Thoughts on Tech, Deals, and Markets

Even as retail has fallen off a cliff–down 10.2% in December–video game sales (the combination of software, hardware, and accessories) were reported up 9% in December.   Software was up 15%.  That is astonishing.

Ben Edelman, the young HBS prof who has build a reputation for revealing unscrupulous online advertising practices, has a new article fingering Yahoo’s Right Media for featuring “widespread ads exactly designed to deceive.”  He mentions deceptive ads that tell viewers that someone has a crush on them, that they have won something, that their computer has systems problem, etc.–yet all are bogus and intended to attract a click that inevitably leads to another page, laced in subterfuge, that attempts to monetize the unwitting visitor.

These practices are in clear violation of FTC regulations.  However, those regulations are enforced with the consistency of speed limits.  Not surprisingly, companies continue to transgress with few, if any, consequences.  Not surprisingly, these practices are extremely profitable.  Not surprisingly, they give the online performance-based marketing sector a bad name.

Good news on credit market conditions from the WSJ last Monday:

Best Week for Debt Sales in a Year Raises Hopes

Everyone knows about the real estate industry’s crash by now.  But few know about the crash in the online real estate industry–that is, the marekt for domain names.  It’s a story worth telling, though the space is so opaque it’s unlikely anyone ever will do it.  It’s dripping with irony.  For example, a major selling point of domain industry advocates  was that domains are like real estate.  I don’t think they meant it in this way, but they were smarter than they realized–like offline real estate, domains experienced a huge bubble.  Now, both markets have crashed.

The list of domain companies that took private investment is ugly:  Geosign, Oversee.net, and Dotster, to name a few, have not been able to hide their massive problems.  Internet REIT raised a ton of money and has also had huge layoffs.  NameMedia pulled its S-1, leaving its investors tied up in a troubled asset.  The public companies with large domain portfolios have been crushed.  Marchex (MCHX) is off about 60% from its 52-week high, and about 80% from its high back in mid-2006.  Dark Blue Sea (DBS, listed on the ASX) is down over 60% since last May.  Not counting Demand Media (which has large domain assets, has attracted over $200m in capital, will likely lose investor money, but has signifiant non-domain assets as well) the space has attracted over $600m of institutional capital in recent years.  Equity investors will be lucky to get half of their money back, particularly given they sit behind large levels of debt.

What happened?  I don’t have the space or the knowledge to give  a comprehensive list, but a key driver was the success of early speculators.  They earned growing domain parking revenue then plowed that revenue back into buying more domains.  Just like flippers bidding up the prices of housing of all price levels, domainers bid up the prices of domains of all quality levels.  Likewise, the housing run up attracted hot money that drove prices even higher.  Same in domains where, as referenced by the companies above, hot money entered the market and accelerated price increases.

What truly staggers me is the magnitude of ignorance displayed by industry players in both industries.  In real estate, investors such as the buyers of RMBS were utterly disconnected from the value of the assets underlying their securites.  In domains, investors were similarly in the dark.  They would buy hundreds of thousands of domains while only visually inspecting a fraction of them.  As a result, they had little understanding of which domains were actually producing revenue.  Not only were the most brandable generic names not producing as much revenue as often assumed, but often the lion’s share of revenue in domain portfolios was generated from typos and trademark-infringing domains.   If investors in either industry had dug just a bit into what they were buying, much of the boom and bust would have been avoided.

Actually, this qualifies as very good news.

Hat tip to Calculated Risk:

The TED spread is at 0.99, sharply lower. (improved)The TED spread was stuck above 2.0 for some time. The peak was 4.63 on Oct 10th. The TED spread has finally moved below 1.0, although a normal spread is around 0.5.

The TED spread measures the difference between the interest rates on interbank lending (as measured by LIBOR) and  the three-month US Treasury.

And:

The three month LIBOR has decreased to 1.109%. The three-month LIBOR rate peaked (for this cycle) at 4.81875% on Oct. 10. (improved) Imagine all those adjusted rate mortgage loans tied to treasuries or even the 3 month LIBOR? The rates are looking pretty good!

The sudden, huge spikes in the LIBOR and the TED spread were at the center of the financial panic last September and October.  Every participant in the market was scared stiff that every market entity not backed by a developed government was on the brink of worthlessness.  The great irony of that moment was that, due to the panic, everything was, indeed, teetering on the edge.

The frenzied, ‘animal spirits’ of last fall are finally calming.  The credit markets are beginning to thaw.  Gradually, market participants are rebuilding their tolerance for risk.  If this continues, it will shorten the path to economic stabilization and, eventually, recovery.

It’s easy to focus on backwards-facing economic news such as unemployment or earnings reports, particularly when they are as heinous as they have been of late.  But these are lagging indicators, not forward-looking.  On the other hand, real-time measures of risk tolerance in the credit market are causal, and therefore highly predictive.  While we aren’t there yet, when it returns a healthy credit market will spur lending that will drive  future economic activity.

In the M&A and private equity world, improved credit markets will reduce the fear that has gripped many buyers and investors since the last September, catalyzing deal flow.  Frozen credit markets translated into a sky-high cost of capital.  Little leverage was available to goose investor returns.  Combine that with the lack of visibility into ’09 earnings and it’s understandable that the deal sidelines have been crowded of late.  However, as credit conditions improve, there will be opportunities for value for buyers and investors who are willing to move before the crowd.

Yahoo just announced the hiring of a new CEO, Carol Bartz.   Bartz earned a strong reputation as CEO of Autodesk for 14 years, and generally has received favorable reviews in recent media coverage.  Most importantly, unlike the last outsider hired to be CEO at Yahoo, Terry Semel, she is not allergic to technology.   Semel didn’t use email.   Could you imagine an airline company hiring a new CEO who didn’t fly?  Apparently that analogy didn’t occur to Yahoo’s board, which ironically has more execs with experience in airlines (2, Roy Bostock and Gary Wilson) than Internet (1, Jerry Yang).

Having run Autodesk as an independent software company for 14 years, Bartz seems unlikely to lead Yahoo to a quick sale.

My favorite magazine is the New Yorker.  I’m used to receiving emails from them regarding my subscription.  But today was a first–I received an email that was a pure third-party advertisement, in this case for a new Blackberry.   I don’t remember ever signing up to receive third-party advertisements on their behalf, so it’s surprising to get that type of email.  Particularly from a media company that has such high-end demographic.  On the other hand, given their financial difficulties, it’s understandable.

At the same time, this is a sign that email quality will suffer.  As media companies become more aggressive in emailing their lists, it will crowd inboxes and diminish the marginal value of extra email.

I have started to encounter businesses that rely on Amazon’s Mechanical Turk for key components of their product or service.  For those not aware, it’s a labor marketplace where anyone can pay anyone else to do “HITs,” or Human Intelligence Tasks.  There are currently 722 available tasks, such as “Find the Addresses for  a Business” and “Label images of a device.”  Bidders are offering $.05 and $.04, respectively, per completed task.

It’s non-trivial to figure out where a business can use it and how to implement it.  But those that I’ve talked to who have figured it out have a very scalable, margin-enhancing asset.  I expect to see more and more businesses using it in coming years.  I wouldn’t be surprised to see a cottage industry arise in consulting for businesses that could use it profitably but need external help to make it work.

On a smaller scale, it looks a bit like early days of PPC advertising.  Before PPC become ubiquitous, profitable keyword-buying opportunities were abundant.  As the value of PPC became established and market awareness grew, competition drove up keyword prices and made it much harder to profit.   Similarly, I think there is low-hanging fruit right now with Mechanical Turk, but within a few years it should become much more competitive.

As an M&A advisor, negotiating is a critical part of my job.  I’m often asked about what it takes to be a good negotiator.  There’s a stereotype of the negotiator as cool in the most tense situations, with quick wits and silver tongue.  Throw the good negotiator into the diciest of situations and they’ll pacify it, leaving with pockets brimming with whatever loot they could carry.

Composure and eloquence under pressure don’t hurt, but focusing on that as the defining factors of good negotiations is way off the mark.  The most important dynamic in any negotiation is alternatives.   If you want a raise at your current job, the best way to get one is to let your boss know you that you are seriously considering an attractive offer from another company.

A friend of mine felt he was due a promotion, but it wasn’t forthcoming.  So, he interviewed around and just got a offer from a competitor that comes with higher comp and a better title.  He told his employer that he was going to take it, though hadn’t signed anything yet.  Guess what?  They are offering him that promotion.

My friend has been an extremely effective negotiator with his current company.  Yet it required neither manipulation nor deceit.  What he did was simple.  He improved his alternative, then was transparent with the other side in his negotiation.   It’s that simple.  The best negotiating tactic is to improve your alternatives.  (Another key point:  honesty pays.)

Some might wonder if that tactic can backfire.  What if you improve your alternative, then tell the opposing side of the negotiation, and they say ‘go to hell.’  You might not have actually wanted that alternative, but now you’re stuck.  In that case, you learned something about your original option–it’s not as good as you thought.  If it’s in a negotiation with your employer, you now know that your employer isn’t interested in giving you fair market value (and is probably a prick).  So you’re better off taking your alternative.

Tree.com is en fuego.  Anyone else notice that it’s basically doubled in the past week?