Throughout most of history a company’s stock performance has been linked to its intrinsic value creation, or at least its intrinsic value creation potential. Every few years, the market gets worked into a speculative frenzy with stocks often separating from any semblance of economic reality or intrinsic value creation potential as a mass of indiscriminate buyers blindly lever up and throw capital at story stocks. Often in these situations a new breed of “stock market genius” emerges, and they essentially have only two criterion on their checklist: a large total addressable market (TAM) and a rapidly rising stock price. So the metrics that begin to matter are not cash flow, not even revenue, but the perceived potential for revenue and a rising stock price (e.g. price momentum). Your goal is to tailor your message towards this genus of stock market speculators, of which there is an endless supply. Presumably if things are going well operationally, you would not need to hype your company’s prospects, but for the sake of this writing we will assume you are at least capable of admitting to yourself that you have little hope of true fundamental value creation.
We will also assume that your main goal is generating extreme wealth for yourself in a quick manner, in which case the best hype-vehicles will have limited current revenue, or preferably none at all so you can start with a small base and a completely blank slate. The hype-vehicle should be in a somewhat new industry, should have an unproven business model and should be perceived to have a large total addressable market. In this era where profitless, perceived secular revenue growth as an investing "theme" is one of the best performers, it is critical you learn to effectively hype your Total Addressable Market. When your hype campaign is just getting started, the more abstract your business strategy can be (hence less current sales), the better, for if you follow all of the Laws of Hype, an abstract blank canvas with a large TAM will allow investors of all kinds project some of their greatest hopes for humanity onto your equity valuation. If you are a company with no revenue, analysts and investors will not have much else go on so your valuation will be abstract to begin with, but if you can operate within an unproven niche you can substantially influence how investors will project your potential revenue opportunities. Another key to hyping your TAM is omit any mention of the competitive landscape, rather you should assume it is as if you operate within a "free market vacuum" and state that there is "no competition" in sight and therefore everyone can assume its open blue ocean all around you as sail smoothly into substantial market share. If you are directly confronted about the competitive landscape, downplay and deride your established competition as inferior and ripe for easy disruption.
Observance of the Law:
“The addressable market for residential real estate advertising is massive at approximately $12 billion annually, yet on a combined basis Zillow and Trulia have less than 4% share of this market.” – Spencer Rascoff, CEO of Zillow, Conference call for proposed acquisition of Trulia, July 28th, 2014.
The sell side's focus on the TAM for Zillow can be traced back to when the company had just gone public. From the Pac Crest Zillow initiation in 2011:
“The real estate market is a large opportunity. The U.S. real estate industry spent over $20 billion in advertising in 2010. The opportunity for Zillow to tap into the ad spending directed by the 1.8 million real estate agents and 266,000 mortgage brokers is just getting started and should fuel over 60% CAGR in revenue over the next three years.”
Zillow is also another master at getting the market excited about the TAM of other adjacent opportunities, this is from the more recent 2014 Macquarie initiation of Zillow:
“Mortgage and Rental adjacencies add ~$14bn of TAM – These small but emerging businesses for Z represent advertising TAMs (total addressable markets) of $11bn and $3bn, respectively. Penetrating each will hinge in part on Z’s marketing initiatives, but early signs suggest both can be solid complements to Z’s core “for-sale” marketplace. Our valuation framework assumes Z’s share of Rentals reaches ~18% and Mortgages reaches < 4% by 2024.”
Zillow has hyped up adjacent TAMs so much so that now “these small” businesses for Zillow are somehow 55% larger than their core business ($14 billion in combined TAM versus $9 billion core opportunity used by Spencer on the latest conference call). To show you just how important hyping up the TAM is, often a price target and valuation are based “primarily” or entirely on an assumed penetration rate of all TAM, and then Price/Sales ratio gets slapped on that revenue opportunity. Again, from the recent Macquarie initiation on Zillow:
“Valuation: Our US$164 target is based primarily on a long-term market penetration analysis.”
Here is another great example from Exact Science's COO, Maneesh Arora, at the Goldman Sachs Global Healthcare Conference, June 12th, 2014:
"…which lead to just this tremendous market opportunity..there [are] 80 million people that are in this addressable population in the US. And if you look at the population demographics, they’re between 4 million and 5 million people turning 50 every year, right? So, we think that we keep our focus on that and there’s plenty of market for that.”
A few years earlier, when the investment opportunity was more abstract, the total addressable market was even bigger, to wit: “Our focus on early detection of colon cancer presents a sizable market opportunity…The population of those who should be screened based on age, medical history and other factors is roughly 90 million. Based on three and five year screening interval assumptions and assuming an achievable 40% penetration rate the annual colon cancer screening market is more than $0.5 billion.” Kevin Conroy, August 12th, 2009. Fast forward all the way to 2014 and the total addressable population they tout is 10 million smaller, the assumed penetration keeps coming down, yet the revenue opportunity has gone up by at least 100% as sell side analysts have $1 billion+ revenue run-rates modeled in just a few years out. As recently as today (August 12th, 2014), Kevin Conroy called the revenue potential for Cologuard a "multi-billion dollar US opportunity" and a "multi-billion dollar global opportunity." This is the type of progression you should follow to hype your growing TAM: $500 million..to $1 billion, to multi-billions.
If you tout the sheer size of your TAM, regardless of how you derive those estimates or the validity of your logic, the revenue assumptions can take on a life of their own as people’s imaginations run wild. What is most important is to reiterate how large the TAM is over and over again (repetition is key) regardless of faulty logic. Admittedly, it would be best if you are in an entirely new industry or market niche where there is no established TAM, because if it’s an unknown quantity you can do your best to mislead investors and shape the perception that it is actually much larger than economic reality it will prove it to be. Of course, being in a new industry is not a necessity to follow this Law of Hype. Take Exact Sciences or Tesla, for example. They both have numerous well established competitors in their respective industries (cars and colon cancer diagnostics) which are both very mature industries. In both cases, management cites the TAM and investors just assume they will capture meaningful market share with little regard for better and cheaper products already available on the market. It would be even better if you could choose a market where the TAM will grow. If you sense that your stock valuation has priced in the entirety of capturing the TAM you have been hyping for a while, you must come up with ways to increase the perceived TAM by talking about different verticals and adjacent market opportunities. For example, if you are Tesla and the analysts’ DCF models have maxed out on your luxury sedan EV market opportunity, you must then get them excited about all the other possibilities: SUVs, entry level sedans, minivans, buses, trucks, airplanes, flying cars, personal spaceships, jet-packs, scooters, etc. If you are EXAS, you must expand beyond the US borders and being to cite your efforts to capture the even larger global TAM. You must begin to talk about other molecular diagnostic screens you can come up with for other cancers that arise in the GI tract, etc. After all, your goal is to eradicate cancer entirely so why stop with colon cancer?
Raymond A. Myers, Analyst, Alere Financial Partners: "Yeah. I'm asking, can you elaborate more on what your research projects are involved in stomach cancer?"
Kevin T. Conroy CEO, EXACT Sciences Corp.: "Let me say that our order of priority is most likely going to be pancreatic and esophageal cancers, with stomach cancer being a tremendous opportunity in a limited part of the world initially. In Korea, there's a huge stomach cancer screening program, national screening program that already exists. China, stomach cancer is a big problem. Japan, stomach cancer is a big problem. In fact, a number one cancer killer in some of those regions. So our current platform technology and markers that we've identified in our collaboration with the Mayo Clinic would potentially be utilized and readily adopted to the platform. In terms of the real – the greater opportunity both in the U.S. and globally, pancreatic cancer screening and diagnostic is the high priority, and esophageal screening and Barrett's esophagus screening and diagnostics is the second high priority. We'll talk a lot more about that as we go forward. But remember that we invested millions of dollars into a automated platform and millions – all together, tens of millions of dollars in the technology platform, the chemistry platform, the DNA extraction platform, the marker development. We haven't talked about that much over the last five and a half years. It's there. It's real. And it's applicable to other disease states and we think we're way ahead of where other people are. We will start to talk about our plans a little bit more as time goes on. We have a dedicated team that is focused on this, from marketing project management and most importantly, R&D and clinical, be in the Mayo Clinic. So we think we have some exciting things to talk about just not right now.”
Even way before your repulsive, inferior and more expensive products have hit the market and flopped, it is recommended you follow Exact Science’s lead and begin pumping potential products that are years and years away from commercial development when you've already gotten credit for capturing the bulk of your core TAM. Keep the sense of momentum of a growing TAM going, and whatever you do don't play all your cards at once.
Another biotech firm that has executed Law #2 flawlessly is Raptor Pharmaceuticals, true masters of hyping an extremely limited TAM and adjacent TAMs. Raptor makes a me-too drug with 3x as many adverse side effects for patients for a rare disease known as cystinosis. Cystinosis is an easy to diagnose rare disease with a very steady number year after year of known inflicted persons in the US (~500 the last four years in a row). They are over one year into launch of their sole drug Procysbi, and surprisingly having captured much of the available US market with revenues still ~27% of the assumed peak in sales. With no end in sight to Raptor's significant cash incineration, investors have been conditioned to not only assume 80% market share capture versus the existing drug that cost 1/20th as much, but then also have hockey-sticked the presumed growth in available cystinosis patients in the US and globally by a healthy high single digit CAGR. into perpetuity. Raptor has a supposed solution in search of additional problems and the sell side gladly plays along hoping to cash in on future equity offerings that will be needed to shore up the balance sheet.
"We believe the clinical data, orphan drug status, and patient need for a better tolerated/effective therapeutic option support high Procysbi patient uptake and ~$235MM peak revenues in NC worldwide. RPTP is developing DR cysteamine for the treatment of NASH (nonalcoholic steatohepatitis), which could be as large or larger an opportunity considering its close association with diabetes and obesity." - Leerink Swan on Raptor, August 7th, 2014 earnings recap.
Transgression of the Law:
“While we are pleased with the record bookings, we remain even more excited about the opportunity ahead. Despite our growth and run rate, we still only represent a tiny fraction of the addressable market for real estate advertising. Of the $27 billion spent annual by the category that borrell Research identifies approximately $9 billion is spent on advertising by residential real estate agents, brokerages, and homebuilders. With our current run rate, we are on track to capture just over 2% of the market this year, which highlights just how early we are in the shift from offline to online and the sizable opportunity and runway we have ahead of us.” – Spencer Rascoff, Zillow CEO, Q2 2014 Earnings Call on August 5th, 2014, a week after the quote from Spencer above in Observance of the Law.
As pointed out above, Spencer was on the merger call just a week earlier citing a $12 billion revenue opportunity. A few days later he then throws out $27 billion, oh now wait, its just $9 billion seven days later. Spencer rarely makes missteps in Zillow's strict adherence to the Laws of Hype, but he made a clear mistake here by citing a smaller TAM than just a week before. Also given that Zillow is much larger than Trulia yet only running at 2% penetration of this opportunity, I am not sure how the combined companies were at 4% of the market a week ago when the TAM was 33% higher at $12 billion.
Spencer's heart is in the right place by focusing the market on the "exciting opportunities" and "long runway" ahead in their "under-penetrated" TAM, but he is very inconsistent with his numbers. If you are going to be inconsistent in what you say about the TAM, it is crucial your number is steadily climbing, not shrinking--especially within one week's time frame. Try to make sure your management team and IR representatives have a unified hype message to deliver with regards to your TAM and when you find an official sounding source with a higher estimated TAM, or come up with an innovative new methodology that derives a higher number and has at least a facade of reasonableness to it, switch over to the higher number when your stock is floundering.
Marc Benioff, CEO of Salesforce.com, plus other Salesforce executives.
Marc Benioff is the undisputed King of the TAM, especially guiding for a steadily growing TAM over the years.
From a recent Salesforce.com earnings call:
Samad Samana, FBR: “…how penetrated is the core Sales Cloud outside of the United States?"
Marc Benioff, CEO of Salesforce.com: “I really think International remains a huge upside opportunity for Salesforce. We’ve invested very heavily in the United States market, which was a very good decision because it is the mega-market for enterprise software…we have a lot more opportunity internationally.” Translation: we’ve lost a lot of money in the US, we’ve got a long runway of losses coming internationally. Benioff continues: "We believe that there is huge opportunity in the enterprise, huge opportunity in the mid-market, huge opportunity in the small market."
Salesforce.com has been pumping the TAM in an expert way since their early days. Here is a great passage to study and refine for your own purposes from George Hu, CRM's COO at the Wells Fargo Technology Transformation Summit on April 4th, 2012:
"I think the most important thing to understand about salesforce.com is that we – because of this massive secular shift that we're riding, that we just have tremendous distribution opportunities everywhere in the world. And that we are fundamentally a distribution constrained company, which is why we're investing so much in distribution. And that we're very different than the other traditional enterprise software companies because we – our mantra we like to say is, like, a third of our business is small business, a third is medium, a third is enterprise and that's very different. We have in some ways – at least right out of the chute doubled or tripled the total addressable market that most of these companies have in the traditional old days. And so that just means that in the markets that we already have some – you would think of as the more mature markets, we just still have a lot of opportunity, like we see tremendous opportunity all over the world but even in Americas, which is kind of our home base where we just see tremendous return to that distribution investment and we're just pouring it on. There is just – I think we've really hit the tipping point in the Americas...there is so much energy there. And so, I think that's one of the big drivers actually of why Americas is just growing so quickly is that's hit that tipping point. And, I think that – in terms of the rest of the international strategy...I think you're going to see some exciting – even more exciting frankly results there."
Let's travel back in time to May 2012 when Adam Holt from Morgan Stanley did a bottom up analysis trying to estimate the total true number of Salesforce.com users. He had the insight to include jobs such as dental assistants, legal secretaries, and bank loan officers as potential users of CRM and came up with an added 15 million potential users to Salesforce's TAM.
In the report's opening paragraph Morgan Stanley says, "Industry analysts currently peg the market at $5 billion, we believe the market could be 4-7x larger or $23-38 billion." Holt used this bottom up analysis to raise his price target and raise estimates. Never mind their adjusted EPS estimates using the flawed analysis derived a $2.16 2014 EPS estimate, with consensus estimates now a full 84% lower (consensus now sits at 34 cents adjusted EPS for 2014 and -42 cents for GAAP EPS) than that as of this writing. (source: Morgan Stanley report: Bigger Sales Potential in Salesforce, May 9th, 2012. Earnings estimates source Bloomberg)
Now fast forward to November 7th, 2013 to another Morgan Stanley report from Keith Weiss, who swallows the hype management has spoon fed him and finds a way to peg the TAM at a measly $100 billion. The report breaks it down as follows:
- "Sales Cloud: $23-39B opportunity based on 49-53 million potential sales seats worldwide. This suggests ~6% penetration of the opportunity by Salesforce.com today (at he midpoint) versus industry analyst average estimates of a $5B market, implying an average 33% share.
- Service Cloud: $6-11B opportunity based of 10-13 million potential customer service seats worldwide. The midpoint of our estimates suggests ~7% penetration of the opportunity today, below industry analysts’ average view of 13% share by Salesforce.com.
- Marketing Cloud: $30B+ opportunity based on a percentage of digital marketing activities related to external spend on technology vendors. Salesforce.com has penetrated <1% of this opportunity to date.
- Platform Business: $30B+ opportunity based on 15-35% potential penetration of the global base of 400-600 million information workers. Our analysis suggests <2% penetration of the opportunity today versus industry analysts suggesting an average 8% share today." (Source: Morgan Stanley report, Salesforce.com, Stronger for Longer $100B+ Opportunity Ahead.)
As you can see, the perceived increased TAM is likely the single most important hype-metric driving CRM's stock price and here once again it resulted in a stock upgrade and 21% price target hike. If possible, pumping your TAM should start in your S-1 filing, but if you are just now taking over a company it's not too late to begin hyping your TAM, no matter how mundane your industry.
Recommended further reading: Any Salesforce.com Investor conference and earnings call transcripts or company presentations. Review Raptor Pharmaceutical Corp's conference call transcripts for how to hype a very constrained TAM. Review Exact Sciences conference transcripts on how to hype an inferior product in a competitively crowded landscape.