Investors and Advertising technology: Rocket Fuel lists for IPO

Yesterday the Ad-tech company Rocket Fuel, listed and raised $116m at a valuation of $1b. Before the end of the day the share price had almost doubled, raising the valuation to almost $2b. The S-1 filing for describes the pretty tempting proposition that Rocket Fuel is a company founded by ex-NASA scientists (hence the name of the company) who have developed an artificial intelligence system that is capable of trialing thousands of advertising targeting techniques and purchases each second, learning from the results, and optimizing the future ad spend based on this constant feedback. Apparently these guys got sick of spending their time on the frontiers of science and have decided to create Agent Smith from the Matrix, and then make him focus on digital advertising.

Combine this apparently genius team with a massive market (US$43b digital display market), a growing customer base and revenues, and it is easy to see how investors will get carried away.

My doubts on this subject are not about whether the company will be successful – who am I to doubt a rocket scientist My problem is with the money managers that I suspect are now entering this area.

One of Peter Lynch’s rules was “never invest in anything that you can’t explain with a crayon”. I am relatively sure that Rocket Fuel’s 2 main shareholders (Nokia Growth Fund, and a Tech focused VC Mohr Davidow) more or less understand what is going on under the hood of this Artificial Intelligence learning machine, could probably explain it using a crayon, and that is why they are technology investors. However, although the dust has not settled from the IPO on Friday given the massive jump in valuation on day 1, when things calm down you can be sure that on the main shareholders list there will be several funds that spend most of their time studying and investing in the fortune 500. I suspect most would have little to no understanding of how this “product created by rocket scientists” is superior to all the other digital advertising optimizing companies out there, and are relying on the “customer numbers are growing, so it must be good” argument. I can accept that. However, I would like the funds to admit that as they are valuing the company at a ~20x multiple of forward earnings, which is higher than Facebook currently trades at, this is a high risk bet.

So we have large, high risk investments from fund managers who don’t understand the products they are investing in. I’ve never seen that end badly.

Lachlan Champion de Crespigny