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The DL - What $500M Buys You in Seattle, Companies Taking Stands (Or Not), What's Next for Software Multiples, and Social Cooling

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October 12 · Issue #69 · View online
The DL
Welcome to The DL, a weekly newsletter about tech, startups, and investing in the Pacific Northwest.

This week’s issue explores what $500M can buy you in Seattle, whether or not companies should take stances on political and social issues, where software multiples go next, and the 21st century’s latest problem - social cooling.

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What $500M Buys You in Seattle
* this is what their gross margins would be if they had any revenue
* this is what their gross margins would be if they had any revenue
Here are some financial metrics for three Seattle area companies. They look very different, but all are valued around $500M. Can you guess what each of them are?

Company A is a high margin, unprofitable business growing at a good (but not great) pace. It should reach $100M in revenue in a couple years, and it is currently valued at ~7x revenue. Definitely looks like a tech company with that gross margin, but the multiple looks a bit low for SaaS.
Answer: Porch. Definitely a tech company, but 90% of revenues come from transaction fees, so their multiple is lower than a SaaS company. Here’s the investor deck from the SPAC that is taking them public.

Company B is worth $500M+ but has no revenue, so half of the value comes from the $285M of cash on the balance sheet. The (estimated) gross margins and cash burn make it look like a tech company, but normally startups can’t raise this much money without some revenue progress.
Answer: Athira Pharma. Biotech funding is so different than tech. Drug companies need much more money and take a lot more dilution. Athira raised $200M+ in an IPO last month, just three months after raising an $85M Series B. They also only have 25 employees, which explains the low burn rate.

Company C. Ok, so what the heck is this company that makes $24B in revenue but is somehow only worth $560M? That is insane!
Answer: Rite Aid. So last week Rite Aid acquired Bartell’s for $95M, and my first reaction was, “Holy crap, that’s a 2020 seed round.” Bartell’s has 67 stores that did $550M in sales last year (which means if they were a software company, they could be worth $70B), so that led me to look at what’s going on with pharmacy valuations.

Obviously, Rite Aid has been heavily impacted by COVID, but the short story is they trade at ~6.5X Enterprise Value/EBITDA, and they will generate ~$500M of EBITDA this year. They also have ~$3B of debt, so that’s why their market cap (i.e., equity value) is only ~$500M.

Pretty interesting seeing three totally different companies with similar equity values here in Seattle (I’m loosely counting Rite Aid as a Seattle company now). It really puts early stage startup valuations into perspective, and it’s a good reminder that eventually companies need to make money!

Should Companies Take Political Stands?
One interesting story from the last couple of weeks was Coinbase CEO Brian Armstrong’s blog post stating that Coinbase is a “mission focused company” that will not engage in political causes and broader societal issues because they can be a distraction and create internal division.

He offered an exit package of four to six months severance to anyone who disagreed or no longer felt aligned with the company’s mission or culture, and last week, he published another blog post that said ~5% of Coinbase’s employees (60 people) decided to leave and take the exit package.

This is such a difficult and controversial topic - I’d love to hear what you think. Is Coinbase totally crazy or spot on? Does it depend on what type of business you operate, or how large the business is? Would you leave your company if it chose to be apolitical?

My quick take is this is how companies truly define their values. It’s great to say you are 100% behind your mission, AND you are 100% behind social causes, but the actions you take when two ideals come into conflict is how you truly demonstrate your company’s values. Either way, you reveal your company’s culture, and hopefully your culture attracts the type of employees that you want.

What's Next for Software Multiples?
Morgan Stanley published an interesting report last week on valuation multiples for software companies and why they are at decade highs. Their take was that software stocks are up 50%+ YTD, but for good reasons:
  • Interest rates have gone down
  • Subscription revenue has continued to grow despite the crisis
  • Lower growth and lower T&E have improved margins
  • Customers are increasing investments in digital transformation

However, they also say that it will be tough for multiples to continue expanding based on these secular trends, so now they are focusing on companies in a handful of categories where they still see opportunity:
  1. Businesses with consumption-based models - Microsoft (Azure), MongoDB, and Twilio can still outperform because their growth is based on usage, not just contract renewals
  2. Companies that were impacted by 2020 demand issues - Companies like Intuit and Smartsheet will have more room to outperform in 2021 as small businesses “snap back”
  3. Companies with a fundamental change in demand - While Zoom’s “change in demand” is already priced in, companies like Docusign and Veeva might still be underappreciated
  4. Business model transitions - Companies like Atlassian, Nuance, and Sailpoint are moving more and more customers to the cloud, which should improve their financials over the next few years

Other stuff Dan's talking about
🧊 Social Cooling - Interesting argument that big data and “digital reputation” is leading people to self-censor and avoid taking risks. This is a “subtle, complex issue” like global warming and deserves more attention
📚 Ebook Libaries - Ever wonder why you have to wait two years to check out popular ebooks from the library? Turns out they have to buy special licenses, which cost $40 and allow only 26 or 52 checkouts
🧑‍🚀 Johnny Kim - What a scrub! This guy is a former Navy SEAL, doctor (Harvard Medical School grad), and NASA astronaut. This was a fascinating podcast where he talks about his upbringing and approach to life
💥 Biggest YC Failures - YC has invested in 2,200 companies, and 18 of them have become unicorns. Here’s the list of the five companies that raised the most money and then failed

Please hit reply! (Or subscribe or forward!)
About me: I work as an investor at Madrona Venture Group, a Seattle-based venture capital firm that has been early partners with companies like Amazon, Smartsheet, Apptio, and Redfin.
If you have thoughts, questions, or comments, hit reply! If you’re new, check out some of the DL’s top articles from the last few months:

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