In Reel Time

2010.48 Thoughts on the media industry

Last weekend I was asked twice about what will happen with the media industry long term. I get asked this question often (or the variant…what are your thoughts on the media industry).

The question is so big and broad I always inhale and think for a minute before saying a word (it’s like being asked if there is a God or how we’ll fix social security).

So the short answer is that I don’t know.

But the long answer revolves around the best way to figure out any evolving industry. Start with what you know. Evolution is an iterative process and the end result isn’t pre-determined; rather it takes shape as each individual step or change is implemented (and chosen by a related party). Good ideas often repeat.

So, what I do know (including some clichés that we all know):

1. Story telling goes back before written history; it won’t disappear. It isn’t disappearing.

2. Quality content can’t be free; otherwise artists can’t afford to create much of it (and, to date, newer content has more value than does older content, in general).

3. People are social creatures; blockbusters and the mass market will continue to exist as people want to have common discussion topics.

4. Technology will continue to disrupt media. It always has (the printing press…).

5. A friend’s point: technology is actually adding less value over the past ten years than it did in the years leading up to 2000 (think the PC or Internet over arguably the biggest tech breakthrough of the past ten years – the iPad).

6. Artists need to be more multidimensional. As radio killed the video star and talkies cratered the career of the silent greats the distribution platforms have gotten more demanding and diverse. Lady Gaga is a performer; not a singer.

7. But, I don’t believe that all content should reach its audience over all platforms all of the time. If your audience isn’t watching television don’t spend (money and employee time) to get on television. Note the original argument only works well if you take mainstream media onto the newer avenues of portable devices or the Web and not vice versa (no Farmville movie planned in my knowledge).

8. Digital content is much harder to monetize; no one has perfected the model but I’ve met with some companies that are successfully monetizing (and not just pennies). Look at online gaming!

9. Anecdotal evidence only but the tech world seems to be hiring more out of the studios or other mainstream media companies than vice versa (except in tech systems and support areas).

10. People really do like fragmented distribution. It’s fun and convenient.

11. My kids love games. Kids love games. Women, who make up a lot of the monetizable online traffic right now increasingly, love games.

12. The MacBook Air is great. I like the iPad less (no flash). My Blackberry and Kindle are dear to my heart. Books and Kindles can co-exist.

13. The studio model will continue to be under attack from many Silicon Valley types. The core question is whether it will adapt quickly enough to survive by migrating to a – highly different – form (“protected and feudal microcosm that was only able to stay artificially alive as long as it did because the artists were a part of this small community and helped protect it longer than was wise” was what I heard today from a friend).

14. Iteration broken by big break throughs is the pattern.

15. The old definitions no longer apply: “technology” and “media” are imprecise.

16. Cisco has a tough job. After hours on the line with tech support making my home network “work” I can attest that seamless home networks are not a plug and play concept yet.

17. Some people are open to new ideas and others will resist disruptive change and related solutions (one of my promised clichés). Our brains aren’t wired to accept or process ideas that are vastly different than what we’ve accepted to be true in the past. Having been windows based for so long I’ve had a harder time working my daughter’s Mac than she has (at 9). I keep looking for an X in the right hand upper corner.

18. I haven’t been as excited by so many companies in ten years or more.

Are we in the early stages of this change? No; most industries continue to evolve but the media industry gets more press (it’s more fun!). And the related innovations have accelerated (with the music industry leading the charge).

Coming from the tech world I’ve lived the fast pace of such cycles; and the Internet has clearly injected that speed into media, which had been protected from certain competitive forces by its strong dominant niche position. Consumers have more choice now and the ramifications have been felt throughout all forms of media and created new ones. Some won’t survive. This resolution is far from pre-determined and I’m enjoying meeting with and advising companies that are at the cutting edge of such changes or creatively meeting them head on.

So, in conclusion, what are my thoughts on the media industry? The business model is shifting from protected windows to a more tech style model of proactively focusing on the customer/audience. But, actually, there is no true conclusion for this blog posting. Rather, the debate will continue.

2010.41 My last week: ITExpo; Digital Music Forum West: Caltech/MIT Enterprise Forum

Last week I dabbled in a few conferences and then committed to a panel. What did I learn?

At ITExpo in downtown my big takeaway was speed. Evolution. Regulation. The cloud. Opportunities continue to develop at an increasing pace. And the battle of net neutrality continues. Indeed, Hank Hultquist gave a riveting speech on the major issues and regulation that comprise net neutrality issues…from AT&T’s viewpoint.

Panels at the Digital Music Forum West (Roosevelt Hotel) sometimes got confrontational, with the forces for change arguing against those with a vested interest in staying the same. A few later panels were too politically correct and mutually supportive (for my taste). But Rick Alden, SkullCandy’s CEO provided insight and emphasis on branding, which distinguishes how his company operates. Visionary and charismatic (with freebees to hand out) he garnered a lot of questions and a crowd outside the main hall. Best quote? “The best ideas won’t come from sitting behind a desk”.

Later panels on Brands & Music and Touring explored further specific instances of how acts and brands can customize and define themselves. The real message? Define clearly who you are and your audience. Then set yourself apart creatively in that context. And don’t tie your brand to an artist; develop your own broader, richer personality.

The conference highlighted innovation (and spots that lack innovation) within the music industry. As we all know, the music industry was ahead in getting hit with digital change, making mistakes in their response and now in coming up with new ideas to survive and prosper.

The Caltech/MIT Enterprise Forum – From Past Time to Prime Time (on Social Networking) – was where I committed. Kevin DeBre of Stubbs Alderton & Markiles introduced. Mark Suster of GRP and Jay Samit of SVnetwork spoke. You want to hear the message straight? They both deliver that. Mark told us to look outside of walled gardens (if you rely only on Facebook they own your audience – keep your website) as both closed and open systems work. Jay advised entrepreneurs to get between big trends and pick up the crumbs (great imagery).

The panel: Jay, Sean Moriarty (Mayfield Fund currently), Jonathan Strauss (awe.sm) and Andy Wilson (Momentum Ventures), with Mark Suster moderating. The panel offered so many insights; I only have room to list a few. The social capital that you bring to business is critical today. Traditional analytics don’t work in social media…the space is so fragmented; do you want pages views or transactions? Brands need to get where the customers are and realize that their “important” doesn’t matter as much as does their customers’. Individuals now communicate across channels. Local is (still) the great unsolved problem. Women are over-served in the major success stories of the past few years: daily deals, flash sites and social games (take the women away and…). Tigertext effectively erases the record of your digital communications.

My conclusion on the week? I’d prefer not to go to conferences/panels everyday (fun though they can be).

Next up, Digital Hollywood starting October 18. I myself am on a panel on Wednesday, October 20.

2010.44 The Web is dead? Is Wired right or just good at headlines?

I’ll go with the headline option as the other point is nuanced.

The article in question starts with “Who’s to blame?” Chris Anderson takes the ” us” argument with Michael Wolff blaming “them”. The title on the cover, asking whether the Web is dead, is clearly an attention getter, but the related articles are very thoughtful.

What points stuck with me – for those who haven’t read the article (and those who did and may want to discuss related thoughts). I’ll break my argument up by discussing Anderson’s points first.

Anderson is making a distinction between closed systems on the Internet and the Web itself. We have moved over the past few years from search engines and the broader web to semi-closed systems such as Pandora and Facebook. The screen comes to the user, not the other way around; so these systems often provide a better experience. He also resurrected the “push” concept which I remember so clearly when first discussed in the mid to late 1990’s. Now push comes in the form of APIs, apps and the Smartphone.

Content delivered via browser currently only accounts for a quarter of Web traffic and the number is still dropping. Increasingly traffic consists of peer-to-peer file transfers, email, company VPNs, the machine-to-machine communications of APIs, Skype, World of Warcraft and other online games, Xbox live, iTunes, VOIP phones, iChat and Netflix movie streaming. Shifts are accelerating and Anderson quotes Morgan Stanley as saying that within five years the number of people accessing the Net from mobile devices will exceed those using a PC. Phones have a smaller screen; traffic is often accessed not through a browser but specialty software (a closed or semi-closed system).

Results? A pressure for profits from these “walled gardens” and monopolies. Ah, monopolies. Networks are more monopoly prone, Anderson claims; using Metcalfe’s law, that the value of a network increases in proportion to the square of connections, a winner takes all market is created. As Facebook’s user base grows more people are drawn to it because that is where they can find the largest number of their friends (and they miss out if they aren’t thus connected).

The victory of convenience over openness? People are often choosing quality over free, yet also appreciate choice. Some watch content and others create it.

According to Anderson, “The Internet is the real revolution, as important as electricity; what we do with it is still evolving.”

To sum up some of Wolff’s key points, online power blocks are real due to concentrated user numbers. He references some statistics from Compete, a Web analytics company, which says that the top 10 Web sites accounted for 31% of US page views in 2001, 40% in 2006 and about 75% in 2010. Big dominates; and those related companies control enormous numbers of people.

An example he sites is Google, who he analogizes to being like the only movie distributor, who also owns all of the movie theatres. Google may stand for open systems and level architecture but it also heavily dominates its space. Disruptive business models and the breakdown of incumbent power structures are only one part of the Web. Struggles for control are another.

Content companies had to face their own disruption online. Wolff points out that the Web was built by engineers and not editors. HTML-constructed Web sites aren’t the best as an advertising medium. While growth initially masked the resulting revenue generation crisis it has become clear to all now. Ads can be tracked online but we also know how many consumers ignore them.

Wolff states that the online audience is a fraud. He says that nearly 60% of people find websites from search engines, driven by search engine optimization (skewed results based on the related algorithm). And, as Web audiences have gotten larger, the quality of those audiences has dropped. Hence companies such as DemandMedia produce ever cheaper content for audiences that don’t want to pay for it (a spiraling that leads to less and less valued content).

Those coming from the media side don’t typically know technology and vice versa (as an aside, I recently met the CEO of a local tech based content distribution company who made movies before going to grad school – I was thrilled). But then Wolff brought in Steve Jobs…who aligned himself with media interests and found one solution.

Further points are to be found in the pages of Wired Magazine’s September issue

George Gilder, in his newsletter dated Friday, August 27 titled “Wired Weirds Out”, criticized the Anderson/Wolff articles. (Free sign-up at http://earth.lyris.net/cgi-bin/lyris.pl?join=gilder-technology-report). I’m never one to easily argue with George Gilder! I think the essential disagreement with the respect to the two positions is that Wired gave the walled gardens too much credit for displacing the broader web. Gilder points out his nuance: the massive growth of usage/traffic and credits the online world with killing TV and the Internet. Essentially, the network needs to meet the continued increases in demand (and type of traffic) and no solution has thus far come forward (who pays…who controls the network…neutrality or not?). He also criticizes Wired for its extensive name dropping of media darling companies – and he’s right on that point.

All three pieces are worth reading. Gilder’s focuses more on the actual technology; the Anderson and Wolff pieces are more thought pieces – hence the attention getting title. Viewed in sum, we get insights onto the evolution of an industry – digital media – which continues to evolve. We may all be surprised with the results of that evolution.

2010.37 Imax to partner with Laser Light Engines

IMAX, which specializes in immersive motion picture technologies, recently signed a deal with Laser Light Engines for development of high brightness technology systems exclusively for IMAX digital theatre systems.

Under the terms of the agreement, IMAX will make an equity investment (of undisclosed amount) in Laser Light Engines; who in turn will develop a custom version of its laser light technology for exclusive use in IMAX digital projection systems. Laser Light Engines will also develop custom features to help enhance the IMAX experience. Additionally, LLE’s technology won’t be available to the general market for two years, and to other large format theatre systems for three years.
Laser Light Engines designs, develops and manufactures OEM laser-driven light engines that provide high brightness, long lifetimes, energy efficiency and color control capabilities.
One particular challenge of theatrical 3D is that the viewer’s 3D glasses filter out a significant percentage of the available luminescence as they “trick” the mind’s eye into seeing a 3D image. That means that a brightness that is adequate for 2D viewing is insufficient for 3D exhibition, and many viewers consider 3D movies to be too “dark.” This challenge is the backdrop for IMAX’s interest in LLE.

IMAX screens typically go from floor to ceiling, and extend to the edge of viewers’ peripheral vision, which creates an immersive experience. Their sound system is of exceptionally high quality. The company’s 3D theatres even further increase the viewers’ feeling of immersion. Most IMAX theatres feature a steeply inclined floor which allows each audience member a clear view of the screen.

The deal is subject to due diligence.

IMAX has had a busy year thus far in 2010 – quickly signing up deals to open new theatres around the globe. Most recently, on July 15 they announced an agreement with Lumiere Pavilions, one of the fastest growing private movie exhibition chains in China, to open three new theatres, one a year starting in 2010. This deal brings the total number of IMAX theatres scheduled for operating in China by 2012 to 57. The total number of IMAX signings announced this year is 95, as compared to 35 systems during 2009. And the mix of openings signed spanned the globe with sites to include Japan, the Philippines, Thailand, Singapore, Russia, the Ukraine, Croatia, France, the Netherlands and the UK. They have also expanded an earlier agreement with AMC by adding 15 to 25 more theaters to the original 104 agreed upon.

Inception, which opened on a record 197 IMAX screens over the past weekend, was also the top grossing picture, taking in $60.4 million.

The company will announce earnings on July 29.

2010.35 Different M&A bidder types; as demonstrated in recent content library-related announcements: Miramax, Lions Gate, MGM, EMI and the Weinstein Company.

A slew of recent media-related deals and announcements has me wondering. Blogs have reported that Colony Capital is teaming up with Ronald Tutor to buy Miramax. While Colony is known as a real estate private equity fund, it started out buying distressed assets during the S&L crash. Richard Nanula, a Colony partner, was Disney’s CFO years ago so he probably grasps studio economics as well as anyone. Also as covered here before, Carl Icahn – known as a corporate raider – is making a run at Lions Gate. Lions Gate is reported to be in talks with MGM about a possible merger. MGM’s debt holders, in turn, reportedly rejected a $1.5 billion bid from Time Warner. EMI’s owner, private equity firm Terra Firma, invested an additional £105 million into EMI to avoid a default on the music company’s debt; if the bankers hadn’t gotten paid they could have taken over EMI. The Weinstein Company recently negotiated a restructuring agreement in which its lenders are relieving it of $450 million in debt and providing new cash in exchange for a $115 million payment from Ambac and the rights to 200 Weinstein movies, including the $233 million in related accounts receivable (Once Goldman and Assured Guaranty recoup their money the film titles will revert to Weinstein).

What do all of these (possible) transactions have in common? All of the related companies have content libraries; their valuations are functions of both legacy assets and in some cases efforts to create new content. Lenders are also having an impact on deal negotiations. Lions Gate and Weinstein’s lenders have been working with them to give them time to address their business issues, while EMI’s lenders (led by Citigroup) have been more aggressive in their willingness to potentially take over the company. In all cases, investors and debt holders are assigning value to libraries of content (music in the case of EMI, film content otherwise).

What they also have in common is that a wide range of buyers is demonstrating interest in these content library-based businesses (potentially including existing debt holders).

So, the using these transactions to illustrate the types of buyers common in M&A transactions and depending on circumstances:

Strategic buyers: Strategic buyers are essentially other corporations, most typically in the same or a related business. MGM and Lions Gate – should one buy the other – are examples.

Financial buyers: most typically private equity firms. They buy businesses that have enough stable cash flow to support the addition of debt (added to leverage their investment and, hopefully, their return). Their goal is to run the company better than the prior management team and sell a few years down the road at a profit.

Distressed investor: comes in when they think an asset is (generally grossly) underpriced. Defaults on debt, market turmoil (and an overreaction with respect to valuations which plunge as the panicked or illiquid dump related assets), bankruptcies and predictions of gloom are all signals. Colony Capital made its name buying distress bank and commercial real estate holdings.

Corporate raider: targets a company whose publically traded equity he believes is undervalued. The raider then pressures management to make certain changes in an effort to raise the share price. Carl Icahn made his name as a corporate raider. The goal is typically to turn a quick profit.

White knight: What Lions Gate is likely looking for. A white knight is a bidder who comes in and usurps a corporate raider – typically by working with management to come up with a higher or more favorable bid. Example? None thus far in any of the transactions discussed herein.

In the above related transactions existing debt holders are also sometimes expressing interest in taking over the company – either to liquidate the assets of the business or assume operations.

An investment banker can and will tailor potential buyer lists in advance of any solicitation to maximize long term benefits from any transaction to shareholders, employees, management teams and even the company’s customers.

2010.28 Toy Story 3 – to infinity and beyond?

Last Sunday, as we drove by a Shrek Forever billboard, my nine year old daughter told me that she wasn’t going to see the movie. She declared that a trick the studios use is to make one good movie then follow it up with a bunch of bad movies under the same name. She then stated that they especially use the trick on children. She doesn’t seem to be alone in her wariness toward the studios’ summer slate as Memorial Day weekend attendance was the lowest since 1993. Box office receipts for the following weekend were down 24% compared with the like period in 2009.

So how is the new calendar market really doing? After all, last year (2009) box office receipts were up. The time period between May and Labor Day typically accounts for about 40% of annual ticket sales. Yet since early May, with the strong “Iron Man 2” release, total domestic box office revenue has fallen about 6.4% to $1.02 billion from $1.09 billion a year ago. This past weekend was up 11% with the strong $56 million (over three days) release of “The Karate Kid” yet a lot of high profile sequels such as “Sex and the City 2” (with some of Warner Brothers worst reviews ever) have disappointed.

What ails the calendar? I’ve researched the expert comments on and offline. An improved economy means that consumers no longer flock to movies as a relatively inexpensive entertainment option. Ticket prices are also up (so tickets aren’t as inexpensive which consumers may not appreciate even if they have the money to spend). Despite the 3D hype only one major 3D movie has been released since May – “Shrek Forever”. But I’m also reading a lot of articles questioning the momentum the current crop of movies has been able to build. And if the audience is already wary of the calendar will the summer prove to be a disappointment?

Last year – during this same summer time window – eight action fantasies and animated films topped $150 million, including four that had already been released by today’s date (“Up”, “Star Trek”, “X-Men Origins- Wolverine” and “Night at the Museum: Battle of the Smithsonian”). Thus far, the current crop of movies isn’t matching that performance.

What’s on the slate for the rest of the summer? At least four 3D movies, including “The Last Airbender” and “Despicable Me”. The much advertised during last night’s Lakers game, “Knight and Day” with Tom Cruise and Cameron Diaz and “Grown Ups” with a slate of five names (though none of the seven actors in those two films has broken the $150 million mark since 2005). “The Twighlight Saga: Eclipse” will be released on June 30. Will Ferrill, Julia Roberts, Angelina Jolie and Sylvester Stallone all have a movie in the cue. And, let’s not discount the possibility of a smaller surprise hit making an impact.

Two links for the summer calendar and related previews are: The movie insider and Teaser-trailer.

I quote my children often on media related topics because they view the various options without a legacy overhang. Hearing my daughter’s comment yesterday – coming from someone who thought the Squeakquel was one of the best movies of all time – and then reading an article in this morning’s NY Times about viewer malaise with the current movie calendar re-kindled some issues I’ve already discussed herein. How can content providers define and target quality experiences to viewers who have so many other options? Can they continue to re-tread the names and story lines that worked in the past? If nothing else, they continue to try.

To be fair, the studios’ core strength is their ability to finance large budgets and give them worldwide visibility and distribution, and to maximize revenue in all forms (including games, licensing and spin-offs). Quality? Well, we can debate that term forever (and I have).

Truly, some franchises continue to work. I’ve already posted an earlier photo from ShoWest in which I’m flanked by Buzz and Woody. We’ll be in a theatre for “Toy Story 3” because Pixar has done a great job in maintaining the franchise’s quality. Like most movie goers I’m perfectly happy to pay for an extraordinary experience.

What movies have you seen this summer that justified the time and expense involved?

Note on the picture – The Toy Story 3 preview can’t be embedded from YouTube as the embed code is blocked. So, I did The Karate Kid instead and highly recommend the clip. It was cheaper – also – than buying a picture from the photo source I use. Example of pricing model issue?

2010. 22 Reflections on quality from Digital Hollywood and The Cable Show

Recent wanderings got me pondering quality – across many fronts, from content to technology to the overall experience.  The definition, of course, can hinge on what side (economically) you represent.  Is quality an intangible that we recognize, like obscenity, when we see it but can’t articulate in concrete terms?

At Digital Hollywood a few weeks ago I listened to two different panels that addressed quality but from very different perspectives.

The first panel consisted of representatives from studios, media distributors, agents and creatives.  One of the studio panelists addressed quality by saying, “For us quality means we need to have a celebrity or other name attached otherwise it just isn’t quality content.  We are an old media company after all.”

In contrast, a 3D panel, with representatives from AEG Live, IMAX, Sony, 3ality, Cinedigm, Reliance MediaWorks, a movie director and the 3D VFX Supervisor from Avatar, addressed quality very differently.  The participants discussed aesthetic challenges along with making and presenting 3D content.  Their entire focus was on the overall consumer experience and how it had to justify the added ticket cost.  Quality meant that the consumer experience had to be exceptional.  I asked myself if perhaps James Cameron had been the “name” that attached itself to the whole 3D ecosystem enabling it to break out as a hot “new” industry focus.

Still pondering this issue of quality I headed up to San Francisco (sure to get some “techie” inputs).  Running into Rich Maggiotto of Zinio, we flipped through his company’s assortment of magazine and related pages on an iPad (many of the top magazines are available for subscription viewing through Zinio on a PC, iPad or iPhone and the experience is stunning).  He showed me a few newer online ad options and I would watch them (I usually don’t).  I asked Rich about quality from his perch.  He spoke of the user experience and the tough balance of providing branded or name content while weighing the extensive list of popular alternative content that the consumer can get so easily.

Flying home I wondered about the studio audience bleed.  The vast majority of media-related dollars (content not technology) come from what is termed old media sources.  Yet at the consumer level little distinction exists between old and new media as they continue melding together.  Has the definition of quality changed?  Or does it rest, ultimately, in the individual?  Chris Anderson, years ago, in his Wired piece on “Free” used the example of his kids – if given a limited two hour window to watch content – choosing not Star Wars the movie but YouTube videos of Lego Star Wars characters made by other nine year olds.

My last step pondering quality occurred when I attended The Cable Show at the Los Angeles Convention Center.  The exhibits were lavish and celebrity-strewn.  The show was visually stunning with large, high def screens lining the aisles.  Every step of the media distribution (cable) process was represented; from the studios, to the cable companies, to technology providers and enablers.  Cablevision had one of the best and most lavish booths refreshment-wise with nice champagne, assorted ice creams and a coffee bar.  The first two were known brands while the later was brand-less.

And that offering, by a cable company, sums up my current state of mind with respect to quality.   The flavor or form often varies per person or their mood (I had a coffee, later in the day maybe it would have been champagne; 24/7 my kids would have chosen ice cream).  But you aim to provide the best overall experience, ensuring that each offering tastes good, and let the consumer decide for themselves.

Challenges faced in the continuing battle to provide and monetize a consumer experience will always rest on consumers’ ultimate determinations of quality.  As the various providers along the value chain try to provide an experience based on an amorphous but sometimes recognizable definition the consumer continues to benefit.  From 100 plus channels, to the iPad, 3D, Glee, Avatar, YouTube (my kids’ favorite) quality itself is being monetized, sometimes more directly than indirectly.

I’d greatly appreciate hearing what others think of quality.

Ideas came from, other than the people above:  John Rubey, AEG Live; Greg Foster, IMAX; Buzz Hays, Sony; Angela Wilson, 3ality Digital; Chuck Comisky, Avatar; Keith Melton, director; Jonathan Dern, Cinedigm; Jim Hannafin, Reliance; Marty Shindler, The Shindler Perspective; Keith Quinn, Paramount; Pam Schechter, NBC/Universal; Jonathan Foqualityrd, ContentFilm International; Chris Jacquemin, WME Entertainment; Michael Kernan, NuMedia Studios.



2010.21 Venture capital 2010 – Digital Hollywood update

The days of high valuations and large capital expenditures are over….

I listened to a few panels on (or related to) venture capital during my days at Digital Hollywood May 2010.  Below is a state of the industry 2010 based on those panels and some common sense “interpretation” on my part.  Rarely will I identify the speaker because doing so will clutter up the commentary.  I’ll list the names of the venture capitalists (and in one case a lawyer) who were on the panels.  Anyone wanting credit for points below feel free to comment or email me and I’ll post credit.

The past ten years have flipped venture returns into negative territory and their own investors are being much slower to fund new venture investments.   Some newer funds are likely to disappear and it’s only the large granddaddies (the Sequoias, NEAs… with their $500 to $700 million funds) that can chase large valuation companies.  

Over the past few years there have been few venture exits – almost no IPOs and M&A activity is down dramatically (with valuations also having dropped).  The exits have predominantly been in the $30 to $70 million range.  While venture targets a ten times return (almost impossible to get in today’s environment) they need a four to five times (investment) return.

Out of ten investments, a VC hopes for one to two that do very, very well; three to four will at least double their money; with the rest likely being written off or sold for scrap. 

In today’s environment, a “capital efficient” company can still generate a venture return.  That term essentially means that hiring can be reasonably priced, not a lot of equipment is required and minimal investment is needed.  Those parameters may sound constraining but more and more can now be outsourced or is cheaper (Google AdSense, Amazon hosting, cheaper bandwidth and equipment).  Capital intensive businesses – such as chip or hardware companies – are finding financing a tough go.

Since some of the basic start up costs have plummeted VCs are more focused on other factors including defensible IP, quality of the team, evidence of traction and a network effect.  Indeed, over the past year the VCs have been able to invest in what would have been, in the past, a B Round at what used to be an A Round valuation – while getting the benefit of seeing the company at that later and more developed stage.

In 2009 almost all companies did down rounds – if they could do a financing.  All panelists agreed that today it’s wise to keep valuations reasonable in round A because a down round on B or C or not having existing investors participate in the next round is the kiss of death – you’ll look distressed and get a distressed valuation if you can get money at all (hotly contested by many audience members).  Surprising on the upside is better in the long run for the company than getting a high initial valuation (10% of a $300 million company is the same as 50% of a $60 million company).

Areas of opportunity:

For larger companies in tech and media – practically – development no longer exists and they need to buy growth.  Therefore, in designing a business plan just don’t just target an amorphous exit – think about which large companies could buy you and start working with them on business partnerships/development opportunities (think Ankeena and Juniper).  True growth comes from small companies since they don’t have a legacy overhang and the large companies won’t eat their babies (existing cash cow businesses) no matter how dire their industry changes are.

Find an “unfair sustainable competitive advantage”.  Build multiple revenue streams.  Closed versus open is debatable (Twitter was so open they may have killed their true opportunity and aren’t monetizing their business; Facebook was so closed they’re now opening up).  An app alone is not a company.  Customize.

The value of the studios will keep going down over time.  Quality content is where value rests; the supply of distribution channels will continue to grow.

Sports, games (especially social network related games), companies that can shift ad dollars their way, creative ecommerce with proven monetization models, core data center components, location based.

Mobile is in its very nascent stages of development being where the internet was in the late 1990’s

In closing, the overall message was that now is a great time to start a company!  Lots of disruption is swirling through numerous markets, it’s cheaper to ramp up and capital exists for the right idea.

List of VCs who’s comments helped shape the above:  Jon Chait – Dace Ventures;  Tim Chang – Norwest Venture Partners; Neal Hansch – Rustic Canyon Partners; Alex Hart – Revolution Partners; Paul Lee – Peacock Equity Fund; Ross  Levinsohn – Fuse Capital; Erez Levy – TriplePoint Capital; Schuyler Moore – Strook & Strook & Lavan LLP; Robert Raciti – Raciti Capital Advisors; Len Rand – Granite Ventures; Kevin Spain – Emergence Capital; and Richard Yen – Saban Ventures.

I’ll be at Digital Hollywood in Santa Monica next week

Digital Hollywood starts this coming Monday at the Loews in Santa Monica. I’ll be there for most of the conference and at least one dinner (the Finance dinner on Monday night).

Before I go to such events I read through the program to figure out what I want to get out my time investment. Listening to panelists who only market their own company or stick with standard, clichéd viewpoints always frustrate me. If I think back over the past few years and like events the best panels have always included individuals with widely divergent viewpoints. It’s always easy to agree with someone who espouses what we read and think we know. But how much better to listen to someone trying an innovative or even crazy idea. Even if that person fails this time they may learn from their mistakes and succeed the next.

Earlier today I heard Father Cunnane of St. Thomas Church say something along the lines of a leader needing to be one step ahead of his followers; if he is two steps ahead then no one will follow. But, he continued, once and a while, the situation requires a prophet, someone who is both many steps ahead and not grounded in reality.

Will anyone at Digital Hollywood stand out as a prophet? If so, who? Is expecting someone to do so reasonable?
What expectations does anyone else have for the conference?

Feel free to comment here, email me at jones@hadleypartners.com or – best – tell me at the conference.

Past Digital Hollywood Session videos are a click away.

2010.19. Michael Lewis and The Big Short

Michael Lewis has great timing and a strong nose for Wall Street scandals. The Big Short: Inside the Doomsday Machine (Amazon.com Michael Lewis The Big Short) describes the investors, including the now-famous John Paulson, who shorted CDOs and made a fortune when the market crashed.

I finished it a week before the Goldman/SEC complaint – SEC Goldman complaint 2010 – was announced. The book is a perfect introduction to the ensuing, very public media flurry about Goldman, Paulson and the SEC.

And no one has emerged unscathed (one piece of smut literally being smut: how much porn was watched on SEC computers as the financial system was tottering on the verge of collapse).

I’ll skip the Goldman story; writing about that is journalism and not my calling. What about Lewis’ book? First, he does an excellent job portraying the financial story as a series of personal narratives. He’s able to entwine his pages with complex securities dealings in an understandable, entertaining and even humorous way. Like a novelist he describes people’s quirks and thoughts. He still mocks the innocent – with both humor and abandon (I’d hate to be on the receiving end). As always, his caricatures of dinner party attendees are unparalleled.

Overall, I loved the book and learned a lot about the CDO mess and how it unrolled. An interesting subsequent Wall Street Journal editorial (The Misguided Attack on Derivatives by L. Gordon Crovitz explains the irony of John Paulson getting such bad press now. Many have asked why no one saw this collapse coming yet someone who did and bet right is now being demonized. When did making a right bet on a trade become a bad thing? Personally, the right bets are what keep me solvent.

Essentially, the book covers a few individuals (investors, sales people, analysts) who noted how risky CDOs had become and looked for a way to profit from the coming crash.

As the mortgage pools started to be made up of ever lower quality loans, the risk of those CDOs increased more (in retrospect) than valuation models indicated (due to how entwined institutions were, the lack of black swan events being properly accounted for in the models and numerous other factors). The Big Short is an interesting primer to this tottering market, increasingly out of synch with reality. Lewis is brutally critical of many participants. I not only enjoyed the book but got a timely overview of what is now front page news. In sum, I’ll put a “strong buy” rating on the book.

Liar’s Poker (Amazon.com Michael Lewis Liar\'s Poker), Lewis’ first book, is a Wall Street classic. It described the Salomon Brothers of old, before a scandal brought down Lewis’ ultimate boss, John Gutfreund (at Salomon and in the period covered in the book) and the firm. The book gets its designation as a classic because it, in an engaging and entertaining manner, identified and captured a point in time that was about to disappear. Indeed, Lewis has often been credited with accelerating Salomon’s downfall through his scathing disclosure. The macho, extreme culture Lewis described softened over the ensuing years industry-wide but Salomon itself disappeared completely (sold to Citibank) after a trader was caught submitting false bids to the US Treasury.

Now Lewis has written a new classic; has he chronicled another world that is about to end, but perhaps on a larger scale? To answer that question we’d need to be looking back at history but the signs indicate that he may have spotted another “market top” for one part of Wall Street. The Obama administration is aggressively pursuing a larger and more involved governmental role in our financial services industry – which would change the sector immensely. Certainly, the common view of derivatives, with their complexity and entwining nature (causing the systematic risk we just experienced), are viewed differently now than they were a mere few years ago. Warren Buffett’s much quoted characterization of derivatives as “financial weapons of mass destruction” from years past, thought then to be alarmist, seems ever more prophetic (though he himself engages in large derivative plays now). Indeed, Buffett has morphed into the new JP Morgan: he stepped in after the Salomon scandal because he had a large share holding; in the current crisis he took large positions in Goldman Sachs and GE; and now he’s actively involved in the derivatives legislation debate. Warren Buffett\'s annual shareholder letter 2010

One thing is certain; the complexity level of securitization will decline, at least in the short run. Long held economic theory is even under attack (The Black Swan being only the most obvious example – definitely, the reliability of the ubiquitous “quant” models used to value the most esoteric securities has been discredited).

If I could ask Michael Lewis one question it would be “what is the next Wall Street topic you’re planning to write about?” And then I’d figure out the appropriate short.

A few questions to those who have read the book: what did you think of it? Do you agree with my comments? Buy or not?

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