Andreessen Tweet Stream: 4/16/14
1/A few common fallacies about valuation of public and private technology companies:
2/First, ask any MBA how to value tech companies, she’ll say “discounted cash flow, just like any other company”
3/Problem: For new & rapidly growing tech co’s, up to 100% of value is in terminal value 10+ years out, so DCF framework collapses.
4/You can run as many DCF spreadsheets as you want and may get nothing that will help you make good tech investment decisions.
5/Related to fact that tech co’s don’t have stable products like soup or brick companies; future cash flows will come from future products.
6/Instead, smart tech investor thinks about: A future product roadmap/opp’y, B bottoms-up market size & growth, C talent and skill of team.
7/Essentially you are valuing things that have not yet happened, and the likelihood of the CEO and team being able to make them happen.
8/Finance people find this appalling, but investors who do this well can make a lot of money, but spreadsheet investing is often disastrous.
9/Doesn’t mean cash flow doesn’t matter, in fact opposite: this is the path to find tech companies that will generate tons of future cash.
10/Corollary: For tech companies, current cash flow is usually useless for forecasting future cash flow–lagging not leading indicator.
11/This trips up value investors (Prem Watsa!) all the time; tech companies with high cash flows often about to fall off a cliff.
12/Because current cash flows are based on past products not future products. And profitability often breeds complacence and bureaucracy.
13/Always, always, always, the substance is what matters: WHO and WHAT. WHO’s building the products, and WHAT products are they building.
14/Brand will not save you, marketing will not save you, channels will not save you, account control will not save you. It’s the products.
15/Which goes right back to the start: Who are the people, what are the products, and how big is the market. That’s the formula.