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Digitization in Europe
PHIlIpp FREISE Member, Private Equity Head of KKRs European Media Industry Team
Attractive Opportunities
16 Outlook
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Digitization in Europe
The wave of digitization a series of trends that have transformed how we shop, consume media and drive efficiencies in all aspects of doing business is well advanced in Europe in our view. The European Union alone boasts approximately 368 million online users and 193 million Facebook users1 versus 245 million online users and 166 million Facebook users in the U.S.,2 and a broadband penetration rate of 72 percent3 (vs. 70 percent in the U.S.).4 In 2012, European business-to-consumer (B2C) e-commerce grew by 19 percent to reach 311.6 billion,5 according to Ecommerce Europe. In fact, the United Kingdom (UK) has the highest e-commerce penetration globally with 87 percent of the UKs Internet population having bought a product or service online versus 43 percent in the U.S.6 Mobile adoption has also been rapid, with smartphone penetration in the UK and parts of Northern Europe already being higher than in the U.S.7 So if European consumers and businesses have so fully embraced the digital economy, why is it essentially dominated by U.S. companies like Google, Amazon, Facebook and others?8 Why is the digital balance of trade so skewed toward the U.S. with Europe being a large net importer of digital services and technology from the U.S.? Is this imbalance changing and what could be the potential drivers behind such a change? The following analysis explores these questions, drawing on KKRs insights as well as interviews with leading entrepreneurs, investors and officials from across Europe. We will discuss the key structural advantages that are underpinning Europes digitization. In addition, we will explore the key reasons why Europe is lagging behind the U.S. in the creation of successful global digital powerhouses. In particular, this paper will examine the role that limited access to growth capital may be playing. We will also discuss an emerging funding chain that is developing around a complex international eco-system, which will hopefully help Europe to unlock its full digital potential, and in which private equity can play an important role. Finally, we will look at the potential of large exits to energize the European digital landscape and reinject capital into the next generation of startups.
1 Internet World Stats, European Union. Retrieved 22 October 2013. 2 Internet World Stats, European Union. Retrieved 22 October 2013. 3 Eurostat News Release. Internet access and use in 2012. Eurostat Commission 2012. Available at: http://europa.eu/rapid/press-release_STAT12-185_en.htm 4 Pew Internet. Home Broadband 2013. Pew Internet, 2013. Available at: http://pewinternet.org/Reports/2013/Broadband/Findings.aspx 5 Ecommerce Europe. European E-commerce to reach 312 billion in 2012. Ecommerce Europe, 2013. Available at: http://www.ecommerce-europe.eu/ press/2013/05/press-release-european-e-commerce-to-reach-312-billion-in2012-19-growth 6 Digital Strategy Consulting. Global ecommerce penetration by country: 2013. Digital Strategy Consulting, 2013. Available at: http://www. digitalstrategyconsulting.com/intelligence/2013/08/global_ecommerce_ penetration_by_country_2013.php 7 Google. Our Mobile Planet. Google, 2013. Available at: http://www. thinkwithgoogle.com/mobileplanet/en/graph/?country=no&country=se&count ry=uk&country=us&category=DETAILS&topic=Q00&stat=Q00_1&wave=2013 &age=all&gender=all&chart_type=&active=stat 8 See Most visited website per Country visualization created by the Information Geographies department at the Oxford Internet Institute. Available at: http://geography.oii.ox.ac.uk/
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Europes Key Advantages: Multiple Hubs of Innovation, Great Talent and Experience with Internationalization
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created various tax incentives for investments in startups and boasts a lower corporate tax rate than the U.S. and most European countries. Stockholm has also become a thriving digital hub. Despite a population of only 9.6 million as of August 2013,11 Sweden boasts a disproportionate number of high-quality success stories like the music-streaming site, Spotify, the online payments company, Klarna, and the online advertising company, Tradedoubler. Although Swedish start-ups may face the disadvantage of a small home market and high cost of living, they benefit from a population of early adopters. Together, with access to high-quality engineering and design talent, this makes for an excellent test market, from which companies with global aspirations can expand to the rest of Europe or the U.S. Berlin has similarly emerged as a serious digital media hub, although it has not seen yet the quality success stories that London
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Number in 1,000
32.0 2 7.5
In Londons Silicon Roundabout, some 1,300-1,400 digital and media startups are creating new jobs and have transformed East London into a global entrepreneurial hub.9 The UK attracted $656 million in venture capital in the first half of 2013, which compares to $1.8 billion for all of Europe.10 London is benefitting from its role as the financial and media capital of Europe and is able to attract talent from all over the world. The British government has, moreover,
9 Bloomberg. Hipsters Flocking to Silicon Roundabout as Bankers Fade. Bloomberg, May 13, 2013. Available at: http://www.bloomberg.com/ news/2013-05-14/hipsters-flocking-to-silicon-roundabout-as-bankers-fade. html 10 DFJ Esprit. Scarcity of follow-on start-up funding exposed DFJ Esprit, July 22, 2013. Available at: http://www.dfjesprit.com/news/scarcity-offollow-on-start-up-funding-exposed-in-first-half-of-2013-as-uk-surrenderslead-to-france-in-european-venture-deals-over-usd-5million/
and Stockholm can showcase. In the first half of 2013, Germanspeaking countries including Germany, Austria and Switzerland collectively captured $343 million of the total invested in venture deals.12 Berlin offers a combination of low rents, a highly creative and trendy culture, affordable talent and an advanced network of accelerators and incubators. The city boasts thriving digital companies such as SoundCloud, founded by two Swedes who relocated to be near Berlins thriving music scene, as well as the scientific-research network, ResearchGate. The Silicon Sentier in Paris is powered by high-quality
11 Statistics Sweden. Population Statistics accessed October 22, 2013. Available at: http://www.scb.se/Pages/Product____25799.aspx 12 DFJ Esprit Op cit.
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engineering talent from Frances Grande Ecoles. Talent in Paris is competitively priced relative to Silicon Valley and other markets. Equity pools to attract key employees are often lower in France than in the U.S., where startups typically hand over 10 to 20 percent of their equity to employees.13 Cyrille Vincey, CEO and founder of Paris-based data visualization startup Qunb, says such pools typically represent 3 to 5 percent in France, in his experience. Investors and entrepreneurs, however, have recently been rattled by the French governments intervention in the attempts of Dailymotion to sell a controlling stake to Yahoo! Berlin is also the European capital of incubators. Rocket Internet, which calls itself the worlds largest Internet incubator on its website, is a prominent global player. Incubators like Project A Ventures (funded by German Otto Group and the media company Axel Springer) or EPIC (funded by the German media company ProSiebenSat.1) are more focused on Germany and Europe. Incubators either develop and execute business models by themselves or help entrepreneurs to fund and execute their ideas. In the latter case, incubators not only provide funding to entrepreneurs, they also give access to an in-house backbone of operational support services such as online marketing, data warehousing, web development and sales. While entrepreneurs usually have to give up a larger share of their ownership in an incubator-funded model, they can benefit from an operational machine that potentially de-risks their execution. Finally, Helsinki, Finland is associated with the successes of the mobile phone maker Nokia and Angry Birds maker Rovio. While Nokia is struggling with the transition to smartphones, we believe it has provided Finland with strong experience in developing mobile apps and platforms. Supercell, the company behind the no.1 mobile game hit Clash of Clans, is just the most recent example of Finlands mobile development prowess. The company was founded in June 2010 and announced the sale of a 51 percent stake to SoftBank for $1.5 billion in October 2013.14 Other notable hubs in Europe include Barcelona, Amsterdam, Moscow and Tallinn.
market.15 This inborn roll-out DNA is becoming more and more valuable as the relative share of the U.S. in the digital marketplace is decreasing and truly global online economies are formed. In 1996, two-thirds of global Internet users lived in the U.S. Sixteen years later, U.S. users represented only 13 percent of the global total, an indication of how much of the world has gone online, according to a recent digital trends report by comScore.16 We believe European companies are well positioned in the cyber land-grab that is currently unfolding in many online verticals to penetrate these high-growth markets. Rocket Internet, for example, has been rapidly rolling out its incubator business to Latin America, Eastern Europe, Africa and Asia. It now boasts seven offices in Latin America, five in Asia and four in Africa, which have been set up to roll out attractive business models globally. The company intends to invest a significant portion of the more than $500 million-plus it raised in July 2013 into emerging markets such as Latin America, Asia and Africa.17
15 The Wall Street Journal. Skype Founder to Students: Dont Follow the Obvious Path. WSJ.com, March 11, 2011. Available at: http://blogs.wsj.com/ venturecapital/2011/03/11/skype-founder-to-students-don%E2%80%99tfollow-the-obvious-path/ 16 comScore. State of the Internet Q1 2012. comScore. 17 The Wall Street Journal. Rocket Internet Raises $1 Billion in a Year. WSJ.com. July 16, 2013. Available at: http://blogs.wsj.com/techeurope/2013/07/16/rocket-internet-raises-1-billion-in-a-year/
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Berlin
GerMANY
SOUNdcLOUd AcTIVITY
WOOGA AcTIVITY
MAdVerTISe AcTIVITY
EYeeM AcTIVITY
Online games
FOUNded
Online Advertising
FOUNded
2009
FUNdING TOTAL
2008
FUNdING TOTAL
2007
FUNdING TOTAL
2011
FUNdING TOTAL
$32.2 million
FOUNderS
$10 million
FOUNderS
$63.3 million
FOUNderS
$6 million
FOUNderS
Carsten Frien
keY BAckerS
Doughty Hanson Technology Ventures, Union Square Ventures, Index Ventures, Kleiner Perkins Caufield & Byers, GGV Capital
Point Nine Capital, Earlybird Venture Capital, Blumberg Capital, Felicis Ventures
Helsinki
FINLANd
ROVIO ENTerTAINMeNT
SUperceLL AcTIVITY
Online games
FOUNded
BITBAr AcTIVITY
AppLIFIer AcTIVITY
(Angry Birds)
AcTIVITY
2010
FUNdING TOTAL
Online games
FOUNded
$272 million
FOUNderS
Online games
FOUNded
2008
FUNdING TOTAL
2003
FUNdING TOTAL
$42 million
cO-FOUNder
Visa Forsten, Lassi Leppinen, Petri Styrman, Mikko Kodisoja, Ilkka Paananen
keY BAckerS
1995
FUNdING TOTAL
$6 million
FOUNder
$3 million
FOUNder
Jussi Laakkonen
keY BAckerS
Niklas Hed
keY BAckerS
Marko Kaasila
keY BAckerS
Accel Partners, London venture Partners, Index Ventures, Atomico, Institutional Venture Partners, Initial Capital, Lifeline Ventures, Cerval Investments
Finnvera Venture Capital, Creathor Venture Management, DFJ Esprit, Qualcomm Ventures, Draper Fisher Jurvetson (DFJ)
Lifeline Ventures, MHS Capital, PROfounders Capital, Webb Investment Network, Tekes
London
UNITed kINGdOM
BAdOO AcTIVITY
SHAZAM AcTIVITY
HAILO AcTIVITY
Social Network
FOUNded
Online games
FOUNded
2006
FUNdING TOTAL
2002
FUNdING TOTAL
2003
FUNdING TOTAL
2010
FUNdING TOTAL
$30.6 million
keY BAcker
$72 million
FOUNderS
$10 million
FOUNder
$50.6 million
FOUNderS
FINAM Global
Kleiner Perkins Caufield & Byers, Institutional V enture Partners, DN Capital, Amrica Mvil
Russell Hall, Gary Jackson, Terry Runham, Jay Bregman, Caspar Woolley, Ron Zeghibe
keY BAckerS
Accel Partners, Atomico, Wellington Partners, Red Swan, Union Square Ventures, KDDI, Richard Branson, Felicis Ventures
Paris
FrANce
CrITeO AcTIVITY
JOLIcLOUd AcTIVITY
DeeZer AcTIVITY
VIAdeO AcTIVITY
Online advertising
FOUNded
Music streaming
FOUNded
2005
FUNdING TOTAL
2006
FUNdING TOTAL
2004
FUNdING TOTAL
2009
FUNdING TOTAL
$149 million
FOUNder
$50.2 million
FOUNderS
$4.2 million
FOUNderS
Daniel Marhely
keY BAckerS
IDInvest Partners, Elaia Partners, Index Ventures, Bessemer Venture Partners, SoftBank Capital
Access Industries, IDInvest Partners, CM-CIC Capital Prive, Xavier Niel, Dotcorp Asset Management, Business Angels
Stockholm
SwedeN
2006
and sharing
FOUNded FUNdING TOTAL
NArrATIVe
KLArNA AcTIVITY
TIcTAIL AcTIVITY
(formerly Memoto)
AcTIVITY
Ecommerce
FOUNded
Life-logging camera
FOUNded
$288 million
FOUNderS
2005
FUNdING TOTAL
2012
FUNdING TOTAL
2012
FUNdING TOTAL
$166 million
FOUNderS
$1.57 million
FOUNderS
$3 million
FOUNderS
Creandum, Northzone, Horizons Ventures, Wellington Partners, Sean Parker, Founders Fund, Kleiner Perkins Caufield & Byers, Accel Partners, Digital Sky Technologies, Goldman Sachs, Li Ka-shing
True Ventures
Balderton Capital, Klaus Hommel, Gustav Sderstrm, Fredrik Nylander, Gustaf Alstromer
Tallinn
eSTONIA
TrANSFerwISe FITS.Me AcTIVITY
GrABcAd
(Headquartered in London)
AcTIVITY
ErpLY AcTIVITY
2010
FUNdING TOTAL
2010
FUNdING TOTAL
2009
FUNdING TOTAL
$8.95 million
FOUNder
2009
FUNdING TOTAL
$7.37 million
FOUNderS
$4.22 million
FOUNderS
Heikki Haldre
keY BAckerS
$13.6 million
cO-FOUNder
SmartCap, Conor Venture Partners, Fostergate Holdings, Entrepreneurs Fund, Estonian D evelopment Fund
Hardi Meybaum
keY BAckerS
Matrix Partners, Atlas Venture, Charles River V entures, NextView Ventures, David Sacks, John McEleney, Alex Ott, Angus Davis, Jon Stevenson, Seedcamp, Techstars
Seedcamp, Redpoint Ventures, Index Ventures, Marten Mickos, Kenny Van Zant, Zack Urlocker, The Accelerator Group, 500 Startups, Felicis Ventures, Dave McClure
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Europes Key Disadvantages: No Uniform Home Market, Stigma of Failure and Limited Access to Growth Capital
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Despite these differentiating factors, we believe Europe is suffering from three important structural issues that have put European companies at a disadvantage to their U.S. peers.
U.S. competitors on the other hand can gain scale faster, accumulate capital and can then challenge European players in their home markets, or alternatively simply buy them out. Examples include Groupons acquisition of MyCityDeal or eBays acquisition of various local listing sites in Europe. This phenomenon of strategic take-outs of local European players by U.S. companies is one of the key reasons why the digital balance of trade is so skewed towards the U.S.
b) Stigma of Failure
Culture and regulatory factors may also be constraining the growth of European companies in the digital space. Historically, the stigma attached to failure in a business or bankruptcy has been more pronounced in Europe than in the U.S. A 2012 poll by the European Commission, for instance, found that roughly half of EU respondents said the risk of failure would deter them from starting their own businesses. The aversion to failure tends to vary by country, ranging from 66 percent of respondents in Portugal to 52 percent in Germany, and from 48 percent in Sweden to 38 percent in the UK.18 By comparison, 2012 polls by the group, Global Entrepreneurship Monitor, found that fear of failure would deter only 32 percent of respondents in the U.S. In addition, bankruptcy laws in European countries have historically often resulted in full liquidation despite protracted proceedings, forming another deterrent to risk-taking startups. Until a recent change in the bankruptcy code, Italian bankruptcy proceedings,
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20 0 5
20 0 6 Investments
20 0 7
20 0 8
20 0 9
20 1 0
20 1 1
20 1 2
Divestments
18 European Commission. Entrepreneurship in the EU and Beyond. EC. May 23, 2013. Available at: http://ec.europa.eu/public_opinion/flash/fl_354_en.pdf
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for example could last a decade. But several countries including France, Germany, Spain and Italy have now adopted laws similar to Chapter 11 in the U.S., which may afford companies some protections. In Germany, for example, companies can now more easily convert debt to equity and attract new investors.19 We also believe a shift in attitudes is taking place in Europe, with entrepreneur becoming an increasingly viable and desirable career choice, especially as traditional industries, including financial services, have declined since the financial crisis began in 2007.
19 Global Entrepreneurship Monitor Fear of Failure data. Available at: http:// www.gemconsortium.org/visualizations 20 The Wall Street Journal. Europe Builds Own Chapter 11. WSJ.com, April 5, 2013. Available at: http://online.wsj.com/news/articles/SB1000142412788732 3296504578398612178796882 21 British Venture Capital Association. European Venture Capital: Myths and Facts. BVCA. January 2013. Available at: http:// www.bvca.co.uk/ResearchPublications/ResearchReports/ EuropeanVentureCapitalMythsandFacts.aspx
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If one combines the high level of digital adoption by European consumers and businesses with the quality of talent, creativity and diversity of its multiple tech hubs, one would think that Europe offers a good supply of investment opportunities. On the other hand, capital supply, in particular in the critical growth stage of a startup, is scarcer than in the U.S. and capital markets are often not an option to raise capital or exit a company. This supply/demand imbalance can lead to attractive investment opportunities for investors, as deal competition is more limited and the resulting valuation levels are lower in comparison to the U.S.
Jean-David Chamboredon, the head of Paris-based venture firm ISAI summarizes this dynamic well, when he says, Clearly, the competition between investors remains relatively modest, which means that for an ecosystem of startups that in terms of quality competes with the U.S., the entry price for an investor remains much lower. Adding to that, Matthias Ummenhofer, the head of venture capital for the European Investment Fund (EIF), a publicprivate partnership that provides finance to small and medium enterprises across Europe says, Very good companies are being sold at a nice discount.
DIGITAL INVESTMENTS A S
0.8 0.7 (As a percentage of nominal GDP) 0.6 0.5 0 .4 0 .3 0.2 0 .1 0.0 2005 2 0 06 United States
Source: INSEE, CapitalIQ, Global Insight WMM
20 0 7 United Kingdom
20 0 8 France
20 0 9
20 1 0
13
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Attractive valuations and lower levels of competition are leading to an interesting emerging funding chain that is starting to address the European funding gap. In this funding chain, local seed investors, partially supported by government incentives, fund the start-up in its early stages. Supply in this stage is relatively decent in Europe. In the next phase of growth, incubators and accelerators like Rocket Internet, Project A or EPIC are beginning to play a more important role. They combine ample funding, often from European families or traditional media companies, with hands-on support. As mentioned above, incubators are also taking advantage of Europes roll-out DNA to build global businesses from a European home-base. U.S. venture capital funds, VCs, which are facing a highly competitive market in the U.S., are also increasingly investing in Europes digital companies. SoundCloud is a good example of how European companies are taking advantage of the supply of U.S. venture capital and thereby mitigating the fact that homegrown venture funding is scarce. In the Bay Area, there is an abundance of money, so it becomes an entrepreneurs market, says SoundCloud co-founder, Eric Wahlforss. There is so muchopportunity that if you are a savvy entrepreneur, you can pick and choose among the best. SoundCloud raised capital from Union SquareVentures,Kleiner Perkins Caufield & Byersand Index Ventures, among others. In the later stage growth funding phase, private equity funds are starting to take advantage of the fact that European capital markets are often not liquid enough to support companies and founders. They also bring a different skillset than VC funds and can help companies with larger acquisitions or international roll-outs. With this emergence of international capital, entrepreneurs can potentially hold out longer and grow their companies for a much larger exit, according to Per Roman, a founding partner at Stockholm-based investment bank, GP Bullhound AB. Less than a decade ago, startups would have been pushed by VCs to exit at about $100 million in revenue. Now, more risk tolerant investors with longer time horizons are allowing them to build their businesses. Companies in this category include Spotify and Rovio.
For an ecosystem of startups that in terms of quality competes with the U.S., the entry price for an investor remains much lower.
JEAN-DAVID CHAmBoREDoN Head of Paris-based venture firm, ISAI
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In our view, Europes digital economy has great potential. It is buzzing with creativity as well as the diversity that is needed to create innovative new products. It boasts some of the worlds most tech-savvy consumers, benefits from a high-quality talent base that is reasonably priced and can operate from a diverse range of competing hubs like London, Stockholm, Berlin and Paris, to name some of the major ones. Some European governments, in particular in Northern Europe, are supporting these ecosystems with funds and tax breaks. Furthermore, European companies grow up with a roll-out DNA that we believe could give them an edge in expanding beyond their continent.
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Important Information The views expressed in this publication are the views of the KKR Global Institute and do not necessarily reflect the views of Kohlberg Kravis Roberts & Co. L.P. (together with its affiliates, KKR). This publication is not intended to endorse any investment theme or sector. It is being provided merely to provide a framework of the current European digitization landscape and the strengths and weaknesses of this sector. The views expressed reflect the current, good faith views of the KKR Global Institute as of the date hereof and it does not undertake to advise you of any changes in the views expressed herein. In addition, the views expressed do not necessarily reflect the opinions of any investment professional at KKR, and may not be reflected in the strategies and products that KKR offers. It should not be assumed that KKR or the KKR Global Institute will make investment recommendations in the future that are consistent with the views expressed herein, or use any or all of the techniques or methods of analysis described herein in managing client accounts. KKR and its affiliates may have positions (long or short) or engage in securities transactions that are not consistent with the information and views expressed in this document. This publication has been prepared solely for informational purposes. The information contained herein is only as current as of the date indicated, and may be superseded by subsequent political or market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this document has been developed internally and/or obtained from sources believed to be reliable; however, neither the KKR Global Institute nor KKR guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. This publication should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or to adopt any investment strategy. The information in this publication may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning political events and financial market trends, is based on current political or economic conditions, which fluctuate and may be superseded by subsequent events or for other reasons. The KKR Global Institute assumes no duty to, nor undertakes to update forward looking statements. No representation or warranty, express or implied, is made or given by or on behalf of the KKR Global Institute, KKR, or any other person as to the accuracy and completeness or fairness of the information contained in this publication and no responsibility or liability is accepted for any such information. By accepting this document, the recipient acknowledges its understanding and acceptance of the foregoing statement.
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