Unpacking Google’s Acquisition Of Nest

Of all the companies launched in the Valley over the past few years, it would’ve been hard to find one as complex as Nest, the brainchild of the creator of the iPod, who assembled a robust engineering team to build their own integrated suite of “connected home” hardware and controlling software. From the outside, given the top-line success of the company and pedigree of the team, it would seem as if Nest were on a trajectory few companies get to experience: A path to being a huge, standalone, independent technology company. That all changed yesterday, of course, when it was announced that Google would acquire Nest for $3.2Bn, straight cash. It’s a fascinating deal, so I wanted to unpack the acquisition in detail and share some thoughts:

Dissecting Nest’s Decision To Sell

  • Even for the elite, direct-to-consumer distribution is a bitch: Nest completed the improbable task of crafting new integrated hardware and software, but beyond the technology echo chamber, I’d imagine distribution and awareness were problems. To get to real distribution, Nest would’ve needed a sales army corps and/or close tie-ins with real estate developers for new buildings, though this strategy presumes Nest-branded products are desired enough among consumers in purchasing decisions. The only places I see Nest products in the wild are tucked in the back of Apple retail stores, next to other devices which are not as sophisticated (yes, they’re in Home Depot, Best Buy, and others, but it’s the same problem). I also recently heard an ad for Nest on national NPR, which led me to believe they may have been struggling to find the right channels.

  • To keep going, founders would’ve taken on considerable equity dilution: I don’t know the specifics, but I’d guess the founders (Rogers and Fadell) probably owned a combined 50-60% of the company right now. Could they have continued on their march from thermostats and smoke detectors to build alarm systems, motion detectors, garage door openers, or lighting controls? No question, they could build anything. But, to do so would’ve required more venture capital, therefore more dilution, and the distribution challenges would remain.

  • This was likely a “Name Your Price” deal: When I think about other possible acquirers for Nest (excludes Apple, as I’ll explain below), the names that pop up besides Google are Honeywell, General Electric, Home Depot, Cisco, Microsoft, and so forth. While the Nest team and product line is an incredible feat, for a variety of reasons (some irrational) I could not see any of them paying this much for the company. What’s more likely to me is that the Google founders approached the Nest founders and asked them to name their price. The result is that both are perhaps now close to billionaires with an all-cash deal going straight to the bank. Also, by getting cash, this lines the pockets of employees quickly, most likely without the handcuffs of a forced earnout.

Dissecting Google’s Rationale To Acquire

  • Google is a big data and machine learning company: Nest’s thermostats, smoke detectors, and any other subsequent products built under this brand will be built with enough sensors distributed in and around our homes that they act as passive data collection machines. This data can be used by consumers (monitoring, control, savings, efficiency), but can also be lumped into aggregate data for Google to integrate into its own suite of products, such as Maps, their energy trading arm, and so forth.

  • One of the best hardware and design teams in the world: With Nest, Google buys one of the most elite, experienced hardware and software companies in the world, not to mention the talent Fadell and Rogers at the helm bring. Back in 2013, high profile changes at Google included Hugo Barra (now at Xaomi, considered to be the Apple of China) and, of course, Andy Rubin, who has deep history with Android and is now working on different secret projects at the company advanced research division. After buying Motorola Mobility, Google can now leverage the Nest team beyond “connected home” devices, so I’d expect the Nest team to also have their hands inside Chromebooks, what Android will look like in the future, parts of Motorola, and other areas touching Android or Linux.

  • Now the Nest is protected: Like Uber — another Google Ventures investment — Nest was the target of lame legal attacks by the likes of Honeywell, who certainly saw the team as a major threat. Now under the Google umbrella, any corporation looking to mess with Nest may think twice about poking the mamma bird. Additionally, this also sends a signal to other places in the home automation and digital home space, as when Google makes a move like this, it’s usually bad news for others.

Examining Apple’s Disinterest

  • The home automation market may be too small or cumbersome for Apple: Apple is a very rich company, so when it makes a strategic move, they need to have confidence the market they’re addressing (or creating) will be big and dynamic enough for them to squeeze out the profits. With home automation, they may have viewed the market as not sufficiently developed yet, or too small to begin with — they may also have been turned off by the levels of customer support and services a company like Nest would have to offer, which is outside of their core competency.

  • Stick to the roadmap: Another plausible scenario is Apple has detailed plans to continue its current suite of iOS-driven hardware and going into this space isn’t in their purview. It would be a distraction. Given Cook’s statements about a new product in 2014, I guess everyone is wondering about either a new type of iPad, or a smartwatch, or a television — who knows? But, not smoke detectors. That, we now know.

  • Price tag is out of orbit: Many theories abound about Apple’s M&A, but I don’t recall them making an offer for a company that rich, so that alone may have taken Nest as a target off the table.

Venture Morsels Of Note

  • Many VC winners, but two shine: The Series A for Nest only included Shasta and Kleiner Perkins. I’ve known the lead investor at Shasta, Rob Coneybeer, for years, and can personally attest that he and his colleagues were razor-focused on the intersection of hardware and connected devices many years ago, when it was less trendy. If you look at Coneybeer’s blog, as well, you’ll see a true love for hardware, all the way from drones to cars. This is a big win for Shasta and more are likely to come. (Here’s a video discussion I had with Coneybeer years ago, where we talked about hardware and his thesis.)

  • Kleiner Perkins gets a big win: KP has been in the news for all sorts of reasons, but now this is finally getting back to the basics of venture, as Nest will net the firm a great cash on cash return and IRR, as well. This may kick-off a much-needed string of larger victories as the firm’s portfolio is strong and maturing nicely in other hardware (like Jawbone), enterprise (so many), and consumer.

  • The convenient Google discount: Google Ventures, which deploys Google’s money, is a big investor in Nest. I’d estimate their blended return on this investment is upwards of $500M, give or take, so for fun, we can discount the $3.2Bn price tag a bit as Google wisely invested early and then purchased in cash. (One wonders if they’ll do the same with Uber.)

Finally, for fun, there were many hilarious tweets about the deal, where folks on Twitter showed their wit, but none as funny as this one:

BREAKING: BlackBerry buys The Clapper for $22.95 http://t.co/QV3nVpzo18

— Josh London (@joshdlondon) January 13, 2014