My Snap Story: Valuing Snap ahead of it's IPO!

Five years ago, when my daughter asked me whether I had Snapchat installed on my phone, my response was “Snapwhat?". In the weeks following, she managed to convince the rest of us in the family to install the app on our phones, if for no other reason than to admire her photo taking skills. At the time, what made the app stand out was the impermanence of the photos that you shared with your circle, since they disappeared a few seconds after you viewed them, a big selling point for sharers lacking impulse control. In 2013, when Facebook offered $3 billion to buy Snap, it was a clear indication that the new company was making inroads in the social media market, especially with teenagers. When Evan Spiegel and Bobby Murphy, Snap's founders, turned down the offer, I am sure that there were many who viewed them as insane, since Snap had trouble attracting advertisers to its platform and little in revenues, at the time. After all, what advertiser wants advertisements to disappear seconds after you see them? Needless to say, as the IPO nears and it looks like the company will be priced at $20 billion or more, it looks like Snap's founders will have the last laugh!

Snap: A Camera Company?

The Snap prospectus leads off with these words: Snap Inc. is a camera company. But is it? When I think of camera companies, I think of Eastman Kodak, Polaroid and the Japanese players (Fuji, Pentax) as the old guard, under assault as they face disruption from smartphone cameras, and companies like GoPro as the new entrants in the space, struggling to convert sales to profits. I don't think that this is the company that Snap aspires to keep and since it does not sell cameras or make money on photos, it is difficult to see it fitting in. If you define business in terms of how a company plans to make money, I would argue that Snap is an advertising business, albeit one in the online or digital space. I do know that Snap has hardware that it is selling in the form of Spectacles, but at least at the moment, the glasses seem to be designed to get users to stay in the Snap ecosystem for longer and see more ads.

So, why does Snap present itself as a camera company? I think that the answer lies in the social media business, as it stands today, and how entrants either carve a niche for themselves or get labeled as me-too companies. Facebook, notwithstanding the additions of Instagram and WhatsApp, is fundamentally a platform for posting to friends, LinkedIn is a your place for business networking, Twitter is where you go if you want to reach lots of people quickly with short messages or news and Snap, as I see it, is trying to position itself as the social media platform built around visual images (photos and video). The question of whether this positioning will work, especially given Facebook's investments in Instagram and new entrants into the market, is central to what value you will attach to Snap.

The Online Advertising Business

If you classify Snap as an online advertising company, the next step in the process becomes simple: identifying the total market for online advertising, the players in that market and what place you would give Snap in this market. Let’s start with some basic data on the online advertising market.

1. It is a big market, growing and tilting to mobile: The digital online advertising market is growing, mostly at the expense of conventional advertising (newspapers, TV, billboards) etc. You can see this in the graph below, where I plot total advertising expenditures each year and the portion that is online advertising for 2011-2016 and with forecasted values for 2017-2019. In 2016, the digital ad market generated revenues globally of close to $200 billion, up from about $100 billion in 2012, and these revenues are expected to climb to over $300 billion in 2020. As a percent of total ad spending of $660 billion in 2016, digital advertising accounted for about 30% and is expected to account for almost 40% in 2020. The mobile portion of digital advertising is also increasing, claiming from about 3.45% of digital ad spending to about half of all ad spending in 2016, with the expectation that it will account for almost two thirds of all digital advertising in 2020.

   

   Sources: Multiple

2. With two giant players: There are two dominant players in the market, Google with its search engine and Facebook with its social media platforms. These two companies together control about 43% of the overall market, as you can see in this pie chart:
   
   If you are a small player in the US market, the even scarier statistic is that these two giants are taking an even larger percentage of new online advertising than their historical share. In 2015 and 2016, for instance, Google and Facebook accounted for about two-thirds of the growth in the digital ad market. Put simply, these two companies are big and getting bigger and relentlessly aggressive about going after smaller competitors.

In a post in August 2015, I argued that the size of the online advertising market may be leading both entrepreneurs and investors to over estimate their chances of both growing revenues and delivering profits, leading to what I termed the big market delusion. As Snap adds its name to the mix, that concern only gets larger, since it is not clear that the market is big enough or growing fast enough to accommodate the expectations of investors in the many companies in the space. 

Snap: Possible Story Lines

To value a young company, especially one like Snap, you have to have a vision for what you see as success for the company, since there is little history for you to draw on and there are so many divergent paths that the company can follow, as it ages. That might sound really subjective, but without it, you are at the mercy of historical data that is both scarce and noisy or of metrics (like users and user intensity) that can lead you to misleading valuations.

Link to my book

That is, of course, another shameless plug for my book on narrative and numbers, and if you have heard it before or have no interest in reading it, I apologize and let's go on. To get perspective on Snap, let’s start by comparing it to three social media companies, Facebook, Twitter and LinkedIn and to Google, the old player in the mix, at the time of their initial public offerings. The table below summarizes key numbers at the time of their IPOs, with a  comparison to Snap's numbers.

	Google	LinkedIn	Facebook	Twitter	Snap
IPO date	19-Aug-04	19-May-11	18-May-12	7-Nov-13	NA
Revenues	$1,466	$161	$3,711	$449	$405
Operating Income	$326	$13	$1,756	$(93)	$(521)
Net Income	$143	$2	$668	$(99)	$(515)
Number of Users	NA	80.6	845	218	161
User minutes per day (January 2017)	50 (Includes YouTube)	NA	50	2	25
Market Capitalization on offering date	$23,000	$9,000	$81,000	$18,000	?
Link to Prospectus (from IPO date)	Link	Link	Link	Link	Link

At the time of its IPO, Snap has less revenues than any of its peer group, other than LinkedIn, and is losing more money than any of them. Before you view this is a death knell for Snap, one reason for Snap’s big losses is that unlike its competitors, Snap pays for server space as it acquires new users, thus pushing up its operating expenses (and pushing down capital investment in servers). There is one other dimension where Snap measures up more favorably against at least two of the other companies: its users are spending more time on its platform that they were either on Twitter and LinkedIn and it ranks second only to Facebook on this dimension.

The more important question that you face with Snap, then, is which of these companies it will emulate in its post IPO year. The table below provides the contrast rather by looking at the years since the IPO for each company.

Google and Facebook stand out as success stories, Google because it has maintained high revenue growth for almost a decade with very good profit margins and Facebook doing even better on both dimensions (higher growth in the earlier years and even higher margins). The least successful company in this mix is Twitter which has seen revenue growth that has trailed expectations and has been unable to unlock the secret to monetizing its user base, as it continues to post losses. Linkedin falls in the middle, with solid revenue growth for its first four years and some profits, but its margins are not only small but showed no signs of improvement from year to year. Now that it has been acquired by Microsoft, it will be interesting to see if the combination translates into better growth and margins.

My Snap Story & Valuation

To value Snap, I built my story by looking at what its founders have said about the company, how its structured and the strengths and weaknesses of its platform, at least as I see them. As a consequence, here is what I see the company evolving.

1. Snap will remain focused on online advertising: I believe that Snap's revenues will continue to come entirely or predominantly from advertising. Thus, the payoff to Spectacles or any other hardware offered by the company will be in more advertising for the company. 
2. Marketing to younger, tech-savvy users: Snap's platform, with its emphasis on the visual and the temporary, will remain more attractive to younger users. Rather than dilute the platform to go after the bigger market, Snap will create offerings to increase its hold on the youth segment of the market.

   

   Source: The Economist

3. With an emphasis on user intensity over users: Snap's prospectus and public utterances by its founders emphasize user intensity more than the number of users, in contrast to earlier social media companies. This emphasis is backed up by the company's actions: the new features that it has added, like stories and geofilters, seem designed more to increase how much time users spend in the app than on getting new users. Some of that shift in emphasis reflects changes in how investors perceive social media companies, perhaps sobered by Twitter's failure to convert large user numbers into profits, and some of it is in Snap's business model, where adding users is not costless (since it has to pay for server space). 

These assumptions, in turn, drive my forecasts of revenues, margins and reinvestment. In my story, I don't see Snap reaching revenues of the magnitude delivered by Google and Facebook, the two big market players in the game, settling instead for smaller revenues. If Snap is able to hold on to its target market (young, tech savvy and visually inclined) and keep its users engaged, I think Snap has a chance of delivering high operating profit margins, perhaps not of the magnitude of Facebook today (45% margin) but close to that of Google (25% margin). Finally, its reinvestment will take the form of acquisition of technology and server space to sustain its user base, but by not trying to be the next Facebook, it will not have to over reach. Is there substantial risk that the story may not work out the way I expect it to? Of course! While I will give Snap a cost of capital of close to 10% (and in the 85th percentile of US companies), reflective of its online advertising business,  I will also assume that there remains a non-trivial chance (10%) that the company will not make it. The picture below captures my story and the valuation inputs that emerge from it:

To complete the valuation, there are two other details that relate to the IPO.

1. Share count: For an IPO, share count can be tricky, and especially so for a young tech company with multiple claims on equity in the form of options and restricted stock issues. Looking through the prospectus and adding up the shares outstanding on all three classes of shares, including shares set aside for restricted stock issues and assorted purposes, I get a total of 1,243.10 million shares outstanding in the company. In addition, I estimate that there are 44.90 million options outstanding in the company, with an average exercise price of $2.33 and an assumed maturity of 3 years.
2. IPO Proceeds: This is a factor specific to IPOs and reflect the fact that cash is raised by the company on the offering date. If that cash is retained by the company, it adds to the value of the company (a version of post-money valuation). In the case of Snap, it is estimated that roughly $3 billion in cash from the offering that will be held by the company,  to cover costs like the $2 billion that Snap has contracted to pay Google for cloud space for the next five years.

These valuation inputs become the basis for my valuation and yield a value of $14.4 billion for the equity (and you can download the spreadsheet at this link).

Download spreadsheet

Allowing for the uncertainty inherent in my estimates, I also computed probability distribution for three key inputs, revenue growth, operating margin and cost of capital, and my value for Snap's equity is in the distribution below:

Snap Simulation Details

Assuming that my share count is right, my value per share is about $11 per share. As you can see though, as is the case with almost any young company where the narrative can take you in other directions, there is a wide range around my expectations, with the lowest value being less than zero and the highest value pushing above $66 billion ($50/share). The median value is $13.3 billion and the average is $14.9 billion; one attractive feature to investors is that there is potential for breakout values (optionality) that exceed $30 billion.

• The numbers at the high end of the spectrum reflect a pathway for Snap that I call the Facebook Light story, where it emerges as a serious contender to Facebook in terms of time that users spend on its platform, but with a smaller user base. That leads to revenues of close to $25 billion by 2027, an operating margin of 40% for the company and a value for the equity of $48 billion.
• The numbers at the other end of the spectrum capture a darker version of the story, that I label Twitter Redux, where user growth slows, user intensity comes under stress and advertising lags expectations. In this variant, Snap will have trouble getting pushing revenue growth past 35%, settling for about $4 billion in revenues in 2027, is able to improve its margin to only 10% in steady state, yielding a value of  equity of about $4 billion.

As I learned the painful way with my Twitter experiences, the quality of the management at a young company can play a significant role in how the story evolves. I am impressed with both the poise that Snap's founders are showing in their public appearances and the story that they are telling about the company, though I am disappointed that they have followed the Google/Facebook path and consolidated control in the company by creating shares with different voting rights. I know that is in keeping with the tech sector's founder worship and paranoia about "short term" investors , but my advice, unsolicited and perhaps unwelcome, is that Snap's founders should trust markets more. After all, if you welcome me to invest me in your company and I do, you should want my input as well, right?

The Pricing Contrast
As I finish this post, I notice this news story from this morning that suggests that bankers have arrived at an offering price, yielding a pricing for the company of $18.5 billion to $21.5 billion for the company, about $4 billion above my estimate. So, how do I explain the difference between my valuation and this pricing? First, I have never felt the urge to explain what other people pay for a stock, since it is a free market and investors make their own judgments. Second, and this is keeping with a theme that I have promoted repeatedly in my posts, bankers don't value companies; they price them! If you are missing the contrast between value and price, you are welcome to read this piece that I have on the topic, but simply put, your job in pricing is not to assess the fair value of a company but to decide what investors will pay for the company today. The former is determined by cash flows, growth and risk, i.e., the inputs that I have grappled with in my story and valuation, and the latter is set by what investors are paying for other companies in the space. After all, if investors are willing to attach a pricing of $12 billion to Twitter, a social media company seeming incapable of translating potential to profits, and Microsoft is paying $26 billion for LinkedIn, another social media company whose grasp exceeded its reach, why should they not pay $20 billion for Snap, a company with vastly greater user engagement than either LinkedIn or Twitter? With pricing, everything is relative and Snap may be a bargain at $20 billion to a trader.

YouTube Video

Link to book

1. Narrative and Numbers: The Value of Stories in Business

Attachments

1. Snap: Prospectus for IPO
2. Snap: My IPO Valuation
3. Snap: As Facebook Lite
4. Snap: As Twitter Redux
5. Snap: Simulation Inputs & Output

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Apple: The Greatest Cash Machine in History?

As as sports fan, watching Brady and Belichick win the Super Bowl, Roger Federer triumph at the Australian Open and LeBron James carry the Cleveland Cavaliers to victory over the Warriors, it struck me how we take uncommon brilliance for granted. It is so easy, in the moment, to find fault, as many have, with these superstars and miss how special they are. That was the same reaction that I had as I watched another earnings report from Apple and the usual mix of reactions to it, some ho hum that the company made only $45 billion last year, some relieved that the company was able to post a 3% growth rate in revenues and the usual breast beating from those who found fault with it for not delivering another earth-shaking disruption. Since this is a company that I have valued after every quarterly earnings report since 2010, I thought this would be a good time to both take stock of what the company has managed to do over the last decade and to value it, given where it stands today.

The Cash Machine Revs up

In my last post on dividend payout and cash return globally, I noted that large cash balances don't happen by accident but are a direct result of companies paying out less than they have available as potential dividends or free cash flows to equity, year after year. Since Apple's cash balance almost reached $250 billion in its most recent quarterly report, by far the largest cash balance ever accumulated by a publicly traded company, I decided that the place to start was by looking at how it got to its current level. I started by collecting the operating, debt financing and reinvestment cash flows each year from 2007 to 2016 and computing a free cash flow to equity (or potential dividend) each year.

Starting in 2013, when Apple started to tap into its debt capacity, the company has been able to add to its potential dividends each year. In 2015 alone, Apple generated $93.6 billion in FCFE or potential dividends, an astounding amount, larger that the GDP of half the countries in the world in 2015. Each year, I also looked at how much Apple has returned to stockholders in the form of dividends and stock buybacks.

Note that while Apple took a while to start returning cash, and it needed prompting from David Einhorn and Carl Icahn, it not only initiated dividends in 2012 but has supplemented those dividends with stock buybacks of increasing magnitude each year. In fact, Apple returned $183 billion in cash to stockholders in the last five years, making it, by far, the largest cash-returner in the world over that period.

There are two amazing (at least to me) aspects to this story. The first is that in spite of the immense amounts of cash that Apple has returned each year, its cash balance has increased each year, partly because its operating cash flows are so high and partly because they are being supplemented by debt payments. You can see the cash build up between 2007 and 2016 in the chart below:

Note that while Apple was returning $183 billion in cash between 2013-2016, its cash balance continued to increase, as its cash inflows increased even more.  If having a cash spigot that never turns off is a problem, Apple has it, but I am sure that it will not get about as much sympathy from the rest of the world as a supermodel who complains that she cannot put on weight, no matter how much she eats. The other equally surprising feature of this story is that Apple's managers have not felt the urge (yet) to use their huge cash reserves to buy a company, a whole set of companies or even an entire country, a fact that those who like Apple will attribute to the discipline of its management and Apple haters will argue is due to a lack of imagination.

My Apple Valuation History

As many of you who have been reading this blog are aware, I have valued Apple many times before but rather than rehash old history, let me summarize. For Apple, the story that I have been telling about the company for the last five years has been remarkably unchanged. In my July 2012 valuation, where I looked at Apple just after it had become the largest market cap company in the world and had come off perhaps the greatest decade of disruption of any company in history (iTunes, iPod, iPhone and iPad), I concluded that while Apple was one of the great cash machines of all time, its days of disruption were behind it, partly because Steve Jobs was no longer at the helm but mostly because of its size; it is so much more difficult for a $600 billion company to create a significant enough disruption to change the trend lines on earnings, cash flows and value. 

So, in my story, I saw Apple continuing to produce cash flows, with low revenue growth and gradually decreasing margins, as the smartphone business became more competitive. I won't make you read all of the posts that I have on Apple, but let me start with a post that I had in August 2015, when I updated the Apple story (and looked at Facebook and Twitter at the same time). The value I estimated for Apple in that post was $130, higher than the stock price of $110 at the time, prompting me to buy the stock. I revisited the story after an earnings report from Apple in February 2016 and compared it to Alphabet. At the time, I valued Apple at about $126 per share, well above the $94/share that it was trading at the time. In May 2016, Carl Icahn, a long time bull on Apple sold his shares, and Warren Buffett, a long time avoider of tech companies, bought shares in the company. In a post at the time, I argued that while these big names entering and exiting the stock may have pricing consequences, I saw no reason to change my story and thus my value, leaving my Apple holdings intact. 

Apple's Earnings Report & My Narrative

Last week, Apple released its latest 10Q and in conjunction with its latest 10K (Apple's fiscal year end is in September). It contained a modicum of good news, insofar as there was growth in revenues as opposed to the decline posted in the prior quarter and still-solid profit margins, but the revenue growth was only 3% and the margins are still lower than they used to be.  Using the numbers in the most recent report, I took at look at my Apple story and guess what? It looks just like it did last year, a great cash machine, with very slow-growing revenues and declining margins. Using the process that I describe, perhaps in too much detail in my book on narrative and numbers, I converted my story in inputs to my valuation:

Some of you may find my story too cramped , seeing a greater possibility than I do of Apple breaking through into a new, big market (with Apple Pay or the Apple iCar). If you are in that group, please take my structure and make it yours, with a higher growth rate coming from your disruptive story, accompanied by lower margins and higher reinvestment. Others may find this story too optimistic, perhaps seeing a more precipitous fall of profit margins in the smart phone business and a greater tax liability from trapped cash. You too can alter the inputs to your liking and make your own judgment on Apple!

An Updated Valuation of Apple

Once you have a story for a company and convert that story into valuation inputs, the rest of the process becomes just mechanics. In the picture below, I have my February 2017 valuation of Apple. 

Download spreadsheet with valuation

Just as my valuation looked too optimistic a year, when the earnings report contained darker news, it may seem too pessimistic this year, after a much sunnier report. That said, it is worth emphasizing how much Apple is on the iPhone roller coaster ride, reporting better earnings in the quarters immediately after a new iPhone is released and much worse earnings in the quarters thereafter. While the market seems to want to go on a ride with Apple on its ups and downs, my fundamental story for Apple has barely shifted in the last few years and my valuations reflect that story stability.

Apple's Price/Value Dynamics

I have taken my share of punishment on investments that have not gone well, with Valeant being a source of continuing pain (which I will return to after its next earnings report). Apple, though, has served me well in the last decade, but even with Apple, I have had extended periods where my faith has been tested. The picture below graphs Apple's stock price from 2010 and 2017 with my valuations shown across time:

I held Apple from 2010 to 2012, as it traded under my estimated value. I sold in April 2012, just before a brief interlude where the price popped above value in June 2012, it reverted back to being under valued until June 2014. After spending a few months as an overvalued stock, the price plummeted in the late summer of 2015, making me a buyer, but it continued to drop until almost April 2016. It's been a good ride since, and much as I want to attribute this to my valuation insights and brilliant timing, I have a sneaking suspicion that luck had just as much or perhaps more to do with it. Now that the stock is fully valued, decision time is fast approaching and I am ready with my sell trigger at $140/share, the outer end of the range that I have for Apple's value today.

Conclusion

Apple is the greatest corporate cash machine in history and it is fully deserving of its market value. Its history as a disruptive force has led some investors to expect Apple to continue what it did a decade ago and come up with new products for new markets. Those expectations, though, don't factor in the reality that as a much larger player with huge profit margins, Apple is more likely to be disrupted than be disruptor. Until investors learn to live with the company, as it exists now and not the company that they wish would exist in its place, there will continue to be mood swings in the market translating into the ebbs and flows of its stock price, and I hope to take advantage of them.

YouTube


My book

1. Narrative and Numbers (Columbia University Press)

Prior Blog Posts on Apple

1. Narrative Resets: Revisiting a Tech Trio (August 2015)
2. Race to the top: The Duel between Apple and Alphabet (February 2016)
3. Icahn exits, Buffett enters: Whither Apple? (June 2016)

Spreadsheets

1. Apple: FCFE, Dividends and Cash Build up - 1988-2016
2. Apple: Valuation in February 2017

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Narrative and Numbers: How a number cruncher learned to tell stories!

When I taught my first valuation class in 1986 at New York University, I taught it with numbers, with barely a mention of stories. It was only with the passage of time that I realized that my valuations were becoming number-crunching exercises, with little holding them together other than historical data and equations. Worse, I had no faith in my own valuations, recognizing how easily I could move my final value by changing a number here and a number there. It was then that I realized that I needed a story to connect the numbers and that I was not comfortable with story telling, and that realization led me to start working on my narrative skills. While I am still a novice at it, I think that I have become a little better at story telling than I used to be and it is this journey that is at the core of my newest book, Narrative and Numbers: The Value of Stories in Business.

Story versus Numbers

What comes more naturally to you, story telling or number crunching? That is the question that I start every valuation class that I teach and my reasons are simple. In a world where we are encouraged to make choices early and specialize, we unsurprisingly play to our strengths and ignore our weaknesses. I see a world increasingly divided between number crunchers, who have abandoned common sense and intuition in pursuit of data analytics and complex models and story tellers, whose soaring narratives are unbounded by reality. Each side is suspicious of the other, the story tellers convinced that numbers are being used to intimidate them and the number crunchers secure in their belief that they are being told fairy tales. It is a pity, since there is not only much that each can learn from the other, but you need skills in investing and valuation. I think of valuation as a bridge between stories and numbers, where every story becomes a number in the valuation and every number in a valuation has a story behind it.

When I introduce this picture in my first class, my students are skeptical, as they should be, viewing it as an abstraction, but I try to make it real, the only way I can, which is by applying it on real companies. I start every valuation that I do in class with a story and try to connect my numbers to that story and I try to be open about how much I struggle to come up with stories for some companies and have much my story has to change to reflect new facts or data with others. I push my students to work on their weaker sides when they do valuations, trying  asking story tellers to pay more heed to the numbers and beseeching number crunchers to work on their stories. Seeking a larger audience, I have not only posted many times on the process but almost every valuation that I have posted on this blog has been as much about the story that I am telling about the company as it is about the numbers. In fact, having written and talked often about the topic, I thought it made sense to bring it all together in a book, Narrative and Numbers, published by Columbia University Press, and available at bookstores near you now (and on Amazon in both physical and Kindle versions). (Update: The hardcover is not available yet outside the United States, but should be accessible in about 4-6 weeks. The Kindle version is available everywhere.)

From Story to Value: The Sequence

So, how does a story become a valuation? This book is built around a sequence that has worked for me, in five steps, starting with a story, putting the story through a reality check, converting the story into a valuation and then leaving the feedback loop open (where you listen to those who disagree with you the most and try to improve your story).

There is no rocket science in any of these steps and I am sure that this is not the only pathway to converting narrative to value. These steps have worked for me and I use four companies as my lead players to illustrate the process.

1. Uber, the ride-sharing phenomenon: I start with the story that I told about Uber in June 2014, and the resulting value, and how that story evolved over the next 15 months as I learned more about the company and its market/competition changed.
2. Amazon, the Field of Dreams Company: Amazon is a story stock that seems to defy the numbers laws and I use it to illustrate how the value for Amazon can vary as a function of the story you tell about it.
3. Alibaba, the China story: The China big market story has been used to justify the valuations of many companies, but Alibaba is one case where the use of that story is actually merited. In my story, Alibaba continues to dominate the growing Chinese online retail market and my value reflects that, but I also look at how that value will change if Alibaba can replicate its success globally (Alibaba, the Global Story).
4. Ferrari, the Exclusive Club: I value Ferrari as an exclusive club, leading into its IPO, and explore how that value will change if you assume that it will follow a different business model.

In the later chapters, I bring in other familiar names (at least to those who read my blog), Vale to illustrate how macroeconomic factors affect stories and Yahoo! to examine the effect of the corporate life cycle. In the final part of the book, I turn the focus on management and look at how the story telling skills of top managers can make a significant difference in how a young company is perceived and valued by the market and how that skill set has to shift as the company ages.

Personal, Applied and Live!

This is my tenth book and I have never had more fun writing a book. There are three aspects to this book that I hope come through:

1. It is a personal book: If you read the book, you will notice that rather than use the formal "we" or "you" through much of the book, I talk about "I" and "my". Before you decide that this is a sign of an ego run wild, I did this because this book is about my journey from an unquestioning trust in numbers to an increasing focus on stories in valuation and my stories about the companies that I value in this book. I don't expect you to buy into my stories. In fact, I hope that you disagree with me and tell your own stories and that this book will help you convert those stories into valuations. 
2. It is applied: One common theme across all my books is that I believe that financial tools are best illustrated with real companies in real time. That is the reason that I not only chose real companies as my illustrative examples, but companies that many of you will have strong views (positive or negative) about. 
3. It is live:  The most exciting part of this book, for me, is that is is never going to be complete. The companies that I use in the book are dynamic entities and I am sure that the stories that I have told about them will change, shift and perhaps even break over time. Rather than dread these upcoming changes, I view them as opportunities for me to revisit my stories and valuations and to update them. You will see these updates on this blog but you will also be able to find them at the website for the book, where I also have pulled together YouTube videos and other material relevant to the book.

Closing

I am usually too embarrassed to ask people to buy my books, since many of them are obscenely over priced, one reason that I don't require them even for students in my classes. I feel no such qualms about this book, since it is (I think) priced reasonably and I hope it offers good value for the money. I hope that you will read the book and that that you enjoy it, and if you can learn something that helps you improve your valuation skills, I will view that as icing on the cake. Drawing on one of the themes in the book, where I argue that the key to keep the feedback loop open, I would also like to hear from those of you who don't like the book and what I can do better! I'll try!

YouTube Video

Book Links

1. Columbia University Press
2. Amazon page
3. Webpage for book, on my site

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Investing and Valuation Lessons from the Renaissance

I just got back a few days ago from a two-week family holiday in Italy, where we spent the bulk of the second week in Florence, which we used as a springboard to see Tuscany. I kept away from work through much of the period, though I did check my emails once in a while and even tried answering a few on my iPhone, where my awful typing skills restricted me to one-sentence responses. So, if you were one of those people that I responded to, I apologize if I seemed brusque. That said, I am also afflicted with a disease of seeing connections between everything I see around me and investing, and this vacation was no exception. Thus, in Florence, as I gazed at Brunelleschi’s magnificent Duomo on the Cathedral and marveled at the beauty of Michelangelo’s David, I could not help but think about how much we (as investors) can learn from those renaissance geniuses.

The Story of Brunelleschi’s Dome

If you have visited Florence or even read about the dome on its cathedral, I am sure that you have heard its story. The construction of the cathedral was begun in 1296 and continued in fits and starts through much of the next few decades with the Plague bringing it to a standstill in the second half of the fourteenth century. The centerpiece of the cathedral was to be its freestanding dome, but since architects of the age lacked the capacity to build one large enough to cover the church, it was left for another generation to complete. In 1418, two goldsmiths in Florence, Lorenzo Ghiberti and Filippo Brunelleschi, competed in a contest for designing the dome, with Brunelleschi winning by a hair. Brunelleschi spent time studying the Pantheon in Rome, a concrete dome built more than a thousand years prior, but one where all records of its construction had long been destroyed. He started work on his Duomo in 1420 and completed it by 1436, and the result speaks for itself:

Brunelleschi was an artist, skilled in its many forms, but to build the dome, he not only drew on science but actively used it to solve practical problems. To allow the huge dome to stay standing without visible supports, Brunelleschi came up with the ingenious concept of a dome within a dome (a double shell) and stone ribs designed to defend against the spreading created by the weight of the dome. He had to construct hoisting machines to lift the almost four million bricks and large stones and structural innovations to let workers complete the construct. The dome, once completed, was as much an engineering feat as it was an artistic triumph and it remains so today.

Investing and Valuation Lessons

I can think of at least three big lessons that investors can learn from the Renaissance masters. The first is the meaning of faith, a scarce resource in today's markets, as we eagerly seek confirmation that we are right in market movements and are quick to give up, when things don't go our way. The second is the need for humility, an acceptance that much of what we claim to be new and innovative in investing is neither, and that we can learn from looking at the past. The third is that just as the best of the Renaissance required a melding of art and science, the best of investing is built on a combination of story telling and number crunching. 

Lesson 1: The Importance of Faith

Investing is as much about faith as it is about mechanics. As our access to data and models increases, I will borrow words that Tom Friedman used in a different context, and argue that the investing world is becoming flatter. It is not getting any easier to make money from investing and one reason may be that we have no faith in either our ability to attach values to companies, in the face of uncertainty, or in the market’s capacity to correct its mistakes. As a consequence, even those investors who are well versed in valuation mechanics are generally unwilling to act on the valuations that they generate, or when they do, to hold on to them in the face of adversity.  Like many of you, I find myself getting impatient when the stock price does not correct quickly towards my estimated value on my investments and growing uncertain with my own judgment, if the divergence persists for months. As I looked up at the Florence skyline and pondered the patience of those who were willing to build a church first and then wait almost a hundred for someone to come along with its dome, I understood the meaning of faith and how far I have to go to get there.

Lesson 2: There are no new investment lessons, just old ones to relearn

With superior resources and better investment education, we tend to think that we are not only more sophisticated than investors in prior generations but less likely to make the same errors in judgment. If only that were true! Just as the skills that allowed the Romans to build the Pantheon were forgotten for a thousand years and had to be rediscovered by Brunelleschi, there are simple lessons that investors learned in past markets that we seem to forget in new markets. Each time we make collective mistakes as investors and there is a market correction, we are quick to say "never again" only to repeat the same mistakes a few years later. 

Lesson 3: Art and Science

Are you an artist or a scientist? An engineer or a poet? We live in an age where we are asked to pick sides and told that the two cannot co-exist. In the context of valuation, the battle is fought out between the story tellers and the number crunchers, with each claiming the high ground. In the last few years, I have argued not just for a truce between the two sides but also for more engagement,  a marriage of numbers and narrative in valuation and investing. Even my best efforts pale in comparison to one look at Brunelleschi’s dome, since he understood that there was no divide between art and science. It is a lesson that we seem to have forgotten over time, as we force people to choose sides in a battle where there are no winners.

An Investment Renaissance

We live in an age of specialists, and in investments, this has taken the form of experts who operate in silos, option traders who act as if their derivative securities can exist without their underlying assets, fixed income investors who function as if bonds are the only game in town and equity investors who can only talk about stocks. This specialization comes with consequences and one of them is that we tend to operate in echo chambers, talking to people who think like us, act like us and not surprisingly, agree with us. If the words "Renaissance man (or woman)" are used to describe someone whose expertise spans different subject areas, in the context of investing, I would use those words to refer to those investors who can move with ease across markets and are just as comfortable with stories as they are with numbers. This is my subjective judgment but I think that there used to be more of them three decades ago, when I started in investing, and they seem to become rarer by the day.  In corporations, banks, money management units, consulting firms and even in academia, we could use more Renaissance thinking.

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Tesla: It's a story stock, but what's the story?

The last few weeks have tested Tesla’s shareholders and frustrated short sellers in the stock. Shareholders have had to weather a series of bad news stories, ranging from a failure to meet its shipment targets in the last few months to a fatality with a driver using its autopilot function to a surprise acquisition of Solar City. While each of those stories has created pressure on the stock, the price has held up surprisingly well, frustrating long-time short sellers who have been waiting for a correction in what they see as an overhyped stock.

Tesla Stock Price: Google Finance

So, what gives here? Why has Tesla’s stock price not collapsed facing this adversity? I think that Tesla's price action illustrates the power of the “big story” and the sometimes difficult-to-understand market dynamics of story stocks.

Story Stocks

In earlier posts, I have made a case for valuation being a bridge between story and numbers, with every number telling a story and every story being captured in a number. Thus, while your final valuation may be composed of forecasts of revenue growth, profit margins and reinvestment, it is the story that binds together these numbers that represent the soul of the valuation.

That said, the balance between stories and numbers can vary across companies and for the same company, can change across time. For most companies, it is the story that comes first, with numbers following, and for others, it is the numbers that tell the story. 

There are some companies that I would classify as story stocks, where the story is so dominant in both how people price the stock and what determines its value that the numbers either fade into the background or have only a secondary effect. There are three characteristics that story stocks share:

Amazon remains one of my longest-standing examples of a story stock, a company, with a CEO (Jeff Bezos) who was and continues to be clear about his ambitions to conquer big markets, told that story well and acted consistently with it. You can see why Tesla also has the makings of a story stock, going after a big market (automobiles and perhaps even clean energy), with an unconventional strategy for that market and a larger-than-life CEO in Elon Musk. With story stocks, it is the story that dominates how the market perceives the stock, and that has consequences:

1. Story changes and information: it is shifts in the story that cause price and value changes. An earnings report that beats expectations (in either direction) or a news story of significance (good or bad) may not have any effect on either (value or price) if it does not change the story. Conversely, a shift in perceptions about the business story, triggered by minor news or even no news at all, can trigger major price changes. 
2. Wider disagreements: When a company’s value is driven primarily by numbers, there is less room for disagreement among investors. Thus, when valuing a company in a market with steady revenue growth and sustainable profit margins, there will be less divergence in what investors think the stock is worth. In contrast, with a story stock, investor stories can span a much wider spectrum, leading to a much bigger range in values, as illustrated with Uber in this post. 

The key to understanding story stocks is deciphering the story behind the company, then checking that story for reasonability and making it your own.

The Tesla Story

So, what is Tesla’s story? To structure the process, let me lay out the dimensions where investors can differ on the story and how these differences play out valuation. The first is Tesla's business, i.e., whether you see Tesla primarily as an automobile company that incorporates technology into its cars, a technology company that uses automobiles to deliver superior electronics (battery and software) or even a clean energy company with its focus on electric cars. The second is focus,  i.e., whether you believe that Tesla will cater more to the high end of whichever business you see it in or have mass market appeal. The third is the competitive edge that you see it bringing to the market, with the choices ranging from being first to the market, superior styling & brand name and superior (proprietary) technology. The fourth is the investment intensity needed to deliver your expected growth, with much higher reinvestment needed if you consider Tesla a conventional manufacturing company (like autos) than if you see it as a tech company. Finally, there is the risk in the company, with the auto story bringing with it the risks of cyclicality and high fixed costs and the tech story the risks of being rendered obsolete by new technologies and shorter life cycles.

The value that you attach to Tesla will be very different if you consider it to be an automobile company, catering to a high-end clientele than if you view it as an electronics company with a superior technology (in electric batteries) and a mass market audience.

My thinking on Tesla has changed over time. In my first valuation of the company in September 2013, I valued it as a high-end automobile company, which would use its competitive edges in branding and technology to generate high margins, with investment and risk characteristics more reflective of being an auto than a tech company. The resulting inputs into my valuation and valuation are summarized below:

Download spreadsheet

The value that I obtained for Tesla’s equity was $12.15 billion (with a value per share of $70) well below the market capitalization of $28 billion (and a stock price of $168.76) at the time.

In July 2015 I took another look at Tesla, keeping in mind the developments since September 2013. The company had not only sent signals that it was moving towards offering vehicles with lower price tags (expanding towards the mass market) but also made waves with its plans for a $5 billion gigafactory to manufacture batteries. The focus on batteries suggested to me that I had understated the role that technology played in Tesla’s appeal and I incorporated it more strongly into my story. Tesla remained an automobile company, but with a much stronger technology component and wider market aspirations, which in turn led the following inputs into value:

Download spreadsheet

The value of equity based on these inputs was 19.5 billion (share price of $123), much higher than my September 2013 estimate, but still below the value of $33 billion (share price of $220) at the time.

I took my third shot at valuing Tesla about two weeks ago,  just prior to its Solar City acquisition announcement, and I incorporated the news since my last valuation. The announcement of the Tesla 3 clearly reinforced my story line that it was moving towards being more of a mass market company. The unprecedented demand for the car, with close to 400,000 people putting down deposits for a vehicle that will not be delivered until 2018, indicates the hold that it has on its customer base. I have tweaked the inputs to reflect these changes:

Download spreadsheet

The value of equity that I obtained was $25.8 billion (with a share price of $151/share), climbing from my July 2015 valuation but the market capitalization stayed at $33 billion. Before I embark on looking at how the Solar City acquisition and Musk's master plan have on the narrative, it is worth looking at how the value changes as a function of revenues, reinvestment and profit margin:

Download spreadsheet

Note that there are pathways that lead to the value at or above the current stock price but they all require navigating a narrow path of building up sales, earning healthy profit margins and reinvesting more like a technology company than an automobile company.

So, what effect does acquiring Solar City have on the story? If nothing else, it muddies up the waters substantially, a dangerous development for a story stock and that is perhaps even why even long-term Tesla bulls and nonplussed. The most optimistic read is that  Tesla is now a clean energy company, with a potentially much larger market, but the catch is that Solar City's products don't have the cache that Tesla cars have as well as the competitive nature of the solar power market will push margins down. If you add the debt burden and reinvestment needs that Solar City brings into the equation, Tesla, already stretched in terms of cash flows, may be over extending itself. The most pessimistic read is that talk of synergy notwithstanding, this acquisition is more about Musk using Tesla stockholder money to preserve his legacy and perhaps get back at short sellers in Solar City.

The X Factor: Elon Musk

The Solar City acquisition spotlighted how difficult it is to separate Tesla, the company, from Elon Musk. Musk's strengths, and there are many, are at the core of Tesla's success but his weaknesses may hamstring the company.

• On the plus side, Musk clearly fits the visionary mode, dreaming big, convincing customers, employees and investor to buy into his dreams and, for the most part, working on making the dreams a reality. Like Bezos at Amazon and Steve Jobs at Apple, Musk had the audacity to challenge the status quo. 
• On the minus side, Musk is less disciplined and focused than Bezos, whose story about Amazon has remained largely unchanged for almost 20 years, even as the company has expanded into new businesses and markets. In fact, as someone who has followed Apple for more than three decades, it seems to me that Musk shares more characteristics with Steve Jobs in his first iteration at Apple (which ended with him being fired) than he does with Steve Jobs in his second stint at the company. Musk is a large social media presence, but he does strike me as thin skinned, as his recent exchange with Fortune magazine about the autopilot fatality showed. 

Your views on  what you think Tesla is worth will be a function of what you think about Elon Musk. If you believe, as some of his most fervent defenders do, that he is that rarest of combinations, a visionary genius who will deliver on this vision, you will find Tesla to be a good buy. At the other extreme, you consider him a modern version of P.T. Barnum, a showman who promises more than he can deliver, you will view Tesla as over valued. Wherever you fall in the Musk continuum, Tesla is approaching a key transition point in its life, a bar mitzvah moment so to speak, where the focus will shift from the story to execution, from master plans to supply chains, and we will find out whether Musk is as good at the latter as he is in the former.

Can Musk the visionary become Musk the builder? He certainly has the capacity. After all, if you can get spaceships into outer space and back to earth safely, you should be able to build and deliver a few hundred thousand cars, right? Given Tesla's missteps on delivery and execution, though, Musk may not have the interest in the nitty gritty of operations, and if he does not, he may need someone who can take care of those details, replicating the role that Tim Cook played at Apple during Steve Job's last few years at the company.  

Investment Direction

Tesla is a company where there seems to be no middle ground. You are either for the company or against it, believe that it is on a pathway to being the next Apple or that it is worth nothing, a cheerleader or a doomsdayer. I think that both sides of this debate are over reaching. I don't buy the talk that Tesla is on its way to being the next trillion dollar company, especially since I have a tough time justifying its current valuation of $33 billion. Unlike some of the high-profile short sellers who seem to view Tesla as an over-hyped electric car company that is only a step away from tipping into default, I do believe that Tesla has a connection to its customers (and investors) that other auto companies would kill to possess, brings a technological edge to the game and has viable, albeit narrow, pathways to fair value.  I will choose to sit this investment out, letting others who are more nimble than I am or have more conviction than I do to take stronger positions in Tesla.

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Blog Posts on Tesla

1. Valuation of the week I: A Tesla Test (September 2013)
2. Tesla: A Follow up (September 2013)
3. Many a slip between the cup and the lip (September 2013)
4. Return to the firing line: Revisiting Tesla and hopefully living to tell the tale (March 2014)

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1. Tesla (September 2013) valuation
2. Tesla (July 2015) valuation
3. Tesla (July 2016) valuation

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Runaway Stories and Fairy Tale Endings: The Cautionary Tale of Theranos

I saw the new Steve Jobs movie, with the screenplay by Aaron Sorkin, over the weekend. As a long-time Apple user and investor, I must confess that I was bothered by the way in which the film played fast and loose with the facts, but I also understand that this is a movie. Sorkin clearly saw the benefit of using the launches of the Macintosh in 1984 and the iMac in 1997 as the bookends of the movie and the tortured relationship between Jobs and his daughter to create an emotional impact, and took dramatic license with the truth. As I watched the movie though, I kept thinking about Theranos, a company with a gripping narrative and a CEO who, like Steve Jobs, wears only black and who seemed headed for a biopic until a few weeks ago.

The Theranos Story: The Build Up

The Theranos story has its beginnings in March 2004, when Elizabeth Holmes, a 19-year old sophomore at Stanford, dropped out of college and started the company. The company was a Silicon Valley start-up with a non-Silicon Valley focus on an integral, but staid part, of the health care experience, the blood test. Ms. Holmes, based on work that she had been doing in an Stanford lab on testing blood for the SARS virus, concluded that she could adapt technology to allow for multiple tests to be run on much smaller quantities of blood than the conventional tests did and a quicker and more efficient turn around of results (to doctors and patients). In conjunction with her own stated distaste for the needles required for conventional blood tests, this became the basis for the Theranos Naotainer, a half-an-inch tube containing a few drops of blood that would replace the multiple blood containers used by the conventional labs.

The story proved irresistible to just about everyone who heard it, her professor at Stanford who encouraged her to start the business, the venture capitalists who lined up to provide her hundreds of millions of dollars in capital and health care providers who felt that this would change a key ingredient of the health care experience, making it less painful and cheaper. The Cleveland Clinic and Walgreens, two entities at different ends of the health care spectrum, both seemed to find the technology appealing enough to adopt it. The story was irresistible to journalists, and Ms. Holmes quickly became an iconic figure, with Forbes naming her the “the youngest, self-made, female billionaire in the world” and she was the youngest winner of "The Horatio Alger award" in 2015.

From the outside, the Theranos path to disrupting the business seemed smooth. The company continued to trumpet its claim that the drop of blood in the Nanotainer could run 30 lab tests and deliver them efficiently to doctors, going as far as listing prices on its website for each test that were dramatically lower (by as much as 90%) than the status quo. In venture capital rankings, Theranos consistently ranked among the most valuable private businesses with an estimated value in excess of $9 billion, making Ms. Holmes one of the richest women in the world. The world seemed truly at her feet and reading the news stories, the disruption seemed imminent.

Source: Wall Street Journal

The Theranos Story: The Let Down

The Theranos story started to come apart on October 16, when a Wall Street Journal article reported that the company was exaggerating the potential of the Nanotainer and that it was not using it for the bulk of the blood tests that it was running in house. More troubling was the article’s contention that senior lab employees at the company found that the nanotainer’s blood test results were not reliable, casting doubt on the science behind the product.

In the following days, things got worse for Theranos. It was reported that the FDA, after an inspection at Theranos, had asked the company to stop using the Nanotainer on all but one blood test (for Herpes) because it had concerns about the data that the company had supplied and the product's reliability. GlaxoSmithKline, which Ms. Holmes had claimed had used the product, asserted that it had not done business with the start up for the previous two years and the Cleveland Clinic also backed away from its adoption. Theranos initially went into bunker mode, trying to rebut the thrust of the critical articles rather than dealing with the substantial questions. It was not until October 27 that Ms. Holmes finally agreed that presenting the data that the Nanotainer worked as a reliable blood testing device would be the most “powerful thing” that the company could do. It is entirely possible that the data that the company has promised to deliver will be so conclusive that all doubts will be set aside, but it does seem like the spell has been broken. 

The Lessons

Looking back at the build up and the let down on the Theranos story, the recurring question that comes up is how the smart people that funded, promoted and wrote about this company never stopped and looked beyond the claim of “30 tests from one drop of blood” that seemed to be the mantra for the company. I don’t know the answer to the question but I can offer three possible reasons that should operate as red flags on future young company narratives:

1. The Runaway Story: If Aaron Sorkin were writing a movie about a young start up, it would be almost impossible for him to come up with one as gripping as the Theranos story: a nineteen-year old woman (that already makes it different from the typical start up founder), drops out of Stanford (the new Harvard) and disrupts a business that makes us go through a health ritual that we all dislike. Who amongst us has not sat for hours at a lab for a blood test, subjected ourselves to multiple syringe shots as the technician draw large vials of blood, waited for days to get the test back and then blanched at the bill for $1,500 for the tests? To add to its allure, the story had a missionary component to it, of a product that would change health care around the world by bringing cheap and speedy blood testing to the vast multitudes that cannot afford the status quo. The mix of exuberance, passion and missionary zeal that animated the company comes through in this interview that Ms. Holmes gave Wired magazine before the dam broke a few weeks ago. As you read the interview, you can perhaps see why there was so little questioning and skepticism along the way. With a story this good and a heroine this likeable, would you want to be the Grinch raising mundane questions about whether the product actually works?
2. The Black Turtleneck: I must confess that the one aspect of this story that has always bothered me (and I am probably being petty) is the black turtleneck that has become Ms. Holmes’s uniform. She has boasted of having dozens of black turtlenecks in her closet and while there is mention that her original model for the outfit was Sharon Stone, and that Ms. Holmes does this because it saves her time, she has never tamped down the predictable comparisons that people made to Steve Jobs. If a central ingredient of a credible narrative is authenticity, and I think it is, trying to dress like someone else (Steve Jobs, Warren Buffett or the Dalai Lama) undercuts that quality. 
3. Governance matters (even at private businesses): I have always been surprised by the absence of attention paid to corporate governance at young, start ups and private businesses, but I have attributed that to two factors. One is that these businesses are often run by their founders, who have their wealth (both financial and human capital) vested in these businesses, and are therefore as less likely to act like “managers” do in publicly traded companies where there is separation of ownership and management. The other is that the venture capitalists who invest in these firms often have a much more direct role to play in how they are run, and thus should be able to protect themselves. Theranos illustrates the limitations of these built in governance mechanisms, with a board of directors in August 2015 had twelve members: 

Board Member	Designation	Age
Henry Kissinger	Former Secretary of State	92
Bill Perry	Former Secretary of Defense	88
George Schultz	Former Secretary of State	94
Bill Frist	Former Senate Majority Leader	63
Sam Nunn	Former Senator	77
Gary Roughead	Former Navy Admiral	64
James Mattis	Former Marine Corps General	65
Dick Kovocovich	Former CEO of Wells Fargo	72
Riley Bechtel	Former CEO of Bechtel	63
William Foege	Epidemologist	79
Elizabeth Holmes	Founder & CEO, Theranos	31
Sunny Balwani	President & COO, Theranos	NA

I apologize if I am hurting anyone’s feelings, but my first reaction as I was reading through the list was “Really? He is still alive?”, followed by the suspicion that Theranos was in the process of developing a biological weapon of some sort. This is a board that may have made sense (twenty years ago) for a defense contractor, but not for a company whose primary task is working through the FDA approval process and getting customers in the health care business. (Theranos does some work for the US Military, though like almost everything else about the company, the work is so secret that no one seems to know what it involves.) The only two outside members that may have had the remotest link to the health care business were Bill Frist, a doctor and lead stockholder in Hospital Corporation of America, and William Foege, worthy for honor because of his role in eradicating small pox. My cynical reaction is that if you were Ms. Holmes and wanted to create a board of directors that had little idea what you were doing as a business and had no interest in asking, you could not have done much better than this group of septuagenarians.

My sense of Ms. Holmes's unquestioned authority was reinforced when I read a December 2013 letter that she sent to investors in the company, asking them to agree to a five for one stock split and the creation of two classes of shares with different voting rights (class A would have one vote per share and class B would get 100 votes per share), with Ms. Holmes retaining the voting shares and voting control of the company. Lest I be accused of being sexist in begrudging her this power, I have been just as harsh in my assessments of Mark Zuckerberg (with Facebook) and the Brin/Page duo (with Google) for their desire to raise money from investors but not give them a proportional say in how the business gets run, and Ms. Holmes has not quite earned the rights (that Zuckerberg and Brin/Page have claimed) to be a corporate dictator.

Bottom Line

I would like to believe that I would have asked some fundamental questions about the science behind the product and how it was faring in the FDA approval process, if I had been a potential investor or journalist. However, it is entirely possible that listening to the story, I too would have been tempted to go along, wanting it so much to be true that I let hope override good sense. Some of my worst mistakes in investing (and life) have been when I have fallen in love with a story so much that I have willed a happy ending to it, facts notwithstanding.

The question of whether Theranos makes it back to being a valuable, going concern rests squarely on the science of its product(s). If the Nanotainer is a revolutionary breakthrough and what it needs is scientific fixes to become a reliable product, there is hope. But for that hope to become real, Theranos has to be restructured to make this the focus of the business and become much more transparent about the results of its tests, even if they are not favorable. Ms. Holmes has to scale back many of her high profile projects (virtuous and noble though they might be) and return to running the business. If the Nanotainer turns out to be an over hyped product that is unfixable, because it is scientifically flawed, Theranos has a bleak future and while it may survive, it will be as a smaller, low profile company. The investors who have put hundreds of millions in the company will lose much of that money but as I look at the list, I don’t see any of them entering the poor house as a consequence. There is a chance that the lessons about not letting runaway stories stomp the facts, never trusting CEOs who wear only black turtlenecks and caring about governance and oversight at even private businesses may be learned, but I will not hold my breath expecting them to have staying power.

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Blog Posts in this series

1. Divergence in the Drug Business: Pharmaceuticals and Biotechnology
2. Checkmate or Stalemate? Valeant's Fall from Grace
3. Runaway Stories and Fairy Tale Endings: The Theranos Lesson
4. Value and Taxes: Breaking down the Pfizer- Allergan Deal

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