Bronte Media

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!?

It always puzzles me that advertisers spend billions of dollars on mediums like TV and radio based upon rudimentary diaries of a small sample of consumers. And so too newspaper circulation. For the past 50 years newspaper circulation has been declining as the dailies failed to attract younger readers. Luckily for them, medical advances meant that the readers they did have didn’t die and kept their sanity for longer.

The latest ABC numbers show circulation declined 10.6% from April-September 09 compared to the same period a year ago. That was an acceleration from a 7.1% decline and 4.6% decline in the preceding two reporting periods.

For sure, newspapers have gone bust. And likely some readers have left. But the reality is that unlike other digital media (TV, radio, the Internet), newspapers have a ticking time bomb under them: the cost of paper.

Mastheads have always goosed circulation. The biggest scandal that was revealed was Newsday and others around 2004. Basically, they’d print the paper, ship it to a junkyard, the ABC would count it as circulation (and multiply it a few times to get ‘readership’) and the advertiser would get screwed into paying for a few more readers.

Now it’s not even economic to do that. It’s not even worth USA Today to print the hundreds of thousands of copies that sit outside a hotel door each morning, lonely and unread.

Rimm-Kaufman, a search marketing agency, has yet more valuable data, this time on the effect the holiday shopping season has on conversion rates. The data suggests that conversion rates jump by roughly half for the typical online retailer in the run up to Christmas.

Unfortunately, nearly all that improvement filters down into higher CPC bids on the Google during this time.

Online commerce and advertising are quite skewed to the fourth quarter – as much as 35-40% of the year’s activity occur during Q4. Why does that matter? Well as we find ourselves wading through the financial crisis I’ve noticed quite a few wrap ups of quarterly earnings calls focus on sequential (quarter over quarter) rather than yearly comparisons.

Q4 vs Q3 will be up by a mile. The real question will be how Q409 will fare against Q408. Remember this time last year the Lehman bankruptcy and AIG failure were happening and essentially the corporate deers froze in the ensuing headlights. So in some respects Q409 will have an easier hurdle even when comparing year over year. But from all I see (given I look at real estate data all day long) there is very little sign of improvement and it seems for the US economy stablization is about all you can hope for.

I found myself trawling through SEC filings and wandered off down memory lane to Scient, a symbol of the dotcom boom and whose ad pages used to adorn Red Herring, The Standard and other periodicals whose issues swelled to phonebook proportions.

To any entrepreneur consulting seems like a great business to get started. Charging clients more than you pay to hire consultants offers an immediately satisfying cash return after which you can laugh at companies like Twitter “who have no business model”. But there is a perpetual adage to the consulting business: Times are tough during boom times as it is hard to hire people and times are tough during bad times because you have to fire people.

Firing people, especially when nothing was particularly wrong with the job they did, is probably one of the most awkward and saddening experiences a manager will do.

Now put yourself in the shoes of Scient management in the second quarter of 2001 (pre 9/11 mind you).

In the quarter the firm was forced to layoff 78% of its staff and soon after was acquired for pennies on the dollar.

I wonder how many of the management decided to work in consulting again?

Wired has one of the best articles I have read for some time on the state of online content via a profile of Demand Media. Wannabe William Randolph Hearsts and Benjamin Franklins be afraid. Be very afraid.

The article charts the evolution of Demand from a few sites to the acquisition of Expertvillage.com through to the creation of Demand Studios, a centralized cyborg editor assigning work to humans drones plugged into the private matrix. Interestingly, Demand Studios is likely one of the largest freelance marketplaces (eLance, oDesk etc.) given that Demand’s revenues are now circa $200m and it’s not hard to see them spending $60m on content creation.

It’s hard for me not to see something beautiful.

Caterina Fake, the co-founder of Flickr and Hunch, wrote an excellent blog post recently entitled “Working Hard is Overrated“. The point she was making was that in hindsight with her experience all the ‘hard work’ was actually fear and running around in circles worrying about what other people thought (competitors, investors, etc).

Now comes empirical evidence with this little Jeff Bezos chestnut in Ken Auletta’s book excerpt about Google that was run in this week’s New Yorker:

In being one of the four investors in Google’s initial angel financing round that stake is now worth $1.5bn at today’s prices. Bezos’ total net worth according to Forbes’ latest estimate was $6.8bn. Now that figure was as at the end of 2008 and Amazon’s stock has risen 75% since then.

But roughly one-sixth of Bezos’ wealth came in that one decision. The legacy and company he has created at Amazon is truly amazing, and perhaps he wouldn’t have even been able to have the opportunity to invest if he hadn’t already started that journey but it does go to show that life comes to down to just a few moments.

It’s easy to get riled up over the New York Times’ feature article on THL Partners takeover of storied matress firm Simmons Bedding Company. The article charts how the big bad private equity firm took over the industrious and loyal small town company, gouged it for a number of dividend re-caps and management fees and now the firm is bankrupt.

The story comes with an utterly pointless video lead about how ‘private equity is everywhere in our lives’ and some guy who went to business school’s friend bought an island recently and he works in private equity.

I am not condoning private equity firms levering up companies with 80% of debt to equity and then paying themselves more than the value of equity they put in with the purchase price by borrowing more money. It’s completely inappropriate but it also entirely misses the point: That THL was able to do it in the first point.

For THL to be able to do that, some dumb fuck had to buy the bonds to allow the dividend re-cap to happen. Where in the world was he in the story? It’s not as if private equity firms are clandestine about this. They spell out in the offerings exactly what the money will be used for.

There is a gross misplacement of blame about this whole financial mess. That it was the private equity firms, the investment banks that helped arrange transactions and the fatcat CEOs who lived large. Or even that guy from Mexico who bought 6 apartments off the plan in Vegas.

Their behavior might be obscene but if we are to avoid a repeat (highly doubtful) then it’s about time the people who handed out the money – institutional investors and pension funds on behalf of consumers (and insurance companies too) – took the brunt of responsibility. At the individual level, if your 401k or individual mutual fund investments held any of these type of investments, change them. If you don’t then those obscene actors are just acting on behalf of you.

There is a metaphor that sticks in my mind: Kids in candy stores. It’s ridiculous to expect that kids in a candy store wont want to buy candy and gorge themselves on it. But there is usually a powerful force stopping them: The Parents.

There are weak parents in the financial services industry. Investment managers (whether mutual funds or pension funds) are completely submissive to management of large companies. Independent directors who represent shareholders are the same. There are no consequences because the individual investors who appoint them do nothing. I expect them to keep doing nothing, which is why I expect we’ll be discussing exactly these type of issues in 7-9 years at the same point in the next cycle.

All the talking about reform is bullshit. The kids are still going to want candy in the end. What can change though is the parents can start saying no, or begin limiting purchases.

There is no evidence that they will mind you. There hasn’t been any shaming of Yale or Stanford or Harvard for investing large amounts in private equity (after all private equity firms are stewards of capital and just service providers, ultimately the universities own and benefit from dividend re-caps) and letting the money be invested in this way. Only they have the power to change by banning the practice. There hasn’t been any shaming of or consequences for large mutual funds who sat by and let company management get fat on the land and destroying America’s ownership culture. Or the insurance companies that invested in any bond that gave equity like returns.

These are ultimately the architects of the situation we have today. Usually architects build things by design but here you have a situation where the problems stemmed from every decision not to act, not to say no and to let the candy to be bought. Stop blaming the kids and start blaming the parents.

Forget about Google or eBay’s early days for outstanding feats in profit per employee, just check out Citadel’s high frequency trading group whose activities are under the spotlight with an employee court case at the moment. For those counting at home, that $1.15bn profit with 55 employees, or nearly $21m profit for each employee!

99% of the people who prognosticate on Twitter raising $100m at a $1bn valuation will focus on one thing: $1bn for a company that has no revenue! And that’s fine. But what are some of the subtleties for those involved?

1) Are the investors leading the round, T Rowe Price and Insight Venture Partners crazy? Maybe they are but there is likely very little downside for them. That is, it may be extremely hard for them to make money but they probably won’t lose it. Shares bought are of the preferred variety and so if Twitter sold for $100m they get their money back and no one else gets anything.

Additionally, liquidation preferences of > 1 are most common for East Coast firms with later stage investment – exactly the kind of deal this is. So in theory, just say the investors got a 2x liquidation preference, then the first $200m would go to them. A 2x is probably a stretch but something like a locked in 10% a year is not.

What I am saying is that the investment expectation is not so much ‘venture capital’ but a ‘loan with some upside potential’.

Private equity firms are sitting on gigantuan piles of cash (or rather gigantuan piles of commitments from stretched pension funds who, although they are legally obligated to, would very much not like to fulfill in the next 1-2 years). Counting all the probability scenarios, the two firms will likely make the 10% a year (or whatever number) in a huge percentage of cases. The one case they need to worry about is whether Twitter could ever be worth less than $100m, which is likely small (but still real).

2) That’s great for T. Rowe Price and Insight Venture Partners but what about the rest of the investors? The earlier investors, particularly Union Square Ventures, have a real choice to make. They have a small fund relative to the size of this investment. To keep their pro-rata share they would have to put a decent chunk of their fund into an investment with the risk profile of point 1 – something their limited partners have not asked them to do.

Also, in some ways the funding is a negative for USV and Spark as now there is the overhang of this $100m (plus the $35m from Benchmark and IVP). Just like the founder and senior management, taking larger and larger amounts of preferred equity financing puts the early venture investors on an ever distant express train where there is very little scope to get out profitably at lower amounts. A $100m IPO on a $1bn valuation is much more attractive as that is for common stock, every preferred stock holder converts to common stock and the strings go away.

3) On the upside, Union Square Ventures, Spark Capital just got a huge valuation validation that would put the respective funds in the money on this investment alone. They can now go out and raise another fund easily.

4) Twitter is now legitimately not for sale. The management team can tell reporters that they are not for sale until they are blue in the face but now those claims actually have credibility. No one has any incentive to sell for less than 10 figures. It will now be easier to tell the magpies of the corp dev teams at Google, Facebook, Microsoft, News etc. that they really aren’t looking to sell.

5) Raising this much money at this point in time is a huge risk for the company. As anyone who has ever heard of the name Steve Blank will tell you: The number one cause of startup failures is pre-mature scaling. Twitter may have found product-market fit with one of its constituencies (users) but they are so early on with paying users (businesses, power users) and have not even started with some (advertisers) that there is a huge risk they will scale up with the wrong product and then put themselves in a death spiral following that.

6) Do they actually need this money? No. There is a paradox in that only companies that don’t need to raise money can but with this amount it’s actually quite perplexing. The standard answer will be more servers and look at what Facebook has spent etc. but there is one huge difference with Twitter: They don’t host photos.

Facebook is the largest photo site on the Internet and has to store a shitload of images and deliver them to users around the world. Twitter has no such problems. It would be analogous to saying AT&T needed to upgrade their network due to the boom in text messaging vs needing to upgrade because of rabid iPhone users in the bay area. The latter is valid but the former is not.

7) With such a large amount of money it would not be surprising if some early employees and angel investors, particularly those from Summize, cashed out at this round. There is limited upside for them with a long line of preferred investors ahead of them in the que. And a $1bn valuation would be a fantastic outcome and nothing to scoff at. No one got poor selling at a $1bn valuation.

8 ) Good luck to employees joining Twitter now. Although the common stock valuation is not $1bn because of all the preferred stock obligations and given the stage of the company, if you are interested in Twitter go out and build a Twitter app instead of joining the company.

One of the most interesting companies to present at Techcrunch50 was Yext, a startup trying to build an online yellow pages business piece by piece starting with vets and gyms.

I had only heard about the company a few weeks ago because my good mate and fantasy baseball adversary Ross Weinstein joined as the SVP of Media. I was surprised I hadn’t heard of the company despite it being based out of New York, had raised a venture round from Sutter Hill and was on target to do $20m in revenue this year.

They achieved that mainly by selling calls to vets and gym owners and acquired traffic through Google Adwords and other sources. Howard Lerman, the CEO, was a little disingenious in the presentation saying both “as you can imagine we spend a lot of money with Marrissa [Mayer]’s company” and “we have done no marketing” to the TC50 panel.

What’s likely is that they simply take on the risk of getting the call to their 20,000 customers and don’t ‘resell’ clicks packages like Yodel, Orange Soda and Reach Local. If this all sounds pedestrian up until this point (besides from the great traction they have gotten so far in the vets and gyms categories) you’d be right. But what they are doing now is not.

There are a number of problems with pay per call advertising and Yext is looking to solve a lot of them. The first problem that will be hard for any firm to solve is simply that a lot of the time the phone goes unanswered at small local businesses. The second is that because the business owner is paying on a per call basis and they are the ones answering the calls it’s easy for them to be the ‘call-fraud’ detection. Unlike pay per click marketing where it is software based and fairly detached, the business owner is able to judge whether a call is a good one or not.

To respond, Yext has taken advantage of a growing trend: Voicemail transcription as a service (see an example here) and applied it to the phone calls themselves and created a gmail-like interface that not only archives and transcribes all the calls a business owner receives through their pay per call program but classifies them as junk (tele-marketers) and real (the company says it’s roughly 50/50). For the real calls they then add action attributes like what needs fixing on a car and what model car etc as well.

That leaves an audit trail and also a very easily searchable interface that helps a local business owner stay on top of everything. Yext hinted that they would open up the interface to not just calls channeled in from their pay per call program but to all calls a business owner receives in the future.

In effect, it’s a phone call CRM dashboard and a very good looking one at that.

Yext said in the presentation that they are currently generating half a million calls a month for their 20,000 advertisers. If we assume the $20m revenue is “our revenue would be $20m if we multiplied last month’s revenue by 12″ that means Yext is getting around $3.33 for a call and generating around 25 calls a month for an average monthly advertiser cost of a little less than $85/mo.

The risk of getting the advertisers to pay $6.66 for only the 12.5 higher quality calls a month (assuming the 50/50 split) is a fairly large one but ultimately the right move for the company and one in which I think they’ll nail. I’ll also say that businesses will pay another $30-50/mo just to have the dashboard handle all their incoming calls.

A company to watch for sure.