Don Dodge on The Next Big Thing

Red Herring coming to Boston June 26-28

I have been a Red Herring reader since 1993 so it was a real treat to be invited to speak at the upcoming Red Herring conference on Innovation and Opportunity. Red Herring East 2007 will be held at the Hyatt Harborside Hotel in Boston, June 26 through the 28th.

Red Herring has assembled an all-star cast of speakers including; Jim Lanzone, CEO, Ask.com, Dixon Doll from Doll Capital, Marshall Phelps, Corporate VP, Intellectual Property at Microsoft, and Alan Spoon, Managing Partner at Polaris Ventures.

The agenda covers innovation, entrepreneurship, venture capital, Web 3.0,  web search futures, Advertising 3.0, Killer Apps in Mobile, M&A, and other topics.

The agenda covers all the usual topics, but the speakers really make the conference. Several sessions are interview style where a Red Herring editor will interview a panel of industry experts on the topic.

You can sign up for the conference here. Please stop by and say hello. I would like to meet as many of you as possible. 

CBS acquires Last.fm, eBay buying StumbleUpon

Acquisitions are being announced every day now. CBS, the TV network, will acquire Last.fm, the streaming music service. eBay, the auction company is buying StumbleUpon, a social bookmarking service. A while ago eBay bought Skype, a free VoIP telephone service.

Acquisitions are usually about synergy, market share, cost savings, leverage, or strategic moves into new markets. Hmmm...what will CBS do with Last.fm? And what will eBay do with StumbleUpon? The synergy isn't obvious to me now, but acquisition strategies play out over many years.

My good friend Ashkan Karbasfrooshan over at HipMojo wrote a brilliant piece today on the music business and acquisitions in that space. Ash suggested that Apple should acquire one of the major music labels. His analysis of the traditional music business versus the online music business was interesting. But, his financial analysis of the stock market implications of such a merger really made me stop and think. Think about this excerpt from the HipMojo post;

How Much Would Owning the Music Add to Apple’s Bottom Line?

Say the percentage of WMG (Warner Music Group) and indie songs sold is actually 25% (and not 33%), that represents 500M songs, which at $1 would help retain $500M in profits for Apple...Using the example above where a company buys the indies and smallest major record label for about $3B would add $500M in profits, which would in turn add 500M x 35 P/E = $17.5B in market value for Apple

So, if Ash's estimates are correct, Apple could buy Warner Music for $3B and the stock market would immediately reward Apple with an additional $17.5B in market cap. Now that is a deal that would make an investment banker smile.

Companies with high Price/Earnings ratios should buy companies with lower P/E ratios. From a financial point of view this makes obvious sense. However, most acquisitions are not done with financial engineering in mind. They are done for strategic reasons. And usually the tables are reversed. The big companies with lots of cash and low P/Es are acquiring the small hyper-growth companies with astronomical P/Es.

Music, television, and radio companies have low P/E ratios and stock market caps compared to technology companies.  Entertainment content is mashing up with technology as digital distribution of music and video move to the Internet. We have seen this coming for a long time. Steve Case saw it when he merged AOL with Time Warner. It was the classic high P/E technology company acquiring the low P/E content company. It was too early in the evolution and the synergies didn't materialize.

Maybe the time is now right for traditional content companies to merge with technology companies. CBS and Last.fm may be the first of many such mergers.

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Why 1% of search market share is worth over $1 Billion

ComScore released their April 2007 search market share numbers showing that Google increased its market share lead to about 50%. Yahoo has about 27%, Microsoft 10%, AOL 5%, and Ask.com has 5%. That got me thinking. Should AOL and Ask just give up...hopelessly behind with only 5% market share? In a word...NO!

Each 1% of market share is worth at least $1 Billion in market cap. Google has 50 points of market share and a stock market cap of $150B, or $3 Billion for each 1% of search market share. Other competitors don't win the same revenues and market multiples, but even at the low end, 1% of market share is worth over $1 Billion.

Lets do the math - That was easy at a macro level, but there is more to it. Lets dig deeper. First lets look at the ComScore data for total searches performed (USA) in the first quarter of 2007.

• January 2007 - 6.9 billion searches - Google did 3.3B of them
• February 2007 - 6.9B searches - Google did 3.3B
• March 2007 - 7.3B searches - Google did 3.5B

So, Google did 10.1 billion search queries in the US in the first quarter of 2007. Now lets look at Google revenues of $3.66 Billion for the first quarter of 2007. The simple math is $3.66B in revenue divided by 10.1B search queries equals $0.36 per search. But, that would be comparing US searches to total revenue, so we need to do a little more math gymnastics.

Breaking down Google revenues

International revenues were $1.71B or 47% of the total. So, US revenues can be estimated at 53% or $1.95 Billion. OK, we are almost there. We also need to break out the AdSense advertising revenues.

AdSense serves ads to other web sites. When a user clicks on an ad the advertiser pays Google a CPC fee and Google splits the revenue with the site owner. Google’s partner sites generated revenues, through AdSense programs, of $1.35 billion, or 37% of total revenues. Here we need to make an assumption that AdSense revenues were evenly distributed across the US and international markets.

US Search related revenue - We know that US revenue was 53% of the total, or $1.95 Billion, and we know that AdSense accounted for 37% of total revenues, leaving 63% related to search. So, search accounted for 63% of the $1.95 Billion US revenues or $1.23 Billion.

Revenue of $0.12 per search query - Now we can compare total US search revenue of $1.23B to total the 10.1 billion US searches, which yields $0.12 for every search performed. You could argue that all of Google's revenues derive from search. If they didn't have search they wouldn't have ANY of the other revenues. Taking that approach and comparing US revenues of $1.95B and dividing by total US searches yields $0.19 in revenue per search.

Each 1% of search market share is worth over $100M in revenues - Here is the math. There were 7.3 billion searches performed in March of 2007. One percent of that is 73 million searches times $0.12 revenue per search or $8.76M per month. That translates to $105.1M in annualized revenue.

The stock market values 1% market share at over $1 Billion - Google (NASDAQ: GOOG) stock sells for more than 10 times revenues. There have been several acquisitions over the past few months that have also been valued at in excess of 10 times revenues. Using this multiple, that 1% of market share that generates $105M in revenues is worth over $1 Billion in market cap. Google gets a higher market multiple, so their 1% of market share is worth $3 Billion.

So now we all understand why Yahoo, Microsoft, AOL, Ask, and a host of others are fighting hard for every 1% of search market share. The search business generates huge revenues and profits...even for competitors with just a small market share.

VCs are investing big bucks trying to find the next Google. New comers like Powerset and Hakia would be quite happy with 2 or 3 percent market share although they have aspirations of much bigger things. Do the math...it is staggering.

UPDATE: Be sure to take time to read the comments to this post. Readers have contributed lots of interesting points and insights. Please join the discussion and add your comments too.

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Popfly in your Face...book - Microsoft and Facebook

Microsoft has announced a formal partnership with Facebook. The partnership will enable integration of Facebook’s new platform using Popfly and Visual Studio and further extend the reach of Silverlight applications to Facebook which has 23 million users and 40 billion page views a month.   The Microsoft and Facebook partnership means Facebook are now empowered to customize their Facebook pages.

Facebook is allowing its users to use third party tools to build all kinds of mashups and fun applications. Facebook is becoming a platform for innovation. MySpace stands in contrast, resisting developers and widget innovators.

Popfly is an awesome, easy to use tool, that allows anyone to build fancy web pages, mashups, and fun applications. If you can use PowerPoint...you can use Popfly. It is that simple. Simple, yet powerful.

See my earlier post on Popfly for more details about what it can do. Popfly and Facebook are a match made in heaven. Facebook users will love using Popfly and will build amazing things we never thought about.

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Angel Capital Association Summit - Angels invest $26B in 2006

The Angel Capital Association is holding its annual meeting in Chicago this week with over 330 angel investors from around the country (USA) representing more than 250 angel groups. Angel investing is big. In fact, angels have invested more dollars in more startups than VCs over the past 4 years.

Angels invest just like VCs except they do smaller investments $200K to $2M and they do about 10 times as many deals. However, Angels have the same investment criteria and expectations of significant returns. The "average" angel group makes 8 investments per year for a total of about $1.8M. The average deal size (seed stage) is about $250K.

The larger angel groups in Silicon Valley and Boston do significantly more deals and invest between $350K and $600K per round, and maybe $1.5M to $2M per company.

James Geshwiler, Managing Director of Common Angels in Boston, provided this profile of the Common Angels;

• Currently 66 Members and 130 investors in the CA network
• Most members are founders, CEOs of tech companies
• Common Angels members currently serve on more than 80 Public, Private boards (ie., large market reach)
• Members are expected to invest $50K-100K/year in at least two companies, make at least 1/2 the meetings, participate in diligence & sit on boards
• $10M Co-investment Funds + $30M in capital from our members ='s $40M investment plan over next 4-5 years.
• Investment strategy: target the "capital gap" and back new areas of technology
• Typically invest $8-10M/year in 4-6 new companies & as many follow-ons
• Invest $500K-$1M in the first round; 2-3x over life of company
• Seek $2M-3M Series A typically & <$20M over life of company
• Funded 33 companies; with >$37M from CA + >$100M from co-investors (ie., when we invest, it's very likely to have VC $ at the same time or after)
• We lead 3/4th of our investments.Those investments have generated >$200M in liquidity.

Average returns in Angel Capital are similar to average returns in Venture Capital. Meaning, the top quartile of angels or VCs do very well, the second quartile does OK, and the bottom half lose money. Angels and VCs understand this is a high risk game.

The Angel Capital Association did a survey of its members and got data on 590 deals that achieved an "exit".

• 47% lost money
• 26% returned 1X to 4X multiples
• 15% returned 4 to 6 times their investment
• 8% returned 6 to 30 times
• 4% returned 30X or more

Luis Villalobos of TechCoast Angels has been angel investing for 10 years. Their returns were better than average. Luis said the average for 10 deals is;

• 30% are a total loss
• 20% - will lose about 50% of your investment
• 30% - get a 3X return
• 10% - return 10X
• 10% return 30X plus
• Overall average expected return is 4.8 times investment.

I suspect that VC portfolio investments follow a similar pattern. One big winner can cover lots of losers. Angels do 10 times as many deals as VCs, but on average the success rate is about the same.

Other interesting factoids from the Angel survey;

• 40% of investments are seed stage = pre-product and pre-revenue
• 40% of deals are "start-up stage" = revenues of less than $150K
• Fail fast - Failed investments were held for 2 years before dying
• Exits normally happen within 5 years

Jean Hammond from Hub Angels presented some interesting data on IPOs in 2006.

• Average market cap $165M
• Amount raised $42M
• Last Quarter revenues Annualized $46M
• Price to Sales multiple - 2.7X
• 56% of Nasdaq companies have a market cap of less than $300M

The Toronto Stock Exchange did a presentation on listing profiles and alternative financing vehicles. The TSX is very innovative and is making a huge market in small IPOs. They have something called the TSX Venture Exchange for small start-ups to gain some liquidity. The TSX profile;

• 270 IPOs last year
• $3M is the average amount raised
• $26M is the average market cap after one year
• Average revenues are $5M with a forecast to $9M, and then $13M
• Many of the Venture Exchange companies graduate to the TSX
• Average TSX market Cap is $143M

Boston has around 20 Angel Capital groups. Some of those in attendance included; Beacon Angels, Boston Harbor Angels, Common Angels, eCoast Angels, Hub Angels, and Launchpad. See the Angel Capital Association site for leads to angel groups in other parts of the country.

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Google Hot Flashes - Hot today, cold tomorrow

Google announced a new service today called Hot Trends...which is really just hot flashes of the day...not really trends. They list the top 100 search terms of the day measured by their deviation from the norm. So, terms like sex, MySpace, etc don't show up unless they are abnormally high that day.

What is interesting about Hot Trends is that it points out how fickle search users are. There are no trends...they search for everything. My guess is that only a handful of the hot search terms today will show up on the Hot Trends list tomorrow.

However, that doesn't mean there isn't a way to optimize the search index for popular search terms. There is indeed a way to do that, and Google Zeitgeist provides a view into what terms should be optimized. Analyzing the Zeitgeist changes you can identify trends and shifts in popularity.

Web search is a tough business - After 10 years and billions of dollars spent the web search scorecard reads; Google 70%, Yahoo 10%, MSN Live 4%, AOL 2%, Ask 1%, and everyone else less than 1%.

Widgets - The Remora Business Model - Photobucket and MyBlogLog figured it out

BusinessWeek has a story "Sharing the Widget Wealth" that talks about the effect of widgets on social networks like Friendster, Facebook, and Bebo.

Widgets like Photobucket, MyBlogLog, Lijit, and others ride like a Remora on the wave of social networks. Photobucket attracted millions of users and was recently acquired by its "host" MySpace for about $250 million. MyBlogLog is a cool widget that rides on many different blog "hosts" and was recently acquired by Yahoo (NASDAQ: YHOO)  for about $10 million.

I use MyBlogLog on my blog for free. I have no idea how they make money...no advertising that I can see. MyBlogLog is that widget on the right sidebar that shows the pictures of registered users who have recently visited my blog. Pretty cool, but I wouldn't pay money for it.

Lijit Wijit for search. Starting today I am using Lijit for searching my blog. My friend Brad Feld invested in the company and suggested I try it. I have tested it out and it works great. The installation was simple, automatic, and flawless. I was up and running in a few minutes. Lijit uses Google Custom Search (NASDAQ: GOOG) to build a custom search "Wijit" just for your blog. They also provide some really cool statistics to show you what readers are searching for. Very interesting! Try Lijit and let me know what you think.

What is the business model? Free services layered on top of other free services doesn't seem to be a very compelling business model to me. But...some of these services are getting acquired for big bucks...so there you go. I guess I don't yet understand all the nuances of the Remora Business Model. But, if Brad Feld is investing in it...there is money to be made somewhere.

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CNN goes local - sees big growth in local advertising

CNN announced a deal today with Internet Broadcasting, a company that publishes web sites for 70 local TV stations. The deal will allow CNN to use the local content in exchange for CNN national content.

The Wall Street Journal has the story and contains this interesting quote "Growth in the market for local ads online has outstripped that of the online ad market as a whole. Advertising online by local companies more than doubled over the past two years, to $5.7 billion in 2006, according to local media analyst Borrell Associates. The overall online ad market in the U.S also grew briskly, but less so -- rising about 71% over the same time period, according to eMarketer."

CNN sees the growth opportunity in local news and advertising. I have been talking about the local news opportunity a lot lately. Actually, it is local search and advertising that is the business opportunity, but local news is what attracts the audience. Look at this chart from the WSJ article. That growth curve is very appealing to the big media companies. MSNBC, Yahoo, CNN, and AOL have huge national audiences and want a piece of the local pie.

Microsoft (NASDAQ: MSFT) (is working hard on Live Local Search. Google (NASDAQ: GOOG) is also going after it. There are some smart start-ups that are already focused on local search and advertising. Smart move.

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Newspapers need to go hyper-local to survive

The San Francisco Chronicle announced it will cut 25% of its news staff due to falling circulation and ad revenues. Mark Cuban thinks newspapers and TV stations should merge, reduce duplication of efforts, and make a strong push on the web.

Newspapers are dying slowly while craigslist and Monster.com attract most of the lucrative classified advertising. The San Jose Mercury News has certainly felt the impact of readers moving online, losing $100 million in classified ad revenue. Remember this quote from my March 2006 post;

At its peak in 2000, The Mercury News had a Sunday circulation of 326,839 subscribers, according to the newspaper. Last September, the company counted 278,470 Sunday subscribers, a drop of about 15 percent. Revenue from the company's help-wanted ads fell to $18 million a year from more than $118 million, according to the paper. The newsroom was whittled to 280 people from 404, a 30 percent decline.

Newspapers are in a tough spot. They publish once a day, so they are usually 24 hours out of date in terms of breaking news. TV, radio, and the web can react faster. Magazines have the advantage of being published once a week or once a month, so they take a longer, more in depth look at news events. So newspapers are stuck in the middle...too slow for the breaking news, not in depth enough to compete with the news magazines.

Newspapers should go hyper-local. Focus on local news, school sports, local businesses, and local people. Radio, TV, and the web can't do local reporting as well as the newspapers. Newspapers should play to their strengths. Provide the best classified advertising rates, and make it easy to place and monitor ads online. Local newspapers should be THE source for local search results...which I believe is The Next Big Thing in search. Take a look at CitySquares Online as an example of how to do local search right. The newspapers should be doing this...and more.

UPDATE: I just read Mark Evan's blog. Mark is a former newspaper writer, and agrees that newspapers should go local.

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Popfly with Silverlight - now anyone can create mashups

Microsoft announced Popfly beta release today.  Nik Cubrilovic at TechCrunch loves it. Ryan Stewart, a Rich Internet Applications  guru, and Adobe employee, also has nice things to say.

Popfly is a free, easy to use tool, to build and share mashups, gadgets, Web pages, and applications. If you can use Powerpoint you can use Popfly to build mashups, gadgets, and web pages...just like a real developer. It is really simple...yet powerful.

Nik Cubrilovic says "Popfly is a big leap forward from the competitors above because it lets you do so much more, and it is one of the nicest web application interfaces I have ever seen. With Popfly, you can create applications, mashups, web pages and widgets (gadgets) and it is all tied together in a social network (as part of the Live Spaces platform) where you can connect with other users and publishers of applications. Mashups are created by dragging in and connecting ‘blocks’ which produce an output. Blocks are modules that connect to various web services API’s, and even today there are dozens of different blocks that work with a whole variety of different web services."

Ryan Stewart, a writer for ZDnet says; "Microsoft announced one of the cooler Silverlight applications to be built today when they took the curtains off of Popfly. I didn’t get a beta invite to Popfly, but after seeing the screencasts and reading the blog reports, I’m really excited about it. It’s a psudeo-competitor to Yahoo pipes, but the user interface makes it much more accessible to the general public and makes creating mashups a lot easier."

This is the first of lots of cool tools and applications enabled by Microsoft's Silverlight and Expression Designer tool suite. Microsoft has always been very strong in developer tools with Visual Studio. Now designers and web creators will be able to enjoy new tools from Microsoft that work seamlessly with Visual Studio. Cool stuff !!