Simon’s Blog

Looks like there’s a bit of controversy surrounding the suggestion in Business Week that Digg.com might be sold for in excess of $200M. The controversy surrounds the company’s revenues, which are estimated at $3M.

Jason Calacanis says:

DIGG has not been sold yet, from what I understand BusinessWeek is basing the $60M number on someone telling them that DIGG would sell for $200M. DIGG is making $3M a year from what people are saying. That would give them a 65x revenue, and if they have $500k in profit a 400x earnings multiple ($1M in profits would give them a 200x earnings multiple). Wow.
.. makes Google look cheap!

and the comments in Rafats blog entry and the 37signals blog tell similar stories.

If this were a fairly boring, but good, software-as-a-service company, then you might expect Digg to be sold for around $20M. However, Digg has a massively high profile. Revenues and/or profits aren’t the only measures acquirers use to value such a business. So, if you’re pondering how much Digg might be bought for, and you’re searching for a reason why someone might pay $200M, the real question is: could Digg be a strategically important buy for a big player out there?

What do I mean by “strategically important”? Well, it could be that a company sees that Digg, when combined with that company’s core business, adds huge value for customers. For example, when eBay paid over $4B for Skype, it was because eBay believed that integrating voice communicatations would add value to the buying/selling process; and that eBay saw that Skype had millions of users that could be potential eBay customers. Or it could be a defensive move. For example, a competitor that currently has a lead over a small player is worried the the small player might become dominant and destroy them if bought by a major player. In that case, they would have to either buy the small player at any price, or get out of their current business. There are many examples of this. Possibly the best example is the biotech industry. Large pharmaceutical companies dropped the ball when they let the first few biotech companies become large. Today, it’s all but impossible for biotech companies to grow to become large companies. As soon as they reach a certain size, they get acquired by larger players.

I’m surprised that so many people commenting on the Business Week cover ignore this. Having said that, though, I can’t think of a reason why Digg would be a strategically important asset for anyone; at least not with a $200M price tag… but then, I haven’t thought about it too much. I guess Yahoo! could see some value in adding Digg to their portfolio - maybe doing something around integrating Digg and del.icio.us. But I doubt Digg brings enough unique users, or technology, to the table to make it worth $200M to Yahoo!

Comparators are often a good way to get a handle on valuation. If you’re searching for a comparator sale for Digg, look no further than Slashdot. Remember, VA Software paid $1B for Andover.net (Slashdot) back in 2000. Andover.net only had $2.1M in revenues at the time. While 2000 was the height of the bubble, it does illustrate that using over-valued paper to buy companies can up the price you’re prepared to pay.

Now you might argue that VA Software would want to acquire Digg; and they might (as a defensive move). However, they couldn’t afford to pay $200M. When they paid $1B for Slashdot, their market cap was $5B. Today, VA Software is valued at $250M.