In Reel Time

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.

2010.18 RealD files for an IPO

NOTE: this posting was slightly delayed because we were busy last week in connection with NAB.

On April 9, 2010, 3D technology company RealD Inc. filed an S-1 registration statement for an IPO. This is our second post this week on IPO’s. That is some coincidence, but it also reflects the fact that the IPO pipeline is the strongest it has been since before the financial crisis. A select group of entrepreneurs should be paying attention. As a service to our dear readers we thought we would provide summary and perspective on RealD’s filing.

RealD’s business is growing nicely. RealD generates substantially all of its income by enabling 3D viewing of motion pictures in theaters, both installing 3D projection equipment and providing eyeglasses for viewers. As of March 26, 2010, the company had its proprietary technology installed in 5,321 digital theaters. This number is up 152% from 2,108 screens in March 2009. Further, the company is working to install another 4,900 screens pursuant to agreements with existing licensees.

The Company is aligned with Digital Cinema Implementation Partners (DCIP). The three exhibitor co-owners of DCIP – AMC, Cinemark and Regal – are all licensees of RealD. Given that DCIP completed $660 million in financing in March to continue its digital cinema deployment, that roll-out should give RealD a tailwind of new theaters to support. DCIP’s financing will fund the digital deployment of approximately 14,000 screens. RealD’s exhibitors also have penny warrants equal to 8.9% of the Company’s pre-IPO shares – while no individual warrantholder reaches the 5% threshold required for disclosure in the S-1, it is safe to assume that the DCIP owners hold a chunk of these warrants.

The Company has recently valued its equity at $578 million. Other than paying a registration fee to the SEC for aggregate IPO proceeds of up to $200 million, neither the Company nor the underwriters (JPMorgan and Piper Jaffrey) take a view on RealD’s IPO value. However, for accounting purposes the Company is required to value its exhibitor warrants as they vest, because the value of such warrants must be deducted from revenue (as if they were a sales allowance, which in a way they are). In December 2009, the Company estimated the fair value of its common stock to be $21 per share, which suggests a pre-IPO equity valuation of $578 million.

RealD’s business model is a direct play on the commercial success of 3D. RealD is definitely eating its own cooking. By the terms of the majority of its exhibitor deals, RealD buys and installs the necessary equipment at the exhibitor, and then collects a per-attendee fee from the exhibitor. The exhibitor thus takes limited risk (they are giving RealD some exclusivity), while RealD has a business model with some capital intensity (they buy and install the equipment up front) but high margins on incremental revenue. So…

RealD should be marketing its IPO on a terrific March 2010 quarter. Because of RealD’s business model as noted above, the March quarter should be strong. Avatar was released 12/18/2009 and rolled well into Q1, and Alice in Wonderland was released 3/5/2010. Those two smashes alone should give the company continued strong growth.

RealD’s bet on 3D is a slightly different play than, for example, Cinedigm’s (NASDAQ: CIDM) economics on digital cinema. Cinedigm gets a “virtual print fee” from a studio every time it delivers a digital movie file to a screen. Oddly, Cinedigm’s revenue goes up with the velocity of movies delivered, not how long they stay in theaters. So for example, Avatar’s long run in Q1 will modestly depress Cinedigm’s results, while the big Avatar gate will favorably affect RealD’s. That difference works both ways, a quarter of weak releases will probably help CIDM and hurt RLD.

It’s the glasses, stupid. Currently, RealD’s income statement is dominated by eyeglass sales, not exhibitor licensing. For the nine months ended December 2009, gross licensing revenue was $44.4 million while product sales (eyeglasses) were $68.4 million. The licensing business is highly profitable on a stand-alone basis, but the gross margin on eyeglass sales is currently negative (RealD lost $9.2 million on its eyeglass sales).

RealD is handling eyeglasses differently in North America and overseas. In North America, it is receiving a per-admission eyeglasses fee from the exhibitor, and is assuming that eyeglasses last eight weeks for the purposes of amortizing their cost. Overseas, RealD is selling the glasses outright. As anybody who has seen a 3D movie knows, the glasses are a logistical challenge for the exhibitor, and Joe Morgenstern at the Wall Street Journal has written about the quality issues with 3D glasses (subscription required). RealD is working to increase recycling of glasses and generally to reduce their cost. In the long term, this logistical challenge is probably second only to the success of 3D generally in determining the long-term profitability of the company.

3D in the home – just starting. The Company is working to license its 3D technology to consumer electronics manufacturers, and also has 3D technologies on the way which do not require eyeglasses. However, these initiatives do not yet have any impact on the Company’s revenue and near-term prospects. This IPO will be bought and sold largely on the prospects for theatrically released 3D content and RealD’s competitive position.

Stay tuned for updates as the IPO proceeds!

2010.15 My NAB highlights … the top 10

Over 1,500 companies are on the NAB (click NAB for site) floor, and 479 of them are non-US based. Below is my attempt to edit a huge show into a few minutes. My personal show highlights….

1. 3D is the talk of this show. The lines to watch demos were long at Sony (Sony’s Hiroshi Yoshioka gave an opening keynote in which he stressed consumer demand for 3D), Panasonic and others. Buzz remains that 3D is the next technology invention to save the entertainment industry. Options are growing quickly and costs are coming down.

My specifics: I saw a great panel – with demo videos – on 3D sports. Incredible; and I’m one who generally doesn’t get excited about sports. On the panel were Anthony Bailey, Phil Orlins and Bob Toms from ESPN and Vincent Pace of PACE (and Avatar). Glen Dickson from Broadcasting and Cable Magazine moderated. I learned that the event rights holders were driving the production demand and that viewers are eager to watch the resulting product. Thus far, it is still a next generation experience and not a replacement for regular 2D sports. Not enough legacy work has been done to automate the process. Indeed the cameras often need to be placed lower to the action than are traditional cameras and the graphics must be scaled back so the screen doesn’t look too busy. Listening to Vincent Pace, a true 3D innovator, discuss the aesthetic challenges inherent in shooting 3D sports gave me my own Steve Jobs/calligraphy moment: I now view the images floating across the screen in an entirely new way.

2. Gadgets still sell… regardless of a recession.

How many panelists had iPads? Well, given the so recent Apple introduction they were pretty ubiquitous. One set of panelists agreed that the iPad is great for media or surfing the web on their couch but, as it didn’t fit in their pocket, wasn’t even to close to replacing their cell as number one.

I learned that Android smartphones now make up close to 7% of the market.

And, the GoPro HD Hero Naked is the coolest gadget of the year in my book (so far). The company has a booth at the show and their camera sold out of the NAB store in less than a day (at about $200). They make wearable, high quality HD cameras for sports. Waterproof, many versions (not just the Naked) including ones that fit on your surfboard – race car – bike – or wrist, durable (obviously) and great quality shots either as a video or a series of stills. Want to surf inside the curl of a wave at high definition? See the whole story by clicking GoPro.

3. The lack of available bandwidth and carry fees continue to be core issues. FCC Chairman Julius Genachowski gave a speech in which he discussed the FCC’s broadband plan. Broadcasters will be “encouraged” and “incented” to give up some of their broadband spectrum to be re-allocated to telecom companies.

“We’re at serious risk as a country in not moving quickly enough on our technology infrastructure and in other areas to remain the world’s leader in innovation,” he said.

The day prior, in another speech, NAB president Gordon Smith had compared the Chairman’s request for spectrum to Vito Corleone, in The Godfather, making people offers they couldn’t refuse. Chairman Genachowski joked back about the comment saying that as a result of the analogy “all the good restaurants have been offering to comp me.”

Later that day, a consortium of many of the countries’ largest broadcasters struck a deal to create a joint venture that would develop programming for mobile devices. The content provided could reach up to 150 million people (broadcast by them on their existing spectrum). Click article to read the entire story.

Chairman Genachowski also said that the agency is looking into (and looking for comments about) retransmission fees. We all remember the battle between Disney and Cablevision in March, during which certain Cablevision subscribers were threatened with no Oscar broadcast. He didn’t give any insight as to what the FCC will decide, just that Time Warner Cable and a few other like companies had asked them to look into the issue.

4. Multi-platform is a big buzzword. I liked how Dana Walden and Gary Newman, co-Chairmen of Twentieth Century Fox Television (Joe Flint of the LA Times moderated), described it in the context of Glee (click to see videos), their hit music show . They explained that the goal was to get the content into as many channels as possible – some of which are for marketing and not direct payment. Consumers all still appreciate quality content with universal themes and strong characters. Studios just have to be more creative in finding multiple channels in which to monetize the content. Glee did that, in part, through music, with a show over the summer, albums, etc. And, content needs to be monetized more quickly now (forget the days of relying on syndication or DVDs in a few years – 24 was put on DVD right after the first season ended). However, the idea of the network season, they stated, is still sacrosanct.

I also sat in on a mobile TV panel with execs from companies that included: Transpera, IBM Global Business Services, Flo TV, AT&T, MobiTV and Ion Media TV (if I missed you please let me know – the program differed from the actual speakers). For mobile, do we just use the content that exists? Not exclusively; though we do use it and cross device content portability is increasingly important. Currently, online narrative shows are watched more often on PCs; news and sports are viewed more on a mobile platform. On Flo TV their average viewer watches 25 to 30 minutes of mobile TV daily.

Overall, media viewership time itself is up dramatically. But the related revenue is going to different people (Apple, telecom carriers, concert promoters as opposed to music companies). From IBM’s Saul Berman, 4G will be the real inflection point of mobile television…if only we had the bandwidth to support the coming demand.

5. Ray Kurzweil matters. When I asked people I met what most struck them about the show his speech came right after 3D. In a keynote, he spoke about the acceleration of technology in the 21st century. No matter what the related topic he knew and could speak about it brilliantly. Agree or disagree … he’s an impressive guy. Click Ray to learn more about Kurzweil and singularity.

6. Social networking was another hot button. I attended a few panels on how to create a presence, market, advertize, brand, organize and more. Essentially, we’re in the early stages of the social networking reality. People will add more specialized social networks and means of organizing them but privacy (to a certain extent) is gone. Network.

And, social networking has become content.

7. People were spending. On Tuesday afternoon I couldn’t fight my way through the store and certain items were beginning to sell out (including some books!).

8. One of my cab drivers mentioned that Nevada unemployment is at 23%. For some even softer data, she told me that last month, finally, the larger strip-based casinos were busy. During the worst of times the smaller casinos were the only ones that had any business because they catered to a local clientele.

9. Convergence? The means of production haven’t changed as much as the means of consumption keep evolving. I saw a lot of cameras and reporters from paper based media companies. On display were satellite dishes, companies that build sets or send trucks. But the digital technology companies were out in full force (and filled some pretty large spaces).

10. Harmonic was the only booth (in my experience) whose reps didn’t just scan NAB badges for attendee information. Rather, they asked to look at a business card – it was given back – to get information, then asked about my company and interest in theirs so they could direct the information to the appropriate person within Harmonic (who would then respond). Smart.
The above is by no means a summary of NAB. It’s merely one person’s comments regarding what she saw and heard in a few days. Click Harmonic to learn more about the company.

The above is by no means a summary of NAB. It’s merely one person’s comments regarding what she saw and heard in a few days. Anyone who wants to add their own list please do.

To learn more about our firm please go to hadleypartners.com at link.

2010.14 Who shot my business model?

Creative destruction plus debt rarely miss a solid shot at any business model.

EMI and MGM share many things in common: they’re both studios (one music, one movies) with storied reputations, a history of hits, large and still-selling catalogues and owners (the hedge fund Terra Firma for EMI; Sony, Comast, TPG, and Providence among others for MGM) who loaded them with debt. Both are reeling as they battle to preserve value in light of creditor demands (which are justified under the debt terms) and negative industry trends.

The old studio business models are very obviously no longer working, and are still in flux. In the case of EMI and its music peers, nobody has found an adequate replacement for the sale of richly priced CD’s. In the case of MGM, which has a substantial library relative to a modest production slate (at least recently), the decline of DVD sales and the lack of equally lucrative replacement revenue streams sound like a similar tale of woe. And both businesses are beset by piracy and ever-increasing consumer entertainment alternatives. So who’s to blame? And why? The importance of the question hinges on the reality that if quality content can’t be monetized then no one can afford to make it.

The list of villains includes: the Internet, Netflix (rent, don’t buy), pirates, private equity firms, banks, consumers (read pirates), YouTube, video games and the studios themselves.

Ultimately, why these companies are tottering in 2010 is simple: private equity firms loaded up these media companies with too much debt, not expecting a precipitous decline in their revenues and much tighter credit. Let’s dig deeper. EMI has seen ten or so years of digital downloads siphoning sales. At MGM, DVD sales slid from $395 million in fiscal year 2008 to $70 million in 2010 (with a fiscal year end of March 31). The reality is that in both cases, the cash cow has been slaughtered. Neither EMI nor MGM has that steady stream of royalties to cover both their costs and their debt loads. New content remains unpredictable – will it be a hit – and is hurt by the destructive cracks to the historical monetization models of media’s recent past.

I blame what the economist Joseph Schumpeter most famously called “creative destruction.”

I’ve been reading Inventing the Movies by Scott Kirsner. It reinforces the story that’s been told before: media business models have repeatedly been disrupted by new technologies. “This time” is never different. Silent movies gave way to talkies, which gave way to radio, which gave way to network television, which gave way to cable, now the Internet (now 3D and our smartphones) – for a highly simplified overview. Media businesses have always been entwined with the then-prevailing technology. Progressive technological advances, from Technicolor to mobile video, have always disrupted media business models. As a result, whole sectors have been transformed or ended (silent film stars with bad voices…). Does anyone remember the song “Video Killed the Radio Star”? Yet we still have radio; we also have satellite radio, iPods, podcasts, MP3 players…

Further, no one should put a lot of debt on companies subject to full-blown technological disruptions in their industry. A company in the early stages of a new technology paradigm introduces something new so people start consuming it; when people get bored or a newer and better option arises then the business declines UNLESS you’ve anticipated the change and responded with a solution. Examples of responding to challenges by innovating: Apple, YouTube and Fred.

Assets – or in these cases libraries – are only worth what people are willing to pay at any given moment. And what people can or will pay changes (remember the tulip craze). EMI and MGM are learning that the hard way as they try to sell an asset which is in a downturn – the valuations are low (even if the content itself has long term value) because there is UNCERTAINTY in the long term monetization realities so buyers are avoiding risk.

Whether content is the core product, or rather it’s the larger entertainment, matters little. Monetization models have been disrupted with the introduction of new technologies. The response, since the disruption is so large (being creative destruction and not just a business cycle issue), will have to match the change and not just struggle with little tweaks in all that’s been done before. Some ideas that are working (already!) I’ll post about in future blogs.

And for now, I’m sticking with cowboys…

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2010.03 Video on History of Technology in the Movie Industry

Below is the link to a Scott Kirsner (of the Cinema Tech blog) video discussing the history of technology in the movies, and based on his great book Inventing the Movies.

Inventing the Movies (click for full video). For a preview see below.

The video is long but worthwhile, and from the fora.tv site.“>

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