Tumblr’s Value Tumbles Again – Being #2 May As Well be Last Place

Lost in the Yahoo! acquisition by Verizon was the announcement that Yahoo! would write down the value of Tumblr by $482 million – the second write-down this year.  Although Yahoo! bought the social networking site only in 2013 for $1.1 billion, the fact that the acquisition was a dud is hardly news.  Although it’s obviously piling on, it must be noted that Yahoo! CEO Marissa Mayer was famous for vowing that “We are not going to screw this up“.  Not exactly as inspiring as say, President Whitmore’s speech in Independence Day, but whatevs.  

When Yahoo! purchased Tumblr in 2013, about $350 million, or 32% of the purchase, was associated with some specific asset – customer relationships, technology, and trade name.  The rest was associated with goodwill.  While goodwill is often associated with “overpayment”, that in fact isn’t the correct interpretation.  Goodwill simply refers to value that isn’t tied to a specific asset that could be parceled off and sold – for example, an in-place workforce, or operational synergies.  In fact, the accounting world will almost never allow/force an acquirer to admit they overpaid (or underpaid) for any asset right off the bat, which is why almost all acquisitions are booked at the acquisition price.  You are more likely to be hit by a meteor than have an acquisition impaired at the time of the acquisition (that’s a blog post for another day).

An impairment is more properly interpreted that the business case and circumstances that drove the acquisition in the first place have structurally changed for the worse.  The reason given for the latest impairment (the second in 2016) is “decreases in projected operating results and future cash flows“.  In other words, Tumblr is not going to make nearly as much money as Yahoo hoped it would.  The reason?  Yahoo! projected Tumblr to bring 300 million users to Yahoo!.  As of 2015, Tumblr had only 227 million users (assuming all registered accounts are actually users).  If you miss your user targets by 25%, you’re going to get dinged.  The impairment itself consisted of $395 million of goodwill impairment, and $87 million in intangible asset impairments.  

There are all kinds of analyses about how Yahoo! ultimately did “screw Tumblr up”.  Yahoo! didn’t meddle enough, or Yahoo! meddled too much, or Yahoo! just didn’t have the mojo to carry an upstart social networking service to success.   In fact, the Tumblr acquisition was likely doomed from the start.  While Tumblr was a hot, sexy upstart company a few years ago, it was way behind in key areas to Facebook and LinkedIn, and was never going to have the capital required to expand its user base to achieve critical mass.  Yahoo! simply incorrectly assessed that 2nd place is valuable in social networking.  It isn’t.  Social networking only works if you are where everyone else already is.   This illustrates a very important point about the social networking business.  If you don’t become #1 in your category, you may as well be 208th, which is why Yahoo! alerted investors to the possibility it may write off the whole purchase.

You now hear about someone actually using Tumblr so rarely you might be tempted to think it’s in the witness protection program.  Tumblr, in fact, lives on, with a seemingly healthy 37 million or so monthly users. However, compared to Facebook, Tumblr’s chief competitor, which has 1.65 billion active monthly users, Tumblr is practically invisible.   Tumblr is not going to hit its numbers and Facebook and LinkedIn are rapidly encroaching on its user case.  If Tumblr did, in fact, have a window of opportunity to achieve critical mass, that window is likely closed.  In fact, it’s the nightmare of every Internet company playing out.  What happens when an established, well-capitalized rival decides they like your business?  They often come in, dominate your market and marginalize your company.

In a broader sense, this phenomenon of “first or bust” explains how the market values Internet based or enabled companies.  When you see a high valuation for Internet companies (such as a unicorn), it means that investors are making a bet that that company will ultimately dominate its market segment, however that is defined.  Think about your own usage.  Who is Facebook’s #1 rival?  Who is LinkedIn’s?  Twitter’s?  You probably can’t think of one – and that’s why these companies are so valuable.

Yahoo!’s acquisition of Tumblr was contrarian to this mindset.  While Yahoo! might have believed that Tumblr could overtake Facebook and LinkedIn or at least carve out and defend a niche from them, it seems more likely that Yahoo! made a bet that it could coax value out of a second-best-in-class (i.e. bargain) asset, and it seems clear that Yahoo! lost that bet.

 

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