Yahoo! (YHOO) announced this morning that it is buying social blogging company Tumblr for $1.1 billion in cash.
Tumblr is a six-year old company based in New York. It is run by a charismatic 26 year-old entrepreneur named David Karp, who will pocket hundreds of millions of dollars on the deal and has therefore become an object of fascination for the New York tabloids.
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Tumblr allows users to create simple blogs and share words, pictures, and video. It is one of a handful of massive social publishing platforms created in the past decade, a group that also includes companies like Facebook (FB), Twitter, Instagram, and Pinterest.
Tumblr's audience is massive. The company's blogs receive 300 million unique visitors per month, and a staggering 120,000 new blogs are created every day (not blog posts--blogs). This mind-blowing traffic has made Tumblr one of the largest digital media companies in the world.
The Tumblr deal will vastly increase Yahoo's already huge global audience. It will also bring a new, younger demographic to the company -- a group that has been born and raised on digital and social media. And, as long as Tumblr continues to grow, it will provide a big new traffic growth engine for Yahoo.
Initial reactions to the deal have ranged from raves to pans, with most of the latter coming from the same conservative pundits who trash most digital deals that seem expensive relative to the acquired company's historical financial performance.
And, certainly, relative to Tumblr's historical financial performance, the deal does initially seem expensive.
Tumblr generated about $13 million of revenue last year. It also, presumably, lost money. Some pundits glance at these numbers and conclude that obviously the Tumblr deal is just yet another hallucination by idiot managers who don't understand that they're paying good money for nothing.
These criticisms are silly.
Yahoo is not buying Tumblr's past financial performance. It is buying Tumblr's audience, demographic, and social and mobile expertise. It is buying a company that has the potential to make Yahoo a growing, relevant Internet behemoth again. It is buying a media property that will likely be able to increase the reach and value of Yahoo's own advertising solutions (namely, search). It is also buying Tumblr's future financial performance, which is expected to be a lot more impressive than it has been in the past.
Tumblr has only recently focused on generating revenue. According to sources close to Tumblr, the company's revenue target for this year is $100 million. If Tumblr generates anywhere near that much in revenue this year, the price for the deal will start to look a lot more reasonable. And if Tumblr can do $75 million to $100 million this year, it can probably do $200 million next year. At that point, you're talking about 5x to 6x times revenue for a company that will likely be able to generate very high profit margins, because it has no content costs. That growth would make $1.1 billion a perfectly reasonable price, even if Yahoo gets no other benefits from the combination.
Is there a risk that Tumblr could collapse like MySpace, Geocities, or some of the other deals that skeptics are now citing?
Of course there's a risk of that.
Many acquisitions fail, especially in the technology business.
That's why technology is considered a risky industry -- things change fast and red-hot companies can go stone-cold in a matter of months.
Tumblr's biggest risk is probably that its traffic has flatlined over the past 6-9 months. If Tumblr's audience has reached its peak, the company's future value will be a lot lower than it would be if the audience continues to grow.
Other Tumblr deal risks include integration, culture, and geographic distance.
The pundits who are claiming that Yahoo's Tumblr acquisition is a waste of money don't appear to appreciate the situation Yahoo is in.
Yahoo ruled the Internet world in the 1990s. Thanks in part to management turmoil, the company has missed out on several waves of industry development, from search to social to mobile. As a result, Yahoo has been in a slow state of decline for the past decade. And now Yahoo has reached the point where it is largely irrelevant to the latest generation of Internet users, who have moved to Google, Facebook, Instagram, Twitter, Pinterest, Tumblr, and other companies.
Given this situation, Yahoo has two choices:
It can either give up and run itself for cash flow -- creating value for shareholders by generating as much cash as possible (by cutting costs) and buying back stock.
Or it can be aggressive and try to rebuild and re-energize its business and create real value in the process.
For now, Yahoo has chosen the latter route. That's why it hired Marissa Mayer as CEO. It would be a waste of Marissa's time and Yahoo's time to give up, sit around, and just return cash to shareholders. And that's obviously not what Mayer and Yahoo are going to do.
Yahoo shareholders who just want cash and don't like Yahoo being aggressive are free to sell Yahoo's stock and buy Treasury bonds.
Yahoo shareholders who want Yahoo to take the risk of trying to repair itself, meanwhile, have to get comfortable with the fact that risk is just that -- risk.
Yes, the Tumblr bet is risky.
Yes, it would be "safer" for Yahoo to hoard and fondle its $1.1 billion of cash, at least over the short term.
But when it's late in the fourth quarter and you're losing and you're about to get sacked in your own end zone, it's appropriate to take some risk.
Marissa Mayer and Yahoo are taking some risk. They're throwing the long ball.
Those who are quick to dismiss this move should remember that this is exactly what Yahoo hired Marissa Mayer to do. They should also remember that, based on everything Mayer has done at the company so far, she's the kind of quarterback who is capable of not just throwing but completing the long ball...
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