Bronte Media

There are signs of life in the housing market and an increasing murmur of optimism. But I am so negative on the short to medium term for a lot of reasons.

The total amount owed on mortgages in Las Vegas is more than the current value. And even though the ’sub-prime crisis’ may be over we are about to encounter the ‘Alt-A’ crisis and ‘ARM’ crisis in full force:

Then there is the issue that the people who have defaulted on their mortgage aren’t even being foreclosed upon because there are so many of them and the banks are so battered they can’t even dedicate the resources to complete the foreclosure process.

This is a massive shadow inventory that is sitting on the sidelines. Spencer Rascoff of Zillow explained in this short video:

So whatever you hear from the NAR and so on, this is at least a 5 year mess to be worked through. In the meantime you can buy NYSE:DMM and cash in on the coming misery.

If there is a TV-show equivalent of the knowledge the card game poker can teach us about business, The Wire is it.

If you haven’t seen every season, you should. Here are some of the great quotes Via Kottke:

“Money don’t have owners, it just got spenders”

You’ve heard me harp on about Rimm-Kaufman as being one of the most data-driven, transparent and thoughtful search agencies and today comes with yet more juicy data around the conversion rate by engines.

Rimm-Kaufmann’s clients tend to skew towards large online retailers.

Firstly, Google’s network (position along x-axis is ranked by traffic volume from most to least):

And Yahoo’s network:

There are a few investable nuggets of information because Google and Yahoo “take care of” the difference in traffic quality by discounting but that discounting does not go far enough and so some sources will see their search payouts decline over time as the agreements increasingly resemble reality.

The ‘we’ll handle the discounting’ approach by Google and Yahoo is a load of shit because of the incentives to charge more and secondly, even the mighty Google and Yahoo simply don’t know the depth of information needed (conversion rate, order value etc.)

Rimm-Kaufmann want the search networks to open up domain level bidding and that’s the reason for their post.

For investors, I’d be pretty down on Local.com (a public company) and there is certainly no love for AOL. Good luck to Rupert trying to re-sign Google at anywhere near $300m a year with data like this showing the horrible conversion rate on MySpace.

The other interesting trend is among comparison shopping networks, which tend to convert at a lower rate than normal search. It’s interesting because a lot of the comparison shopping sites have traditionally lived off arbitrage or being a ‘page 2′ search provider. The majority of their revenue is directly from merchants but in the past their deal with Google or Yahoo has accounted for 40% or so of their revenue, so it’s a huge slice. But comparison shopping sites have been murdered in recent times so it’s nothing really new in terms of information here.

The unknown is the gap between what Google/Yahoo discount and what they need to discount based upon conversion data.

Quinstreet, the online marketing powerhouse, has just filed to go public. What better way to spend a lunch time than munching on a sandwich and inspecting the juicy details:

My most significant concern is that the firm hasn’t benefited one iota from scale, as growth in revenue has been largely passed down the media food chain (Google/Yahoo and Affiliates). With that said, Quinstreet could be the perfect counter-cyclical Internet play where power shifts back to the advertiser (see LowerMyBills in 2002-4).

Who are Quinstreet?

The firm started life as a lead generator for online education firms and moved quite heavily into financial services a few years ago. Quinstreet perhaps epitomizes the bread and butter or meat and potatoes of online advertising: measurable results for direct marketing clients.

To further mix the array of food metaphors I’ve just thrown out, sometimes you don’t want to know how the sausage is made. This from the filing:

“Our approaches may be deemed similar to those of our competitors and others in our industry that Internet search websites may consider to be unsuitable or unattractive. Internet search websites could deem our content to be unsuitable or below standards or less attractive or worthy than those of other or competing websites. ”

Now you know what we are dealing with.

Growing But Margins Being Crushed

There is no doubt that Quinstreet is a large and growing enterprise. For the 2009 financial year (which ends June 30) the firm grew revenues a whopping 36% to $260m. But over the life of the company Quinstreet has shown a willingness to give nearly 100% of incremental growth to publishers it works with (primarily Google and Affiliates).

Let’s take a look at cost of revenue as a percentage of total revenue: 60% in 2005, 60% in 2006, 65% in 2007, 68% in 2008 and finally 70% 2009.

For instance, in FY2008 the firm grew revenues by an absolute amount of $24.66m but raised its spending on media by $21.92m.

There is a glimmer of hope and that is a horrible online advertising outlook where Quinstreet can thrive as a tough-handed negotiator when buying ads. For instance, incremental revenue in FY2009 was $68.5m versus a $50.7m increase in media spend.

If you believe that the outlook will be worse in the next 6-12 months as I do, then the firm will likely do pretty well. It’s just that over the longer term, the company will likely get screwed and margins will implode.

Another Ad.com/University of Phoenix Situation Brewing?

Students of the industry will know that Ad.com grew on the back of buying ads on behalf of the University of Phoenix. Search this blog for more on that saga but basically: University of Phoenix bought so many ads it decided to buy its own ad network/agency and dump Ad.com. Since then Ad.com has not been able to replace the revenue and is currently cratering under more management changes and reshuffles than a Russian billionaire’s soccer team.

Well that situation looks to be playing out to some extent with Quinstreet as well. From the filings (emphasis mine):

“A substantial portion of our revenue is generated from a limited number of clients. Our top three clients accounted for 32% and 28% of our net revenue for the fiscal year 2009 and the first three months of fiscal year 2010, respectively. Our clients can generally terminate their contracts with us at any time, with limited prior notice or penalty. DeVry Inc., our largest client, accounted for approximately 19% and 13% of our net revenue for fiscal year 2009 and the first three months of fiscal year 2010, respectively. DeVry has recently retained an advertising agency and has reduced its purchases of leads from us. DeVry and other clients may reduce their current level of business with us, leading to lower revenue. We expect that a limited number of clients will continue to account for a significant percentage of our revenue, and the loss of, or material reduction in, their marketing spending with us could decrease our revenue and harm our business.”

Quinstreet don’t have the mental handicap of being part of the circus that is AOL but the situation remains a rather thorny one.

Where do Quinstreet Make Their Money?

Primarily the company makes its money from online education firms and financial services:

“Our education vertical has historically been our largest vertical, representing 78%, 74%, 58% and 51% of net revenue in fiscal years 2007, 2008 and 2009 and the first three months of fiscal year 2010, respectively. [...] Our financial services vertical, which we have grown both organically and through acquisitions, represented 7%, 11%, 31% and 39% of net revenue in fiscal years 2007, 2008 and 2009 and the first three months of fiscal year 2010, respectively.”

Who owns Quinstreet?

Over the life of the company, Quinstreet has raised $37.4 million from venture and private equity investors. The main shareholder remains CEO Doug Valenti, who holds 18.33% of the company.

Investors and their holdings include Split Rock Partners (16.40%), Sutter Hill Ventures (10.55%), GGV (Global Granite Ventures) Capital (7.05%), W Capital Partners (6.86%), Catterton Partners (5.87%) and Partech International (5.52%).

Conclusion

Following Quinstreet will be fun purely from the point of view they spend so much money on online ads. The company itself benefits from a worsening of the outlook for online advertising but how long can that really last (2-3 years?) Ultimately, margin pressure will catch up to it unless it diversifies and becomes more of a publisher.

Some excellent thoughts from John DeMayo (blog more!) on buying display media through ad exchanges:

“In summary, if you buy display advertising, get sophisticated, and get sophisticated fast. Understand exactly what user actions or conversions you associate value with and make sure you or a company on your behalf can correlate this value to every single data point that you or they or the data exchange has on a possible impressions. Those who fail to de-average groups of inventory will be stuck buying the slop, and firms who properly value inventory across a huge number of dimensions (both declared and proprietary data dimensions) will benefit significantly in this change in the way advertising impressions are allocated to buyers.”

You try to figure it out. From exactly the same interview with Apollo co-founder Marc Rowan.

Insider Information is Bad:

“People who know that they possess confidential information, and trade on that confidential information, have stolen something. It doesn’t need this environment to tell them that. This has been true for 20, 30, 40 years, as insider trading law and insider trading cases have developed. There are many successful hedge funds. There are many smart people. I’m just not sure that it’s even worth the comparison. There are people who step over the line, and people who don’t step over the line.”

But Information ‘Leverage’ is good:

“One of the sectors that I’ve mentioned that we are very active in is in the metals business. We own aluminum plants. We own metals distribution companies. We own metals resources companies. We therefore possess not market-based metal information, but unique, on-the-ground, customer flow, spot information about what is happening in various markets. Sometimes we monetize that information by making equity investments for control. Private equity. Sometimes we use our knowledge of that business to make good debt investments. That’s the core of our lending business. And sometimes what we do is we blend the two. We see both a trading opportunity as well as an opportunity to run a business that can provide differentiated returns for investors, like a metals hedge fund.

So what we are doing is, we’re simply leveraging the information that already exists within our firm, and expressing it not as a private equity fund, or not as a mezzanine fund or as a debt fund, but as a commodities trading fund. You will see us not just grow a commodities trading fund, you will see us build a commodities private equity business around the same capability.”

Conclusion for those at home: If you own the business where you get the non-public information versus paying a ‘fee’ to ‘market informants’ then you’re all fine and dandy.

Unfortunately, the slide title does not seem to match its contents:

Google’s $750m acquisition of AdMob was quite surprising to me and I think very poorly of it. Both the price and the strategic intent of the deal are lousy for Google. Mobile advertising is a crappy environment in both form (small screen) and function (very little commerce/transaction activity in busy micro-intervals of time). And then there is the fact that it’s an ad network, and regular readers will know how I feel about that.

So it is really hard for me to see people I respect use the same flawed logic: That Google is a large company and the price is a drop in the bucket compared to their market cap for the strategic value it offers.

In fact it hurts me to read it. The same logic can be applied to dating advice for a single billionaire: Hopping on a plane to vegas, buying up a kilo of cocaine and paying for 50 hookers on a week long bender may produce a loving and caring wife but it’s pretty unlikely.

Firstly, mobile advertising sucks at the moment because mobile commerce has not developed. The majority of online advertising dollars are tied to online transactions. That’s all of search and a huge majority of display impressions (~70%) and a decent chunk of display dollars.

Everyone is so bullish on mobile advertising but nowhere near as bullish on mobile commerce. They are very much inter-linked. If there is no mobile commerce, there will be no mobile advertising. In the beginning, the majority of mobile ad revenue was ringtone providers. Now they are dying. Granted, the app eco-system is developing at an impressive rate and in-game gifts/enhancements offer a real business model. If they succeed, app developers will buy tons of mobile ad inventory.

People also use mobile phones in small time increments making meaningful activity (researching purchase decisions/discovery) less likely than other types of behavior (lookup of known information).

Finally, in case anyone hasn’t noticed, search has not become as integral to the mobile web as it has to the desktop web. Sites receive about 10% of their traffic from search referrals in a mobile environment compared to 30% in a desktop web (rough numbers).

Then there is the issue of form. Mobile phones fit in a pocket and offer poor creative formats to advertisers and their agencies. This won’t change in the future.

Secondly, AdMob is an ad network. They currently get 40% of the revenue because it is a nascent industry (their net revenue is about $25-30m). That will pretty quickly move to 10-20% cut as the industry scales. We saw it in search advertising (Overture) and display advertising (AdSense). The economics will get worse for the business. There is no doubt Google will add large scale to AdMob but they must have also budgeted for the business economics to deteriorate significantly.

In AdMob’s most recent monthly report for September [PDF] the firm says that it served 10.2 billion ad impressions. Let’s assume the company is at a $10m gross monthly revenue rate. That means the average CPM they are seeing at present is around $1 – more than social networks but a lot less than average display and not in the same league as search.

Specific to AdMob, only half their inventory is in the US as per the report.

So color me skeptical for Google paying 30x net revenue for an ad network operating in a poor advertising medium. The Youtube acquisition was a million times better than this one.

As they say in the classics: You only hurt the ones you love. And any cursory search of this blog for “Murdoch” will know of my love of all things Rupert. But all of the posturing about Google is a parasite and that users should pay for news is ludicrous and must stop.

It has been far too long since Murdoch and others announced their intention to get users to pay for news (an utterly useless and futile exercise as the industry found the first time around in 2001). And now Murdoch is saying that the implementation date will slip past his previously stated and generous June 2010 deadline.

I get that these things are said in public for a reason. Whether it is to negotiate a better deal with Google for advertising or get the government to give them a concession on tax or fool stupid investors for a little while longer. But it already is coming up on a year from when the “user should pay for news” statements were surfaced and it will now be 2 years before we see the start of them.

In the hallowed words of the great Evan Neufeld, whose favorite phrase was uttered in meetings at Jupiter frequently, “Shit or get off the pot”.

Step away from the microphone, stop talking and start doing something. And if you aren’t (which they clearly aren’t), then shut the fuck up.

p.s. Ironically, only one of the “users should pay for news” crowd, Newsday/Cablevision has actually begun charging users for web site access to general news and they announced that revenue had grown 9% year over year [PDF] recently – the two obviously not being correlated *cough* *cough*.

There are not many online businesses that have scale (>$100m in annual revenue) and are growing 30% year on year. ServiceMagic is one such business and is emerging as the jewel in the crown of the recently remade InterActive Corp.

Revenue at ServiceMagic rose 30% to $43.9m in Q309, driven by an 18% year over year increase in customer growth and a 22% increase in leads to nearly 1.5m service requests.

Compare this to CitySearch, another IAC business that garners most of the ‘local’ attention: “Citysearch’s revenue decline reflects a difficult display advertising environment and was compounded by transitional issues related to the relaunch of the site and the integration of a new ad serving platform.”

CitySearch’s revenue is not broken out, primarily because it’s not material and secondarily because IAC probably doesn’t want to dispell the market leadership myth.

ServiceMagic is now doubling down on growing their sales force, expanding overseas and (somewhat worringly) spending more on marketing per service request/lead.

Diller also mentioned that he would be open to selling Ask. Long time readers know that I have been critical of Diller because he buys a lot of businesses but does not sell them and that he would make more money by adopting a private equity model instead of a publicly-listed conglomerate. I also predicted that MSN would end up buying ASK back in February of last year.

The problem is that at the moment he probably wont get that great a price. Even so, the future for Ask is significantly poor that he should unload it.

Interestingly, if you consider Dating ‘local’, what would be left is the largest online local company with a shit-load of cash ($1.8bn+Ask proceeds).

P.S. What is up with all these investor relations vendors like Shareholder.com that can’t even fucking publish the earnings calls in a flash audio widget and instead offer Real Audio and Windows Media feeds!?