The latest report covering the KKR buyout of First Data is disturbing at several levels. It is a clear demonstration that the buyout model of the last 2-3 years is over – the debt markets have dried up for this sort of lower quality paper. Does this mean buyouts will disappear? No – I just think you will see a return to the model championed by Silverlake and others in less buoyant times: Buy what you think are solid-fundamentals quality firms with growth potential (e.g., Seagate), then help get them the operational talent they need to take their game to a new level. We saw a number of marginal buyouts happen over the last two years (I am not trying to paint First Data with this brush) – that’s over for the foreseeable future. The major banks are, as mentioned in the WSJ article, caught in-flight with a commitment of their balance sheets to some of the major buy-out firms, with little or no chance of placing that paper without a SERIOUS haircut.
With the drying up of liquidity, the future for AOL is now made much more complex. There were lots of folk betting on a private equity consortium stepping in to take AOL of TWX’s books. That path now has little or no chance of succeeding in this environment.
What next then for AOL? I am not sure. Under the assumption that the aggregate AOL entity moves into a model of flat to low single digits growth, I am not sure TWX can afford to continue to have it roll up into the aggregate numbers. It makes TWX’s ability to position itself as a 10+% annual growth business a real challenge. If we assume that some structural move is in AOL’s future, what are left as options? Most of the prior musing about AOL has its future going down one of five paths:
1. Acquisition by Microsoft
2. Acquisition by Yahoo
3. Acquisition by Google
4. Standalone spinout as public entity
5. Sale to private equity player.
I think all of these options have way too much hair on them. Buying all of AOL brings a lot of financial baggage with it. To begin the dialog, let me give you my view on AOL and its composite parts. AOL is essentially composed of three major segments (this is not how things are necessarily organized, but is the best way to discuss its valuation):
AccessCo – this is the remnant primarily-dial-up access business. It is a great source of free cash, now that the marketing spend has been dialed back to practically zero, but as the last quarter showed, it is on a pretty fast decline (10% subscriber declines in the quarter), and should be modeled and valued appropriately. To me, on a discounted cash flow basis, maybe it is worth $3.5B-$4B (this is a rough justice estimate, given analyst views on sub profitability and an extrapolation of subscriber trends), assuming there is some tail of folk who will stay customers till the end (like what we saw with Compuserve).
PublishCo – these are all the properties that generate the viewership traffic for AOL to monetize. This is a collection of a lot of disparate assets, ranging from things like AIM and MapQuest to the AOL 9.0 user base. Most of PublishCo is best described as Web 1.0 in nature (no franchise model), with the exception of businesses like Userplane. Valuing PublishCo is difficult – The aggregate US pageviews and engagement metrics are pretty huge, but the trajectory is relatively flat, and even with an optimistic lens, it is most probably a low single digits growth business.
AdCo – these are the operations for monetizing the traffic of both PublishCo and third party inventory. I am putting the search operations in here as well. The centerpieces for AdCo are Advertising.com and AOL’s ad sales force. AdCo has been expanded over the last year through acquisitions like Lightningcast, Third Screen Media, Tacoda, and AdTech AG. Performance of elements of AdCo are pretty stunning. On last quarter’s earnings call, Dick Parsons mentioned sales on third party inventory (versus PublishCo’s) were up 32% year over year. This is driven in large part by the performance at Advertising.com. Valuing AdCo is probably the heart of matter in determining AOL’s future. If you focus on the display ad sales business, solving for a combination of sales within AOL’s own properties and sales on third party sites, you can craft a business of 20+% annual growth, with decent, if not exceptional margins. Adding the AOL search business into the mix gives you a lower growth top line story (the 16% year-over-year growth highlighted in last quarter’s financials), but dramatically improved margins, given the sweet economics of the deal with Google. The structural thinking here is the biggest leverage point in any AOL valuation dialog. It’s well worth the effort – if we use the Microsoft acquisition of aQuantive for $6B earlier this year as a comp, some permutation of AdCo (Advertising.com, the search business, a multiyear commitment by TWX to rep the inventory of PublishCo) could be valued at $10+B, assuming the parts hit the magic 20+% annual growth bogey.
So if these are the pieces and parts, what do you do as the parent?
Cowboy up and stick to the script of giving AOL runway to validate its strategy? I think we are rolling down the runway at 220 mph and have about 1000 feet left. Given the lukewarm feedback to the announcement of the $5B in additional stock buyback and the increase in dividend (the TWX stock closed today at 18.66), time is running out for management to remain masters of their own domain. The harsh words by Pali analyst Rich Greenfield are a shot across the bow – the buy side is losing patience. The only question is who is going to play the role of Carl Icahn this time around.
Sell the aggregate entity? I just don’t think that is something that will attract lots of attention. The three majors (Google, Microsoft and Yahoo) wouldn’t want the mass of no-growth components that the aggregate entity brings with it. How many acquisitions bring with them an immediate establishment of a sizable discontinued operations (AccessCo)? Maybe you could see a three party transaction, where the acquirer immediately lays off the declining cash cow to a private equity player…
Sell/spin AdCo? I think this is an attractive path. TWX retains AccessCo in its discontinued operations segment, and uses the free cash generated for more strategic purposes. AdCo is either sold to one of the majors (let’s add Murdoch and Diller to this list), or spun out to create a growth multiple currency to continue to roll up properties. AdCo is a really complementary acquisition by almost every major player out there (unlike what buying the assets of PublishCo would mean to a Yahoo or Microsoft). It also can survive and thrive in a world of disaggregation of traffic (i.e., it’s not a Web 1.0 bet on portals).
What about PublishCo? There are interesting properties (MapQuest, AIM, etc.) that are worth decent valuations. I just think dealing with PublishCo in the same time horizon as AdCo is a tough act. Perhaps Day 1, PublishCo might be combined with other web properties in the TWX family and given a longer event horizon to determine its course. The other option might be a separate aggregate sale to a player with greater web aspirations (e.g., Comcast). I struggle here on an elegant solution for this, but I think PublishCo’s valuation isn’t the big dial to turn in an AOL discussion – it just doesn’t have legs as part of a growth story. You do need the commitment from PublishCo for AdCo to run its inventory (and its search traffic) for 5 years to make the story all hold together, but I think that’s about the full extent you’d want the operational interop between AdCio and PublishCo.
I am a TWX stockholder, and the retreat to 18.66 pains me. I just don’t see an organic path to material success (i.e., 10+% annual growth) for AOL in its existing form, given current course and speed. In this world of inflated valuations and TWX’s commitments to stock buybacks consuming the available cash for acquisitions, too many deals will trade away that would help AdCo continue its forward momentum. With all the talk about arming AOL with its own currency over the last few years, it’s time to make it a reality – it just needs to take another form – AdCo currency.
First, let me congratulate the AOL team on its latest acquisition, Tacoda. I think that since Randy and Ron have taken the helm, the acquisitions to continue to fill out the advertising infrastructure have been logical and done at sane valuations. At this point, the non-search related portions of AOL are as strong as any of the other majors, and you could even say that Advertising.com continues to be the best-in-class player out there in the display ad network arena.
A brief history of AOL search for the uninitiated: AOL did a deal that, in Mid 2002, swapped out the prior Inktomi-powered search experience with a Google-powered one. The deal was a seminal one for Google, garnering them a lot of US search traffic at a critical time in their history (remember the more dominate position that MSN and Yahoo had in search in prior years).
The nature of the deal involved really favorable economics, as well as warrants in the pre-IPO Google. The deal did, however, have a number of constraints on what AOL could do to customize the Google search experience. The deal was a good one – AOL had much more flexibility than any other Google partner to-date, but even with that flexibility, it was probably correct to paint a picture of AOL being able to build a creative veneer around the core Google results, but not much else.
Well, the search team, led by Jim Riesenbach, Gerry Campell and Mark Canon, actually did a really great job, given the cards they were dealt. They did a number of things to allow for creative monetization of high-value searches, and built an underlying architecture that allowed real-time mixing of a number of external feeds, published in a customized template for each category of search terms. They were able to serve up the results with very little latency, given all the pre-processing they were doing. Overall, a nice piece of work. They also championed the selective use of editorial results in the header of popular searches (later copied by others), giving users really good payoff in the top half of the initial results screen displayed.
The growth in search-related ad revenue was pretty dramatic under their watch, but they knew that they had to test moving further out on the efficient frontier of “veneer design”, if AOL was ever to establish its own unique voice in search.
Their last major release (started long before their departures) was AOL FullView, which built on all their prior learnings/feedback on everything from consumer lukewarm acceptance of clustering, to the navigational issues of excessive reliance on horizontal tabs to toggle between result set types (text, image, video, etc.)..
Here is a sample of what one of the FullView templates looked like for an artist-related search (in this case, Dave Matthews):
To me, it resembles more of what Ask.com has morphed over the last several months – delivering a composite page with lots of rich content payoff above the fold. Compare that to a search for the same artist search today on AOL. using the new “look like Google” philosophy.
It is drab for a content-rich search like a music artist, and is a pretty forgettable experience. Note the heavy use Google branding at the top and bottom of the page. I understood the desire: If consumers felt that they were getting “Google results” from any search originated from the AOL network, maybe they would reduce their tendencies to use the Google site directly. This search traffic capture objective, combined with the newest Google deal (done as part of the Google investment in AOL in 2005) to allow AOL to start selling their own version of adwords to major advertisers, certainly has intellectual appeal at some level.
The challenge with this approach is fourfold:
1. We lost the impact of some of the tips and techniques we had developed as a “veneer” player that maximized the revenue we could get from high-value searches – maybe that will be offset by the private label adwords, but maybe not…
2. Over time, the average consumer is going to develop more of a tendency to just go to google.com directly – I certainly have begun doing that. The value of AOL as part of the value chain in the eyes of the consumer is getting pretty minimal.
3. It under-leverages AOL’s ability to deliver unique rich content assets from within the TWX network.
4. It is, by its nature, defensive in nature – how could you possibly grow search share materially this way?
I do think AOL has some great assets, and its video search is best-in-class, thanks to the Truveo acquisition. A great video search, however, will not have enough of a material financial impact to offset the gradual decline in core algorithmic search that this new Google-clone approach portends.
It’s time to revisit the decision before Google further erodes AOL’s position here. FullView may not have been the answer, but this current approach is definitely not a winning playbook.
Update: Saw the latest TWX earnings announcement this morning. AOL ad revenue up only 16% year-over-year (they did warn about this earlier in the quarter), but certainly better that some (YHOO). Under the assumption that advertising.com continued to do well (since it is less tied to AOL pageviews), I am not sure how the rest of ad/search revenue did (I am assuming lower than the 16% average). I had hoped the paid subscriber declines would slow on a percentage basis, and the 1.1MM sub loss in the quarter pains me – it creates an environment of more OIBDA/cost pressure going forward. Here’s hoping that a lot of them were converted to free AOL users – I think we’ll hear about that “save rate” on the earnings call, since it is a critical leading indicator of the new strategy.
Yahoo and the views of modern Martin Luthers June 21, 2007Posted by John in facebook, google, Jerry Yang, john mckinley, Mahalo, Microsoft, mobile, myspace, newscorp, powerset, rivals, search, yahoo, yahoo go.
Reading all the various views about Yahoo over the last 72 hours, it is pretty easy to join the crowd and opine, since all posts seem clustered at three get-well strategies:
- Fix search (gee, this is easier than I thought)
- Buy MySpace (refined from “Buy MySpace or Facebook” of the first 24 hours following the Jerry Yang announcement)
- Sell Yahoo to Private Equity/Microsoft/Newscorp
Do I agree with the wisdom of crowds here? Well, you’d have to be daft not to observe Yahoo’s search share declines and an effectively flat US story and think all is fine. The answers aren’t easy here – but all pundits agree it is critical to crack the code of search improvement beyond Panama, or there are troubled waters ahead.
Let’s start with search. Fixing search is as much a brand positioning as a technology issue. Pure play brands trump hybrid brands in the eyes of the consumer. Google is Search – pure and simple. Yahoo was search in eyes of consumers in the ‘90s and early ‘00s (and it ads reflected that very clearly), but with its content focus under the most recent regime, it started looking and acting as a media company. In the bull market of online advertising over the last 4 years, that seemed at first to be a winning play (maybe content WAS king), but now seeing Google at the precarious market tipping point in the US, that positioning as a media company is hurting the Yahoo cause. It’s time to reinforce Yahoo’s value here (and stress other unique elements of it search value proposition, like Yahoo Answers). Just don’t mention “the algorithm” ;)
On the search experience front, there is just too little differentiation of the Yahoo and Google search experience. Some people think that maybe an OK play if you just want to settle for trying to maintain your share as search player 3 through 6, and you believe users WANT a more consistent keyword focused search experience… That is the perceived AOL bet (outside of video). For the number two player, however, that is a scary place to be. Yahoo needs to take some risk here (not blind “bet the franchise” risk, but some form of champion challenger testing of a more transformative search experience, ranging anywhere from an editorial focus like Mahalo to a natural language experience like Powerset). Search today is flawed – anyone’s own usability tests reinforces that understanding. It is still fertile ground for a company of the scale of Yahoo. There is innovation happening by Yahoo in the space – the Yahoo Answers experience has been a big win – but even there I am starting to see lots more really low quality “answers” manifest themself. Don’t rest on your laurels. Apply more automated editorial control here, or the great long-tail knowledge base will get compromised pretty quickly. There is a role for some form of post-answer posting editorial control – figure a way to do it at scale by empowering high-scoring community members additional editorial rights by category, or use better algorithms to deal with things like how to weight single-answer submissions better – lots of them are of pretty low utility.
Yahoo has a great and unique asset in its namespace – the size of its explicitly identified users (garnered by circling so much of the web email business for years). Google isn’t there yet, but their thrusts in email, IM, payment schemes, etc., all serve to recognize the strategic importance for Google to be a primary explicit basis for identity on the web. The challenge for Yahoo is figuring out a more aggressive strategy to leverage that namespace beyond Yahoo owned-and-operated experiences. I see them WAY under-indexed here. I do like the idea manifested in the current mail beta to blur the lines between IM and mail for the broader Yahoo community, effectively making everyone a member of the Yahoo IM community (even though this is not really a namespace expansion strategy, but one of increased leverage within the Yahoo experience), but I hated to see the buddy list concept re-manifest itself. By default, the online status of everyone I communicate with via IM and mail should be visible to me, if I am a newcomer to instant messaging). Let the experienced users tweak/refine things. Also, let me see new communications events anywhere I am in Yahoo web properties, not just the home page.
Social networks are another way to expand the Yahoo namespace, and much has been written over the past several months on the need for Yahoo to buy their way in via MySpace or Facebook. I do think that at a 30x multiple for MySpace, it makes a great addition (not the 50x multiple being bandied about), and if I had a choice, MySpace is much more of a Yahoo-scale thought than Facebook. That said, the recent Rivals acquisition is a really nice US-focused acquisition at a very reasoned valuation. It is not of enough scale to move a dial, but is a great step while they ponder “mega” transactions. The challenge in all these social networking plays is coming up with a plan to get more value from the relationships beyond the low CPM ad revenue they currently obtain. Yahoo does have enough other assets to make a recirculation strategy to higher CPM locations/properties a reality. None of these social network acquisitions can be justified using any traditional metric, but if you don’t dive in, they’ll either trade away to a rival with a hyper-valued currency, or they’ll do an ad deal to the highest bidder (in both cases, that has historically meant Google, but now I would add Microsoft to that mix – they are writing some pretty huge checks of late). We’ll certainly see more M&A by Yahoo here, even if the top two properties trade away from them.
On the mobile front , Yahoo has done some aggressive work with Yahoo Go, and 17 months after the original announcement by Terry S. at CES 2006, it is a valiant example at an integrated experience for feature phone users. I use the bits – there is goodness in them – but I find myself using dedicated email and mapping apps from Google more. I am not sure what drove me there. The email experience within Yahoo Go is good. One major differentiator might be the aggregation of inboxes I can get from the Google mail experience for free. Yahoo could and should do the same (heck, that was Oddpost’s lead value proposition at one point). On mapping and local search, I don’t think the Yahoo bits are on par with Google’s – that’s an important sub-element of fixing the search value proposition. Also, there is not a lot of thought leadership yet on testing of mobile advertising within the experience, beyond non-actionable micro-banner ads and the usual sponsored links in the search experience. I would be fascinated to see the usage stats for Yahoo Go, and what’s been learned to date. I do think the over-the-top distribution play was the right way to go – I wonder if that change came as a result of assessing the effectiveness of their prior Cingular cross promotion deal… As I mentioned in an earlier post, mobile may be the right thrust in the big emerging markets for the major players, and Yahoo certainly has the assets to make a much more compelling mobile experience for these markets a reality. Update: have downloaded the just released Yahoo Go 2.0 – I like some of the cosmetic improvements, and mapping seems improved. Performance a bit slow, but I like what I see in the first 20 minutes of hands on use.
Net net, I am a fan of Yahoo, and the quick exit to a private equity player envisioned by some is a misplaced thought, in my opinion. I don’t think you reengage a founder to be a steady pair of hands to navigate a transaction. I think it is much more of a statement of a need to get back to the roots of the company, and be an aggressor once again. It will be interesting to see what the next few months hold for them.
Search and the problem of Google muscle memory May 25, 2007Posted by John in google, john mckinley, Mahalo, Microsoft, search, Uncategorized, yahoo.
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I just looked at last month’s U.S. search share statistics, and it was interesting to see overall search query volume look flat year-over-year. I don’t think one data point is enough to shoot off signal flares and declare an emergency (especially given that March’s year-over-year growth was 14%), but that statistic, coupled with flat average time spent on line, is creating an environment where all boats will no longer rise with the tide.
The first macro event that concerned me about life for the non-Google community was Yahoo’s first quarter performance. While they underplayed the positive impact of Panama, it DID have an impact that, without its contribution, paints Yahoo as a player with little or no domestic growth – a pretty scary thing for a company still trading at a sporty growth multiple.
The second event was the Doubleclick acquisition. Here was a company who barely got $1B when they shopped themselves two years early getting $3.1B from Google. The disturbing thing here was not the premium Google was willing to pay, but the fact that Google, often criticized for far-afield attention to things like radio advertising, has moved their attention firmly back to their original major, online advertising, and made a stepwise change in their display advertising capabilities (why it took so long for a move like this was a mystery to me, but, given their dominant market position, the ship had certainly not sailed on the opportunity).
Now we see the latest search stats, summarized as Google gains 1.4% of the search market month-over-month, at the expense of Yahoo and MSN. That’s pretty huge shift for a given month for a mature market like the US, and you worry if the market will reach a tipping point in the next year, accelerating Google’s share gains even faster. I see selected big markets in Europe, where Google’s share is 80+%, and think that life gets tougher, not easier for the other majors in generalized search over the next year.
Does this mean the game is over? Not by any means, but for me, the opportunities exist via:
- Vertical search
- Highly aggressive generalized search plays
In the vertical search markets, we already have good poster children to validate that the entire fractionalizing of the web is relevant to search as well (WebMD and CNET, who I view as a tech product search play, are two examples). I think there are addressable market size constraints in any vertical search play, but that there are a number of markets of size that possess enough of a specialized nature to allow for niche entrants to survive and thrive. Nothing new here as a concept, but I do think that plays like video search are not vertical search plays – I view them as horizontal plays – and they are going to have a hard time thriving as stand-alone offerings in the face of moves/acquisitions/product extensions of generalized search players (Google’s new composite search page being just one thing that changes that landscape).
Does that mean we will see no new entrants in the generalized algorithmic search markets? No, but it means you need a radically different positioning and algorithmic approach to have any shot at scale. It’s not a new UI wrapper on old concepts. It’s bold bets, backed by hard science. Powerset is probably the best example of what I mean…