The $3B+ Exit Tumblr Could Have Had | Danielle Morrill

It’s all over the news, Yahoo! is in talks to acquire Tumblr. The popular blogging platform, which was founded in New York in 2007, has just a few months of cash left and hasn’t successfully monetized their platform fast enough to cover costs.

To date investors have put $125M into the company, most recently infusing it with $85M more in September 2011 at a valuation of over $800M.

The company started selling ads in May 2012 and revenue was reported at $13M for the year. Tumblr’s source of advertising revenue is the logged in user “dashboard” where sponsored posts are displayed in the sidebar via Tumblr Radar, while recommended posts are injected directly into the feed by Tumblr Spotlight..

Tumblr claims 120M+ daily impressions on Tumblr Radar, which equals 3.6B+ monthly impressions. Assuming $10 – 20 RPM (revenue per thousand impressions), which is within the normal range for premium brand advertising, the total revenue opportunity for Q1 was $108 – 216M. Based on this calculation, at an annual run rate of $15M ($3.75M quarterly revenue) Tumblr is selling 1-4% of it’s total monthly inventory. If you think about this operationally it sounds reasonable, as the company is just beginning to ramp its ad sales.

This analysis rests on the assumption that Tumblr advertising will command premium brand advertising prices. If not, RPMs in the $3 – $9 would be more realistic and you could reduce all the values in these calculations accordingly.

Tumblr may also be enticing early advertisers by selling inventory for a fraction of the price it eventually hopes to charge. At $1 RPM $3.75M in revenue would have paid for 30% of the available impressions, and in order to sell 100% of its inventory in Q1 Tumblr’s average RPM would have had to drop to $0.35. Compared to Reddit advertising, which offers $0.75 CPM, and sub-$1 rates for Tumblr CPMs sound plausible.

Red Flags

There were signals of a possible revenue ramp miss in the first quarter of 2013 with the resignation of Rick Webb, who was brought on board just 10 months earlier to focus on revenue growth and work closely with Tumblr CEO David Karp. He is the latest in a string of senior executive departures characterized by Beta Beat as a “leadership vaccuum”.

The shutdown of Tumblr Storyboard in early April was another worrying signal. The project was touted as a “journalism experiment” but was more likely an experiment in figuring out how to work with brands to create effective content marketing on Tumblr’s advertising platform. The production value of the content and high profile editorial team likely cost the company millions but ultimately it “didn’t work” according to Karp.

The Initial Offer

The initial offer from Yahoo! is $1.1B in cash, but according to TechCrunch it may not be accepted:

“Tumblr employees feel that Yahoo’s $1.1 billion offer is “too low” and view it as “only a first offer,” according to sources close to acquisition talks.” – TechCrunch

Employees’ opinions aside, the lack of cash on hand and lack of trust in leadership to hit revenue milestones are likely having a negative impact on Tumblr’s negotiating position, which is probably contributing to what some consider a “lowball” offer.

Setting the Purchase Price

In an acquisition the purchase the price is usually set as a multiple of existing revenue or expected near-term revenue. For media companies a 10x multiple on revenue is quite steep, and with only $15M in 2013 that would put a Tumblr acquisition price tag at just $150M.

My first reaction was that Yahoo! or whoever else was involved in the acquisition talks was about to massively over pay. But Yahoo! isn’t stupid, so what’s going on here? Clearly this is about expected value, not actual revenue. If Tumblr were to hit their own stated $100M revenue target a 10x outcome would be $1B – but employees are saying this is a lowball offer. Why?

Looking at our numbers from earlier, at $10 – 20 RPM and 3.6B dashboard impressions a month (and growing) the annual revenue potential for Tumblr ranges $432M – $1.44B.

Viewing the $1.1B offer from Yahoo! through this lense, it is 2.5 multiple of the low end of the expected revenue range. An acquisition at the high end of the range with a 2.5x multiplier would be $3.6B, and realistically if the company was crushing it on ad sales the multiple could be even higher.

Why sell a company with such a substantial revenue opportunity on the low end of the range?

Pencils Down, Time’s Up

While employees hold onto the hope that the company will be valued on it’s ability to drive billions in revenue, the reality is that Tumblr didn’t pull it off in time. The vast majority of that potential was not realized in time.

It wouldn’t be a problem that Tumblr is lagging in revenue production if the board felt the odds of the company capturing this expected value were good, and that was probably the thinking when they invested $85M in 2011.

Two years later it looks like the CEO who famously quipped to the L.A. Times “we’re pretty opposed to advertising, it really turns our stomachs” may have hesitated to monetize too long, and investor patience has run out.

The path to keep the company independent would probably involve finding a replacement CEO, or at the very least hiring a COO to be Tumblrs own version of Sheryl Sandberg and drive the company aggressively toward revenue. It would also mean raising a boatload more cash at significant dilution to everyone involved, cutting expenses, and buckling down to operate like a serious business generating meaningful ad sales revenues in the next 18 months.

Outcomes

In choosing to sell the company and hand Tumblr over to a professional management team with a track record for monetization through media properties, the board is implying that they do not feel putting more money into the company would enable the management team to achieve a better outcome in a reasonable amount of time. Investors who participated at the $800M valuation are probably welcoming the prospect of a $1.1B exit in cash – assuming some liquidation preferences were put in place they’ll get their customary 2x-3x late stage return, and the deal won’t negatively impact their respective fund’s overall IRR.

Selling now may also allow David Karp to remain in a leadership position at Yahoo! where he can continue his work to revolutionize advertising – maybe even leading Yahoo! to a more competitive position vs. Google for brand advertising and giving them a reason to drop the underperforming partnership with Microsoft in the long term. And if things don’t work out with Karp Yahoo! doesn’t seem to have any problem firing acquired founders who no longer fit with the company’s plans.

In the end Tumblr won’t see a bigger exit because they didn’t prove they could monetize their massive traffic before time (and money) ran out.