Capabilities

Earlier this year, there was a bit of an uproar when it emerged that Chamath Palihapitiya had sold his 10 percent stake in Tinder to IAC for $500 million, implying a Tinder valuation of $5 billion and a mind-boggling windfall for Chamath. 

(Chamath, if you're not familiar, was a key person at Facebook, leading its growth team. He made a bit of cash and became an investor, starting the venture capital firm Social + Capital. And Tinder, of course, is a popular dating app, incubated at the internet company, IAC.)

It turned out the reports weren’t true, and while the exact figure wasn’t known, it was clear the stake had been sold and, while far lower, for a pretty decent sum nonetheless: later reports put his stake at 11 percent and the sale price at $55 million.

As I read more, I was fascinated, and I’m writing the story and my thoughts down now, almost four months after the fact, because I find a lot to admire in what Chamath's moves leading up to that sale imply about Chamath’s thinking.

This is the story:

  • Tinder was jointly developed by IAC and a Toronto-based mobile development firm called Xtreme Labs. IAC retained control and the lion’s share of equity, with Xtreme Labs retaining, it seems, 11 percent. The app was developed inside a joint venture between the two called Hatch Labs, which was shuttered in late 2013. 
  • Chamath bought a majority stake in Xtreme Labs in late 2012 for $20 million of his own money (i.e., not via his venture firm). The co-founder and CEO of Xtreme Labs, Amar Verma, and Chamath had known each since college, and Chamath had worked with Xtreme on some projects at Facebook. 

As detailed by Liz Gannes of All Things Digital:

Palihapitiya told me the deal makes sense in light of the current scarcity of good mobile developers. It will be worth it to him to be able to use Xtreme’s spare time to help with Social+Capital projects, and to spin out interesting start-ups. And Xtreme is now working on open-source frameworks that will bring its native app expertise to a broader audience.

— All Things Digital

  • The structure was $6 million up front and $20 million (unclear whether that is inclusive of the $6 million) over the next three years.
  • The most recent comment in the All Things Digital piece, which about captures the general confusion around the purchase (and that from the small number that cared at all), read:

This is the worst thing I’ve seen an investor do. Are you serious? This is a development shop with low margins. I know this team, and I know this space incredibly well. Just pull out of this deal ASAP or reduce your stake for Jesus sakes. Wow. I had respect for Chamath once. Horrible.

  • In late 2013, Xtreme Labs was sold to Pivotal Labs (EMC) for $65 million cash plus incentive compensation to the staff of 300 or so. Chamath, however, kept the equity stake in Tinder for himself as part of the deal. Exactly what Chamath earned on the sale is a function of how much of the total $20 million committed he ended up investing and what exactly “majority stake” means, but regardless it’s a decent multiple. Let’s say it was $20 million for 80 percent. The $65 million sale would have netted him $52 million for a 2.6 return with a holding period of about a year. 
  • Then, about six months later, Chamath sold the stake in Tinder for $55 million if we believe the reports. The $52 million from Xtreme plus $55 million for Tinder yields $107 million for a 5.4x return in about a year and half. Not bad. 

This is what I think is noteworthy:

  • Forget the economic return, though that alone is noteworthy. 
  • When everyone else, including Chamath himself via his venture firm, was investing in applications, Chamath bought a development firm. 
  • My guess is that, having looked at a large sample of companies and given his own experience, he did the back of the envelope math on number of possible opportunities and the scarcity of good development teams. He referenced the "scarcity of good mobile developers" thesis to Gannes, but I’d word it differently: there’s a scarcity of good development engines, groups that can work together to put out good product.
  • A slightly different lens is that there even fewer good mobile development engines with great optionality. Yes, good teams come together and start companies in which case the thesis is defined and the initial direction largely set. Good teams leave themselves open to insight and groups do "pivot" so often there is a lot of optionality, but there aren’t many truly experimental development engines. I believe Chamath saw Xtreme Labs as a way to learn and experiment, to engage in "black swan farming" (stealing Paul Graham's phrase). He ended up selling and netting a great outcome, but there’s an argument that he may have sold too soon.
  • What I like most about this story is the unconventional, first-principles thinking. If you're investing in ideas around mobile and being thoughtful about the macro trends, comparing the supply of talent with the demand for (and dramatic upside in) offerings, buying a development firm is a natural outcome of that logic. Unlike others though, Chamath was willing to follow the logic of his analysis all the way into core development talent. He was investing in teams and companies via his venture firms, but he was also building core capabilities and learning via the investment in Xtreme Labs. 

Clarification: Beyond the facts, I don't know if any of this is trueall conjecture.