Entrepreneurs, Entrepreneurship, Founders, Government, Philippines, Startups

Why Would Anyone Invest in Rappler if it’s Losing Money?

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Pierre Omidyar’s fund invested in Rappler. Is he trying to destabilize the PH? Uhm, no.

 

A blogger posed this question, and posited that the reason anyone would is to achieve devious ends, in this case, to destabilize the government.

The blogger had three problems about Rappler’s financial affairs: its disclosures in its GIS and financial statements, its issuance of Philippine Depository Receipts to foreign investors, and the reasons why these investors would invest in a media company that was losing money.

Oscar Tan adequately addressed the first two in his Inquirer column. I want to talk about the third. According to the blogger, it was obviously irrational for savvy foreign investors to invest in Rappler if it generated a cumulative loss of PHP 163 million from 2011 to 2015.

Thus, there must be some other non-economic reason why these investors keep infusing their capital – to destabilize the government perhaps?

Believing this sends the wrong message to Filipino founders and is bad for promoting entrepreneurship. Full disclosure: some of Rappler’s founders have also invested in one of my businesses.   

The blogger makes a ridiculously inappropriate comparison to a sari-sari store that is losing money. Why would the store owner keep injecting cash to fund an unprofitable operation?

And therein lies the problem. Rappler is not just a media company, it’s also a technology startup. And early stage venture capital investing in the technology industry works differently.

What makes Rappler a technology company? It’s not just because it’s online or it has an app. Rappler’s built it own  infrastructure to manage and process its content, via a proprietary content management system, its mood meter, and its own data science operation.

Unfortunately, the sari-sari store analogy doesn’t capture the fundamental nature of how Rappler does business.

So why would two big foreign investors infuse capital in a money-losing technology startup?

Since people are fond of easy analogies, let me offer a more apt one.

Let’s say Ramon and Joey decide to start a company to launch a news app. They put in PHP 100,000 each of their own money. Their total capital is Php 200,000. They incorporate with 200,000 shares and a par value of Php 1 per share. So Ramon and Joey each own 100,000 shares, for a total of 200,000 shares.

Thus, their ownership split is 50-50. Ramon has 50% ownership. Joey has 50% ownership.

They use the Php 200,000 in 6 months to fund development of their app, and by the 7th month, they enter into a deal with Alibaba’s Jack Ma. Jack likes media investments. Previously, he also acquired a stake in the South China Morning Post.

At month 6, Ramon and Joey’s company is losing money.

Jack Ma’s offer is to give Ramon and Joey’s company Php 1 million in exchange for a 20% ownership of the company.

To do this, the company issues 50,000 new shares to Jack. Why 50,000? Because 50,000 shares is the equivalent of Jack’s desired 20% ownership stake in the company.

Thus, the total number of outstanding shares in now 250,000 shares, broken down into:

Joey = 100,000 shares (40% of the company = 100,000 shares / 250,000 total shares)

Ramon = 100,000 shares (40% of the company)

Jack = 50,000 shares (20% of the company)

Why would Ramon and Joey accept a deal wherein their ownership stake in the business is reduced from 50% to 40%? (We call this “dilution”).

Because the value of Ramon and Joey’s shares went up 20x. Twenty times.

WTF OLIVERSEGOVIA, how did this alchemy happen???” you might say. “In just 6 months??? For a company that is losing money??? That is magic. Or deception. Or both. You are destabilizing the stock market. I will report you to SEC Chairperson Teresita Herbosa. You must also be on drugs???”

Well, I can tell you if you aren’t so angry. (I’ve actually had reactions like this when I run my Startup Valuation workshops. The concept of equity value is so abstract for most people to understand!)

This is why. Recall that Ramon and Joey started the company by incorporating with PHP 200,000 in capital, 200,000 shares and thus, a value of P1 per share.

When Jack Ma invested his Php 1 million, he is buying new shares at a price of PHP 20 per share (P1 million divided by 50,000 shares). And because all shares in the same class must have the same value at any point in time, Jack’s investment implies that Ramon and Joey’s shares are also worth PHP 20.

Note that Ramon and Joey personally did NOT receive PHP 20 for each of their shares. Jack’s money goes to the company, not to Ramon and Joey. But Ramon and Joey each increased their net worth by PHP 2,000,000, at least on paper.

Where does the value come from? In simple terms: it comes from the past, the present, and the future.

The company created an app in the past 6 months. A customer can buy the app for a certain price. Jack is implicitly saying that the app is worth PHP 4 million.

Why? By investing PHP 1 million for 20% of the company, Jack is saying that the whole company (100% of it) is worth PHP 5 million. Minus his PHP 1 million cash infusion, their app is worth the residual: PHP 4 million.

It also comes from some estimate of the future value. Because of Jack’s investment, the app can grow its user base. It can start to sell advertising, or sell premium reports in its app. If all of these revenue streams resulted in the Ramon and Joey’s company being acquired by a bigger media company (say, ABS-CBN or GMA) for PHP 100 million in 5 years time, then Jack’s stake will be worth PHP 20 million at that point. Jack grew his PHP 1 million investment by 20x in 5 years. You can’t get a deal like this investing your savings in a bank.

At its core, borrowing money or investing money is all about forecasting the future value of something and estimating what price one has to pay for that future value, at the present time. This is what enables a bank to give you an auto loan or a housing loan – because you can continue to grow your salary and thus pay down the loan, or the house can appreciate in value in the future. This is also why the state invests in public education. Because the collective output of the iskolars ng bayan will be worth a lot to the country one day.

You might be wondering, why would Jack only invest in a minority stake? Because he knows that for the company to be worth more in the future, Ramon and Joey need to feel that they are true owners in the business, and not just employees. To achieve that, Ramon and Joey must retain a majority stake. Investors call this an alignment of interests. Otherwise, why would Ramon and Joey continue to work hard when majority of the gains go to Jack?

So, back to the original question: why would two big foreign investors infuse capital in a money-losing technology startup?

Because they believe their stake in Rappler will be worth more in the future. Plain and simple.

And like ABS-CBN and GMA – media companies with foreign investors – Rappler opted to use PDRs as the financial instrument rather than common shares.

*****

The heart of the blogger’s dilemma is that most people do not understand how venture capital valuation works.

Now you might say: the analogy of Ramon and Joey assumes a venture that’s been around for only 6 months. Rappler has been losing money for 5 years!

Guess what?

It will likely continue to lose money for the next 5 years. And that’s what could actually make it a good investment.

Amazon first registered an annual profit in 2004, a full 10 years after it was founded. It continued to lose money for the next 10 years after that. It’s only today that Amazon’s started generating profits.

Why? Because Amazon continues to reinvest its operating cash-flows into new technology, platforms, products, and services. That’s brought us affordable cloud computing, Prime delivery, video streaming, the Kindle, the Amazon Echo, and more. And I don’t doubt for a second that anyone would turn down a deal to invest in Amazon circa 1995.

That’s because profit isn’t the only measure of value. In technology, it’s actually a very poor measure of value as startups need to keep re-investing its cash flows to fund the best talent and to launch new products. So rather than profits, venture capital investors also look for milestones over the long term to measure value.

For anyone in the know, digital media is also a particularly hard business to monetize. From my understanding, other media sites like Tech in Asia, e27, and Vox are also unprofitable. So Rappler isn’t doing anything out of the ordinary, investment-wise. If Maria Ressa pushed Rappler to be profitable by Year 2 – she is actually not doing her job right!

Now that is something very hard for you to fathom, if your model of entrepreneurial success has been Henry Sy, John Gokongwei, or Lucio tan.

In the 1970s, Xerox funded a lab in California, called the Palo Alto Research Center – or PARC. For many years, PARC lost huge amounts of money doing research on information systems. One early result was the Alto: an integrated desktop workstation, with a keyboard, memory, processing power, and connected to a laser printer and other workstations via an ethernet.

If that sounds familiar, that’s because it is: the Alto was the early prototype of the personal computer and the rest, as we know, is history. If Xerox purely focused on PARC’s bottom-line, you wouldn’t be reading this post in your PC, Mac, or smartphone.

Measured within this frame, the correct question is not “Why invest in Rappler when it is losing money?” but “Why can’t Rappler be investing more to build new products, acquire the best editorial talent, and expand to other countries?

Will Rappler turn out to have as big an impact on Philippine media? We don’t know yet. That uncertainty is what makes technology investing fun.

But singly them out for issuing PDRs when it is a perfectly legal financial instrument and imputing some nefarious motive on the part of its investors without first understanding how venture capital investing works or the broader nature of technological revolutions is just hilariously foolish.

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7 thoughts on “Why Would Anyone Invest in Rappler if it’s Losing Money?

  1. Angela says:

    Hi, Oliver,

    Great Piece! I now have a better idea on PDR’s and media start-ups.

    I don’t doubt that Rappler’s financial background is sound, after all, it’s been vetted by KPMG.

    How does Rappler or the foreigners get their money back x 20? Is it through IPO, or if someone buys the company?

    Can they decide to just operate like a “normal” company and earn via revenues? If so, based on Rappler’s FS, this would take forever for an investor and Rappler founders to get their money back. Or are most tech companies end goal to go public and sell?

    It seems that Rappler’s a losing venture, and stays afloat with capital infusion.
    Based on the FS, the last one was disclosed, but the first 4 years of infusion remains a mystery. This matters because Media Companies need to disclose the owners and be transparent. The same way they demand transparency and accountability with anonymous blogs. The same mirror should be held for them.

    ABS-CBN with their businesses and affiliation with some politicians (Mar Roxas), therefore has been the subject of attacks and accusation of bias.

    If Rappler’s secret funder (if there is), turns out to be Manny Pangilinan, then this is the height of hypocrisy because they wrote a scathing article of how media companies that he owned can remain neutral, citing Inquirer, Philstar, Business World and TV5. MVP wasn’t being anonymous in Media Quest’s investments, yet a magnifying glass is already on the media entities he owns. Shouldn’t we demand the same for Rappler?

    If there’s no secret funder, and they did their own cash call for their seed funding, are we to believe that with the exception of Nix Nolledo and Manny Ayala, (who owns 17% combined), Maria Ressa and the Journalists put up 213 Million by themselves? In my book, this is even worse than finding out MVP put up the 213 Million. Why? Because Journalists practically have a vow of poverty (not by choice) because they make a pittance. Maria Ressa and the other Journalists have been practicing journalists all their lives. Where did they get this money?

    Before you get the wrong idea that I’m a Thinking Pinoy Incarnate, am not. I just want to understand.

    Thanks!

  2. Thanks for this; it’s a nice assessment. I haven’t read the blogger’s accusations, but with this post, I get the picture.

    Anyway, you argue that Rappler has its proprietary technology like the mood meter, but 5 years down the line, do we see any indication that this technology is to be sold/leased? Is it even in their business plan? From a perspective of a layman, it seems Rappler simply wants to dish out articles for ad revenue, like most online media companies. I could be wrong though.

    I think the blogger also makes some point that it’s problematic to invest in a company that has been continuously bleeding money. I mean couldn’t it also be an indication that there’s a mismanagement happening?

    I acknowledge that Rappler’s investors might be seeing its potential that we’re not–but let me play devil’s advocate. Couldn’t these investors be interested in Rappler since it’s part of the “fourth estate” and having a stake in a media company (that, in fairness has established its place) is giving power/influence to your buck? Couldn’t their investors be interested in Rappler to advance its interests?

    Would love your thoughts.

  3. Didn’t Rappler file their GIS stating they are “Other Monetary Intermediation” and the nature of business is “Property Investment and Development”?

    I can understand the “Property investment and development” part, especially if they distinguished it as being “online”

    I’m unsure how they could consider themselves as “Other Monetary Intermediation” though.

    Why not include those points in this article?

  4. Anne says:

    In summary its just valuation plain and simple. Yet we cant conclude the author as foolish because it just focused on one aspect of the authors dilemma as what was stated. Besides, he did not write his article to focus on venture capitalism.

    Im very interested to see how Rapplers valuation was affected after the decline of its readers. Given that, Rappler may release technologies and go out of the country in the future. But actually the losses that was sited may just be for lower payment of tax as what other companies do.

    The thing is this kind of article is informative on certain individuals. It can be used to refute the article of TP but its weak. Unless you try refuting it on the three points that was stated and on journalistic ethics.

    Probably if rappler will improve and change how it is run today, probably theyll recover.

  5. Marietta Turingan says:

    Excellent treatise on venture capital and PDRs! I learned so much from it. I invested some money in something and right now, I have experienced a paper loss of 20% after less than 2 years and this article gives me hope. Thank you.
    By the way, I read Rappler regularly.

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