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01/31/2005

The Coming Blog Wars: Google vs. Yahoo

For Yahoo and Google, the Internet’s two search titans, Blogs are rapidly becoming both an important distribution channel and a growing cost center.  The battle to control this distribution channel, while at the same time reducing its costs, will intensify greatly this year and will most likely be characterized by some rapid fire acquisitions within the “Blogsphere”.

It’s The Channel Stupid
According to Technorati, the number of blogs on the web has grown from about 100,000 two years ago to over 6,500,000 today with about 20,000 new blog being added every day.  Over at Pew research, their latest study indicates that 27% of Internet users in the US, or 32 million people, are now reading blogs, up almost 150% in just one year.

Right now, Google owns the blog-channel thanks in part to its acquisition of Blogger, but mostly to its self-serve Adsense platform that allows bloggers to easily add paid placement and search services to their sites.  (I set up both services on this site in 30 minutes with no human help or interaction.)  While Google doesn’t say just how much of its revenues it generates via blogs, with growth numbers like those above it’s no doubt that Google’s “blog-related” revenues are growing quite quickly.

While Yahoo is rumored to be building a competitive offering to Adsense, for now it is limited to only serving large sites, so its blog-related revenues are likely miniscule, however Yahoo clearly is aware of the growing importance of blogs and knows that it must have a competitive response to Google’s Adsense platform.

If either player were able to control or at least significantly influence which paid placement services bloggers chose to incorporate into their sites, it would given them a substantial competitive advantage in their head-to-head competition and control over one of the fasting growing channels on the web.

For example, not only would control allow Yahoo or Google to push their own paid placement and search services at the expense of the other, but it would allow them to route other “affiliate” traffic through their own hubs and thereby take a piece of the action.  For example, rather than having bloggers link directly to something like Amazon's Associates program,  the bloggers would instead send their traffic to a “master” affiliate account at Google, one in which Google was able to negotiate a larger % cut due to its overall volume, or they might just send it to Froogle if that was a better deal.  In such a case both the bloggers and Google win.  Google gets a cut of affiliate revenues that it previously missed out on and bloggers get a slightly higher rev share thanks to Google’s much greater bargaining power.

A Costly Partnership
While integrating blogging more closely into their business models offers Google and Yahoo additional revenue opportunities, it also presents them with significant costs, mostly in the form of revenue share payments that they must make to blogs.   While they must make similar (and often higher) payments to traditional media partners, the payments to blogs are more costly to process (due to large number of blogs) and much more susceptible to click-through fraud schemes.   Controlling the cost of the channel is therefore likely to be almost as big a focus as increasing the revenues its produces.

While controlling fraud will be very important, it likely won’t be a source of competitive advantage as both firms have similar incentives to control fraud.  One can even imagine both firms partnering, directly or indirectly, to jointly fight fraud.  That leaves reducing payments to blogs as the most obvious way to control costs, however reducing payments will be difficult to achieve due to competitive pressures.

Blog Barter: Spend Money To Save Money
The best way to save costs may actually be to spend some money and acquire companies that currently offer services to bloggers.  These services can then be bartered to blogs in return for a reduction in payments.  For example, a blog that pays its hosting firm $20/month might be willing barter $20 worth of its click-through revenues for hosting instead of writing a check.  At the very least, Google and Yahoo might be able to buy such services for $18/month and resell them for $20 in click-through credits thus saving themselves 10% cash in the process. 

This math, plus burgeoning payments to bloggers, is likely to prompt both Google and Yahoo to make some rapid fire acquisitions in the space.   For Google, the acquisitions will be about protecting its lead and denying Yahoo the chance to become competitive.  For Yahoo they will be about quickly catching up to Google and potentially surpassing it.  Of the firms, Yahoo is perhaps in the best position to initiate this “blog barter” economy given that it has a broad range of existing subscription services that it can barter, however they are also the further behind in terms of using blogs as a channel for their services.

The Hit List
While it’s tough to say with 100% accuracy which start-ups will be on the blog-inspired M&A “hit list” of Google and Yahoo, it is clear that such firms will do one of two things:  they will either enhance control over the distribution channel or they will reduce its costs by enabling “blog-barter” transactions.  Google early on struck the 1st blow in this M&A battle with the acquisition of Pyra Labs (creator of Blogger) in 2003, but more deals are undoubtedly on the horizon due to blogging’s explosive growth in 2004.  A few of the most likely candidates for acquisition include:

  • Six Apart:  Creator of the popular TypePad blog authoring software and service (this blog is hosted on their service), TypePad has long been rumored to be a potential acquisition candidate, most recently for Yahoo.  With 6.5M users after its recently announced acquisition of LiveJournal is completed, Typepad is clearly the biggest piece of the blog channel that it potentially up for grabs.  While the odds on bet is that Yahoo will acquire TypePad given that it has no blog platform to date, Google may well try to lock up the channel by acquiring TypePad ahead of Yahoo, but it’s also possible that long shots such as Amazon and Microsoft may make their own bids.
  • Burning Door:  Operator of the increasingly popular Feedburner service that provides detailed usage statistics of RSS feeds, Feedburner is an ideal acquisition both as an incremental revenue generator and a “blog barter” service.  On the revenue front, Feedburner offers a fantastic platform for “splicing” contextually relevant RSS advertising and affiliate offers into RSS feeds creating yet another advertising platform for the search players.  On the blog-barter front, serious bloggers will easily part with a few “barter bucks” each month in return for the detailed usage and reporting statistics that Feedburner is able to provide.
  • MySpace:  Originally pitched as a social networking site, MySpace has melded social networking with blogging to the point where the site has become some kind of strange youth-centric amalgam of the two worlds.  The risk is that MySpace is really just GeoCities 2, but this may turn out to be the best kind of platform for advertisers to reach the youth market in a contextual, non-obtrusive way.  In addition, if MySpace can help its members earn a little pocket change through blogging, they may be able to solve the input-output asymmetry problem that I wrote about in an earlier post on social networking.

There are a bunch of blog aggregation sites such as Bloglines, Technorati, del.icio.us that appear on the surface to be interesting acquisition opportunities, but it is unclear what these sites really add to the existing capabilities of Yahoo and Google as these sites focus on end-users, not bloggers, and Google and Yahoo already have plenty of end-users.

As for VCs, this round of blog-inspired M&A will be a nervous game a musical chairs as quickly placed wagers either pay-off or are permanently bypassed.  Watching how this , the Great Blog Battle, plays out will be entertaining indeed!

January 31, 2005 in Blogs, RSS | Permalink | Comments (11)

01/25/2005

Saving RSS: Why Meta-feeds will triumph over Tags

It’s pretty clear that RSS has now become the de facto standard for web content syndication. Just take a look at the numbers. The total number of RSS feeds tracked by Syndic8.com has grown from about 2,500 in the middle of 2001, to 50,000 at the beginning of 2004, to 286,000 as of the middle of this month. That’s total growth of over 11,300% in just the past 3.5 years!

Feed Overload Syndrome

However, as I wrote at the beginning of last year, the very growth of RSS threatens to sow the seeds of its own failure by creating such a wealth of data sources that it becomes increasingly difficult for users to sift through all the “noise” to find the information that they actually need.

Just ask any avid RSS user about how their use of RSS has evolved and they will likely tell you the same story: When they first discovered RSS it was great because it allowed them to subscribe to relevant information “feeds” from all of their favorite sites and have that information automatically aggregated into one place (usually an RSS reader like Sharpreader or NewsGator). However, as they began to add more and more feeds (typically newly discovered blogs), the number of posts they had to review started rising quickly, so much so that they often had hundreds, if not thousands of unread posts sitting in their readers. Worse yet, many of these posts ended up either being irrelevant (especially random postings on personal blogs) or duplicative. Suffering from a serious case of “feed overload”, many of these users ultimately had to cut back on the number of feeds that they subscribed to in order to reduce the amount of “noise” in their in-box and give them at least a fighting chance of skimming all of their unread posts each day.

The First Step: Recognizing That You Have Problem

Many in the RSS community recognize that “Feed Overload Syndrome” is indeed becoming a big problem and have begun initiatives to try and address it.

Perhaps the most obvious way to address the problem is to create keyword based searches that filter posts based on keywords. The results from such searches can themselves be syndicated as an RSS feed. This approach has several problems though. First, many sites only syndicate summaries of their posts, not the complete post thus making it difficult to index the entire post. Second, keyword-based searches become less and less effective the more data you index, as the average query starts to return more and more results. Third, keywords often have multiple contexts which in turn produce significant “noise” in the results. For example, a keyword search about “Chicago” would produce information about the city, the music group, and the movie among other things. That said many “feed aggregation sites” such as Technorati and Bloglines currently offer keyword based searching/feeds and for most folks these are better than nothing. However it’s pre-ordained that as the number of feeds increase, these keyword filtering techniques will prove less and less useful.

Tag, You’re Categorized

Realizing the shortcomings of keyword-based searching, many people are embracing the concept of “tagging”. Tagging is simply adding some basic metadata to an RSS post, usually just a simple keyword “tag”. For example, the RSS feed on this site effectively “tags” my posts by using the dc:subject property from the RSS standard. Using such keywords, feed aggregators (such as Technorati, PubSub and Del.icio.us ) can sort posts into different categories and subscribers can then subscribe to these categorized RSS feeds, instead of the “raw” feeds from the sites themselves. Alternatively, RSS readers can sort the posts into user-created folders based on tags (although mine doesn’t offer this feature yet).

Tagging is a step in the right direction, but it is ultimately a fundamentally flawed approach to the issue. The problem at the core of tagging is the same problem that has bedeviled almost all efforts at collective categorization: semantics. In order to assign a tag to a post, one must make some inherently subjective determinations including: 1) what’s the subject matter of the post and 2) what topics or keywords best represent that subject matter. In the information retrieval world, this process is known as categorization. The problem with tagging is that there is no assurance that two people will assign the same tag to the same content. This is especially true in the diverse “blogsphere” where one person’s “futbol” is undoubtedly another’s “football” or another’s “soccer”.

Beyond a fatal lack of consistency, tagging efforts also suffer from a lack of context. As any information retrieval specialist will tell you, categorized documents are most useful when they are placed into a semantically rich context. In the information retrieval world, such context is provided by formalized taxonomies. Even though the RSS standard provides for taxonomies, tagging as it is currently executed lacks any concept of taxonomies and thus lacks context.

Deprived of consistency and context, tagging threatens to become a colossal waste of time as it merely adds a layer of incoherent and inconsistent metadata on top of an already unmanageable number of feeds.

Meta-Feeds

While tagging may be doomed to confusion, there are some other potential approaches that promise to bring order to RSS’s increasingly chaotic situation. The most promising approach involves something called a Meta-feed. Meta-feeds are RSS feeds comprised solely of metadata about other feeds. Combining meta-feeds with the original source feeds enables RSS readers to display consistently categorized posts within rich and logically consistent taxonomies. The process of creating a meta-data feed looks a lot like that needed to create a search index. First, crawlers must scour RSS feeds for new posts. Once they have located new posts, the posts are categorized and placed into a taxonomy using advanced statistical processes such as Bayesian analysis and natural language processing. This metadata is then appended to the URL of the original post and put into its own RSS meta-feed. In addition to the categorization data, the meta-feed can also contain taxonomy information, as well as information about such things as exact/near duplicates and related posts.

RSS readers can then request both the original raw feeds and the meta-feeds. They then use the meta-feed to appropriately and consistently categorize and relate each raw post.

RSS Nirvana

For end users, meta-feeds will enable a wealth of features and innovations. Users will be able to easily find related documents and eliminate duplicates of the same information (such as two newspapers reprinting the same wire story). Users will also be able to create their own custom taxonomies and category names (as long they relate them back to the meta-feed). Users can even combine meta-feeds from two different feeds so long as one of the meta-feed publishers creates an RDF file that relates the two categories and taxonomies (to the extent practical). Of course the biggest benefit to users will be that information is consistently sorted and grouped into meaningful categories allowing them greatly reduce the amount of “noise” created by duplicate and non-relevant posts.

At a higher level, the existence of multiple meta-feeds, each with its own distinct taxonomy and categories, will in essence create multiple “views” of the web that are not predicated on any single person’s semantic orientation (as is the case with tagging). In this way it will be possible to view the web through unique editorial lenses that transcend individual sites and instead present the web for what it is: a rich and varied collective enterprise that can be wildly different depending on your perspective.

The Road Yet Traveled

Unfortunately, the road to this nirvana is long and as of yet, largely un-traveled. While it may be possible for services like Pubsub and Technorati to put together their own proprietary end-to-end implementations of meta-feeds, in order for such feeds to become truly accepted, standards will have to be developed that incorporate meta-feeds into readers and allow for interoperability between meta-feeds.

If RSS fails to address “Feed Overload Syndrome”, it will admittedly not be the end of the world. RSS will still provide a useful, albeit highly limited, “alert” service for new content at a limited number of sites. However for RSS to reach its potential of dramatically expanding the scope, scale, and richness of individuals’ (and computers’) interaction with the web, innovations such as meta-feeds are desperately needed in order to create a truly scaleable foundation.

January 25, 2005 in Blogs, Content Managment, Development Tools, RSS | Permalink | Comments (7)

01/20/2005

God I wish I Could Still Short AOL

As I was watching my beloved Steelers miraculously avoid embarrassment at the hands of the Jets this weekend, I did something I seldom do these days (thanks to my DirecTivo), I watched commercials.  Most of the commercials were standard football fare (beers, cars, IBM, ED treatments), but there was one set of commercials that were clearly out of place.  They were for America Online.

Perhaps you also saw the spots I am taking about.  All them featured rather ordinary people sarcastically begging for their computers to be afflicted with some kind of computer virus.  The sales pitch, which is at its core was a blatant scare tactic, was that AOL offers their users free Virus-protection software and you, dear consumer, had better get AOL before some similar malady befalls your computer.

As I saw these ads, it confirmed to me 4 things about AOL:  1.  That the once proud "proprietary fortress" has nothing positive left to keep its members within the confines of its clunky client except for cheesy scare tactics.  2.  That the management of AOL is in complete denial about the severity of the crisis their business faces.  3.  I wish I could short their stock.  4.  Steve Case is one of the smartest investors in history and should be folk hero to all pre-merger AOL shareholders instead of the corporate scapegoat that he has become.

Let me briefly address each of thoughts in turn.  First, it is clear that the "walled gardens" of the old dial-services have been completely torn asunder by the power of the Internet and broadband.  AOL's party line has been that proprietary content (presumably Time Warner magazines, videos, etc.) and services (most prominently e-mail and to a lesser extend AIM) would enable them to survive in a broadband world and would keep their customers from defecting.   With each passing day I think this party line looks increasingly like the wishful thinking it is.  If AOL's proprietary services are so great, why are they spending tens of millions on marketing campaigns focused on scare tactics instead of touting their great proprietary content? Because they know that the Internet offers several orders of magnitude more content and services, mostly for free, and they will never be able to compete with that.

My second thought was that while AOL's management team either implicitly or explicitly has accepted that they have lost the content war (and must therefore resort to scare tactics), that they have not accepted that their business is headed, Titanic-like, straight into a massive iceberg called broadband.  AOL does not stand a chance competing against the RBOCs and the MSOs for broadband customers.  Why in world will someone pay an additional $20/month ($240/year) for AOL when they are already paying more for broadband access to begin with?  At first they might pay to keep their e-mail address, but overtime the pull of the Internet (and their wallet) will be inexorable.  This point was driven home to me when my own parents recently sent around e-mails saying that they were switching from a Compuserv (one of AOL's low cost brands) e-mail account to a ComCast e-mail account.  They switched to broadband about 6 months ago but only made the e-mail switch after Comcast made available a very easy to use "e-mail address change" application.   For them it was a no-brainer as it is bound to be for everyone else.  If AOL was serious about avoiding the iceberg they would either be A) drastically cutting their prices  B) spinning off their access business C) selling themselves to an MSO, RBOC, or Wireless carrier.

This led me to engage in a a bit of fantasy and wish that I was still able to short AOL's stock instead of having it buried within the bowls of TWE.  With management in denial, broadband competitors stealing their high-end customers and competitors like NetZero stealing their low-end customers, AOL is clearly getting ripped apart.   I say this despite the fact that I believe they still have a salvation strategy in which they essentially replicate what Yahoo!/MSN have built.  While they claim to be doing this (via AOL.com), the ads they are running suggest that they are still investing their incremental dollars in the old, soon to fail, business model instead of the new one.  The right hand clearly doesn't know what the left is doing and that's what makes a great short.

Departing from my fantasy, I feel compelled to come to the defense of Steve Case who has generally gotten a bad rap in the press (and the Time Warner board room) following the merger.  All of what I outlined above was hypothesized well before the early 2000 merger of TWE and AOL and one has to assume that Steve was well aware of this.  Sure he may have believed that proprietary content would save AOL, but more likely he believed his own stock was seriously overvalued in the face of the competitive threats he faced and thus it was a great time to acquire a real business with significant cash flows based on truly proprietary content (Movies, books, magazines) and monopolies (Cable Systems).  What a sales job he did to get the Time Warner board to agree to that deal and what a favor he did to AOL's shareholders.  Steve, you da man!

January 20, 2005 in Stocks | Permalink | Comments (7)

01/07/2005

Software Stocks Update: Year End 2004

The Software Stock Index was up 2.9% in December, lagging the NASDAQ market’s 3.7% gain for the month, however if you exclude Microsoft, the index was up 4.6%.  For all of Q4, the Software Index was up 10.7% (19.4% excluding Microsoft) vs. the NASDAQ's impressive 14.7% rise.  For the year (or least since 1/26/04 when I first starting tracking the Software Index), the Software Index was up 4.2% vs. the NASDAQ's 1.0% rise, so overall software stocks had a decent but not great year.  You can find a spreadsheet that details these figures here.

In terms of my hand picked virtual software stock portfolio, the portfolio was up a respectable 3.9% this month and it would have been up much more if it wasn't for a highly suspicous performance by one stock (more on that later). On an overall basis, for the year the portfolio was up 27.2% since late January vs. an 1.0% gain for the NASDAQ during that same time, so it handily outperformed the market by 26%.

Long Picks
Company: Actuate Ticker: ACTU
Sub-sector: Business Intelligence
Investment Thesis: This is a turn around story in the hot business intelligence space. The story took a hit last quarter though when the company missed top line estimates and didn’t inspire confidence about Q4.
Performance: Since 1/26/04: -27.6%, Nov vs. Dec: 7.6%
Comments: Closed on an up note, but still concerned about this pick.

Company: SumTotal Ticker: SUMT
Sub-sector: E-Learning
Investment Thesis: SumTotal was formed by the merger of Docent and Click2Learn which closed in mid-March. I liked Docent before the merger because as it was relatively cheap, had good products, and was in a space still seeing good corporate spending (E-Learning). The combined companies promise to be solidly profitable after the debris from the merger clears which should help the overall valuation as they cement their leadership position in the e-learning space.
Performance: Since 1/26/04: -31.7%, Nov vs. Dec: -3.8%
Comments: Q4 is a critical report.  Either they have put the merger behind them and they are now solidly profitable or I am moving on.

Company: SPSS Ticker: SPSS
Sub-sector: Business Intelligence
Investment Thesis: SPSS is another player in the business intelligence space with a particular emphasis on predictive analytics, something that is particularly hot right now. The stock has been battered by a restructuring that the company went through last year as well as an accounting restatement. My thesis is that the new product set is strong and the accounting trouble is overblown.
Performance: Since 4/30/04: 10.0% Nov vs. Dec: -2.2%
Comments: Still very jumpy but have decent hopes that they will get this thing stablized in 2005 and back into the investment mainstream.

Company: Stellent Ticker: STEL
Sub-sector: Content Management
Investment Thesis: Stellent is a relatively sleepy, but well established, content management company that is attractively priced. Q1 was the first quarter of positive cash flow in awhile and Q2 saw pro forma, but not GAAP positive, EPS. With $20-25M/quarter in revenues, Stellent has a lot of room to work on expenses and should be able to return the company to solid GAAP profitability at which point the stock should recover from its current 1.1X ev/sales to something much closer to 2X.
Performance: Since 6/30/04: 3.3% Nov vs. Dec: 12.4%
Comments: Closed the year with its second strong month.   Looks like it is finally getting credit for turning the corner.

Company: Neteller Plc. Ticker: NLR.L
Sub-sector: Internet Payments
Investment Thesis: Every portfolio needs a flyer and this sure counts as one. Neteller is Europe/Canada’s answer to PayPal and it has been making a killing by servicing markets, particularly online gambling, that PayPal has been pressured into exiting by the US Justice Department.  I know, I know, this is not a software stock, but I still follow online financial services quite closely and I feel compelled to point out this stock because it is such an attractive buy.
Performance: Since 6/30/04: +135.8% Nov vs. Dec: 25.6%
Comments: The portfolio's big winner this year closed out on another strong note.  At 15X 2000 earnings I still think it has some life left in it, but I wouldn't expect a repeat peformance in 2005.

Company: Sportingbet Plc. Ticker: SBT.L
Sub-sector: Internet Gambling
Investment Thesis: Continuing my trend of UK-based non-software stocks, I feel compelled to add Sportingbet.com to the portfolio.  Sportingbet is the largest online gambling operator in the world and just last month executed an accretive deal to buy one of the largest online poker sites on the net (Paradise Poker).  At 16-17X 2005 EPS this stock is very attractive relative to its growth rate (25-30%) and especially attractive relative to other internet commerce plays.  In addition, in November the World Trade Organization ruled that it is illegal for the US to prevent US citizens from placing bets on non-US Internet sites.  While the US is appealing the ruling, it raises the possibility that US citizens will be able to legally gamble on-line which could lead to further industry growth.  I don’t like the big options overhang in this stock or the poor margins (due to sports betting business) but this is a chance to own the #1 player in an important online commerce player at an attractive valuation.  Too bad I didn’t buy it at the same time I bought Neteller as it is up about 50% since the middle of 2004.  Acquisition by one of the major US gambling concerns (once online gambling is legal), seems a distinct possibility.
Performance: Since 11/30/04: 19.8% Nov vs. Dec: 19.8
Comments: A nice addition to the portfolio last month.  Q4 report should be strong, so I expect the stock to do well for at least the next couple months.

Short Picks
Company: Autonomy Ticker: AUTN
Sub-sector: Content Management
Investment Thesis: Autonomy is a UK-based purveyor of advanced enterprise search software a space I know well from some of my VC investments. The enterprise search space is crowded and getting even more competitive with the entry of folks like Google. Autonomy’s secret sauce, its categorization software, is increasingly being duplicated by it competitors. Autonomy continues to trade at a premium to the market at 3.9X enterprise value to sales however its decline has brought it to a more reasonable level. This premium appears to be largely an artifact of the fact that autonomy is a bit of a cult stock in its home country of the United Kingdom.
Performance: Since 1/26/04: +41.7%  Nov vs. Dec: -10.5%
Comments: AUTN closed the year on a strong relatively strong note.  I am not sure if the stock has bottomed here or not.  I will watch it closely this month.

Company: RSA Security Ticker: RSAS
Sub-sector: Security
Investment Thesis: I have always wanted to short RSAS. I covered the security sector when I was an analyst and basically came to hate the sector due to the fact that almost every company blows up once every 12-18 months and does so with no warning whatsoever. RSA used to be called Security Dynamics and its main product remains a "hard token" called Secure ID which they already have sold to just about everyone on the planet that is going to buy one.   Right now the street is infatuated with an AOL deal which I think has no legs.
Performance: Since 8/1/04: -7.8% Nov vs. Dec: 4.8%
Comments: Stock was weak going into the end of the year which may indicate a pending miss.  Hard to say, but I still feel good about the short. 

Company: Salesforce.com Ticker: CRM
Sub-sector: Vertical Applications
Investment Thesis: Salesforce.com is a, mostly, hosted sales force management application. It's a good product,
most of my start-up companies used it, but it is expensive the longer you use it and the larger your company gets. CRM is 2nd most highly valued stock in the software space despite the fact that it is facing increased competition from the big boys of enterprise software and that it’s very hard to rapidly grow subscription-based revenues. Any misstep and this stock will down 25% in a heartbeat.
Performance: Since 1/26/04: -30.2% Nov vs. Dec: 3.3%
Comments: This month was supposed to be a better month. CRM's lockup came off and while the stock was weak for a bit, it recovered nicely on good volume.  That worries me because it means there are plenty of deep pockets willing to buy this stock even at 105X 2005 earnings.    I guess I will wait to see what their earnings report says.

Company: Wave Systems Ticker: WAVX
Sub-sector: Security
Investment Thesis: I first encountered Wave when I wrote my initial analyst report on Wall Street in the mid-1990s. Wave has remained in business largely by claiming that it is developing revolutionary security technologies, kind of like a bio-tech company that never gets out of trials. With a grand total of $1.4M in revenues over the last 3.5 years, almost $14M in cash burn during the first nine months of this year and only $6M in cash left, Wave finally appears to be approaching judgment day. It may take a few more quarters, but I fully expect Wave to follow in the footsteps of CMRC or to wash out the existing common with a new financing.
Performance: Since 10/1/04: -25.7% Nov vs Dec: -41.2%
Comments: I guess this stock proves the lesson that you should never underestimate what desparate men will do.  Running low on cash in early December, Wave made an announcement on 12/14 that they had released a version of their software for a potential Dell OEM deal.  The stock promptly jumped 80% on 20M shares in volume.  Never mind that Dell has not committed to selling the software, that the software retails for only $20/copy and that the Dell OEM version was basically just a rebranding of an existing version that a distributor called Envoy was already selling on Wave's behalf.  Then on the 16th, Wave drops another press release saying that the company has won a contract with the US Army.  That generates about 8M shares of volume at $1.36/share.  Lo and behold on the 17th, Wave announces that it has closed a $5.8M private placement, just in the nick of time, but unlike the other private placements it has done (in which it sold the stock at market close and offered out of the money warrants) this placement sold the stock at $1.05/share or a whopping 23% discount to the close of the stock on the day the deal was agreed.   Any trader worth his salt knows how this deal went down.   Wave's placement agent had the deal teed up and ready to go, probably for several weeks.  The agent undoutedly knew that there would be some good news coming that would help the stock trade up dramatically.  Once that news was announced, the investors went into the market and in the midst of the greatly increased positive volume were able to sell short almost their entire position.  With their position locked in, the investors signed the deal and promptly covered their short with the delivered shares.  Wallah!  A 23% guaranteed, overnight profit.  God bless America!  This is one of the oldest penny stock tricks in the book, it's just surprising to see it used so blantently in this day and age of Sarbanes-Oxley, etc.  Just to make this situation even more comical, on the 20th, which was likely well after all the shorts were covered, Wave quitely filed an 8K with the SEC in which they mentioned that the US Army contract was for a whopping $80K, a fact they ommitted from the press release on the 16th.  And why not, $80K is not going to make much of a dent in a $4.5M/quarter burn rate.  The only solace I take from this episode is that it smacks of true desperation to me.  By playing these kind of penny stock games, Wave is clearly indicating that it can no longer get reputable investors to buy from its "shelf offering".  At their current burn rate they will have to go back to the shelf by the end of this quarter or early next quarter so it will be interesting to see just how much juice they will have to offer to get the deal done.  It will also be interesting to see just how much they are willing to risk attracting SEC attention with another one of their pump, short, issue, cover schemes.  While they may be able to keep up the charade for another quarter or so, I like the smell of desperation and therefore I am keeping my short on.

Company: Convera Ticker: CNVR
Sub-sector: Content Management
Investment Thesis: I ran into Convera when I was on the board of Stratify.  I was unimpressed with Convera’s business then and I am unimpressed with it now.  They have a decent market niche in the government sector but have never been able to really expand out from there and face increasing competition from the likes of Google, Verity, and Microsoft.  The stock is up strongly in the past few months thanks to the company’s announcement that they are going to enter into the web search market.  This hype has disguised very poor license sales of the core product and a continued high burn rate (averaging about $4M-5M a quarter).   Eventually the chickens will come home to roost and investors will realize that these guys are a just a third rate enterprise search vendor.
Performance: Since 11/30/04: 0.2% Nov vs. Dec: 0.2%
Comments: Very flat month on thin volume.  With the company putting so much emphasis on their web search product for corporations I have to imagine that they are having difficulty keeping people's eyes on the ball when it comes to closing traditional license sales.

The winners and losers were pretty evenly split between long and short positions with the biggest winners being Neteller (Long, 135.8%) and CommerceOne (Short, +97.8%).  The biggest losers were Blue Martini (Long, -43.5%) and SumTotal (Long, -31.7%).  I have definitely learned the value of a well balanced long/short fund this year though I have to get more disciplined about closing out dead money on the long side. We'll see how things go this year!

I did not make any changes to the portfolio this month as it's net long right now and January is traditionally a good month to be long.  I will try to do some serious re-evaluations at the end of this month.

January 7, 2005 in Stocks, Wall Street | Permalink | Comments (1)

01/06/2005

Shotgun Wedding: Is Symantec Afraid of Microsoft's Baby?

The investment bankers marrying off Symantec and Veritas had better not ask Wall Street to “speak now or forever hold its peace” because they are likely to get quite an earful.  Indeed, with Symantec’s stock down almost 23% since the deal was first rumored The Street has already spoken, and from what it’s saying these two lovebirds are going to have a hard time formally exchanging vows.

Conventional wisdom holds that much of this sell-off has been driven by (mostly valid) concerns that Veritas’ relatively lower growth rates will drag down Symantec’s high flying multiple, but underneath these surface issues likely lies a more deep-seated fear that Symantec’s Cinderella story may soon be over thanks to the fact that Microsoft is finally fully pregnant with a new, security focused “baby”.  Viewed from this perspective, Symantec’s surprise merger with Veritas is a shotgun wedding that implicitly acknowledges the fact that Microsoft may shortly make the consumer and SME security software marketplaces a very bloody battlefield leaving Symantec with no choice but to “go corporate” in a hurry.

Waiting For Godot

Pundits, hedge funds, and Pollyannaish anti-trust types have long speculated that Microsoft intends to make security software one of its core business units.  At first such desires were assumed to simply be motivated by Microsoft’s insatiable appetite for growth and their Conan the Barbarian-like desire to crush their enemies, see them driven before them, and to hear the lamentations of their women.  However in the last couple years, thanks largely to Outlook and IE born viruses, Microsoft’s security software ambitions have been transformed from mere sport, into a critical business issue.  With every widely publicized e-mail virus, Microsoft’s reputation takes a heavy hit and its customers become more and more perturbed. As a result, security software has gone from a “nice to have” to a “must have” for Microsoft.

With Windows XP Service Pack 2, Microsoft took its first tentative steps in this direction, but the company realizes that the only way to fully protect its software from security threats it to deeply integrate security technology into the core of operating systems and desktop applications.  This realization set the stage for two small acquisitions by Microsoft.   The first acquisition was of a small anti-virus software maker called GeCAD in June of 2003 and the second was of a small anti-spyware company called Giant in December of 2004.

Collapse of the Confident Facade

Symantec has paid close attention to Microsoft’s moves and has gone to great pains to downplay them and insist that their anti-virus corporate accounts were not at risk even if Microsoft moved with full force into the anti-virus marketplace. Most investors have taken Symantec at its word assuming that the management team had reason to be confident and that Symantec, like Intuit, might be one of the few companies that could not only survive but thrive in the face of full fledged Microsoft assault.

Unfortunately for Symantec, actions often speak louder than words and in this vein its surprise acquisition of Veritas speaks volumes.  If Symantec was so confident that it could survive Microsoft’s antivirus onslaught, why then are they suddenly purchasing a software company growing at half their rate and operating in sectors that have little if any synergy with Symantec’s current security-focused product lines?  In fact, of all the potential companies that the street has theorized Symantec might buy (I actually had my own theory), Veritas was one of the last companies that people expected Symantec to buy.  It’s almost as if Symantec is trying to move away from its core business as far and as fast as possible.

Thus Symantec’s acquisition of Veritas is an implicit admission of two key points:  1) that Microsoft’s entry into the security software market is making that market a much less attractive incremental investment space and 2) that SYMC can’t sustain the growth rates that were, until recently, supporting its lofty PE. In this light, the 23% decline in SYMC’s stock price is not only understandable, but probably less than one might otherwise expect. If Symantec and Veritas can’t counteract these concerns and convince the Street that their merger is the result of mutual love and respect for a viable long term growth strategy, then they had better cut short their romance as shotgun weddings don’t work when the real issue is another person’s baby.

January 6, 2005 in Operations Management, Security, Stocks | Permalink | Comments (2)

01/03/2005

Betwixt and Between: Can IBM afford to stay out of the applications business?

For a decade or so, IBM has pursued a determinedly ISV-friendly course when it comes to the enterprise applications business.  During this time IBM has gone to great lengths to convince ISV’s to build their applications on top of IBM’s infrastructure software (primarily Websphere and DB2) all the while assuring those ISV’s that IBM had no plans to compete with them in the applications space.

This strategy has arguably served IBM very well.  It has helped build broad acceptance and support for their infrastructure products within many ISVs and has been well received by customers who want a vibrant and competitive applications market.  However, unfortunately for IBM, the software industry is evolving to the point where it may be impossible for IBM to stay out of the applications business if it wants to remain competitive over the long term.

A Tale of Two Forces

Two separate, yet simultaneous, forces are pushing IBM towards the applications business.  The first force is vertical consolidation set in motion by IBM’s competitors and the second is increasing price competition within the core infrastructure software business.

In terms of the software industry’s vertical consolidation, the most recent and high profile example of this consolidation has been Oracle’s acquisition of Peoplesoft (which I wrote about last week).  With this acquisition Oracle is trying to solidify and legitimize its vertical software suite, which starts at Oracle 10g, moves up to Oracle Application Server, and then ends with Oracle’s Application suite (and whatever remnants of Peoplesoft that are left over). For IBM, the Oracle deal is somewhat bad news as it had announced with great fanfare just four months ago that Peoplesoft was going to base all its products on IBM’s infrastructure software.  Instead, Oracle will now try to migrate all of those customers to an Oracle-only software stack which could hurt both IBM’s Websphere and DB2 businesses.

At the same time that Oracle is trying to move its center of gravity up the stack into applications, another major software company, SAP, is trying to move down from applications and into the infrastructure.  While it hasn’t got a lot of attention, SAP’s NetWeaver application server and suite of infrastructure software products is clearly designed to try and create a Websphere-like layer of branded infrastructure software that SAP can sell to its customers … in place of IBM’s software.   Can an SAP branded relational database be far behind?

Both SAP and Oracle appear to be taking a page out of the playbook of Microsoft.  By tightly tying its office applications to operating systems Microsoft has been able to create a tremendous 1-2 punch that compels customers to install Windows and .NET if they want to get the full impact of Exchange, Excel, and Word.  One can imagine similar efforts underway at SAP and Oracle where engineers are tightly integrating applications into their supposedly “open” application servers to the point where those applications only seem to work best on each company’s infrastructure stack.

This trend of consolidation reached its logical absurdity when Microsoft and SAP seriously considered merging in late 2003.  While most people laughed at the idea of Microsoft and SAP combining from a cultural and management perspective (including me), IBM software executives must have found the discussions to be quite sobering.  On paper at least, an SAP/Microsoft combination would be a vertically integrated behemoth that could really give IBM a run for its money across almost all platforms and markets (which is no doubt why Microsoft broached the topic).

The Price Is Wrong

Outside of consolidation, IBM’s ISV friendly strategy is also under attack from pricing pressures, particularly within the infrastructure software space.  This pricing pressure is coming from two fronts: the integrated vertical players and the open source players. As the integrated vertical players build out their software stacks they can start to selectively target competitors, such as IBM, with specific pricing strategies. For example, SAP can lower prices on NetWeaver because it knows it will make up much of the lost revenue by selling its ERP applications.  IBM can’t respond to such “bundling” tactics because it lacks an applications business.

On the open source front, while IBM masterfully embraced open source and Linux as a way to defeat Sun’s and Microsoft’s push into the glass house, they have created somewhat of an uncontrollable monster that threatens to erode margins in their application server and messaging products. With corporations embracing Linux as an operating system, many are now looking at open source applications servers (such as JBoss) and databases (such as MySQL) as potential ways to cut additional licensing fees. This pricing pressure is starting to be felt in the infrastructure space with per CPU pricing for application server licenses declining quickly even as IBM and BEA bundle more and more functionality into their products in an effort to justify their premiums relative to open source alternatives.

The Empire Strikes Back

It appears as though IBM’s response to these trends has been to redouble its efforts to make its infrastructure the center of the software universe by fragmenting applications into lots of little pieces.  By heavily pushing J2EE, grid computing and SOA’s, IBM is trying to fragment the application layer into lots of little pieces.  Fragmenting the application layer lets customers mix and match best-of-breed application components and therefore undermines much of the utility and rationale for monolithic application suites such as R3.  It also benefits IBM’s services business by making it easy for customers to custom develop application components and integrate them with 3rd party software.

While in the long term such architectures may predominate, in the short term customers are still looking for solutions and it’s still very difficult to piece together a robust enterprise application using next generation technologies and architectures.

All Over But the Buying?

Thus, with competitors acquiring IBM’s best ISV channels and with pricing eroding thanks to bundled pricing and open source alternatives, IBM may be forced to enter back into the enterprise applications business, if anything, as a purely defensive move against its chief rivals.    If IBM does enter the applications business it will likely have to buy its way in, although with many of the most attractive ISV’s already acquired, IBM would have to cobble together a solution by buying several companies such as Siebel and Lawson.

On the other hand, IBM may simply fight a rear guard action and be content to gradually let its software growth and margins decline as software isn’t really its core business now anyway. From this perspective, IBM will accept gradually lower margins and growth in its software business as simply the price to pay for keeping its services and hardware businesses in the black.  After all, IBM had its chance to get into the applications market by buying Peoplesoft, and instead of playing the white knight (which Peoplesoft clearly desperately wanted IBM to do), it just stood by and let Oracle acquire Peoplesoft without batting an eye.

It’s hard to say which strategy IBM will settle on, but it is clear that thanks to deals like Oracle/Peoplesoft and trends like open source, the software world is changing and the status quo won’t survive over the long term.

January 3, 2005 | Permalink | Comments (1)