Internet Outsider

Market Crash = End of Web 2.0?

Probably not, but it's worth considering. 

Using cyclically adjusted valuation measures (those that take into account today's record-high profit margins), the U.S. stock market has been overvalued for years.  The Internet sector is not particularly stretched, especially not relative to the multiples of the late 90s, but if the entire market goes into the tank, the 'Net stocks will go with it.  Any number of factors could end the party--housing, flattening corporate profits, recession, China recession, etc.  Whether the market will actually tank is anyone's guess, but it could drop another 30% and still not be "cheap" using cyclically adjusted measures.

For the past few years, meanwhile, Internet entrepreneurs have become ever more brazen about not needing a business model in order to cash out big (and who can blame them, given the bounteous rewards that have gone to Google, MySpace, YouTube, and dozens of other companies that postponed revenue for as long as possible--not to mention the vast amounts of venture capital that keep pouring into the sector?).  This is reminiscent of the late 90s, when all that was needed (apparently) was a business plan. 

In the late 90s, of course, the early stages of the market crash revealed that much of the Internet economy was dependent on public-market leverage (10 companies a week going public, raising $100 million each, and spending it on advertising, software, real-estate, accounting services, etc.).  When the IPO market dried up, so did the Internet sector.  Today, the situation is different--today's start-ups aren't usually "exiting" via the public markets but by acquisition, and a fraction of the number of companies are competing to win the entrepreneurial lottery.  But a crumbling of the public market would still have a significant impact on the industry. 

Reduced market caps and multiples would mean lower acquisition prices and, likely, a more cautious approach to risk-taking (no more $4B eBay-Skype fliers, for example).  This, in turn, would mean more caution on the part of the angels and VCs who are funding the revenue-less prosperity of many Web 2.0 companies.  And a slowdown in the economy (either as a result of or as a cause of the market decline) would mean that revenue of all types would be harder to come by.  So, just when they needed it the most, many emerging companies might find that the AdWords bounty they had always kept tucked in their back pockets might amount to less than they had once imagined.

A disaster scenario?  Not likely.  But a scenario that would lead to another cold winter for the Internet start-up ecosystem?  Very possible.  Possible enough, certainly, that conservative Netrepreneurs (and their backers) might want to hit the summer-time bids while they still can.

No Gambling Online! Just Everywhere Else

The WSJ on the destruction of the former online gambling giant, BetonSports, as well as the Houdini-act of its fugitive founder, Gary Kaplan, whose whereabouts are "unknown."  Based on some of the details in the story--the machine-gunning of a computer terminal after the company lost big on a football game--Kaplan sounds like a tough guy to love.  This said, given the explosion of "legal" gambling in the United States, from Vegas to riverboats to Indian reservations to state lotteries to, yes, the stock market (investing isn't gambling, but trading is), the Puritanical crusade against online gambling seems, at best, arbitrary.

Can gambling addictions wreck people's lives?  Of course.  But now that we're all within a couple of hours of a legal casino, the addicts are certainly going to find a way to get their fix, and it is arguably a heck of a lot more dangerous to drive home after losing your shirt than to stumble out of your desk-chair and into your bed.  And now that quasi-reputable companies have been banished from the 'Net, the gamblers will just do business with the less-reputable ones, etc.

So it is not hard to believe that the law Congress passed last October banning online gambling was, in fact, just an act of protectionism, presumably sponsored by one of our country's most profitable and successful industries.  Oh, you can gamble all you want, says Congress--we just want to make sure that you have to buy some plane tickets, rent some hotel rooms, and eat at some restaurants while you do it.  And we want to make sure that you lose your money to our upstanding friends in the gambling lobby, not some sleazy dude in Costa Rica.

UPDATE

A reader writes that it's the potential loss of state tax revenue that gets politicians all up in arms about online gambling, not the Vegas and local-gambling lobbyists.  It seems that the industry could be regulated in a way that would allow each state to collect its generous helping, but then this would bring the potential loss of campaign funding and votes into play. 

Google Paints Bullseye on Microsoft; I Eat Crow

It has been obvious for some time that my theory of a year ago--that Google and Microsoft weren't really going to go to war with each other (because Microsoft had already lost the web game and because Google wasn't going to be stupid enough to take aim at Microsoft's crown jewels)--was wrong.  I was right about the first part--Microsoft is still nowhere on the web--but wrong about the second: Google clearly has its sights set on that pot of Office gold.

So, what is the current status of the office productivity battle?  And what are the long-term implications?  The current status is that Google's offerings are fine for low-end use but won't start meaningfully cannibalizing Microsoft's sales for years.  No self-respecting IT manager at a Fortune 500 company is suddenly going to throw out the global standard and bet his or her job on the sideline business of an Internet media company.  Over the years, a parade of web and technology titans--AOL, Oracle, Sun, Yahoo--have tried to upend parts of the Redmond monopoly, and all have found the crossover from their core business to PC software far harder than it looked.  And if Google is serious about stealing some of Microsoft's sales and support customers, it will undoubtedly find this transition hard, too.

On the other hand, Google's current offerings--Gmail, Docs & Spreadsheets, etc.--bear all the markings of a classic disruptive technology.  As Harvard professor Clayton Christensen observed, disruption begins when a dominant market leader has built so so much functionality into its core products that it has begun to over-serve its core customers.  Some of these customers, realizing that a simpler, cheaper product will do, abandon the old technology.  At first, this does not concern the incumbent, as it maintains a chokehold on the highest margin business--the high-end customers who need most of that complicated functionality and support.  But, gradually, as the lower end product gets better, and the incumbent is forced to migrate to even more complex and expensive solutions, more of the overall customer base defects.  And, then, voila, one day the incumbent wakes up and discovers that it is DEC, Sears, or AOL...and by then it's far too late to do anything about it.

From a long-term perspective, Google's initial offerings look mighty disruptive.  And although Microsoft will no doubt assert until it's blue in the face that it has long since gotten Google religion and is already adapting all of its products for web-based delivery, it will likely find this easier to say than do--if only because each new free or low-priced subscription seat of a web-based Office won't immediately drop a couple of hundred dollars to the bottom line.

At the same time, by targeting Microsoft's crown jewels, Google is risking not only failure but its own monopolistic dominance of its core business--search.  Selling and servicing technology solutions is a fundamentally different business than selling and providing advertising solutions, and will eventually require the creation of an entirely new sales and service organization.  No company in history has dominated the hearts and minds of both marketers and IT buyers, although several have tried.  Even with Google's awesome talents and power, therefore, success is far from guaranteed.  Especially because the opponent in question, a sleeping giant that has so thoroughly dominated its industry that not one but two governments were forced to try to stop it, won't likely give up without a fight.

Dvorak on Viacom: Old Media Boneheads

John Dvorak concludes that Viacom just doesn't get it--to invoke the omnipresent Internet mantra of the Nineties (hat tip to Victor).  As Dvorak sees it, the 100,000 Viacom clips formerly uploaded on YouTube had no value except for marketing, and YouTube and Viacom fans were providing that marketing for free.  So Viacom basically flipped its middle finger at free marketing and tens of millions of fans and huffed on over to a firewalled beta site that won't have an audience until June.

To the extent that the 100,000 clips were, in fact, "three minutes of an old Daily Show," as Dvorak suggests, I agree.  To the extent that they were full-length copies of last night's Daily Show--with YouTube acting as a sort of universal TiVo containing all the programs you've missed--then Dvorak is overstating the case. 

Viacom would be quite reasonable to want to recoup some value lost if Daily Show viewers decided that they couldn't be bothered to watch TV at night when they could just catch up the next day at work.  My guess, however, is that full-length, next-day Daily Show-type videos were a tiny fraction of the 100,000--and, therefore, that Viacom is being, at best, myopic.

Analyzing Skype

eBay has now owned Skype for more than four full quarters.  How's that little $4 billion flyer doing?

Answer: Pretty well, actually.  Not amazing, not terrible.  Pretty well.

eBay doesn't release much Skype information, but we can still get a good snapshot:

• After decelerating through Q2 last year, both revenue and user-growth are now reaccelerating. 

• If the current growth trajectory remains stable, the company should do $400-$500 million in revenue in 2007 (which would put the purchase price below 10X revenue--a far cry from the outrageous binge-buy that many commentators described).  I still think eBay was the wrong company to buy Skype and that the "synergy" story management cooked up to explain it was a joke, but the price is looking more reasonable all the time.

• Monthly revenue per user is gradually increasing and now stands at about $0.13.

Want to see for yourself?  Fiddle with the future projections?  Then check out this free model, courtesy of Internet Outsider (now published on Google Docs and Spreadsheets).  See the second page, labeled "key," for an explanation of how the model works and instructions on how to change the assumptions. 

Skype Financial Model

(I've always been curious whether such models would be of general interest...I'm about to find out.  I was also curious about Google Docs and Spreadsheets.  Verdict?  Easy upload.  Lost some formatting, and the absence of a "cell contents" window is annoying, but overall pretty simple.)

ADDENDUM: This is the first time I've used Google Docs & Spreadsheets.   I'm not sure whether this allows anyone to use it (change assumptions, etc.).  Can someone please try signing into Google to see?  You'll have to click "edit" in the lower righthand corner, then sign in.  The ideal arrangement would be to allow every user to save his or her own copy and then manipulate that one, so the assumptions in the base model don't change.  Anyone know how to set that up?

Joost In: Some Real YouTube Competition?

Perhaps Viacom had an ace up its sleeve after all.  When the company stormed out of negotiations with Google a few weeks ago and demanded that YouTube remove all its clips, the popular thesis was that the "Big Media YouTube Rival" was a go.  It wasn't--and, likely, will never be--but Viacom appears to have found a reasonable Plan B:

Just two weeks after ordering its content to be pulled from YouTube, Viacom Inc. today is expected to announce a broad licensing deal with Joost, a new Internet service that specializes in commercial video content. The anticipated deal, which follows the recent collapse of similar talks between Viacom and YouTube parent Google Inc., involves licensing hundreds of hours of programming from Viacom cable networks such as MTV, Comedy Central and Spike as well as movies made by the company's Paramount studios.The companies declined to disclose financial details. In similar deals in the past, Viacom has received two-thirds of the advertising revenue and other compensation.  (WSJ)

YouTube has already won the online video-clip game.  It may be, however, that the online video-show game--the place where users can go to find full-length TV shows and other Big Media content--may eventually have a different winner. 

According to the WSJ, Joost's strategy is not to run clips but full episodes with high-quality resolution--"real TV online."  It is not hard to understand why this, combined with a guaranteed revenue share and a commitment to partners, is appealing to those in the TV business.

What is hard to understand, at least at this point, is why anyone would want to watch "real TV online"--at least when there is a functioning television set nearby.  YouTube viewers watch 100 million clips a day in part because the clips are a different entertainment product than a television show, one that is well suited to both the smaller screen and short attention span of the average Internet user (for whom a 30-second television ad seems as long as Dr. Zhivago)  Using the internet to distribute TV shows to televisions is one thing, but using it to actually watch those shows on computers is another.

Unless Viacom and other TV companies figure out how to break their shows into clips, and then license those clips exclusively to Joost, deals like today's are probably not much of a threat to YouTube.  If Viacom does figure out the clip thing, however, and Joost signs up a bunch of other media companies... Well, then, YouTube might want to hurry up and get its Big Media act together.

Yahoo Crawls Back Over $30

Given the damage we Yahoo shareholders have sustained over the past couple of years, I hope this won't be viewed as gloating.  I am cautiously optimistic, however, that John Battelle's prediction last month that Wired's "How-Pathetic-Is-Yahoo" story was, in fact, the bottom. 

Anecdotal reports of a nice reception to Panama continue to come in, and it does seem as though, having been shamed into action, Yahoo is once again innovating.  This doesn't change the fact that Yahoo is now running a distant second in a race it used to have all-but-won (global web dominance).  When combined with the possibility of Panama-inspired revenue acceleration (and, perhaps, margin expansion) over the next several quarters, however, it does suggest that Yahoo shareholders might look back on 2007 as a pretty good year.  (Especially relative to Google shareholders, who have now been essentially stuck in the mud for going on 5 quarters.)

Many challenges remain.  First and foremost the management purgatory (Who's going to run the "Audience" division and is he/she going to have designs on the CEO spot?  If not, is he/she really going to be that strong a hire?).  And, second, the need to make the brand cool again.  But, overall, I'm cautiously optimistic that perhaps Terry will retire on a high note, after all. 

Bartiromo in the Hot Seat

Another digression before we get to the next round of Big Media vs. GooTube...   

Landon Thomas of the NYT has weighed in on the Money Honey Scandal, noting that in addition to a Shanghai-NY private jet ride at Citigroup's behest, Maria also enjoyed a Ferrari ride, and that another CNBC reporter, Charles Gasparino, may have had a sock stuffed in his mouth as he attempted to report on some of this stuff.  CNBC has defended Maria and denies gagging Gasparino, and Maria herself has wisely avoided comment. 

If nothing else, the scandal has allowed a planet-full of media organizations to run Maria's picture, resulting in the predictable spike in readership (Landon's story rocketed to No. 1 on the Times' most emailed business stories this morning).  It has also rekindled a debate about what is and isn't appropriate for journalists to do as they cozy up to potential sources.

As with other conflict-of-interest scandals, there is often an element of Puritanism in the Maria coverage (though not Landon's)--the implicit idea that journalists should live in hermetically sealed bubbles or else risk losing their "objectivity."  Usually missing is the acknowlegement that no journalist is ever truly "objective".  Every decision about what to report, how to report it, which sources to listen to, which sources to ignore, and even which words to choose (the difference between "he said" and "he claimed" is enormous) compromises objectivity.  This is not to say that journalists should trade good coverage for suitcases full of cash or midnight visits from the "Pussy Patrol," as a sleazy film critic on Entourage does.  It is, however, to suggest that we should probably get less enamored with the word "objective" and just settle for "fair."

Did Maria's accepting private-jet and Ferrari rides from Citigroup cross the line?  Did spending the 14 hours at 40,000 feet alone (presumably) with a senior Citigroup executive cross the line?  At the very least, it probably made Maria less eager to recklessly bash Citigroup.  This in itself, however, is not necessarily a bad thing.   The most objectivity-compromising influence on most journalists is not sources but readers and viewers--specifically, the need to tell a compelling story or else be ignored.  So strong relationships on the source side can in some cases mean more objective coverage. 

Ultimately, perception aside, the question here is not whether Maria's close relationship with Citigroup (and the senior executive) "affected her coverage"--EVERYTHING affects coverage.  Ultimately the question is whether the relationship prevented her from telling a story that otherwise should have been told.  At this point, anyway, Maria seems to be the only one in a position to address that.

Powerset "Natural-Language Search" to Threaten Google? Please.

Much hullaballoo today with the announcement that a search engine start-up has licensed some cool "natural language search" technology from Xerox.  The start-up, Powerset, hasn't actually deployed the technology yet, but it's apparently pretty cool, so now the story is that Google shareholders should start quaking in their boots.

Google shareholders should definitely quake--the stock's expensive enough that any hitch in the company's performance could knock off 30% off the price before breakfast--but this fear shouldn't be because of any search-engine start-up.  A mistake that Google observers and industry participants repeatedly make is thinking that Google's dominance of the search business is a function of the quality of its search results.  Build a better search engine, this wishful thinking goes, and you'll bring Google to its knees.  Sorry, but you won't.

It's true: Google rose to power because it built a better search engine.  It's early product advantage, however, is not what preserves its power today.  What preserves Google's power is that it has become synonymous with search.  Except for some fringe fanatics who will always defect to the cool new thing, Google's user base has no idea whether its search results are any better than the competition's--and doesn't care.  All they know is that "Google" equals "search" and that, if they try a couple of times, they can usually find what they're looking for, so why bother switching.  (Don't believe me?  Just ask the folks at Ask).

For Google to lose the search game now would require a blunder of Yahoo-like proportions.  Specifically, Google would have to become so obsessed with, say, whipping Microsoft in the office productivity market that it took its eye off the search ball (the same way Yahoo did back in the late 90s, when it threw all its energies into becoming a portal and opened the search door for Google).  It is not inconceivable that this will happen, but its also not likely.  So no matter how cool that Powerset technology is, Google's shareholders can rest easy.

(And, of course, with a $150 billion market cap, they can also remind themselves that, if it's reeeeaaaaalllly cool, Google will just buy the company.)

MySpace Financial Performance: No Longer A Joke UPDATED

MySpace still fails to merit so much as a mention in News Corp's quarterly release, but the financial performance of Fox Interactive Media (some of which is MySpace) continues to improve.  Revenue grew to $518 million in the December quarter, up 41% from a year earlier.  This was a slight deceleration from the 45% Y/Y growth in the third quarter, but the division also turned a modest profit after losing $73 million in Q3.

Precise estimates of MySpace's revenue vary.  In a comment below, Keith Eysmun estimates the Q4 revenue was about $150 million, or a $600 milllion run-rate.  In a recent Forbes' piece, Peter Kafka cites a monthly revenue figure of $28 million, or a $350 million run-rate.  Judging from the Y/Y divisional comparisons, something in the division is still growing extremely fast, and I suspect it's MySpace, but the site's overall revenue may still be relatively small.  My original Microsoft comparison, therefore, was premature.  Using Keith's revenue estimate, a $15 billion valuation for MySpace would also be approximately 22X run-rate revenue, not the 10x-15x I originally estimated below.

So where does this performance put Fox in the overall scheme of things?  Believe it or not, the division itself is catching up with Microsoft (which generated $624 million in the quarter, up a meager 5% year over year).  Microsoft, moreover, lost a boatload of money--$155 million--which means FIM may in aggregate be a stronger business.  Perhaps this impressive performance will garner Fox's Internet division a bit morerespect. 

Wasn't it just a few months ago that analyst Jordan Rohan was roundly ridiculed for suggesting that MySpace could one day be worth, gasp, $15 billion?  Based on MySpace's current run-rate, that sounds like a less than outrageous 20x-30x (depends how much of FIM's revenue MySpace generates).  Now if only Fox would start taking the Interactive division seriously enough as to bother mentioning it in its quarterly press releases.