Tuesday, June 25, 2013

Waze is a huge success for Israel on many levels - but it is not a business model for investors in Israel

Recently there was quite a BIG deal within the Israeli tech scene and VC market as well. Waze was acquired by Google for an estimated $1.1 billion! Waze was founded in 2008; and for those of you that don't know - provides a social mobile application that enables drivers to build and use real-time road intelligence on smartphones. Waze raised $67m since its founding. To put the acquisition dollar figure into context - this is the 5th Israeli tech company in over a decade that has reached a value of more than $1 billion. There was NDS (sold to Cisco for $5b), Mercury (sold to HP for $4.5b), M-Systems (sold to Sandisk for $1.7b) and Conduit (still private, but did secondaries at more than $1b valuation).

This is a giant success for a few key reasons:

1) The entrepreneurs - that started, led and built Waze in such a short period of time to such a large value. amazing!
2) The investors - early stage investing is based on picking market trends and people. They clearly hit a few bull's eyes on this one! Specifically, Magma and Vertex in Israel. These 2 funds invested about $10m and profited about $130m. Kleiner Perkins invested about $30m in a $250m value round about 2 years ago. They did well too, but it escapes me how they justified such a rich valuation of a pre-revenue developing social media consumer facing mobile app...even though they profited so nicely too!
3) The innovation - big data, meets social, meets consumer, meets mobile. a lot of hot trends all intersecting at the right point - mapping.
4) The state of Israel: taxes - I estimate $80m in tax dollars to the Israeli government. the papers reported about $280m, but that is a simple 25% capital gains calculation on the full purchase price. I estimate that at least two-thirds of the cap table will be tax free - since foreign investors do not pay tax and Israeli VCs (Vertex and Magma) have mostly foreign investors that will also not pay. only Israeli shareholders will pay. but still, very big.
5) The state of Israel: philanthropic impact - Many Israelis will become wealthy from this transaction, and I expect a lot of charitable giving from those people. In addition, Tmura received its largest check ever from this deal - $1.5m - which is allocated to social philanthropy in Israel. Huge.
6) The people of Israel: employment - Google is becoming a powerhouse of employment and tech influence in Israel. They have recently invested quite a lot in a new Tel Aviv research and development center; a hub of influence. And Waze will only help them expand that faster into mobile and big data. Also, people from Waze may leave with cash and start new stuff, employing more people, etc.

Let's try and understand where Google can see the value in Waze for such a large price.

a) Financials: Revenue of Waze was below $5m TTM (less than the Goldrock mandate for investing). So definitely it was not driven by a revenue multiple of some kind.
b) User value: Waze has 51 million users, with about 12 million in the US. Assume that each US user is about 3x non-US users (which is consistent in the ad world). The overall average is $22 a user - basically saying a US user is about $45 and non-US at about $15. These numbers are about half of Facebook's...but Facebook is a huge business and cash machine; and people live in Facebook (average close to an hour a day). So I would say Google significantly overpaid - if they paid for social users. On top of that, Google controls a massive amount of the internet, where consumers rely on Google for search, some use Google+, News, Docs and many other services. Therefore, I don't believe Google acquired Waze based on a social user acquisition (even though it may help Google+ troubles).
c) Technology / market leadership in mapping: besides for "fundamental"social network apps (Facebook and Twitter) and some major game titles - mapping is arguably the most important long term mobile app. There has been much press written on the difficulty of developing effective mapping for the mobile - with a focus on Apple's challenges and Facebook as well. I am sure Microsoft has tried too. Google has Google Maps and needs to maintain their market leadership versus the other tech giants within the mobile environment. This $1.1b could very well have been a strong defensive play to ensure it strength in this sought after mobile app segment. And in that context, $1.1b does not seem like too much if it does the job.

So again - great job Waze!

Can this be leveraged by the Israeli tech investment community as proof of the business model?

To this, I say "no" for a few simple reasons:
1) Deal size vs. business size - This is the 5th $1b+ acquisition in over a decade in the Israeli tech market. In addition, the other 4 companies were large multi-hundred million dollar revenue businesses at the time of those rich valuations. The values were linked to REAL business. Not here. Rare.
2) Reason for acquisition - For a giant like Google to acquire a pre-business tech company to maintain market leadership in a very specific technology segment is seldom repeatable.
3) Large values significantly shrink acquirer base - once companies reach significant valuations, like Waze did 2 years ago during a $250m valued venture capital investment round, the community of companies that have the capacity to acquire such a company shrinks dramatically. The companies that could have acquired Waze was few, and the main ones were all talking with them (Facebook, Apple and Google). Perhaps Microsoft could have entered the running, especially since they have a sizable Israel presence. But the chance of success shrinks, due to the reliability on an acquisition from one of very few options.
4) No IPO story - no business, not a platform. Just a really exciting and well positioned pre-revenue mobile app. So it is only an acquisition story for sure.

So for those reasons - no business yet, narrow requirement from an acquirer, few buyers and only an acquisition story - one should not invest in Israel and hope for the next Waze...but we do love when these deals happen!

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