Why a billion-dollar Yahoo bid for Tumblr might still miss

Forbes

Tumblr founder David Karp, photo uploaded in 2011. Yahoo needs revenue growth, demographic expansion and a “white whale” deal. What does Mr. Karp need? (InaFrenzy/Satya Murthy/Flickr Creative Commons)

When Marisssa Mayer took the CEO job at Yahoo, the consensus – and I shared this belief – was that she instantly made Yahoo relevant again. In the subsequent 10 months, much has vindicated that assessment as the stock has risen 70 per cent, Yahoo has acquired a bunch of small startups, and the perception around Silicon Valley has dramatically changed regarding the company.

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But three harsh realities remain for the Internet pioneer: (1) it hasn’t been able to do much to jump start revenue growth (2) much of the improvement in its valuation is because it still owns 24 per cent of fast-growing Chinese online giant Alibaba and (3) it hasn’t been able to land a big acquisition that could remake the company. With rumours abounding that Yahoo is making a play for Tumblr, Mayer is trying to fix at least two of those at once.

Tumblr, for the uninitiated, is a blogging platform that has 108 million blogs and 50 billion posts per the company’s own data. Depending on whether you believe comScore or Quantcast, Tumblr gets somewhere around 120-170 million visitors every month. But more importantly, it’s got demographics that Yahoo doesn’t. While a Pew study put its user base at only about half of Instagram and less than fast-growing Pinterest, it showed that it skews heavily into the 18-29 group. For a lot of those people, Yahoo might as well not exist, which is remarkable given that Yahoo still serves 700 million people a month. “One of our challenges is we have had an aging demographic,” said Yahoo CFO Ken Goldman this week. “Part of [our challenge] is going to be … making ourselves cool, which we got away from for a couple of years.”

Why Tumblr would want to sell

For Tumblr, the growth has been so outstanding, one might think an IPO is the ideal exit and it ought not to consider an acquisition. But the public markets have been a tricky mistress over the past several years. On the one hand, we have companies like LinkedIn, which are both growing fabulously and trading at nosebleed valuations. If you can get in the club with it – as the Zillows and Yelps currently have – you can trade at historically unheard of multiples north of 10 times revenue. On the other hand, there are the sobering cases of Groupon, Zynga, and even Facebook. All are trading well below their IPO prices and yet none are cheap by traditional metrics.

Then there is the perhaps larger issue that a lot of companies don’t want to be public – period. Noted venture capitalist Marc Andreessen went on CNBC the other day to say we’re in a “tech depression” and that “the new running theory among new entrepreneurs is never take your company public or don’t do it as long as you possibly can.” Of course, the challenge there is that in staying private, you have to find a way to keep your valuation up without the brutal discipline of quarterly results forcing you to do it. And that’s no easy feat, especially in fast-moving markets. Just ask Digg founder Kevin Rose. He was once touted as having “made $60-million in 18 months” by a BusinessWeek cover. He didn’t though; the company eventually sold for just $500,000 last year.

For Karp and Tumblr, the hard part is yet to come. There is talk that to really grow the company, it will need a “Sheryl Sandberg” type – a reference to Facebook’s hiring of the former Google exec to build out the business side of the company and let the technology visionary focus on doing his thing. But more than just one person, there’s the time and risk involved in trying to grow a large enterprise out of a smallish one. So one could understand why Karp might want to sell. A cash deal would be in the range of $1-billion – and perhaps quite a bit more as we’ll look into below – and would make Karp’s paper wealth into negotiable currency.

He’d also likely be in position to earn much more in stock from the buyer and in the case of Yahoo, that stock has the potential to appreciate quite a bit from here. Maybe.

Why Yahoo would want to buy

Aside from getting a youth-skewing property that’s growing like crazy, Yahoo gets an interesting advertising platform that has the potential to be huge. Tumblr is going after brand advertising in a big way at what it calls the “top of the funnel,” where people get inspired to buy. The best part about this strategy is that it’s very much where Google isn’t: Nearly all the search giant’s ad revenue comes from “intent based” pitches at the “bottom of the funnel” when people are already looking to buy. On Tumblr, the way it works is that brands can create whatever content they want: video, text, photos, sound. What they pay for is the right to promote it to Tumblr’s huge user base.

There is some evidence it’s resonating, having generated about $13-million last year. The goal for 2013 is $100-million, but whether that’s on track is something the company hasn’t provided any insight into. If it is, paying $1-billion in this market isn’t particularly out of bounds, as those Yelp and Zillow valuations indicate. That’s especially true if the trajectory can continue for awhile. With Yahoo north of $4-billion annually, $100-million or so isn’t going to dramatically move the needle, but it’s a start given that Yahoo’s revenues have more or less gone nowhere for a long while. And it’s not completely out of the question for Tumblr to become a billion-dollar property over the coming years.

But there’s another factor at play here which goes beyond the purely rational. This is about the big score, the white whale, the one that got away. Yahoo in the 1990s used to bag these routinely. It took out GeoCities early for $3.5-billion, which arguably could have led it to building its own social network had it seen the future. It made Mark Cuban rich buying broadcast.com for $5.7-billion only to fail to become YouTube or Hulu or Pandora or Netflix or, well, anything important in streaming media. Later it would haggle with Facebook over a few hundred million long enough for Mark Zuckerberg to lose interest and would be outbid by Google for YouTube only to watch that property become a juggernaut. It even passed on a chance to buy Google itself for pocket change.

The few times it got something right – buying Delicious and Flickr – it botched those up reasonably well too. All this ugly acquisition history leaves the company desperately wanting to do a big deal and get it right. (Let’s be clear, though, the Alibaba deal has made Yahoo billions of dollars. It just doesn’t get the credit it deserves because Yahoo never got to control Alibaba and had to cede some control to get any liquidity after years of fighting with CEO Jack Ma.) For Mayer, Tumblr could be that deal.

The party crashers

The problem for Yahoo is that even if Tumblr is really in the mood to sell – and right now all this is merely rumour – is that others will want to buy. The obvious candidates are Google (who could see Tumblr as a nice fit for the social side of its Google+ service, which continues to struggle) and Facebook. Zuckerberg may not be old, but he’s got a similar problem to Yahoo among the youngest internet users: Facebook also isn’t as cool as it used to be.

And Zuckerberg knows how to make a deal happen. He swooped in and took Instagram from Twitter by bidding more and having the authority to do a deal with pretty much no one else’s approval required. This is because Facebook is cash rich, its stock is worth more than $60-billion and Zuckerberg effectively controls the board of directors. Yahoo doesn’t come to this gunfight with a knife exactly, since there’s $4-billion in cash on the balance sheet and its market cap is now about half of Facebook’s. It can also bet big knowing an Alibaba IPO is likely coming soon and is going to fill that balance sheet with billions more. But working at Facebook still has a cachet that Yahoo doesn’t yet have, at least not until Yahoo can acquire a Tumblr. If Mayer can sell Karp on this deal and in the process make Yahoo anywhere near as “cool” as Facebook, that’d be a big score and so much more.

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