagement is comparable and user growth is strong. This seems to reflect a belief that monetization is still not imminent. Finally, Snapchat's valuation suggests that investors are confident that the company can generate meaningful revenues in a shorter time frame, while also growing its user base.

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