How to evaluate start ups, the case of Wag

Reminder, I will be off and on over the next month because of a big move. Hope you can bear with me. Please email or DM me (@vieteconpg) on Twitter.

So a few months ago now, people were wagging their fingers at Softbank for their outsized investment in Wag, a company that helps provide on-demand dog sitting and walking. Softbank invested $300m at a $650m valuation to help the company supersize and corner the market.

American households with pet. Source: American Pet Products Association

Of course people thought this was crazy. How could you invest that much money in dog walking?! It was either Matt Levine or Scott Galloway that ridiculed the company and Softbank. I like both of their writing (Levine’s more than Galloway’s), and so I took it on faith.

But then when I started to look into it, I actually realized that maybe the valuation wasn’t totally crazy. Or at least not prima facie crazy.

Source: American Pet Products Association survey results

First, there are a lot of pets in the US. So it’s a big addressable market. Two-thirds of US households have a pet, or 85m homes. And there are more than 60 millions households that have a dog and more than 40m that have a cat.

And pets are expensive. People spend more than $200 a year on routine vet care, more than $250 on food, and $229 on kennels/boarding.

When you add up all of this spending, then it starts to get to really big numbers. The main trade association (and let’s take their numbers with a grain of salt, since they have an vested interest in exaggerating the importance of their businesses), says that total spending was almost $100bn in 2019! And that was up 5.7% over 2019.

Source: American Pet Products Association

Diving in, “other services” was $10bn, and that includes “boarding, grooming, insurance, training, pet sitting and walking and all services outside of veterinary care.” So let’s say that about 75% of this is boarding/sitting/walking, which seems fairly reasonable given that kennel/boarding is one of the most expensive things after vet care and food. This gets us to a total spend of $7.7bn - that’s Wag’s addressable market.

Now, a few things before we tie this up to Wag’s valuation. First, this is just the US. People all over the world have pets. I am sure they spend less than the US consumers do, but I think we could fairly say that world spending is probably at least another $4bn. The UK alone spent almost $9bn in 2019 on all pets and pet services. If the same proportions held, that means UK households spent $700m on kennel/boarding.

Second, I should make a personal note here: I have been a pet sitter/walker on a competing site, Rover. Why? Well, I just wasn’t sure that I wanted to own a dog right now, and this seemed like a good way to try out a number of different dogs and see if a) I wanted a dog at all and b) which type of dog I would want. Plus, I would get a little spending money (I am notoriously thrifty). The experience was mixed. We found one dog that we loved more than life itself. But we also didn’t like other dogs at all. Now I know.

Back to Wag. So, the valuation, as I stated above was $650m, according to press reports. But to value the company at $650m and invest $300m, you have to believe that your $300m will actually turn into something much bigger, say at least 2x as big (if not 3-5x). But let’s say that Softbank was willing to call it a win at 2x, or a $1.3bn overall valuation.

Let’s now back into earnings and revenue - what would be needed to justify this valuation. Say the company trades at a 20x multiple, which is kind of inline with the S&P, that would mean it would need earnings of $65m. Now, let’s assume that it is not the highest margin business, because it has to spend a lot on sales and marketing to get new sitters and new pet owners. Just pulling a number sort of out of a hat, let’s say a 15% margin. Of course, the company would probably dispute this, since it is a software product at heart (they just set up the transaction between sitter and pet owner), but it turns out that these businesses (at least right now) cost more than people expect. See Uber, Instacart, Doordash, etc, all of which are losing money.

Backing into a market share for Wag. Source: Vietecon.com

Earnings of $65m would imply revenues of $433m at a 15% margin. But remember that the company only gets at most 20% cut of the actual booking. Let me explain: you pay a dog walker $25 for a visit, but Wag gets 20% of that, or $5. So the implied bookings value is actually $2.2bn.

Remember we said the market right now is $7.7bn, so this is just 28%. Plus, the company may be able to get more money from targeted advertising of dog food or other pet services. And they could move out of the US into Europe.

Of course it wasn’t crazy that Softbank would expect their company to take more than a quarter of the market. Tech companies end up having quasi-monopolies. Amazon has 50% of the print book market in the US and 75% of the ebook market. Pet services may be different, but maybe it isn’t all that different.

In fact, Softbank’s view is that if they give a company tons of money, they can “blitzscale,” mean grow extremely fast and take over the market before the competition can get there.

And once Wag has 50%+ of the dog walking/sitting business, then maybe it move into other pet services, or even take over some of the stuff that TaskRabbit or Postmates does. If you have thousands of people willing to walk dogs for money, it’s not crazy to think that they would be willing to do some other task for money.

Of course, it turned out that Wag is not doing all that well. Late last year it started laying people off. And that was before a 70% decline in their core business because of COVID. At the same time, it has moved into other pet services, like food delivery and a chat line for owners to talk with vets.

Ultimately this has been a bad investment for Softbank. And maybe blitzscaling isn’t all its meant to be. The company probably hired too many people (hence layoffs), and it probably spent too much on promotions to get customers, but now that all that money has been spent, it could be an alright business.

If Wag makes it through, and does end up grabbing something like 10% of the total pet spending, it would have bookings of something like $10bn. Even with a small cut of 5%, that would be revenues of $500m and a net income of $75m. That wouldn’t be too bad.

And remember that this is all hindsight. At the time, I might have thought that taking a bit more than quarter of the market was extremely do-able. People may have had problems with the business model, but it wasn’t crazy to think: Pet services is a really big market, and this is an interesting way to get into it.

Ultimately, it’s just really hard to make investments. I can’t find the source now, but a recent academic study looked at venture investing, and it turns out the best thing to do is to invest in tons of deals, because no one knows what’s going to work. Maybe Wag was just one of those that didn’t work out. Plus, Softbank got some of its money back, much better than I expect they will get with WeWork.