Tuesday, January 13, 2015

Hot Markets For 2015

Being in rapidly growing markets (or ones perceived as hot) increases likelihood of success of a company dramatically[1].  Being in a hot market increases the ability to hire great people, get press and awareness, raise money, and eventually exit via M&A or IPO.

The average startup exit takes 7 years.  Market hotness increases the likelihood of a fast exit dramatically.  In the late 1990's the average time to acquisition or IPO was just 2-3 years due to Internet mania.  The fastest exits usually come via M&A.  Markets with the most natural acquirers will lead to the most exits in a segment.

To successfully IPO you usually need ~$50 million in revenue and a few quarters of profitability behind you.  If you are in a hot market, the profitability constraint may lesson and you can even loose money for a while (see e.g. Hortonworks IPO and big data hotness).

Hot Market Sustainability.

Caveat emptor - about 50% of the markets that are considered hot at any given point turn out to be false alarms.   Examples of past hot markets that turned out to largely be duds include First Wave AI (in the 1980s),  Nanotech (as an industry in the early 2000s), CleanTech (early to mid 2000s) and Geo (smaller scale in late 2000s).

Hot markets that yielded huge companies and large exits include social networking (mid 2000s -Facebook, Twitter, LinkedIn), and mobile social (early 2010s - WhatsApp, Instagram).  Some large market trends are still playing themselves out as per below including big data, sharing economy and other segments.

Hot Markets For 2015

Below is my view of both what markets are hot in 2015, as well as the likelihood of these market segments being medium term duds[2].

1. Gold Rush.
Markets That Will Yield Large Stand Alone Companies and Many Acquisitions
Big Data.
"Big data" as termed in the press has 4 subsegments[3]:
(1) Dealing with large amounts of data (Hadoop, Spark, etc.)
(2) Smart data.  I.e. doing something intelligent with the data you have regardless of the number of petabytes.  This is more analytical tools or tools for data scientists.
(3) Data center infrastructure (sometimes this gets clustered into "big data", sometimes not).  Mesos (and Mesosphere) would be an example of this.
(4) Verticalized data apps (e.g. data store and analytics for medical insurance claims).

In general this market segment has a lot of legs and will continue to create both stand alone public companies, as well as has a large number of natural acquirers.  Potential acquirers include the traditional enterprise companies (HP, IBM, etc.) as well as the earliest companies in the space who support liquid public stock or large market caps (e.g. Cloudera, Hortonworks...).  Additionally, the verticalized data companies for healthcare (and 2-3 other key verticals) will see large of exits to more specialized acquirers (e.g. UnitedHealth for healthcare data companies).

SaaS [Software as a Service - including APIs/developer tools]
As recent players with explosive growth (e.g. Zenefits and Slack) have shown, SaaS still has a lot of legs for everything from enterprise collaboration tools to HR back office management.

I would not be surprised if there will be 1-2 very large companies (or exits) created here per year for the next few years.  The key will be to find differentiated organic distribution (Slack) or business model (Zenefits).

To prevent the listing of too many submarkets, I will toss APIs/developer tools into this bucket as well.  There are lots of services that make sense as an API that traditionally have been performed in a more cumbersome way.  Stripe and Twilio are canonical examples of this trend, Checkr.io a more recent one.

Genomics hasn't hit the mainstream hype cycle yet.  However I think in late 2015 or early 2016 it will emerge as a hot area of investment due to the fundamental underlying shifts in the market.  I think this will yield both a large area of future investment, but also exits ranging in the $100M to multi-billion dollar range.  The genomics wave will include both stand alone genomics software companies (lots of natural buyers including IBM, Oracle, Google, Illumina, and others) as well as more traditional biology centric genomics (with large natural buyers in the pharma and traditional biotech markets).  I think a small number of large, public companies will emerge in genomics.

2. Silver Mines.
Markets That Will Yield Lots of Acquisitions, Less Clear on Independent Stand-Alones
There are two types of AI companies:
(1) Companies trying to develop general purpose AI or are trying to build a "general AI platform".
(2) Companies applying AI to solve a very specific problem or customer need (e.g. machine translation of web pages or screening pathology samples).

The first group of companies will be small to large acquisitions by Google, Facebook and handful of other companies as talent buys.  The second class of companies may yield a small number of large, stand alone, independent businesses.  I am more bullish on the prospects of the second group as truly value creating.  However, if your primary interest is fast time to exit companies in group (1) will likely sell quickly and at a good valuation 1-4 years post founding as Google and others try to stock up on machine learning talent.

IoT [Internet of Things].
IoT is a sexy rebranding of "consumer electronics and appliances".  IoT is modernizing our clunky old school devices in the home and adding software and APIs to allow for seamless interoperability and broaden logging and use of data.

Today's traditional consumer electronics and appliances remind me of the Motorola Razr right before the iPhone - great industrial design but no real use of software.

From an exit perspective large companies like Google, Apple, Samsung, Philips, GE, and others all have an interest in acquiring companies that will accelerate their own efforts in this market. So there are a lot of natural acquirers in the space.  I expect more small to large $500M+ exits in this market, but it is unclear to me which of the new batch of companies will create a long term, sustainable public company of their own.

Now that Nest is gone, I would love to hear what others think are the likely long term stand-alone companies in IoT.

This is a tougher market to crack as a startup hoping to become a massive standalone company, but I expect more startups here in 2015.  On the enterprise side there will be ongoing high-profile hackings and the need to purchase security products.  Barriers to entry in this market are higher due to the need for both a strong sales channel as well as a differentiated product, which will temper overall market momentum.  Basically, a small number of startups will have ongoing small and medium (hundreds of millions of dollars) exits, but the total carrying capacity of this industry is more limited for startups due to sales channel bottlenecks (CIOs will only want to buy security software from a handful of vendors, and too many new startups will focus on a "feature" rather then comprehensive solution).

Recently public Palo Alto Networks and FireEye will likely be industry consolidators as will other traditional enterprise security companies.

3. Roulette.
Binary Markets - Create A Few Huge Stand-Alones, Lots of Failures
Sharing Economy & On Demand Economy.
Distributed labor and work forces, or the sharing of resources will continue be a hot market from a startup founding perspective.  I think the vast majority of the new startups will fail although a handful will still emerge as big hits.  Just as Facebook, Twitter, and LinkedIn where the first wave giants in social, AirBnB, Uber, Lyft, Instacart are the first giants of this wave (by market cap).

Similarly, just as there was a second social wave that yielded break out companies (WhatsApp, Pinterest, Instagram) as well as tons of duds, the shared economy/distributed labor trend will have a few more huge companies emerge.

In general this is an area that will be fraught with lots of failures offset by a handful or truly massive outcomes.  Too many entrepreneurs will do derivative "Uber for X" for tiny markets ("Uber for sports equipment delivery").  The key will be to figure out how to capture an existing large market (e.g. Uber and transportation) or expand an existing market dramatically (Uber again) with a simple use case and product.   The people who win here will win big a they upend entire markets.

4. Tough Short Term Markets For Tech Investors?
While I am bullish on the long term prospects of crypto currencies and blockchain, I wonder if many of the current crop of companies will succeed.  A number of larger structural events need to occur for truly widespread adoption of bitcoin to occur.  Existing bitcoin companies have a ticking clock (aka burning through fundraises) relative to this market timing.  Profitable (or cash rich) bitcoin companies may make it long enough to see this transition just as AOL did with the Interent[4], but any company burning rapidly through its cash will likely fail.  Once a company succeeds sufficiently there will be a large number of potential buyers for BTC companies (including Google, Apple, Microsoft, eBay, and the entire financial system).

I expect there to be an eventual culling of existing bitcoin companies followed in a few years by a massive expansion of cryptocurrency companies when the markets are more mature.  This may be a hard slog for a few years punctuated by one or two large, misleading, exits [5].  Then there will be an explosion in cryptocurrency companies that dwarfs the current trend.   So, I am extremely bullish on this area long term, but worry about the shorter term dynamics.

Biotech Investments By Software Investors.
Outside of genomics, I have increasingly seen technology investors invest in traditional biotech companies.  While genomics has a clear "why now" statement due to its rapidly dropping costs, old school biotech does not share this big shift in market dynamics.  In my opinion this market is going to be a fiasco for tech investors as they misunderstand the industry structure (regulatory issues, IP issues etc.) as well as don't have a good sense for the underlying markets.  While biotech investors may or may not do well in biotech over the next few years (I honestly don't know the market well enough to be certain) I think a subset tech investors may end up loosing big sums of money here (similar to the CleanTech fiasco of the early 2000s).

Other markets I missed?  Comments on existing ones?  Let me know on Twitter.

Thanks to Avichal Garg for comments on this post.

[1] "Success" is defined for the purposes of this blog post as the creation of a large stand alone company or a as a large financial exit.  This is used as a proxy here for impact to the world, as "impact" is very hard to quantify.  How many lives were saved by Google?  Yet Google has transformed the world for the better by providing information access to billions of people.  It is hard to come up with a good metric for doing good for the world.

[2] Like all prognostication, I will undoubtedly get a bunch of this wrong.  This is just my current view of the world, and is obviously subject to change as more data gets generated by that wonderful physics simulation software that we call reality.

[3] From a founder perspective.

[4] AOL is a similar example for the Internet.  AOL was founded in the 1980s and managed to work out an existence until the early 90s, when the bigger Internet wave really hit.  By the late 90s AOL was one of the largest companies in the world by market capitalization.  The next wave of Internet companies were founded a decade later then AOL, when enough infrastructure (markup, browsers, more physical wiring upgrades) allowed for the real Internet boom to occur (Amazon, eBay, Yahoo!, Google, etc.)

[5] Big companies often make large, stupid buys for "strategic" reasons.


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