Local Heroes: The Public Companies of Tomorrow

A big investor mantra over the past few of years has been “SoMoLo”, an acronym for the mega-trends “Social, Mobile, and Local”.  How have these trends been performing for investors?  Social clearly has been delivering huge, as evidenced by the very strong performance of the Facebook, LinkedIn, and Twitter IPOs.  Mobile has arrived with a vengeance, with smartphones and tablets already generating more traffic for many consumer online businesses than PCs.  But at this time last year the bloom looked to be off of the “local” rose, due at least in part to the very poor performance of Groupon as a public stock.  It got so bad that a company that I know in the local space who was looking to raise a round was told by multiple venture firms to look elsewhere for capital as they “don’t do local”.

But I’d argue that local in the past year has flourished as an investment category.  A good chunk of the consumer Internet businesses that have gone public of late focus on local, and these businesses have traded strongly as public companies.  OpenTable probably opened the door here in 2009, but other high quality local companies quickly followed suit including Yelp, Zillow, Trulia, and Angie’s List.  Even Groupon, just last year the poster child of the demise of Local, has enjoyed a resurgence and now sports a market capitalization of $6 billion—a valuation that rivals the price of their oft-ridiculed non-sale to Google a few years back.

marketcapitalization

Source: CapitalIQ

When I talk about local here, I’m focusing primarily on technology businesses that power online to offline commerce.  They typically are two-sided marketplaces, with offline local businesses on one side and consumers on the other.  They typically roll out on a city-by-city basis, and require a sales effort to sign up small businesses to populate and/or monetize the marketplace.

It’s clear that mobile is helping these local businesses dramatically.  The geo-location capability of the smartphone means the computers that all of us are carrying around in our pockets are location-aware.  The resulting killer application is “show me information on businesses that are close by to where I am now”.  Using OpenTable as an example, “show me which restaurants around me have open tables that I can reserve right now”.

Building a local technology business is not all easy, due to three related features:

  • The need to expand by executing a city-by-city rollout.  It can be hard enough to make a business work in one market.  But once a local tech company has proven out its concept in one market, it then needs to roll it out to multiple cities very rapidly or risk losing them to competitors or clones.  And as the world has gotten flatter, this has become even more challenging as fledging startups in many international markets scan the globe for businesses to clone in their home region.  The local food delivery space is an example where no one company has taken their market, at least initially.  Multiple businesses have been competing in the U.S., with different companies winning different markets.  GrubHub is in the process of rolling up their U.S. competition, having acquired CampusFood and SeamlessWeb.  And there is an entirely different competitive set of companies in Europe battling it out among each other for market supremacy.
  •  The need to build up both sides of the two-sided marketplace in each market, aggregating local offline businesses on one side and consumers on the other.  And the skills required to build the two sides of the market are typically different, one with a sales motion and the other with a consumer marketing motion.
  •  A high level of operational complexity that requires armies of people, largely due to the need to sell and service tens or hundreds of thousands of local businesses.  For example, Groupon has over 11,000 employees and Yelp has almost 2,000, resulting in annual revenue per employee of just over $0.2 million and $0.1 million, respectively.

As a result of these challenges, building out a national or even a global footprint tends to take a long time and require a lot of capital:

cumulativevc
But while building local-focused tech companies can be very challenging, it can also be highly rewarding.  Successful businesses in this space tend to have strong “winner-take-all” characteristics that can lead to very strong market positions that tend to endure:

  • Winning companies often sport strong (and largely local) network effects.  I’ve had the privilege of being involved in a number of network effects businesses, and none had a stronger network than OpenTable.  The more restaurants OpenTable has in a city, the more useful it is to diners.  And the more diners in that city use it to make reservations, the more valuable it is to restaurants.  In our IPO roadshow, we made the statement that we believed it was financially irrational for a restaurant to use a different reservation service, even if it was free, as they’d lose access to incremental diners and thus dollars from the OpenTable dining community.  This has subsequently been born out as a number of aspiring competitors, many giving their service away for free, have come and quickly gone.
  • Winning companies also typically achieve scale advantages that are very difficult for aspirants to match.  Critical to every two-sided network is signing up local businesses to use your service.  The market leader quickly has the largest team recruiting these businesses.  Their team is typically the most productive, both because of accrued learning as well as the fact that it’s easier to sell the service that boasts the most consumers in its network.  New entrants typically suffer both scale and productivity disadvantages, which in turn often results in investor skepticism that creates capital disadvantages.

The chart below, generated by my colleague Sebastian Cua, shows the strong premiums that fast-growing local companies are commanding in the market:

EBITDA

Source: CapitalIQ, Wall Street Research Estimates

There is a growing pipeline of late-stage private companies that will become the public companies of tomorrow, including Uber, GrubHub Seamless, MindBody and ZocDoc.  And a newer generation of local-focused companies is showing rapid growth including HomeJoy, DogVacay, Lyft, and Belly (the latter two are a16z venture investments).  We strongly believe that opportunities in local will continue to spawn great technology companies.

I would argue that the winner-take-all characteristics of local businesses create what investors crave in companies: strong “competitive moats”.  Public market investors clearly have developed an appreciation for the moats that surround the public, local-focused tech companies above given their recent stock market performance.  And it’s interesting to see exactly what these public market investors are valuing above all—GROWTH!

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