Facebook, King, and the Worsening Environment for Small Tech Investors

Facebook (NASDAQ: FB  ) spends $2 billion to take out Oculus VR the same day King Digital Entertainment (NYSE: KING  ) goes public. The message? Sorry, tech investors, only billionaires get nice things.

Remember when Oculus VR was a Kickstarted project that appealed mostly to gamers? So much for the old days. Sources: Oculus VR, Kickstarter, YouTube.

The billionaire who said it best
This is the era we live in now. IPOs are mostly reserved for the incrementalists, the tech enterprises whose disruptions didn't threaten the establishment enough to warrant a rich buyout while still private. Companies like King, which derives 95% of its gross bookings from Candy Crush Saga, Farm Heroes Saga, and Pet Rescue Saga, all of which are variations on the same theme.

An IPO built on the sort of incrementalism Google (NASDAQ: GOOGL  ) co-founder and chief Larry Page railed about during an interview with Charlie Rose at a recent TED conference: "Companies are doing the same incremental thing that they did 50 years ago, 20 years ago. That's not really what what we need," Page said. He's right, and you know it. We all do.

Imagine you could own shares of either King, or one of the potential disruptors taken out recently: WhatsApp, Nest Labs, Maker Studios, or Oculus. You can't sell for 20 years. Which business would you back? If King really is your choice, then I need you to explain why in the comments section below.

The big winners: VCs
To be sure, backing start-ups isn't easy business. But for VCs, it has to be nice knowing you have a built-in pipeline for selling your best bets at an outrageous premium, leaving the dicier, more regulated IPO market as the exit pathway of last resort.

Look at Facebook. The social network's board of directors includes VCs Peter Thiel and Marc Andreessen, whose Andreessen Horowitz led a $75 million financing round for Oculus VR in December. According to Bloomberg, the firm owns a 17% stake worth about $340 million as of this morning. Talk about a home run of a return.

Yet this happens more often than you might think. According to research from CB Insights, 57 of the 472 IPO candidates it named heading into 2013 have since exited the private market -- 21 via a public offering and 36 via a merger or acquisition, creating $44.4 billion in value for early backers.

Let's be clear: I'm not accusing Facebook, Google, or anyone else of impropriety. Rather, I'm saying venture capital firms and other private equity specialists haven't been leaving much for common stock investors to choose from.

In a way, I can't blame them. Crowdfunding alternatives and secondary markets like the Nasdaq Private Market, created in concert with private company stock seller SharesPost, have made it easier for entrepreneurs to bypass VCs in the quest for financing. Mix in a slew of cash-rich companies looking to buyouts as an R&D alternative, and you have the makings of a front-loaded tech investing environment, where astounding gains go to those who refuse to wait.

How to mitigate the mess
Judging from the outrage we're seeing on Twitter and elsewhere -- outrage aimed at Oculus by those who first backed the company in 2012 via Kickstarter -- I'm expecting more investors to respond to the shift by rushing into complex and expensive funds that promise access to early-stage deals.

Take the new mutual fund SharesPost is offering. Dubbed the "SharesPost 100 Fund," the vehicle requires a minimum $2,500 investment and a graduating fee scale that could include up to a 5.75% sales charge for early investors and a 2.50% annual expense ratio. (Download a complete prospectus here.)

While both fees could moderate over time -- or even prove inconsequential if the fund produces stellar returns -- the "SharesPost 100" doesn't offer anything that common investors can't already get with a dose of patience. After all, venture capital is as much about strikeouts as it is home runs, and the best returns are earned only after years or even decades of holding fast.

Where VCs and common investors converge
Just look at the numbers. The National Venture Capital Association's Q3 2013 report shows the 1-year venture capital index return at 15.1% through the end of September, noticeably below the Nasdaq's 21% return over the same period. By contrast, the average VC return reaches 26.1% annualized over the past 15 years and 30% over the past 20 years -- figures that absolutely destroy the market's average for the same periods.

You know what? Common stock investors who buy to hold for the long term can also expect excellent results. We've seen it over and over and over again, and not just from Warren Buffett, but also our own David Gardner, whose early bet on Amazon.com has returned more than 100 times his buy-in price, no gimmick required.

So, forget settling for low-quality businesses such as King. Ignore the buyouts and get-rich-quick schemes for cashing in pre-IPO. Instead, be choosy with what you invest in, and then go in with the intent of staying in. If you've bought well, you've nothing to fear.

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Read/Post Comments (8) | Recommend This Article (17)

Comments from our Foolish Readers

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  • Report this Comment On March 27, 2014, at 4:14 PM, TMFBlacknGold wrote:

    Tim,

    Excellent stuff! Although, I don't think VCs complain about using the IPO card as a "last resort ". There are certainly bigger immediate gains from an acquisition, but we can both name worse exits than IPOs. ;)

    "Ignore the buyouts and get-rich-quick schemes for cashing in pre-IPO. Instead, be choosy with what you invest in, and then go in with the intent of staying in. If you've bought well, you've nothing to fear."

    Well said.

    Maxxwell

  • Report this Comment On March 27, 2014, at 5:06 PM, elle33 wrote:

    Despite the outrage, most gamers feel

    that being acquired by Facebook will actually

    benefit Oculus VR:

    http://opi.cc/g2Fu54924QXOQ20V

  • Report this Comment On March 27, 2014, at 5:07 PM, Mega wrote:

    "Imagine you could own shares of either King, or one of the potential disruptors taken out recently: WhatsApp, Nest Labs, Maker Studios, or Oculus. You can't sell for 20 years. Which business would you back?"

    None of the above.

  • Report this Comment On March 27, 2014, at 5:35 PM, fe7565 wrote:

    I think the article misses to identify the potential that Oculus can bring to Facebook and to the rest of the social media. Also, I am not convinced about the speculation that Thiel and Marc Andreessen "manipulated" FB's Oculus acquisition. It comes to the chicken or the egg theory: did they discover Oculus' potential based on the merit of the company's star product alone when they made their original investment, or did they made the connection between the product and what it may contribute to Facebook later?

    Also, I agree with Cramer: FB did a terrible disservice to itself, the investors, and its credibility as a mature social savvy company by not explaining the reason behind their Oculus purchase.

    However, Virtual Reality goggles have a huge (so far sparsely tapped) potential. Virtual Reality goggles are not a single-trick poney used in online gaming only. They have been in use for a considerable time now for example with First Person View (FPV) model airplanes and UAV (unmanned aerial vehicle) flying. Cramer elluded yesterday on Mad Money to the use of the Virtual Reality goggles produced Oculus when interacting on Facebook (and at others social media venues) with each other. One can easily imagine several uses: virtual face-to-face 3D meetings with your financial coach, with your family, with your team at work; virtually walking in and shopping in a store/mall, car dealership; travel by placing yourself on the moon or at an exotic destination in a 3D environment, etc. All this complete with virtual 3D life-realistic avatar presence of others you can interact with in that virtual world. Treat yourself and your family to a virtual 3D or IMAX movie theater with 100 feet high screens; fly a Boeing 777 at 35,000 feet, etc.

    It's still not certain why Facebook missed out (again) on this public relations opportunity. May be from ignorance (in which case they have a problem if they want to keep investors and the public involved), or because they are so sure in their approach/product (like Apple) that they do not need to resort to populist campaigns. However, I wish they would find a middle ground...which a social media like Fb should be able to do.

  • Report this Comment On March 27, 2014, at 6:43 PM, cmalek wrote:

    VR is not a new, disruptive technology. It already was tried in 1990's and it bombed big. Why should it be any different this time. Yes, VR is useful in many ways but it is not disruptive. All kinds of simulators have been in use for decades.

  • Report this Comment On March 27, 2014, at 7:02 PM, TMFMileHigh wrote:

    @cmalek,

    >>Why should it be any different this time.

    It's all in the implementation, and I've yet to read an account that sys Oculus' take isn't mid-blowingly unique: http://www.fool.com/investing/general/2014/01/22/valves-stea...

    FWIW and Foolish best,

    Tim

    --

    TMFMileHigh in CAPS and on the boards

    @milehighfool on Twitter

    http://about.me/timbeyers

    http://timbeyers.me

  • Report this Comment On March 27, 2014, at 7:29 PM, Archaeologist77 wrote:

    I think this is the point of owning shares of Facebook.

  • Report this Comment On March 28, 2014, at 9:09 AM, damilkman wrote:

    I agree with the author that start ups are being gobbled up. However before it is declared a new trend I would be curious what the rates were during the internet bubble. I recall Cisco acquiring multiple companies. Some of the companies Cisco acquired were not purchased for their value to Cisco but the value to some of Cisco's potential competetors.

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