In his most recent book, What Technology Wants, Kevin Kelly provides some colorful examples of the tendency for new innovations and scientific advancement to to be created by multiple individuals around the same time.   Scientists at Bell Labs won a Nobel Prize for inventing the transistor in 1948, but German physicists independently created a transistor in Paris two months later.  Charles Darwin and Alfred Russel Wallace both put forth the theory of evolution at approximately the same time.  The light bulb encountered at least 23 inventors prior to Edison, according to Robert Friedel and Paul Isreal, making Edison “the very last ‘first’ inventor of the electric light.”  A more systematic analysis of this phenomenon was conducted by sociologist Warren Hagstrom, who surveyed 1,718 U.S. academic research scientists.  Over 60% said they believed that their worked had been anticipated, or scooped, by others.

We at SJF certainly see signs of this phenomenon in the venture capital industry.  At times there are waves of new business plans around new themes, such as  crowdsourcing, smart thermostats for the home, smart grids, collaborative consumption, group texting, etc.

The degree to which this tendency for simultaneous innovation indicates that certain technology developments are inevitable versus copycats is a topic of interesting discussion.  But as a venture capitalist, I am struck by the reminder that unexpected competitors can burst on the scene with a frightening degree of frequency, making the development of a leadership position challenging.  Serial inventor Danny Hillis put it to Kevin Kelly this way, “There might be tens of thousands of people who conceive the possibility of the same invention at the same time.  But leass than one in ten of them imagines how it might be done.  Of these who see who see how to do it, only one in ten will actually think through the practical details and specific solutions.  Of these only one in ten will actually get the design to work for very long.  And finally, usually only one of all those many thousands with the idea will get the invention to stick in the culture.”  Whether Danny Hillis’ numbers are accurate, directionally they make a strong point.

The next logical thought, then, is “So, it’s all about execution.”

And the next logical thought after that is “It’s all about the entrepreneur.”  A couple of recent books elaborate on this commonly held belief.  In Jim Collins’ sequel to Good to Great, titled Great by Choice,  Collins cites the attributes that allow companies to thrive despite the forces of uncertainty, chaos and luck.  Those attributes include management’s fanatic discipline, creativity in gathering empirical information, productive paranoia, and “level 5 ambition.”  In Making Ideas Happen, Scott Belsky writes that success is strongly linked to management’s strong organizational skills and ability to tap its community.

I think it certainly helps tremendously to have a management team that is highly intelligent and passionate, but I personally believe there is a tendency for venture capitalists to put too much weight on the “fanatical” and brilliant CEO.  As illustrated above, management teams often face the reality that creating a product or service that sticks in the market is difficult, no matter how talented the entrepreneur may be.  Market validation often speaks louder than management’s capabilities.  Furthermore, there are a number of investment opportunities that do not rely on the next Steve Jobs for success.  A successful company may be created because its founders  have toiled away at an industry for years and come to dominate a niche market.  A business may have created both a critical mass of users and fantastic network effects, driving self-reinforcing success.  Or a company after several years may have developed a well-oiled machine  that is difficult for others to replicate.   Or a company may have created a lock on data assets that are tremendously valuable.

There are certainly other examples of ingredients that can lead to success.  My point is that, yes, execution is hugely important, but I believe that successful venture investing means remaining open to the factors that can drive a company from the idea stage to the successful stage.

Congratulations to MediaMath for being named one of the leading demand side platform companies according to Forrester’s in-depth report.

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Many market participants believe that in order for the European financial crisis to not spiral into a chaotic economic collapse the European Central Bank must signal a willingness to buy a near limitless amount of government bonds.   That arguably will provide private investors with confidence that a floor to the massive problems exists, emboldening them to purchase European government debt and other risky assets.

Fitch echoed this sentiment when it lowered France’s credit outlook this week:

“Of particular concern is the absence of a credible financial backstop.  This requires more active and explicit commitment from the ECB.”

But many market participants also believe that the the ECB and other European policy members will ultimately do the right thing once austerity measures are solidified and when a financial emergency emerges.   That is the the bet.  That is why equity markets and bond markets have held up decently well despite an extremely concerning environment.

It’s hard to figure out the ECB’s real thinking, but I was struck by some comments made this week.

Look at what ECB President Mario Draghi noted, which was picked up by the WSJ:

The ECB’s purchases of government bonds are “neither eternal, nor infinite,” Mr. Draghi said in a speech in Berlin, stressing it would take “a lot” more than monetary-policy measures to restore market confidence in the euro zone.

Asked whether the ECB should copy the U.K. and U.S. in printing money to buy government bonds, a policy known as quantitative easing, Mr. Draghi said: “I don’t see any evidence that quantitative easing leads to stellar economic performance” in those economies. EU treaties forbid monetary financing of government debt, he added.

And the  WSJ further reports these comments this week from German Bundesbank president and ECB governing council member Jens Weidmann:

The idea that the ECB should turn on the printing presses to help finance some debt-ridden euro-zone states should be put to rest for good, Mr. Weidmann said. Central bank “independence is lost when monetary policy is tied to the wagon of fiscal policy and then loses control over prices,” he said.

It certainly is possible that the ECB is simply posturing in order to force European countries to get their financial act in order, but it is also possible that the ECB truly has no intention to provide a massive backstop to this crisis under any scenario.  A very scary thought.

Alan

When I heard that Apple might be trying to change television viewing experience in fundamental ways, I struggled to imagine what that might look like.  So, I was struck by the following comments in BusinessWeek:

“What about 3D? In 2010, Apple won a patent for a revolutionary new 3D screen system that would not require glasses and could be viewed by multiple people at the same time. The patent went so far as to slam current 3D systems, noting that most people dislike goggles and dismissing current non-glasses systems as essentially unworkable for projecting a 3D image … to an entire audience.

What solution did Apple propose? An “unobstructed 3D viewing device” that would give each viewer a different line of sight for both left and right eye, perfecting a stereoscopic image for a group of viewers watching one giant screen.”

In their most recent quarters, Pandora and LinkedIn generated revenue $67 million and $121 million in revenue respectively.  Both companies were operating at about break even.  Pandora grew at a 117% year-over-year rate, and LinkedIn grew at 120%.

Both companies have their opportunities and challenges.  In particular, Pandora needs to show that it can maintain healthy CPMs as it expands into mobile devices and/or run the risk of damaging users’ experience by introducing more audio ads.  LinkedIn needs to demonstrate that it is capable of monetizing its base beyond job postings in order to justify its valuation, in my opinion.  Nevertheless, both are exciting young growth companies.

Despite having similar revenue growth rates and operating at break-even net income levels, Pandora trades at about 7.8x revenue and LinkedIn trades at 15x revenue.  One could give many reasons for the disconnect:  market inefficiency (emotions), LinkedIn’s higher gross margins, broader revenue stream possibilities for LinkedIn, greater awareness of the LinkedIn brand, etc.  I believe, however, the valuation difference is in large part a reminder that meshed networks like LinkedIn tend to be more dynamic and cost-efficiently scalable than hub-and-spoke networks like Pandora.  Great businesses can be built through both meshed and hub-and-spoke networks, but meshed networks deserve a premium for their unusually explosive capabilities.

SJF Ventures’ allied organization, SJF Institute, has merged with Investors’ Circle.  This is an exciting opportunity for SJF to enhance impact investing through a relationship with a 19-year-old investor network.  See news story here.

There has been some healthy differences of opinion in the past 24 hours about the implications of LinkedIn’s IPO.  The splash has brought out another wave of individuals’ asking whether we are seeing another Internet bubble.  The question has been swirling for some months now.  In fact, worries of a bubble have occurred for many years.  People cried bubble after Netscape’s IPO in 1995, Yahoo’s IPO in 1996, extreme valuations in 1999 (when we really did have a bubble), when Web 2.0 began to get buzz in 2005, and when facebook raised money at a $50 billion valuation in January 2011.

What bothers me is when the valuation analysis of LinkedIn stops at a comment on the shares’ price-to-current-sales ratio, i.e. “LinkedIn is trading at 24 times 2011 revenue.  That’s ridiculous.”  After Yahoo’s first day of trading in 2006, the company had a market cap of $848 million on projected annual sales of $1.3 million.  Would buying the shares at 652 times sales in 2006 have been ridiculous?  From the perspective of how things turned out, the answer is no.  Yahoo’s shares now trade more than 10x higher, compared to a roughly 1x increase for the S&P 500.  From the perspective that Yahoo’s results are an anomaly and it was simply imprudent to purchase shares of a stock like Yahoo’s in 1996, the answer is maybe.

But I think the right way to look at things is whether investors are assessing the future prospects for LinkedIn when determining a valuation.  The ideal valuation methodology of a company is to assess the anticipated future cash flows and adjust for risk.  Some venture investors tend to anchor their analyses around multiple of current year revenue.  Some investors in publicly traded stocks tend to anchor their analyses around multiple of  earnings based on current year or next year’s earnings.  I think that these anchors are established in part because the future is hard to predict.  So, one turns to what a company is able to generate now.  I believe the anchors are also driven in part out of a lack of willingness to look deeply at a company in order to assess its future prospects.

I do not have enough information about LinkedIn to say whether I think it is overvalued.  But I can offer my two cents on whether we are in a bubble.  My sense is that markets are generally efficient in discounting future expectations.  Market efficiency can break down when (A) the assumptions underlying future expectations are off (often the case given that market participants lack perfect information), (B) market diversity deteriorates and investors’ decision rules become too uniform, or (C) investors are swayed because of emotional issues.  It’s this last consideration that has received a lot of attention lately.

In the bubble in the late 1990s, there were a number of emotional drivers.  First, there was the lottery effect, whereby many investors were willing to put a small amount of money in Internet stocks knowing that the probability-adjusted returns were not favorable (like the lottery), but were willing to risk a small amount of cash for the possibility of spectacular returns.    Second, bears became discredited by 1998 or 1999.  Those naysayers who decided to not buy stocks like AOL in 1997 or advised their clients to not buy stocks like AOL in 1997 were feeling an incredible amount of pain by 1999 and were at risk of losing their jobs.  By the time the bubble burst, bears were fearful of speaking (leading to both a break down of market diversity and emotional influences).  And additional emotional issues were at play.

So, what emotional issues might be going on now?  Are investors simply too exuberant?  Maybe.  But one could argue that short sellers theoretically should be driving down LinkedIn’s stock if it were clearly overvalued – though smart short sellers should know to short Internet stocks on momentum, not valuation.   Are we seeing the lottery effect again?  Perhaps… maybe some investors look at social media companies like facebook and Twitter gaining value rapidly and see LinkedIn as one of the few publicly traded opportunities to roll the dice with a social media company.  When LinkedIn’s stock was first priced, however, I imagine that institutions drove the pricing of the stock.  And institutional investors would be less likely to be influenced by the lottery effect.

And there are additional emotional considerations.  All of this is to say that I believe one should consider possible emotional issues influencing LinkedIn’s shares, but one should also have a good handle on LinkedIn’s future prospects before dismissing the valuation as absurd.  I think it is healthy to ask if we are seeing bubble-like influences, but I ask that individuals provide some deep analysis before claiming that a bubble is here — analysis that is deeper than simply pointing to the headline of LinkedIn’s 24-times-sales stock price.

The Wall Street Journal adds a great piece to the mix of articles that have been written recently on behavioral tracking.  This article focuses on data being collected from mobile phones.  A few excerpts:

As a tool for field research, the cellphone is unique. Unlike a conventional land-line telephone, a mobile phone usually is used by only one person, and it stays with that person everywhere, throughout the day. Phone companies routinely track a handset’s location (in part to connect it to the nearest cellphone tower) along with the timing and duration of phone calls and the user’s billing address….

Advances in statistics, psychology and the science of social networks are giving researchers the tools to find patterns of human dynamics too subtle to detect by other means. At Northeastern University in Boston, network physicists discovered just how predictable people could be by studying the travel routines of 100,000 European mobile-phone users…  After analyzing more than 16 million records of call date, time and position, the researchers determined that, taken together, people’s movements appeared to follow a mathematical pattern. The scientists said that, with enough information about past movements, they could forecast someone’s future whereabouts with 93.6% accuracy… The pattern held true whether people stayed close to home or traveled widely, and wasn’t affected by the phone user’s age or gender….

“We can quantify human movement on a scale that wasn’t possible before,” said Nathan Eagle, a research fellow at the Santa Fe Institute in New Mexico who works with 220 mobile-phone companies in 80 countries. “I don’t think anyone has a handle on all the ramifications.” His largest single research data set encompasses 500 million people in Latin America, Africa and Europe.  Among other things, Mr. Eagle has used the data to determine how slums can be a catalyst for a city’s economic vitality. In short, slums provide more opportunities for entrepreneurial activity than previously thought. Slums “are economic springboards,” he said…

Dr. Bollen and his colleagues, for example, found that the millions of Twitter messages sent via mobile phones and computers every day captured swings in national mood that presaged changes in the Dow Jones index up to six days in advance with 87.6% accuracy. The researchers analyzed the emotional content of words used in 9.7 million of the terse 140-character text messages posted by 2.7 million tweeters between March and December 2008. As Twitter goes, so goes the stock market, the scientists found.

I love this new advertisement by SJF portfolio company MediaMath.  The team looks quite a bit like the characters on the highly successful show Mad Men.

http://www.madmentomathmen.com/