SoundView Capital

The hosting kaleidoscope

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I’ve come a long way from Yahoo hosted sites in 2004. At the time my colleagues were impressed with how fast I was able to come up with such a “professional website” for what was then called Research 2.0. It didn’t take long to realize that Yahoo was all proprietary and inflexible so something more general purpose and open was called for.

Fast forward to today and even a small company like mine relies on a web of specialized hosting providers. I’ve found LiquidWeb to be a pretty solid general purpose host. There are plenty of alternatives and flavors but we’ve used them for a decade now and the performance, value and support are solid. But the AWS from Amazon is a force too powerful to ignore and we started using it for serving all “heavy content” like PDF files. It might also be hosting our IPO Candy video collection but we’re also looking at companies like Wistia for that.

Synthesis has become our host for the WordPress component of our content. Why? Because I’m tired of managing individual upgrades themes and plugins. Although we are building a new backend that will be hosted on a regular server it will still make sense for this front-end system to stay on a specialized hosting platform like Synthesis. WordPress offers their own enterprise hosting but it’s very expensive.

I have to wonder why nobody has figured out how to combine all these hosted services into one modular yet integrated and effective package. When you add commerce features like subscriptions (in our case) or sales the idea of having a single solution is pretty attractive.

At one end of the spectrum you have hosting providers like LiquidWeb where you have to put it together yourself. There are hosted services like Wix and WordPress.com and the like but they all lack the flexibility and specific features to build a business site that is in any way unique. As soon as you want to do one thing they don’t support you’re stuck.

It’s why soon I’ll be dealing with another host. To build something *really* interesting you need to push the envelope. One of my favorite new platforms is Meteor which we are building on now. Over time maybe everything we do will be on that platform but I’m not sure that’ll make sense. After all content ranges from the social (tweets, pictures, comments) to long-form content, collections of links, PDF objects and videos. They all need to stored and served effectively from somewhere and wrapped in contextual services like user access control, commerce and personalization. It’s not so simple.

Software has always been an intensely creative thing. Now that has morphed into a combination of programming and a web of online services. Much has been written about the API but that’s very much on the programming side of things. Weaving together a combination of insightful code with other services is the challenge of the day.

Screenshot 2015-04-09 09.38.33

 

Digesting the Vringo Markman Hearing

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[Warning label – I am not a lawyer and have no specific information about this case. In fact I’m really not qualified to write about it. But that seems to stop nobody these days. 😉 I also don’t have any positions in any of the stocks mentioned here.]

The awaited results of the Vringo “Markman” hearing rippled through the market in the last day or so as Vringo stock ($VRNG) started to rise again. Since this is such a high stakes soap opera I decided to take a little time to go through the courts “Memorandum Opinion and Order” which was filed with the SEC by the company. It’s already said that the result was a win for Vringo with a score of 4-2 but I wanted to know more.

First of all some bad news for followers of this saga – the 23 page document is concerned with the meanings of terms and the construction of claims. That means that it’s a long and nuanced discussion of what specific terms like “a scanning system” actually mean down to minutia is scanning through information or merely scanning across a network. My summary and analysis follows but if you really want to get the full effect you should read the full document.

So what’s with deal with “terms?” As you’ll see in the analysis the legal definition of what terms mean can play a pivotal role in determining whether or not there is actually infringement. For example let’s say I patented step-by-step instructions with a specific order to whiten teeth. If someone used these instructions but in a different order I would have a hard time asserting infringement since my patent covers a specific order. It’s not black and white but you get the idea.

The Arguments

There were four undisputed terms included “informon” (a unit of information), “user” (thank goodness!), “relevance to the query” (how well the information satisfies) and “query” (request for search results.)

There were six disputed terms:
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“collaborative feedback data” – The sticking point on this one is that defendants wanted this term to apply to the data about what information was most relevant rather than the information itself. The court however focused on the notion of whether or not the users are required to have “similar interests or needs.” The ruling was that the term pertains simply to users and they are there is no requirement for “similar interests or needs.”

“feedback system for receiving information found to be relevant to the query by other users” – Similar to the above the defendants argued for the notion of users with “similar interests or need” and again the judge ruled that there was no language in the claim to support this meaning.

“scanning a network” – The point here has to do with whether scanning is the same as “spidering” or “crawling” the network. Although we can appreciate some confusion over the notion of scanning and spidering it’s not clear how the outcome of this ruling would impact the case. The judge went for the simplest ruling which is that this term can have multiple meanings that include spidering but that ther definition of the term should remain “looking for or examining items in a network.”

“a scanning system” – The dispute here centers on whether the scanning goes on over a network to retrieve the information or goes on though the information to determine relevance. This was also an attempt by the defendants to roll back some of the improved language in the newer patent claim. It failed however and the judge went with the definition of a scanning system as “a system used to search for information.”

“demand search” – Here the defendants argued for the meeting to be more specific as “a search engine query.” There is also a disputed notion around whether a demand search can be persistent and continue to occur for a long time or whether it is a kind of “one shot deal.” The court ruled that this term is more of the one shot variety with the definition “a single search engine query performed upon a user request.”

“Order of Steps” – As hinted at above a specific order requirement might make infringement harder to prove. In this case the court broke things down by patent (the ‘420 and the ‘664) and particular steps. In the case of the four steps in the ‘420 patent the court ruled that “scanning” had to come before “receiving” information. For the ‘664 patent the decision was that “searching for” and “receiving information” must precede “combining.” The specific steps are outlined in the document but that’s the gist of it.

So what does that all mean?

Qualitatively the set of rulings were more favorable to Vringo and less so to the defendants. That doesn’t mean that it’s conclusive. But it does help. As can be seen in the ruling the defense strategy is typically to create increased specificity around terms and thus terms to either defend against any infringement at all or reduce potential damages.

Although there isn’t much room for the defendants there might still be a little. I’d say it would have to hinge on going after the timing and the mechanism of steps that Google uses versus what is in the patents, specifically the notions of “demand search” and “Order of Steps.”

But this case involves multiple defendants (AOL, Google, IAC, Gannett and Target) who all may have greater or lesser arguments for their approaches being different relative to their mechanisms of action. So even if Google might have a decent defense it doesn’t follow that it would apply to the others.

And the stock?

Well the traders are already pushing it higher (again). However the company has a complex (204 page!) document outlining the proposed merger terms with Innovate/Protect. They have a shareholder meeting scheduled for July 12th to approve the merger and additional business.

The merger includes a share exchange whereby the owners of Innovate/Protect will own jut over 56% of the outstanding common stock of the combined company. One concern that has been voiced in the market is the dilution in the stock following the merger and the uncertainty around just how many future shares will be outstanding.

This isn’t a time to roll out the spreadsheet just yet. That’s because if the lawsuit is successful the amounts at stake will be large even compared to a much expanded VRNG company value. For example some very simple back-of-the envelope math using the recent purchase by Mark Cuban and a quick review of the merger terms suggests an effective capitalization figure of something like $200M (versus the quoted $56M cap.) That is a big step up but one that remains small in relation to the stakes.

There is also a legitimate carrier-focused business model inside the company that we continue to believe can be a source of value but it’s lost in the weeds here.

Probably the biggest caution we have is the out-of-left-field ruling we saw recently in the Apple-Samsung case where the judge essentially ruled against the growing absurdity of the patent system. Although profound it’s not a defense that can be planned or counted on so it may not impact potential settlements.

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Further Reading:

If you haven’t seen it the original match to the flame came on March 31st with this post by James Altucher on TechCrunch: Why Google Might Be Going to $0

There are more links to this so please share in comments if you have them and they will be added.

 

Target demonstrates Amazon still rules online commerce.

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Amazon ($AMZN) is a controversial stock these days to be sure. We see 3 to 6 notes a day from short sellers about how this company is wildly overvalued / about to crash. The funniest one though is the recent flurry on the back of Target saying they would no longer sell the Amazon Kindle.

Does anyone else think this is similar to publishers saying they won’t sell books on Amazon and music labels saying they won’t do business with Apple? You may not like it but stopping it is not an option.

As a family man I like Target ($TGT). Considering the way kids go through clothes you have to love the folks at Target for letting you get new wardrobes for your kids at remarkable prices. It’s also great for plastic containers, household supplies and stuff like that. My first reaction to the story that they were going to stop selling the Amazon Kindle was “what they sell electronics?”

Target has tried to be more relevant online but never succeeded. They sell the kind of stuff you go to the store for. Amazon and Target should actually be good partners. Target management should really think about that. You aren’t really competitors. Amazon doesn’t have stores remember?

Target may think that selling the Kindle is aiding and abetting the competition. The short-sellers on Amazon suggest that “Best Buy will be next!” Maybe they will. Both companies give you another reason not to visit their store. Which by the way we can tell you is 100% linked to success. If you have physical assets and fixed costs like Best Buy the whole point is getting more bodies into the store and increasing the propensity to buy just a little tiny bit. That’s all there is to it. Getting philosophical gets you into bankruptcy court. Just ask Circuit City.

The time to stop Amazon was at least 10 years ago. Too late now. On the retail side there is such a big fundamental difference which Target can never even hope to address: selection, availability and price. If I need a garbage can I’m going to Target. I know they have a few and one will be find. But if I want a DVI to VGA cable? What about a pair of 12″ scissors? Clay Shirky’s new book? Flax seed flour? In some cases yes or maybe but they might also be out of stock. So you just pay for prime and buy everything at Amazon. Prices are good and everything arrives at your doorstep in 48 hour or tomorrow if it’s worth $4 to you.

There are concerns of course. What about margins? What’s the right multiple for this? Etc. But arguing that somehow Amazon is going to be dealt a “blow” by Target or Best Buy reflects a basic misunderstanding of the market, consumer experience and the business.

This is the first of a three part look at Amazon that will shift into their cloud services and then into eBooks. The SoundView TechFund (which we advise) is long Amazon stock as a core position.

The biggest reason  to own Amazon in the end may be Jeff Bezos. Steve Jobs is gone. Steve Ballmer is clueless and based on what we see at Target, they don’t get it either.

 

 

What ever happened to Kazaa/Atrinsic?

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We met with Atrinsic $ATRN in 2011 after they attracted attention by acquiring music property Kazaa late in 2010. Back then the shares were trading in the $3-range versus the current $0.08.

At the time company was working on adding to the senior management team and board at the same time they were hoping to secure agreements with music content providers (the “labels”) to grow the service.

Picking through all the filings it kind of looks like the company got what it wished for. The only problem is that the content costs are high so that the Kazaa subscription revenue generates losses instead of profits.

Our old friend Michael Robertson (of MP3.com fame) mentioned this problem in no uncertain terms when we published a note on Pandora $P.

It appears that Atrinsic is running out of cash and lacks enough runway to get their music subscription business in the air. They have recently sold a few none-core mobile and online properties but that only raised a little over $600K.

The company seems to be painted into a box. The current CEO, Nathan Fong, needs to work with the board and map out some kind of strategy. Since content costs are unavoidable it makes it hard to fathom what they might do.

We think the endgame for some of these distribution companies is acquisition by the content owners since the businesses would be instantly profitable if you didn’t have to pay the content fees. In that case $ATRN would be worth much more than the current share price.

Problem is you don’t have any power to bargain with. You’re sitting at the power table with nothing and everyone can see your cards.

Any ideas?

Quepasa QPSA! rebrands as WHAT?

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For reasons we can’t begin to grasp Quepasa held a conference call and presentation for analysts and investors today to “unveil” their rebranding strategy.

We admit that we are new to the story but from a distance the old story at least made some sense. Spanish speaking people are a big segment of the world and it’s not unreasonable to think about having a social network and content company focused on it. (Yandex $YNDX is a good example of a regional company that has done well and we like.)

But Quepasa decided to merge with MyYearbook and consolidate into something new they are calling MeetMe. The ticker of the company will be changed to $MEET. To be sure meeting sites like Badoo are popular and based on most accounts extremely profitable. But nobody is kidding themselves about what these sites are all about.

Unfortunately for Quepasa the “redesign” and integration creates a giant spam/hookup site that few investors will want anything to do with. The consolidation of the two looks more like FriendFinder $FNN then the companies they are comparing themselves to (LinkedIn $LNKD, Facebook and Twitter.)

Strangely the company fails to mention Meetup which is one of the few online sites that is in fact dedicated to helping people connect, albeit around common interests, regions or events. There are some gaps in the online services that would help promote more discovery but this will be emerging in multiple forms from established companies and third parties who will build that functionality alongside the large properties.

The real tragedy though is that the company burned a rare opportunity to actually connect with long-term investors and prove their mettle in terms of strategic thinking, operating expertise and hard and fast goals about product development, revenue growth, operating margins and returns on invested capital.

Their story went along the lines of “we have acquired this big property and put them together into something that makes some sense and are big in terms of registered users and page views.” Investors have seen versions of that story before and know it doesn’t work. Demand Media $DMD is another spammy content company that proved that volume does not equate to sustainable growth and earnings in an increasingly filtered net.

At this point we don’t have enough to suggest we should build an IV model on the company to see how the current market capitalization stacks up to what they might be worth. It’s possible that there is a brilliant strategy lurking around somewhere in the mix but it’s not at all evident from the information we have reviewed. As far as we can tell MyYearbook looks like a disaster and the dilution of what might have been an interesting niche story should be a disappointment to QPSA investors.

All in all another surprising example of a company that appears not to be getting any good advice on what investors expect or perhaps is not listening to it. Given the resources at their disposal they need to go back to the drawing board with good erasers and sharper pencils.

Further reading & references:

Company presentation on the rebranding

Demand Media: Cashing in on Crapification

LinkedIn company snapshot from a year ago.

Disclosures:

This information is prepared to illuminate but could be materially inaccurate in places, omit important information or be flat out wrong. It is not intended for investment purposes. Research 2.0, their affiliates and/or partners may have positions in any of the stock mentioned at any time. As of this writing the author has no position in QPSA and has no knowledge of any affiliate having a position. YNDX is owned in the IPO Candy Folio over which the author has authority and LNKD is owned in the SoundView TechFund which the author advises. Nobody has any obligation to update this information going forward.

What is going on with Vringo $VRNG?

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We’ve known and followed some of the goings on at Vringo since late 2009 when we get interested in their video ringtones business as a potential avenue for automatically generated 3D pictures. The idea may have been far out but we liked what they were doing with more dynamic and richer content delivery in the mobile space.

In 2011 they added some Facebook sizzle to their solid carrier-based story and we wrote up a short overview, Connected Consumer: Vringo, published on Seeking Alpha.

Yesterday the shares jumped 100% on an article posted by the prolific James Altucher. James is a smart, witty and widely followed writer who also happens to be an investor. We’re not going to repeat it all here so it’s worth going back there and reading the whole thing.

Judging by the stock action throughout the day it would seem that his analysis is not easily dismissed. It has also stirred up swirls of controversy not just in terms of the company itself but the evils and virtues of click bait, US Patent law, research and writing with “conflicts” of interest.

Instead of getting into the more philosophical points let’s look at what this is all about from the standpoint of a Vringo (VRNG) investor or potential investor:

[Read more…]

Putting the e-G8 in context

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Nicolas Sarkozy during his meeting in Toulouse...

It’s hard to fathom what the two-day e-G8 meeting in Paris, which starts tomorrow, will offer us. It’s received only minimal coverage, despite the fact that the attendees include such high-profile people as Jeff Bezos, Eric Schmidt and Jimmy Wales, along with scores of other technology company managers, entrepreneurs, political leaders and journalists.

The quasi-governmental sponsorship of Nicolas Sarkozy may explain part of the reason why the event hasn’t received many headlines. He asked Maurice Levy of Publicis to host the event, which is entitled “The Internet: Accelerating Growth”. The aim is to bring technologists and policy-makers together, “to discuss the challenges and opportunities which they believe relevant to the future of the Internet, offering their opinions on a wide range of issues, including for example human rights, intellectual property and technological investment.”

However, we all know that the Internet actually accelerates creative destruction: something France and other countries in Europe are less keen on. That has many wondering whether the real policy objectives of the e-G8 have more to do with additional regulation and control, rather than more freedom, innovation and economic incentives.

The French have an uneasy relationship with the Internet on both an economic and a personal level. Economically, the ability for companies, particularly Google, to be able to extract large economic value out of the French economy is troubling in a model in which the government provides large subsidies (billions of euros) for foundation technologies like broadband. Personally, people in France are just a little less comfortable with the online model, and Internet business, than some other cultures in the developed world. For example, PriceMinister, a French web commerce company, was acquired by a Japanese firm. According to an insider at the French company, “there are no natural French buyers for Internet companies because they don’t really believe in it. They pretend to care about the Internet, and spend some money on it, but they are not serious at all.” [Quote from LeWeb, December 2010.]

There’s a robust band of successful entrepreneurs and business owners on the Internet in France, but big companies see it more as a risk than an opportunity. No wonder they are losing out to more aggressive international competitors. [This is going to get even worse with the dramatic rise of the mobile Internet, but that deserves treatment as a separate and full post.] For most successful French technologists, their path has involved a move or partner outside of France.

There is an agenda, but it’s fairly high level. Other than the welcome by Levy, and the opening speech by Sarkozy, no sessions have speakers listed. We’ve been able to piece together some sessions by matching up Twitter streams with the agenda, but it’s a far cry from a complete, detailed, official agenda. The last time Sarkozy appeared at a technology event, it was LeWeb 2008, which was a disaster. He lectured an unwilling English-speaking audience at length – in French – about the need for interactivity, and then proceeded to end his speech and abruptly leave stage left. The crowd was livid.

But the French are technology friendly and, since then, other French ministers like Christine Lagarde have made a far better impression by appearing at technology events and speaking intelligently and frankly in English to attentive and appreciative audiences. I’ve also met with French officials who oversaw the conversion of many government offices to modern technology using open source software. So all the ingredients are here, but somehow the recipes and presentation are not quite right. This event may be an attempt to improve things, but two days isn’t much time.

Are there Investment Implications?

Probably not the type that will impact 2011 stock performance. But in the longer term, whether we like it or not, business on the Internet is going to be impacted by politics, legal differences, societal needs and human factors. Because the Internet involves personal data, privacy, security and interaction, it’s different from moving a product or a piece of content into a foreign market.

The implications cut in two directions. If countries like France act to protect their near-term interests, it can limit the opportunities for global firms like Google, Apple and Facebook in the local market. We’re all familiar with this from examining the development of business and the Internet in China, where Baidu continues to lead the market. As for Russia, it appears that Yandex will be the Internet search leader there.

Strong domestic companies are important and welcome, but the question is: what cost do consumers and taxpayers have to pay for them? And this isn’t just in terms of money, but also with respect to choice of content, freedom of expression, efficiency and ultimately even the quality of life. Limiting or restricting consumers to narrow and inferior content and tools, merely to preserve local interests, won’t work in the long term.

In conclusion, the objective of the organizers is to have some specific recommendations that can be made to the leaders at the G8 meeting immediately following the event. What kind of things are even possible? Most technologists would say, “spend money on building the roads and ramps (broadband), then get out of the way.” One senses that the leaders of the free world want to put their fingers on the path of progress to influence how it all turns out.

Politics is unlikely ever to welcome the term “creative destruction” into its lexicon, because the destruction part is too lethal for poll ratings. But why not use government power and wealth to incentivize and assist those people who are dislocated by the process? Most developed countries, including the US, still seem to have a problem in creating the jobs that many of us have enjoyed in the past. Healthcare costs are a big reason in the US; slow growth, regulatory burdens and high costs are reasons in France. (Research 2.0 looked into hiring some people in France about five years ago and concluded that it would basically break our admittedly “lightweight” business model.)

With iPad in hand, I’ll don my top hat and tails to stroll under the luxury tents assembled in the gardens of the Tuileries. Few places could host a more sumptuous gathering spot for a discussion of the Internet and policy. At the same time, thousands of students will be shifting gears to spend the summer developing software and Internet sites that may become the next Google, Facebook, Match.com or GroupOn, instead of whining to their parents how they can’t get an interview for that $100K entry-level job at Goldman Sachs that they were planning on. “Dad, maybe if you could get me into that e-G8 thing where I can network…”

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Steady Beats from Digital Music Forum East

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The music industry has been in turmoil for a decade and the longing for the old days of fat profits and content control was palpable at a gathering of industry types at the Digital Music Forum last week in NYC.

We’ve got two clients, Amalgam Digital and JamHub, in the music space that are in the middle of this swirl of creative destruction.  Amalgam Digital is at the frontier of bringing experience and social aspects of music into the equation of online content discovery and commerce. Many visionaries describe the future of music and particularly revenue as being more “experience-based.”  Unfortunately for the industry that means that figuring out how to scale revenue and profits again won’t be easy.

What follows is a summary of the key points that came out of the presentations and discussions at the event.  Some of these points were also touched in in our November Thought Leader Interview with music executive Jeffrey Epstein (PDF).

1. The core business of records continues to wane. The shadow of Napster – now a decade old – hangs over the major labels and the industry in general. One panelist noted astutely that suing your customers is not a viable long term strategy. Some 20 million music buyers have been lost over the past five years. Legal digital downloads at $0.99 or $1.29 is not a panacea, as once thought.  Less the one-fifth (23%) of people with access to the internet purchase digital downloads.  The music industry longs for a revival of the record business but still hasn’t a clue as to how that might come about.  Even as the industry tries to adjust to the digital world it keeps evolving, and now the migration of music into “the cloud” forces another shift on the industry.

2. Music is migrating to the cloud but few know what it will mean. A subscription model is an obvious path, but many industry executives remain skeptical. Streaming music is still a foreign concept to many consumers, although smartphones and the emergence of Pandora (which is giving Muzak a run for its money) are quickly educating the public on streaming music technology.  Currently, only 5% of Internet users subscribe to a music service. This works out to a per capita spend of only $2.

Christina Collo, Director of Music Relationships & Strategy for Microsoft, noted that there was some modest success with their music subscription service.  Microsoft offers subscribers the ability to download 10 MP3s per month as part of a $14 monthly subscription. In a private conversation during one of the breaks, Christina told me that most subscribers do not download the allotted 10 per month.   The Microsoft model is intriguing and they may be on to something, which is saying a lot because Microsoft is not very associated with innovation, especially in the music space.

Not surprisingly, there was a lot of buzz about Spotify.  The company has been signing up major labels to launch a service in the U.S. – recently, Sony and Citibank-controlled EMI – and there are rumors of a pending deal with Universal.  However, many industry observers don’t think a U.S. launch of Spotify is imminent. Spotify is reportedly raising $100 million at a $1 billion valuation.  Some industry veterans were wondering if Spotify is worth $1 billion (the valuation works out to roughly 7-8 times last year’s estimated sales, which seems lofty for a music company, but not for a social networking enterprise).

There was a consensus that Apple will launch a music service later this year. Apple acquired Spotify-like Lala.com last year. Many were concerned about how Apple’s recent subscription announcement would impact iTunes and its music ecosystem.

In sum, we are in the early stages of seeing music migrate to the cloud. This movement is likely to accelerate in the months ahead as Apple, Spotify and Google roll out cloud-based music subscription services in the U.S. this year.  Another company to keep on the radar screen in the cloud space is Rdio, which was founded by the guys that launched Skype.   Rdio is marketing their cloud-based service as “unlimited music, anywhere” and currently is offering two subscription packages priced at $4.99 and $9.99 per month.

In terms of hardware devices enabling music anywhere, Sonos was at DFME marketing their product.  The Sonos player is a Bose-like system that enables music playing in any room through wireless streaming.  Users can control the Sonos unit through a smartphone, laptop, iPad or tablet device. The Sonos system seemed attractive, but a little pricey at $400 per unit.

3. Most are toying with social media and waiting to see how it will impact music. There are one billion people using social media.  Facebook has over 500 million users and is sporting a $50 billion-plus valuation; Twitter has over 200 million users, and LinkedIn is doing an IPO.  Dermot McCormack, EVP of Digital Media at MTV, noted that his company is leveraging all the social networking technology in a big way to promote artists and engage fans.  There was little talk at DFME about MySpace, which has fallen off the map and is reportedly up for sale.  It remains to be seen whether Apple’s Ping will emerge as a meaningful music social network in the future.  Everyone is eagerly waiting to see what Google does in the social music media space. YouTube is a major force in music today, with some 60% of fans listening to music via YouTube.  Wiredset CEO Mark Ghuneim noted that if people clicked on the ‘buy’ links on YouTube videos and Facebook posts, we’d all be rich men.  His comment resonated well with another panelist who observed that “people play what they don’t buy and buy what they don’t play.”

4. There’s some renewed interest in financing music startups. John Boyle, CEO of the BAM Group, noted that VC money is coming off the sidelines. He said that valuations and return expectations are lower, and investments are more diversified than previously. Venrock VC David Pakman said he is focused on social music investment opportunities. He also mentioned he thought there was a multi-billion dollar opportunity in a streaming-based advertising service. Several panelists mentioned Pandora’s forthcoming IPO and thought that the company had a lot of upside in the months ahead.  A successful Pandora IPO will spur more private investing in the music space.

John Boyle stated that he thought 2011 would be the year when companies in many of the music verticals that have emerged over the past several years would begin to gain traction in the market.  John didn’t volunteer any names regarding who might be the key companies to watch in each vertical. Readers are encouraged to check out the appendix of our interview with Jeff for more information.   We will be closely watching the evolution of the various music verticals in the months ahead for signs of emerging winners.

Conclusion

While many people in the music business like to blame their woes on technology and technological change, the industry has itself to blame for many of its problems. This comes through loud and clear in the movie Before the Music Dies.  This a great film and a “must see” if you are involved in this space.

There are quite a few companies beyond the music companies themselves with major stakes in how the reshaped industry looks in a few years.  In addition to private companies like Pandora, Spotify, and SoundCloud we know that Apple, Google, Amazon and Microsoft will all be vying for a piece of this market.  Mostly lost in the shuffle is Real Networks (RNWK) which has languished for years.  Is there any chance they can reemerge in this space?

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Demand Media: Part 3 – Quora, Google and Search Engines

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This is part three of  a longer note on internet content in general and Demand Media in particular.  The full report can be downloaded with this link: Demand Media Crapification.  Below is the section on DMD along with a link to our Intrinsic Valuation of $30.

Do you Quora?

A new kid on the block has captured the attention of alpha geeks and early adopters and has certainly entered the hype cycle as the “next big thing.”  Quora starts with a focus on questions and answers, adds to it elements of social networking (like Twitter) plus a crowd–sourced ranking mechanisms found in Slashdot and made popular by Digg.  This sounds a little esoteric at first but it ends up being effective at turning online information and the energies and knowledge of the many into productive results.

The crux of Quora is that it allows users to determine what questions to ask, answer them, and then provokes the community to rank the best ones so they are at the top.  In this way they combine elements of Wikipedia with Digg; however, the ability to follow topics and have networks of followers adds another dimension.

There are a few reasons Quora is proving more useful than other online networks, so they are worth a closer look:

Topical focus: Quora uses questions and answers to provide a framework for information sharing.  Users can submit new questions as well as answers to existing ones.  There is an approval filter on questions to guard against multiple instances of the same question and “junk” questions.

Notion of authority: Quora has been blessed with a very high level of initial user.  For example, answers are from individuals who are clear authorities.  It’s not unusual to see a founder or CEO of a company answering questions like “how did ABC company get their name?” But anyone can end up with the best answer to any question by dint of knowledge and their effort to express it.

Crowd filtering and ranking: Questions tend to elicit multiple answers, and in addition to authority the users vote for the answers they think best address the question.  In this way, the best information “bubbles up” to the top of the list and silly or wrong answers are pushed out of focus.  Over time this leads to an inventory of “right” answers to interesting and useful questions.   This is a filtering mechanism that works very well.

Intersection with networks: You can “bring your network” to Quora by following people you already know and also start following new ones.  The combination of following people and following questions leads to a more productive filter that still allows for discovery.

There are some other benefits that result from the Quora approach.  The first is that people stop adding their 2 cents when it’s not needed.  After a question has been addressed for a while, the best answer is right on top and is typically quite good.  This helps prevent subsequent visitors from adding content that doesn’t improve the answer and instead encourages them to vote, comment, answer other questions or ask new ones.

Quora is also a good place to build your network and meet new people because it’s based on shared interests, knowledge and constructive interaction.  In other words, it’s about the content that people generate more than the jobs they’ve had or people they know.  LinkedIn takes the latter approach and is not nearly as effective.

Is Quora a flash in the pan?  That’s a question that has some people worried because they enjoy the service so much.  Part of what has made Quora special is the quality of the dialog and the fact that so far the company has been willing to forgo a business model.  Will a huge increase in the number of active users result in a “dumbing down” or a “smartening up and broadening out” of the content?  Quora does have a few mechanisms that may protect them from the adverse effects of a very large user base but these will need to be tested.

The other main risk for Quora comes from within. Users are building something that may be of great value and the company will want to monetize it to stay in business.  Advertising is the most common path but doing so without jeopardizing the character, energy and quality of the site is a challenge.  Right now the costs to run Quora are low and if they stay that way it may be possible to preserve the aspects that make the site special.  Craigslist is an example of a site that was largely able to preserve their free and open model and only charge for specific things like job postings.

What can Google do?

There are some deep concerns about Google being able to address the shortcomings of their search results.  The focus on speed and general answers for search may fail to capture enough semantic processing to deliver improved results.

Of course the folks at Google know all about the problems we have described here, and have myriad solutions they could apply.  Technologies like instant search make it clear how deep their technology reservoir is.  Google now finds itself facing the innovator’s dilemma.

Google has been disruptive by giving away valuable services “for free” since they could earn billions of dollars in advertising fees.  Today that’s a huge and very profitable business for Google.  If the path to continue to delight users happens to involve showing far fewer ads, is it one that Google can afford to take?

Based on recent statements, it sounds as if Google will make noise about improving results but is unlikely to do anything radical. As the market leader they can afford to move slowly, at least for now.  However, there are a few fairly simple but powerful changes Google could implement to improve results:

User-defined site rankings: A simple way to provide positive and negative feedback on sites would make a big difference.  A heavily bookmarked site generally has good content.  Offering the opposite would be sensible. There are many sites for which I would check the box “never show search results from this site.”  Google could make this easy.

Leverage social and professional networks: There are social and professional graphs emerging that also go a long way to defining some notion of authority or at least superior judgment.  Google already can show me a search result that has been bookmarked by someone I’m following on Twitter.   Ranking sites bookmarked or tweeted by people one follows would be a helpful option.

Penalize sites with high advertising content: This is crux of Google’s problem.  Users want more content and less advertising.  We’ve reached the point where pages have more ads than content and viewers are beginning to find other places to look. Google isn’t in danger yet but if they don’t do something about the advertising proportions of returned results they’ll lose share.  It might take years, but once a decline starts it’s hard to stop. [Look how many years it took for Microsoft Internet Explorer to shrink from having the vast majority of market share to now less than 50% and falling.]

More collaborative filtering: Taking bookmarking and combining it with search and networks would allow Google to show users new sites in results lists that are more likely to fit the nature of the searcher. This would generally improve the quality of new sites being discovered.

Making enough changes to produce high quality results would could put a big dent in advertising revenues.

The race is on in terms of who will do the best job integrating social graphs and networks into filtering information and search results.  One likely outcome is that search traffic will spread out more evenly among more players and be less concentrated in Google. It’s already more natural to search Yelp if you are looking for restaurant reviews, Amazon if you want to buy a book, eBay if you want to buy a used motorcycle, Foodily if you want to find recipes, and Craigslist if you are looking for an apartment.  This trend will continue and erode some of the power Google has in the market.

Time for a New Search Engine

Internet content management will be an unending cycle of massive undifferentiated expansion followed by the tools and attenuation need to turn it into real intelligence.  Recognizing that it’s a cycle scientifically and realizing that business models end up getting embedded into the existing players means that starting a new search engine company is a good idea.

However, “search engine” is probably not the right term and should be replaced with something more active like “content finder” or, more charmingly, “librarian.”

As noted, users are already searching on individual sites that tend to offer either the general content they like (as in National Public Radio or The Economist) or better answers to specific questions (like Yelp for restaurants and Amazon for books.)

There’s a “curation” craze on right now that should die out and be replaced by intelligence based on actions (bookmarks) and relationships (social networks) that can scale more effectively.

This is a huge global market that offers extremely high returns on invested capital.  Why aren’t we seeing more investment in better information finders?  We’ve seen a few like Blekko and Wolfram but there should be more.  It turns out it only costs about $25M to create a fully functioning, scalable search engine.  Adding some intelligence to the results and offering improved results would create a large multiple of value on that investment.

There are also some existing companies that deserve a second look.  For example, a search property like InfoSpace (INSP – $8.54) has a small market share but enough of a presence to do something interesting in this market and improve their fortunes.  Other companies like Oracle, IBM and HP are in a strong position to create technology and online services that rival Google.  We’re due for a little disruption in search.

[Disclosure: None]

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Demand Media: Crapification – Part 2

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This is part two of  a longer note on internet content in general and Demand Media in particular.  The full report can be downloaded with this link: Demand Media Crapification.  Below is the section on DMD along with a link to our Intrinsic Valuation of $30.

The launch of the Demand Media IPO provides a detailed look at the massive machine whose purpose is to make money by serving content with a high affinity for advertisers and clicking consumers. First they figure out what people are searching for, intersect that with what advertisers are interested in, and then use a freelance team of thousands of content creators to write articles that will rank highly in search results and draw clicks on paid advertising links.

Although the company takes pains to demonstrate that they do, in fact, produce some decent content that provides complete and unique answers to some queries (like “how to draw a basket of fruit”), the vast majority is basically a page with a blurb of text surrounded by layers of advertising.

Fundamentally, Demand Media is an upgraded, well-capitalized and professionally managed version of other content farms. They are not trying to fool anyone with their statement: “Our Mission is to fulfill the world’s demand for commercially valuable content” (emphasis added). Demand Media brings more technology and resources to this enterprise than the myriad “small time spammers” out there but, in the end, they exist only to push out content that gets clicks. The content is cursory, sometimes cut and pasted from elsewhere, and all the time buried in piles of advertising. It’s certainly not the rich, high quality content users want.

Demand Media is a giant sensing and production engine. They collect and analyze a huge amount of data and then use their production engine, DemandStudios, to publish 4,000 “articles” per day from over 10,000 writers. The company lists articles like “how to become a stockbroker” or “how to look sexy in a bathing suit” that can be written in exchange for a $15 fee. Combine inane questions with uninformed articles by the masses and you have a recipe for a pile of insipid web pages. The last step insert ads on top, both sides, the bottom, and weaves them into the text to complete the exercise.

Of course, an elitist view of content can lead to missing some great investments. YouTube had plenty of garbage on it to start with. Many blogs and instant messaging traffic streams can be just as content-light as Demand Media sites. There are also companies like I Can Has Cheezburger, which has been extremely successful by dealing unabashedly with sites that provide silly content. Their sites comprise a vast network of distracting and useless sites like LOLcats. There’s real money to be made online by giving people fun, distracting or entertaining content.

Unlike these other companies, however, Demand Media is not trying to entertain but instead to inform and do so with the sole intent of driving advertising clicks. This creates what can only be called spam.

Uninformed search algorithms like Google’s will return enough of these results to fill the first page or two of a screen. Most of the time it’s not obvious to users that the results are spam until they click on them. Google sees this as “Another happy user clicks on this link. We’re the best!”

Whether one is happy about what Demand Media is doing is beside the point from an investment perspective. Similar arguments were made concerning QuinStreet (QNST – $23) after their IPO, but in our view a year ago the shares were undervalued at $13. Demand Media has an attractive business even though we think innovations in search technologies may make parts of it harder to monetize. Our Intrinsic Valuation model for DMD suggests a $30 stock price.

QuinStreet took time to prove their model to investors. After a solid IPO early in 2010, the shares reached $17 only to fall back to $10 by the summer. Subsequently, however, the company has executed on their strategy and now the stock is more in line with their IV at $23. Last year we saw similar stock dynamics for Ancestry.com and Higher One Holdings.

In order to shed more light on what will help improve information content on the web, our next post will look at Quora, another player in the online content space that has been turning heads within the “tech-noscenti” and is beginning to enter the mainstream.

[Disclosure: None]