Here is last year’s study.

2008 CompStudy Report in Technology

What’s going on?

It’s no secret there’s a shift underway in the mobile device market. Years after futurists predicted the coming rise of mobile computing, and years after multiple technology companies were burned one after the other by over-investing in this trend prematurely, e.g.

• from Apple’s pioneering Knowledge Adventure video and the failed manifestation of this vision, i.e. Newton, in the 1980s
• to Danger in the 1990s
• to Microsoft’s perpetually misguided foray into the mobile world in the 1990s all the way to the present

a number of factors are finally converging to create a mobility megatrend. The availability of cheap silicon, substantial improvements in network access (baked into SoC silicon), and inexpensive screens and interfaces, has meant a good mobile computing experience is finally possible for the end consumer.

It’s becoming clear to the market who the winner in this emerging space is. The chart below says it all.

In less than two years since when it launched a product in the industry, Apple has grown to capture half the operating profit of the entire mobile device industry. That’s simply phenomenal. For every $1 in profit the industry generates, Apple gets 50 cents. That’s happened virtually overnight, since the iPhone only debuted in 2007. If I was Nokia, I’d be sweating bullets.

To be fair, Apple’s margins do not necessarily come at the expense of the other manufacturers. Its gross margins on its iPhone are significantly higher than anyone else’s and as a result, Apple has grown the pie for the aggregate operating margins available in the industry. Almost all this growth accrues directly to Apple’s bottom line.

It’s acknowledged in the industry that handset market growth hit a plateau at 1.2 billion units per year. Incremental handset growth comes from the replacement market, not greenfields. That means new features and functionality are needed to drive upgrades, and the customer adoption of new phones, primarily smartphones, is where the game for EBITDA will be played. Smartphones are under-penetrated in every geography in the world, with only 30% penetration in North America and Europe and 15% penetration worldwide. In spite of a tough global economy, they are growing 25% yoy.

Not only does Apple have some of the best products in the smartphone market, they are one of the few handset manufacturers that’s been able to build a successful consumer relationship via a platform. You use your laptop to manage your email, calendar and contacts, and have it all wirelessly synced to your mobile phone. You snap photos with your iPhone and have those pictures synced to your machine at home. As a customer, who do you have your mobile relationship with? The carrier? Certainly not. Despite all of its best efforts to stand in the way, the smartphone turns the wireless network into a dumb pipe. Your trusted relationship, more than ever, is with the provider of services and mobile computing platform. That’s Apple.

If you have to switch providers, it’s likely an irrelevant and meaningless (read: commodity) switch. If you have to switch manufacturers and platforms, that probably becomes a bit more nightmarish. Apple stands directly in the center of this mobile computing revolution. If the services and platform are well played, it’s a center that’s increasingly difficult to be displaced from.

The only question now is how much of this is already priced into Apple’s stock.

Europe is perfectly capable of building great technology companies. Below is a graphic from a presentation of mine highlighting successful $1B+ companies built in the US, Europe and China. As you can see, the United States and Europe have been effectively on par with each other since the beginning of the decade.

Now some readers may argue that the graphic may contain a bit of data massaging. Betfair is an unrealized return, although there are rumors it plans to float a $2.5B IPO this year. VistaPrint is a US company but it started in Europe while Robert Keane was studying for his MBA at INSEAD and raised its first round of $8 million from Sofinnova, a French venture capital firm.

A more poignant criticism of the chart is that the $1B line is arbitrary. If you were to consider all the exits from $600M+ in Europe, the balance would tip in the US’s favor (DataDomain, Riverbed, etc are just shy of the $1B mark). Europe doesn’t tend to produce as many of the $600-$1B exits that have become the lifeblood of the US venture industry.

It’s still an impressive bit of data. Europe barely registers as a place to build companies to most people in the technology industry, The data shows otherwise.

If that’s the case, why is the overall European venture investment track record so poor? The data suggests that most European venture firms have a tough time beating the S&P 500. If valuable companies can be built in Europe, why do venture firms struggle so much?

This requires a more careful analysis and will be the subject of another blog post. The short answer is that there is a paucity of investors with sufficient operating experience and know-how about how to build valuable companies. Startups need all kinds of help to sacle, at each stage in their history. Unfortunately, the number of investors who can provide this is pretty minimal in Europe. When you look at the European venture scene, you find a lot of former investment bankers and management consultants, and only a handful of individuals who grok technology, can understand go-to-market challenges, have the ability to help build world-class engineering and commercial teams, and have a wide network across the technology landscape. It also doesn’t help that European investors are more risk-averse than their West Coast colleagues, which is a more pronounced phenomenon of the difference between East and West Coast investors. It also doesn’t help that venture investors in Europe capital-starve their investments, with the data showing that European startups get on average about 1/3rd of the capital that US startups are able to raise. And that’s just the investor side of the equation. There’s also the issue of finding the right technical talent, the challenges of growing a company in the wrong milieu, building the right investor syndicate, being plugged into the right networks, having startups that can quickly iterate and change plans, etc…

On a side note.

When I was last in Silicon Valley, a friend of mine who used to run search for Yahoo! challenged me to name the number of $1B+ companies founded (incorporated) after 2000 from Stanford/HBS who is starting up a new company challenged me to name the number of $1B+ companies founded (incorporated) after 2000. A few names came to mind. The obvious being Facebook but also Silver Spring Networks, which I think will get to a $1B+ outcome. He swatted these all down, saying none of them have had realized exits. The only one in the US he said fit the criteria was YouTube. Scary. If that’s the only one, and we’re in 2009, that’s a pretty ringing indictment of the venture industry’s inability to grow large valuable companies this past decade.

Last night, while having dinner with a colleague at ePlanet Ventures, I realized there is at least one more. Baidu was incorporated January 18, 2000, went public August 5, 2005 and is currently worth $12.81B.

Are there any others I’m missing?

Our initial lineup looks great, with a bunch of colleagues from my Accel days agreeing to drop by campus for an hour, including:

• Robin Klein, probably the most prolific angel investor in Europe right now (bio) on October 1
• Stan Boland, who runs Icera and sold Element14 to Broadcom (bio), on November 5
• Stefan Glänzer, who helped build Last.fm and ricardo.de (bio), on December 3
• Bernard Liautaud, who built Business Objects and is now at Balderton Capital (bio), on February 4
• Jos White, who built MessageLabs (bio), on March 4
• Hermann Hauser, one of the most successful entrepreneurs and investors in Europe and the man behind Acorn, CSR, Entropic, Virata, etc (bio), on May 5
• Mike Hedger, who built and sold KVS to Symantec (bio), on June 3

There are a couple of more big names in the works who also plan to drop by so stay tuned. The full details of the new series is available here: http://london-entrepreneurship.com

Picasso once said “Bad artists copy. Great artists steal.” I hope Stanford doesn’t accuse us of too much intellectual theft. The speaker series is a replica of Stanford’s wonderful Entrepreneurial Thought Leaders seminar – from structure and presentation style down to our intent to put every video online. I see no reason to reinvent the wheel.

Part of my impetus for cloning ETL is that there simply aren’t enough stories of success in the European entrepreneurial community. Unlike the Bay Area where I’m from (although I suppose I’m really a New Yorker), Europe lacks a culture of shared success and failure. The story telling that goes hand in hand with trying to change the world is sorely lacking on this side of the pond. I’m hoping that this series will address part of the gap.

Quick history flashback: I remember when BASES set up ETL with Tom Byers (who’s also a visiting professor at London Business School) back when I was a sophomore. I was too busy building Studio Verso with David Siegel at the time to spend too much time in class, but I recall regularly streaming the series on my PC. The series, along with the Mayfield Fellows program, definitely got Stanford students more plugged in with what was going on in Silicon Valley, if only via a process of osmosis. A lot of credit in setting up ETL goes to the two Toms (the second is Tom Kosnick, who you see in the videos all the time), but also to Erik Straser, who was instrumental in establishing BASES and carrying it for four years. He could do that since he was a PhD student at the time. It served him well, since he got to know everyone in the Bay Area, and he’s now a General Partner at Mohr Davidow Ventures.

I’m hoping our series will give London Business School a chance to do the same thing for the European entrepreneurial community. I’m excited. I’ve wanted to start this for four years now, all the way back to when I first moved to London as a student. I just had my hands full juggling my job at Accel with an MBA class load back then, and then got too busy at Accel to get it going.

I can’t wait for the first Thursday of October. And the best news? I convinced London Business School to commit to opening the series up to everyone. That means you’re all invited.

Like last year, this year’s event was informative and engaging. Dan Cobley, who’s currently running marketing for north and central Europe for Google and who used to be the VP of brand and marketing for Capital One, pointed out a few sites for marketers that can be incredibly handy. I’d never come across some of these before, which just goes to show you how rusty I am at being an operating executive after a few years in venture.

• Google Wonder Wheel, which maps out relationships between search terms (like a mind map): http://www.googlewonderwheel.com/google-wonder-wheel-step-by-step (instructions on how to use it)
• Twitrratr, which tells you whether people are positive, negative or neutral about your brand on Twitter: http://twitrratr.com/
• Brandtags, which informs you what tags people associate with your brand: http://www.brandtags.net/
• Google Insights for Search, which lets you compare search volumes across multiple dimensions: http://www.google.com/insights/search/
• Google Adplanner, which helps you identify sites your users go to: https://www.google.com/adplanner
• Google Internet Stats, which is still unannounced, but is basically a big trivia repository in the cloud: http://www.google.co.uk/intl/en/landing/internetstats
  
• Not mentioned today, but worth pointing out is this nifty Web 2.0 name generator (an oldie but goodie): http://www.dotomator.com/web20.html

One of the best of these papers described how hedge funds rode the technology bubble. It was co-authored by Markus Brunnermeier at Princeton and Stefan Nagel, back when he was still at London Business School (he’s now at Stanford). There’s a widely accepted notion in finance that institutional investors outperform retail investors, often by trading directly against them. (There’s another good paper by John Griffin at UT-Austin that shows exactly how this played out from January 1997 to March 2000.)

Brunnermeier and Nagel’s contribution to the financial community was to show how hedge funds – the smart money in the market – who should have been shorting the technology sector and applying a correcting force to the bubble-era valuations did no such thing. Instead of acting as efficient market arbitrageurs, most of these firms fed the bubble by buying. These firms rode the market all the way up to its peak, at which point they all pretty much got out.

The data is staggering. The paper shows that smart money gets in and out at the right time, collectively, and can ride a clear asset bubble all the way up to the top, only to pull the proverbial ripcord before the market tanks. So much for efficient market theory. This, by the way, is consistent with George Soros’ theory of how reflexivity works in markets, which he outlines in a long-winded way in The Alchemy of Finance.

What made this all stick in my head is the paper underscored to me how far off valuations in the dot-com bubble were. Brunnermeier and Nagel quote another well known paper, DotCom Mania, by Eli Ofek and Matthew Richardson at NYU, writing:

Ofek and Richardson (2002) estimate that at the peak, the entire internet sector, comprising several hundred stocks, was priced as if the average future earnings growth rate across all these firms would exceed the growth rates experienced by some of the fastest growing individual firms in the past, and, at the same time, the required rate of return would be 0% for the next few decades. By almost any standard, these valuation levels are so extreme that this period appears to be another episode in the history of asset price bubbles.

Consider this for a moment as a technology investor. The market was so mispriced that that the future earnings growth exceeded the earnings growth of the fastest growing individual firms in history, and these earnings were all discounted back to present value at 0%. That’s insane. Valuations back in the bubble were downright ridiculous.

I might be going out on a limb here, but there’s no way these numbers are ever coming back. Gone are the days of software and internet companies going public, and getting to $10bn+ valuations on forward revenue multiples of 10x+ or higher (or even 5-7x+). I don’t think that’s going to happen, unless there is some kind of bubble for hedgies to ride and a bunch of retail investors who don’t know any better and are willing to be left holding the bag.

What does this mean for an early stage technology community? That’s for another post, but my fear is that unless you’re doing something incredibly strategic for one of the larger firms that lets you get out at a great multiple by having them become a buyer, or you’re riding a major growth shift or discontinuity in the market (like Gameforge, Playfish or Zynga are doing with online gaming) that lets you scale your revenue and EBITDA significantly, it’s going to be tough to build highly valuable companies. This affects investors, founders and even startup employees. The days of joining a startup, getting 10-25 basis points of ownership, and driving a Masserati four years later is going to be a lot fewer and farther between. It’s telling that since 2000, only one company has been founded with a $1bn exit to date (can anyone guess which one?). Anyone holding out for these bubble-era valuations to come back is living in an alternative reality. I don’t think this is necessarily a bad thing for entrepreneurship but this is probably all for another post. This is supposed to be about some of my favorite finance papers.

One of the funds that famously campaigned against the asset price mismatch and shorted the technology sector was Julian Robertson’s Tiger Management, which ended up closing shop as a result of this decision. There’s a saying that the market stays irrational longer than you can stay solvent. That’s exactly what happened to Tiger. Since then, Tiger has turned out to be the training ground for some of the best equity investors in the market today.

Another great paper that I came cross in a draft form back in the day was recently published, titled Best Ideas and co-authored by Harvey Cohen at Harvard Business School and Christopher Polk at the London School of Economics. Cohen and Polk show how managers who have highly concentrated portfolios, in other words demonstrating high conviction, outperform the market. It’s another arrow in the efficient market hypothesis, since if even mutual fund managers can actively outperform the market with this strategy, de facto the market isn’t efficiently priced. This paper builds on a few others that have all pointed out that managers who have high conviction, demonstrated by small, concentrated portfolios (ala Paulson or Einhorn), generate higher returns for investors.

I’ll also put a shout out to Chris’ paper that’s still forthcoming in the Journal of Finance. Sell-Side School Ties shows how social connections between investors and executive leads to higher returns, with the data in the period showing 5.40% to 6.60% of excess return. It seems obvious, but managers outperform the market when they have an educational tie to the executives of the company they are investing in. Yet another reason to go to a top-tier business school or undergraduate university if you want to be an investor. And the school that had the most links to senior executives or board directors? You guessed it. Harvard University.