This Week in Startups - Emergency Pod! Microsoft in talks to buy Discord for $10B+; breaking down their thesis, Discord’s business & more | E1190

Episode Date: March 26, 2021

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It's an emergency podcast. Microsoft is going to buy Discord for $10 billion. That's right. Microsoft is in talks to buy chat app Discord for 10 billion. Let's get to it. Do you ever wish you invested early in some of the best performing IPOs of 2019 and 2020? Well, our crowd investors did invest early in many of those awesome IPOs. With Our Crowd, accredited investors can invest directly and easily in,

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Microsoft has been in talks to buy Discord for $10 billion. That is a big, big number. And most people don't even know what Discord is. So let's go through in this podcast, why they want to buy it, what Discord is, a little bit of the history here, and what we think the downstream second-order effects of this purchase might be. Discord, of course, is a text-based messaging app. Most people would just compare it straight up to Slack.

Slack is for enterprise, Discord, kind of for everything else, especially gaming. And a server on Discord is essentially the equivalent of a workspace on Slack. So you start a server about a topic. And you saw this kind of grow out of Reddit. A lot of great things will grow out of Craigslist or Reddit. Kind of the platforms that have established themselves and reached Critical Mass, also Twitter. So Clubhouse, Bill. off the back of the social graph on Twitter, obviously. Reddit has been building basically Discord

without even knowing it because people who are on a message board, maybe they want to have a real-time discussion. So I'm on a Mark Knopfler message board, a Dio Shreitz message board on Reddit, but then I found out they have a discord and there's 100 or 200 people who are absolute maniacs talking about bootlegs and special tracks and their favorite Mark Knopfler songs. It's all very geeked out. But there is something to it. And the software is quite elegant, I will say. a little bit hard to get your head around Discord when you first get on there because it's got a lot of power user features. So in June of 2020, after COVID hit, Discord capitalized on the stay-at-home orders. They changed their tagline simply to your place to talk. And of course, they allow voice as well

as text. But I think most people are doing text. I actually don't know actually what percentage is text versus audio. But I'm pretty sure it's going to be mostly text. And so they're targeting things like books, music, art, TV shows, not just gamers anymore. So they're really trying to open the aperture and be about more than just games. And they had some controversy earlier this year when they shut down the Wall Street Betts Discord server. So Reddit doesn't have its own version of Discord, which is crazy. You would think Reddit would see this happening and just decide to build it into Reddit. They haven't yet. Wall Street Betts, those were the people involved in the game stop shorting and the back and forth. They had their community.

turned off, it had 600,000 members in it. Think about how big that is. 600,000 people. That's more than are watching a typical cable news station during the day, just for that one community. And it might have been that people were saying inappropriate things as people are apt to do in an anonymous chat room. Anonymous chat rooms are not a safe space. They are places where people are going to say crazy stuff. And so the server was banned just for a day. And then after it was reinstated, They helped them essentially set some rules for these communities. And it might have been a little bit of a conspiracy there. There might have been people who were against Wall Street bets

who just wanted to stop their coordinating efforts. In other words, the revolution was being coordinated in all likelihood in that Slack room, I'm sorry, in that discord room more than in the message boards on Reddit. Does that make sense to everybody? Reddit is like everybody on Wall Street bets. But then there's that subculture of the really high-end people, the really obsessive people, they're in the chat room. Just like my Mark Knopfler, Dyer Straits,

Reddit, room, you know, for the message board might be people who check it every week or two, but people who are obsessed, they might have Discord open all day long to give you an idea of the metrics. 140 million monthly active users, obviously, that's not people who signed up. Those are people who actually use the product in that month. So when we're looking at companies, looking at the daily active users weekly, monthly, as well as things like downloads or how many people are registered, these are all important metrics.

But our industry has gotten really focused on how many people use your product, every month. It's a pretty good North Star. Well, comparing that to something like WhatsApp, which is global in nature and appeals to everybody, they have 2 billion monthly active users. So if part of the aspiration here is to compete with WhatsApp, which I don't think it exactly is, they need only 10x the product to be in a similar range. Facebook Messenger, 1.3 billion, we chat, 1.2 billion, Snapchat, about 500 million, telegram 500 million. It's kind of right behind those, which is why it's a great acquisition target. Microsoft, can put their weight behind it.

Maybe they double, triple, quadruple, even 10x, that user base for Discord. So how does Discord make money? They sell $100 a year premium subscription called Nitro, and also by taking fees from the game sold on their servers, like an affiliate fee. The benefits of having the Nitro, you know, the pro user account, is that you can do larger file uploads. That might be interesting for people who might be trading assets. Like, I don't want to say it, but wears.

Hack software, videos, movies, TV shows, audio, files, HD video screen sharing, which is kind of cool, extra server support and personal profiles on the service. The core app is basically free. So users only pay when they try to access those premium features. It's kind of similar to Slack in that regard. But we created a this week in startup Slack, but Slack is now trying to charge us and would it be $20,000 a month, which a quarter million dollars to pay for something that doesn't make

any money for us makes no sense. So I'm going to probably move our Slack over to Discord because Discord is free. And we don't need any of those premium features. So Discord was rumored to be up for sale back in 2018, but they didn't proceed with buyers due to CEO Jason Citron's allegedly opposing the ad-based business model proposed by the would-be buyers. Discord had $130 million in revenue in 2020, according to the Wall Street Journal. A $10 billion valuation would be just under a hundred times revenue, right?

So 100 times $100 million to be $10 billion. And so $130, you know, roughly 80 times would be about that. the range we're talking about here, 75, 80 times. Top line revenue. According to LinkedIn, they have about 800 people working at the company. Maybe it's closer to a thousand, 876 to be exact on LinkedIn. That's a good place to look for numbers. I always think LinkedIn undercounts it, but in some cases it overcounts it because people might put, I went to, you know, the launch accelerator and then they come up as an employee, right? So there's a little bit of a funky thing that can happen with the numbers there. So here's a history of

Discord. All right, Jason Citron from Discord has a very similar path. Two, this chat supremacy as Stuart Butterfield from Slack. If you don't know, Stewart started two different video game companies, and neither of them worked as is apt to happen because video games are a hit-based business. They're very hard to raise money from venture capitalists. Don't invest in video game businesses because it's a hit-based business. In other words, they would much rather be in a platform. So his first game, which was called Game Neverending, that pivoted into Flickr.

Flickr got sold for, I think, $25, $30 million to Yahoo back. in the day still exists, actually. It was sold to Smug-Mug, I believe. Then Stuart left Yahoo and went on and he started a new game in 2008 called Glitch. That too failed or failed to get traction. I shouldn't say it's a failure. Just fell to get traction as games are apt to do. Very expensive to build a game and chances of success very low. And so Stewart then focused on taking their internal chat app, which was Slack and making it into Slack, which obviously got sold to Salesforce. for close to $30 billion, which is probably a great deal for Salesforce,

as we talked about on another emergency part. So for Jason Citron, he sold his social gaming site OpenFaint to Gray, which is a Japanese gaming company for $100 million. And then when he was working on his next gaming project, he noticed how awful voice messaging software was, which makes it hard to strategize with your teammates while you're playing online, you know, kids and headsets.

So when you're doing desktop gaming, there really wasn't a standard for that. like there is, like on your Xbox or PlayStation has that built in. When that project, his video game, wasn't getting traction, aka failing, he pivoted to create Discord to meet the needs of his user. Here's a 50-second clip of Citron from 2018 discussing the plan behind pivoting to Discord. So we were building this game and through the experience of working on it and talking with our customers and reflecting on our own behavior, we noticed that the tools that people

were using to communicate inside the game with the people they're playing with were not great. That also caused us to sort of reflect and look at the way that we were playing games on PC and the tools that we were using like Skype, which was really popular at the time for this, and noticed that they weren't that great. You know, people are playing these super fresh, modern games that are pushing the boundaries of technology and using messaging and voice tools that had kind of fallen out of favor, almost built in a different time. And so we came up with this idea of what if we built from scratch,

an amazing voice and text chat experience for people that play multiplayer video games. And that's what we built. It's called Discord. There you have it. Challenged video game folks. Moving on and creating chat. Obviously, this is a trend that we've seen before. Raul worked on Roonscape before Reportive and Superhuman, which were investors in both of those.

You know, if you can make a video game that engages people deeply, making a chat room, pretty easy, right? Making communication software? pretty easy when compared to making a game, which again is a very fickle business like making a movie or an album, hit song. Nobody knows what's going to connect with consumers, so it's really hard.

So I guess what we need to look at here is Microsoft buying this for $10 billion. Slack got bought for, I think, around $28 billion. So Slack had $900 million in revenue. They sold for about 30 times revenue. Discord has $130 million in revenue. They would be selling here for $75 times revenue. Seems like they're paying twice as much.

for this. However, Microsoft has a ton of money and they might have a thesis, a theory, a plan, a strategy that they can make this money back. So that's typically what you're going to see. When there's an acquisition, the acquiring company has done some math in which they believe they could be a catalyst to the company in a way the company would not get there organically. And that really makes for a great, great acquisition for both sides. WhatsApp and Instagram come to mind for Facebook. Did they really help those products row and scale? of course they did. Would those apps been as successful if they just kept going? Probably 80, 90% as effective. Those are two examples where Facebook didn't screw up the acquisitions. Then you look at the

acquisition of YouTube. Oh my lord. You know, that company was on the brink of insolvency because of all the lawsuits. Obviously, Google had just mountains of cash to fight that lawsuit and had tons of servers to store all of those video files, which at the time when they bought YouTube, the server bills and the storage bills were crushing for a company like YouTube, really hard to manage those things. So sometimes there's a theory to grow these things. And in the case of Discord, we'll see what that theory is. Are they going to go enterprise or do they want to go more consumer? Well, because they have Microsoft Teams, which is a product, they created specifically as part of the office, you know, offering to compete with Slack, it doesn't seem like this is designed to boost or to boost

that. They've already got that. They already built it. So this really is probably about the Xbox and Minecraft and that division, the consumer division, and getting people to embrace Windows and to embrace Xbox and to just, you know, sort of give them that foothold in community, which they don't really have. I mean, they do have Bing the search engine, but that doesn't have any community. And if you look at Google, they also don't have any community,

with the exception of YouTube, which is a pretty gnarly community. Facebook obviously has a big community. Amazon has a growing community with Twitch. And so most of these great tech companies have some sort of community. Apple does not, obviously, because community is so hard to manage. So be prepared for Microsoft to have to deal with people doing all kinds of offensive stuff, planning, God forbid, a terrorist attack using one of these servers. All this technology and managing a community and letting people go crazy on it is very challenging. It's one of the reasons why Disney and Bob Eiger canceled the acquisition of Twitter,

if you didn't know about that. So Microsoft obviously really cares about gaming. Satya Nadell has been very clear about this. And they see their Xbox gaming subscription as Netflix for games. They've made that a strategic priority with this Xbox gaming pass, which is 15 bucks a month, which gives you a bunch of premium versions with all the cloud gaming services. You know, Microsoft bought Zeni Max media for $7.5 billion.

They do Bethesda and a bunch of Elder Scrolls, Fallout, the Doom franchises. And so we'll just throw it here to Emily Chang from Bloomberg talking in September of 2020 to the head of Xbox, Phil Spencer. We see gaming as a really strong growth category. It has been for many years. You know, three billion people play video games on the planet, half the connected world. It's nearly a 200 billion dollar, top line business. Both of those numbers growing by double digits. So gaming is just a secular trend in entertainment, people moving from passive entertainment to activity. entertainment. You see it. Kids everywhere playing video games, Minecraft, Fortnite. It's just a really strong place for Microsoft to make an investment with the transformations we're seeing in the business. When I look at our growth aspirations in the consumer space as Microsoft, I think our investments in gaming and reaching communities everywhere is going to be critical to our long-term success with consumers. All right. So obviously Microsoft has got a plan here. And when Microsoft

makes a plan, it's typically a multi-decade plan. They're not in it for the the next two or three years, they really, you know, as a company that's existed since, gosh, you know, through the 80s, 90s, 2000s, and now in their, arguably their fifth or six decade now, they really care about this. Here's a tweet from Satya. Three billion people look to gaming for entertainment community and achievement. Our ambition is to empower each of them wherever they play today is a step forward on that journey and we welcome the beloved studios and franchises. So they care deeply. This is part of that. If they care deeply, this is part of that. If They can sell more games or they can sell more Xbox game passes with the, with Discord.

That would be in sync with the founder's wishes, Jason Citron's wishes, to not be an ad-based one. In other words, they're just going to upsell people on the ultimate game pass and, you know, make the money back that way, which seems to be a great strategy. In summary, Microsoft's almost a $2 trillion company and $10 billion is a very small amount for them to spend on a business, even though it's a colossal number. if they were to lose the whole $10 billion, it would be a swing worth taking. And if it works out and it becomes a YouTube or an Instagram like investment, my God, this could go global. And they would have all of this hardware locked up with the Xbox, the surface, they're doing PCs, obviously. They'd have the software. They'd have the content with all their game studios now. And of course, the Minecraft purchase, so God, I left that out. And now they would have the communication platform

to support all this and not have to rely on Skype. big companies make these big acquisitions. They make mistakes sometimes. But think of about it like a portfolio. If Skype or Yammer or any other product winds up getting deprecated or they stop investing in it and they switch, right? Because you're like, well, why are they still doing Skype when they're doing this Microsoft Zoom competitor, right?

Or what do they do with Yammer? And then they did teams. All of these purchases, a billy here, 10 billy here, all you need is one to work out. And if you look at the history of Microsoft, I believe their presentation soft. Power PowerPoint and Excel were both acquisitions. And of course, Google bought Android and YouTube. Think about where Google would be if all they had was search in Gmail and they didn't have Android sending all that traffic to their search engine or if they didn't have YouTube

to sell video-based ads and they were only selling the click-based ads on search. These were two super critical acquisitions by Google. And then, of course, Facebook would not be anywhere near where it is right now if They had not purchased Instagram and WhatsApp. And Apple, not very acquisitive. Probably a mistake on their part, but their style works for them. It's still a money printing machine. This has been another emergency pod from This Weekend Startups.

We'll see you next time. Bye-bye. This Week in Startups is brought to you by Our Crowd. Our Crowd helps you invest early in pre-IPO companies alongside professional VCs. If you're interested in investing, you can join Our Crowd for free at OUR. CROWD.com slash twist.