Time for a Web 2.0 Vulture Fund?

24 Comments

Brad Greenspan’s LiveUniverse is indeed buying personalized web page startup Pageflakes, the two confirmed today, bringing the curtain down on a critically acclaimed service that failed to gain much traction, mostly because it was chasing savvier competitors with deeper pockets.

The company blew through nearly $4.3 million and was close to running out of cash, as we first reported over the weekend. Their quick embrace of bargain-hunting Greenspan only adds credence to the rumors of them running out of gas.

But in the broader scheme of things, Pageflakes’ sale is not that big of a deal. Startups that fail to become category leaders either shut down or have to settle for the ignominy of being sold for pennies on a dollar — it’s standard operating procedure in Silicon Valley. And as the current Web 2.0 cycle runs out of steam, we’re going to see the startup equivalent of a brownout. I think there is a real opportunity here for someone to make money.

Back in the dark days of the telecom depression, some crazy mavericks started buying up distressed telecom assets, packaging them and flipping them for a nifty profit. More recently, many vulture funds have started buying out distressed real estate assets. Maybe it’s time for someone to start a Web 2.0 Vulture Fund, aggregating startups with decent technologies that have otherwise failed to get themselves off the ground.

Someone could, for example, roll up the social bookmarking startups with social news companies, or bundle Office 2.0 web apps. Aggregating web utilities such as online storage services, or online address books and calendaring services could be another opportunity.

How would such a fund be different than Greenspan’s Live Universe or Internet Brands? Those are companies with a roll-up strategy. In comparison, as Morgan Stanley notes, “Most vulture funds are limited partnerships, but some are retail mutual funds that are open to individual investors.” (The other option is a buyout fund specializing in distressed Web 2.0 assets.) You can help define the properties of this Web 2.0 Vulture Fund, either on your own blog or in our comments section. Or just email me directly.

If you don’t care much for that, answer this big question, dear reader: Which Web 2.0 company do you think is going to run out of steam and is worth being picked up by a Vulture Fund?

24 Comments

Om Malik

@ Q dub, Marty and David Sachs,

I think you guys make a solid argument, and I am going to try and answer that with a post. It can become an unwieldily comment if I tried to do here. I still believe that some of these failing properties are going to have value.

On Pageflakes, I didn’t say they are dead. i think from an investor perspective one group got wiped out while another got a bargain. I am just suggestion, a fund to find-and-buy those bargains when they become available.

David Sachs

I’m late to this discussion, but having spent some time studying distressed investing, I figured I’d chime in.

There are several problems with this strategy, as others have pointed out:
1. The fundamental tenet of most distressed investments is “good business, bad balance sheet.” In other words, two things must be true: a) the underlying business is sound and can generate cash (and not continue to consume capital); and b) due to prior circumstances, the company got over-leveraged or had a mismatch between the timing of cash inflows and outflows that caused it to be insolvent. This means that the fundamental problem that forced the business into distress cannot be that the company has no capability to generate cash over the long term, only that it found itself temporarily upside-down in terms of short-term assets and liabilities.
2. Alternatively, great distressed investments have come from highly out-of-favor assets with long useful lives where the cost to replicate the infrastructure in place is vastly greater than the cost to acquire it. In technology, Digital Realty Trust acquired surplus data center space–which can cost hundreds of dollars per foot to construct–at fire-sale prices during the bust when companies like Exodus went out of business. If you have the cash and the patience to wait out the market, the price will likely eventually return to fair value (though it is hard to know how long this will take, which is why stabilizing cash flow is priority #1 in a turnaround). Likewise, Sam Zell made his billions as “the grave dancer,” buying distressed buildings at times of crisis for far less than replacement cost.

The reason most failed web 2.0 businesses (or, in prior eras, VC-based companies in enterprise software and communications equipment) make poor candidates is that 1) they have few tangible assets that can be acquired below replacement cost, especially given that replacement cost tends to drop over time due to rapid depreciation; 2) the value of IP is fleeting, as technology continues to evolve, meaning that it takes cash to continue R&D; and 3) they never demonstrated a cash-generating ability in the first place.

Contrast this to the acquisition of eHow’s assets out of bankruptcy–there was an enormous library of content that could be acquired below replacement cost, has a long useful life, and is newly valuable given the availability of a new revenue source in the form of Adsense. The site quickly became profitable, and eventually was sold (minus WikiHow) to Demand Media for a large gain.

Ski

I agree with you on the general idea, Om. Honestly, though, isn’t it more likely that companies like Microsoft, struggling to get a foothold in the “future”, will be the ones scooping up failing startups? If the idea or concept itself is a winner, you’d need a company like MS to use its reach to make it financially successful. Not like they haven’t done it before…

Markus Göbel's Tech News Comments

It’s about time for a shakeout.

Look at pages like socialmarker.com and see how many social bookmarking services there are! And all those social networking websites and microblogging services. They flood me with invitations or information which at a closer look is mostly useless spam. I could spend my entire working day on that and get nothing done.

But one has to always be afraid to miss something important. It would be much easier if there were only a handful of Web 2.0 services to follow. At least Facebook gets boring and I have to check it only once a week now.

Sam Jackson

I’m down for whatever! Om, I think someone should organize a little venture/vulture fund with a good number of ethnographers and in-the-know students and young people to beat the trendwatching journalists and analysts to the punch. Call me! ;)

Marty

Q-dub has made the point I was just about to.

The telecoms and real estate vultures actually had hard assets to acquire which had some potential of being of greater value in due course.

Internet start ups have two assets: talent and users.

As Q-dub pointed out the talent is likely to move on.

And if the start up is sick enough for the vultures to be swooping in, I dare say the number (or stickiness or some other metric) of users isn’t impressive.

Alex

There are some really good posts here. After seeing the Ning valuation today of $500M is suffice to say that we are fundamentally still in the expansion stage of this business cycle for Web 2.0. There is no other explanation!

eric

vultures…now that is an interesting thought. you speak as if Pageflakes is done for now that they have joined forces with another company. i think that mergers don’t necessarily mean the death of a company, but continued vitality and growth.

Q dub

I find this analogy rather weak, in most other industries–especially in your real estate example–the acquisition targets have substantial amounts of undervalued assets. What assets do failing web 2.0 startups have besides the talent, who will leave for other pursuits anyway? The technology is often team second-rate and will lose relevance within 12 months due to the rapid pace of innovation.

And integrating a handful of 2.0 properties is no easy task–read Paul Graham’s latest work–even Google isn’t very good at building cohesive packages out of it’s acquisitions.

Mark Sigal

Om, part of what your comments point to is a fundamental re-pricing of a lot of assets, as those assets go from being assessed as standalone businesses with some audience value, proxy of a business model to a technology/team buy of ‘piece parts’ for use in someone else’s larger strategy.

For companies funded on the premise of the former that find themselves looking like the latter, that is a bitter pill to swallow. VCs are also realists, however, when the writing is on the wall so indigestion aside, you are probably right that there is a buyer’s market for vultures and roll-up plays.

It does, though, raise the question why more of the corporate development arms of big companies that have crapped out in Web 2.0 implementation don’t themselves use this time to define a global strategy, figure out the piece parts integral to that strategy and fill their portfolios when the market conditions are right.

The probable answer is that fear is driving more of these companies than greed given the turbulent economy. Plus, few companies excel at technology integration.

Mark

My Blog: http://www.thenetworkgarden.com

Alan Wilensky

Pick any number of CGM metrics and brand monitoring startups that text mine blogs, forums, and main stream news. I guarantee that almost the whole lot will be in tthe dead pool in late 2008 09.

Buzzmetrics may be the last one standing, due to their connection with Neilsen.

Down the toilet for adding nothing to the branding conversation, no framework for decision support, and ignoring the brand intermediaries (retailers, durable goods dealers, and enthusiast products.)

Om Malik

@ craig,

the ecosystem is a bit crowded and needs some cleaning out (consolidation). I don’t mean to suggest the innovation cycle runs out of steam, it is more on the investment side of thing. the macro trends you mention are going to remain intact for a while, but there are issues of economics and those make your your point about “darwin” is spot on.

craig

“as the current Web 2.0 cycle runs out of steam”…

Do you really think that we’re seeing the end of a cycle? Seems like the startup funnel in web 2.0 is just a lot more darwinian than ever before.

A lots more companies were started due to the ready availability of seed money and low startup costs (open source, cheap computing, etc.). But the end game is the same. To raise a successful Series B you need either strong exponential user growth or solid revenue traction.

It’s not surprising that all these companies won’t be able to make it. But that doesn’t mean the ecosystem is broken.

Petabro

Slightly Off Topic – Will Micahel Arrington will be the Tony Perkins of Web 2.0? I think he could be.

Isaac Garcia

I think the most obvious “roll-up” that we’ll see in the next few years is a “collaboration platform” roll-up or a “pure SaaS roll-up.”

The Private Equity guys can smell it.

Om Malik

Actually I broke the story on Pageflakes running out of gas. Arrington got the sale scoop, and good for him. Part of the process is to extend the conversation and try and see if there are longer term implications. If that doesn’t work for you, well too bad.

Drew

It…is…so…quiet…here. It it possible that your readers are tired of the muckracking and doomsaying? You got scooped by Arrington on the Pageflakes acquistion, and the best you can do is to spin this deal as proof of your wisdom as you try to twist your first knife deeper?

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