Market Cap an Issue When Moving up the Stack

There is one practical reason why many service providers, when looking to gain either scope (moving up the stack) or scale (making horizontal acquisitions) almost always choose to go horizontal.

For starters, the risk if often lower. When adding more scale (accounts, customers, revenue) of the type you already sell, it always is possible to gain economies of scale, and reduce overhead costs to some extent.

When moving into a new part of the ecosystem, there is execution risk. By definition, a service provider is moving into a business that has not been its core competency.

There are other practical issues. When a telco buys an asset in the applications or platform portions of the business, it is buying a high-multiple business with a low-mutliple currency. In other words, a service provider is buying an expensive asset with a relatively low-value currency.

For example, AT&T has a market capitalization that is a 1.4 multiple of revenue. Apple has a market capitalization that is 3.7 times revenue. Google has a capitalization about 7.6 times revenue. Facebook has a multiple about 15.8 times revenue.

Assets “up the stack” simply are expensive for a service provider to buy. Other assets in the same space are much more affordable.

source: Kleiner Perkins