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ning_logoI am posting an update to a social media valuation post from last week. There is a growing chorus questioning the high valuations and viability of business models of the social media start-ups.

More fuel was thrown on the fire this week with the announcement of the results of the latest round of fundraising at Ning.

Ning, a social networking start-up, raised $15 million at a $750 million valuation this week. The application allows anyone to launch their own personalized social networks (i.e. an entire network of Brüno aficionados, fans of the HBO show the Wire, or the Silvio Berlusconi support group).

Ning has a lot going for it: vip pedigree of founders – Andreessen and Gina Bianchini, approximately 200,000 active networks created to date, 30 million registered users, and it is revenue positive  from the placement of Google ads.

To beef up the revenue model, the company will be rolling out is own proprietary advertising scheme, $25 premium service network subscriptions as well as virtual gifts. This series- E round led by Light Speed Venture Partners showed significant valuation growth over last year’s $500 million D-round.

The latest successful fundraising round however does not change the fact that revenue will still trail far behind the valuation.  David Dines pointed out that even if 10% of the 200,000 active Ning networks subscribers pay up for the $25 “premium” monthly service upgrade, this would generate $6 M of revenue per year.

Using the advertising multiple for  big social network sites suggested by Raj Kapoor (Managing Director at Silicon Valley’s Mayfield Fund)  of $.20 month of on site advertising revenue per user would add from $6 million active users an additional $14M per year for an approximate total revenue of $20 M per year.

Even for optimists, this kind of revenue numbers stand out sharply in contrast to the $750M valuation.

social-mediaThe steady drizzle of criticism  questioning the viability of Web 2.0  social networking site’s “free” business model turned into a monsoon.  A flood of stories swept over blogs and news reports querying why building huge audiences with cool new entertainment experiences has not  translated into profits. Some of the additional attention was no doubt related to the reportedly “somber” and “bearish” tone the journalists witnessed at the Allen & Co. hosted conference of media industry heads in  Sun Valley.
New York Times M&A reporter did a retrospective on 9 July on the three year old Google – YouTube deal initially valued at $1.65 billion. The story cited a Credit Suisse estimate that YouTube will lose almost $0.5 billion this year, and  Bernstein Research report which “questioned whether YouTube’s advertising revenue would ever be enough to cover Google’s costs related to bandwidth and data storage.” Google simply has not been able to convert the audience numbers into substantial revenues, and it is unclear how it will with audience allergy to more advertising.

Ryan Tate  in his Valleywag story on July 9th describes Max Levchin’s Slide’s business model as a failure, and reported that opinion leaders like Barry Diller  and  New York Times‘ Andrew Ross Sorkin were “disparaging” Twitter’s business model at the conference.

Don Dodge’s latest blog cites his friend’s situation – the Facebook App developer with a killer app that is generating 300 million page views per month. This kind of mammoth traffic however translates into only a total of $6K to $15K of advertising revenue per month, depending on the current range of ad rates.  Dodge explains that Web 2.0 sites don’t have specific search terms like Google AdWords to key off, so instead of Cost per Click (CPC) they have to charge Cost per Thousand (CPM) rates.

Assuming even a very generous $0.40 CPM rate, Dodge  calculates that your Facebook/MySpace app will not earn earn $1 million from advertising, until the app gets to the  outrageous number of 2.5 Billion page views per month. [for perspective - Yahoo has a total of 1.5 billion searches per month and Google has a total of 6.1 billion searches]

Social Networking’s ‘Naked’ Truth, a story published on 10 July by Silicon Valley Bureau Chief Jim Goldman  questions whether we are “staring another dot com boom/bust right in the face.”  Goldman’s post  blows the whistle on social media’s inability to generate profits in the foreseeable future.

Facebook is addictive, even magical to millions. Same goes with MySpace, and Twitter, and LinkedIn, and Digg, Badoo, Classmates, Bebo, Flixster, Friendster, Orkut, and hundreds of others. They are powerful, fun, convenient. They offer value. And they build connection. Look no further than the Michael Jackson news tsunami to see how social networking affects our lives and drives information.

But with hundreds, even thousands of these sites out there already, with many attracting millions in venture capital, I simply ask, Where’s the return on the investment? What’s the business model to MAKE money and not merely to attract investment?

Partly this web 2.0 bashing is just the old media’s response to quickly losing entertainment market share  to the “free” competition on the Internet, but there is something to these warnings of overvaluation. If the current advertising revenue rates remain the same, the Web 2.0 landscape will be forced to change, consolidate and find brand new new revenue models.

Looking at Zynga’s revenues and the profits of virtual gift business around the world, we can see that  monetization can be done quite successfully with some formats. Warrent Buffet recently suggested that he would be willing to pay $5 per month for the pleasure of watching YouTube, and I know I was happy to pay $13,95 for HBO’s great programming  in the US (although it took airing of such phenomenal content as the Soprano’s and Rome to get me to subscribe).

EU electionWhile across Europe the center-right , far-right and green parties are celebrating their election victories with the center-left suffering a historic defeat. In Estonia the big winners are the center- left party and an independent candidate, with the greens and center right showing weak results.

This may seem quite odd to most Europeans and may be written off as further proof to some of failed integration of Eastern Europe, but actually the result makes perfect sense when put into perspective through the local political context. Like elsewhere in Europe the voters voted with their pocket books – the state of the economy was the central issue.

Left wing won based on voter dissatisfaction with the economy

Center-left party (Keskerakond) won the election with 103 525 votes. Their campaign capitalized on the dissatisfaction with the ruling coalition’s inability to deal with the economic crisis which has resulted with drastic pre-election buget cuts of popular programs.

Protest vote went to Independents

The same protest vote that showed the extent of voter anger and frustration with the continuing economic crisis and high unemployment fueling gains by far right in Italy, Netherlands,  Austria, Hungary, Denmark, Slovakia and Finland was the force also behind the independent candidate  Indrek Tarand’s 102 509 votes. Estonia has a fairly small foreign-labor population (no Turkish, Polish or Algerian laborers here to blame for high-unemployment) so the anti-foreigner anti-immigrant theme was not picked up by any parties for their election propaganda.

Ruling right wing parties lost due to the economic crisis

The center-right (Reform and IRL) parties’ coalition has been in power since before the beginning of the economic crisis. The right wing parties that were elected into office under the promise to get “Estonia into the top 5 wealthiest nations in Europe in 5 years” were punished by the voters facing the stark reality of salary, pension and benefit cuts. Therefore, it was inevitable that the voters blame the center-right for its inability to deal with the economic crisis, and the draconian budget cuts that have now been implemented.  This voter backlash explains why the right wing parties did not triumph in Estonian elections, but were glad to just hang on to their seats. In the final tally the Reform party received 60 899 votes and IRL 48 489 votes.

Greens have failed to win economic credibility with the voters

The Green party is still seen by the average Estonian voter as a one-issue novelty group than a legitimate political force that can realistically propose and drive through a full platform of economic and social reforms for the entire nation. Many people also associate the Greens with their leader Marek Strandberg who is seen as a good public speaker as well as a vocal and intelligent critic, but unable to find the necessary political compromises to actually execute strategies.

In the end the Greens were unable to convince the voters that their ideas would bring back jobs and rapidly improve the Estonian economy, rather than making growth based on clean energy, agriculture and manufacturing slower and more expensive. As a result their votes totaled a mere 10 845.

Low voter turnout

Just like elsewhere in Europe voter turnout continued to fall as ever less people use their democratic rights to elect representatives. Only 43% of Estonia’s eligible voters voted (more than in 2004, but still rather low), on par with the low European turnout of 43%.  Although it should be noted that Estonia pioneered Internet voting for these elections, and the electorate seems to have enthusiastically adopted the e-vote with over 14% of the voters casting their vote electronically.

New York lawyers under attackI have noticed over the past few months at various business conferences and networking events a curiously steady rise in attendance by legal professionals. Where before 2007  many top professionals were too booked-up to spend time trawling for new clients, now client relations, conference appearances and networking are back in vouge.

Alan Heuer has an insightful story in the New York Times describing the downsizing taking place at New York top firms. Associates and partners are being let go to adjust to the drop in business.

The recession is crashing the business model for NY full service commercial law firms, which in good times used to compete amongst each other for the right to pay first year incoming baby-lawyers  $160,000 per year plus bonuses. With the Lehman Brothers collapse, CDO catastrophy, and surrounding economic crisis the capital markets transactional work dried up. The transactional deal-flow ran down to a trickle, and there had already been a long drought of  IPO work.

Lawfirms work mostly on a cash on hand basis, and do not carry large reserves. As such, very quickly there is not enough money to keep the large numbers of associates waiting for new work.  The firms have been forced into  firing both partners and associates and telling new recruits their start date will be delayed by a year. Heuer Reports:

In the first quarter of 2009, demand for legal services in New York decreased by nearly 10 percent over 2008, according to the Hildebrandt International Peer Monitor Index. At least 10,000 employees at major firms across the country have lost their jobs so far this year, according to the macabre but wildly popular “Layoff Tracker” run by another blog,

Steve Verrier a Partner at White & Case (2,000 lawyers in 34 offices in 23 countries) described his choices upon assuming the management of the firm as follows:

Do nothing, which risked the firm’s survival; couch layoffs as decisions based on poor performance; or own up to the crisis and bid large numbers of lawyers a harsh but needed goodbye.

They decided for the layoffs. A partner at White&Case explained the atmosphere has changed significantly at the large firms: “The problem is we’re supposed to all be in this together. But at some point, you stop and think: ‘Well, maybe we’re not.’ ”

Crisis forces innovation in the legal field.

Clients are beginning to look ever more closely at the legal bills they receive. Large businesses have started to employ legal auditing service companies. Essentially they audit the clients’  legal bills, identifying incorrect entries as well as inefficiencies and possible over-billing. The company gets paid a percentage of the “savings” achieved. As one can imagine, the performance fee structure ensures sufficient motivation to find mistakes and cost-cutting opportunities.  For example, Stuart Maue saved Kmart $15 million in legal and professional fees in the bankruptcy proceedings.

Denver based Law firm Watson& Associates just announced that it is now offering a  flat-price full-service packages for businesses. The reasoning is as follows:

The firm hopes its innovative approach to helping clients reduce the staggering fees typically associated with legal advice will strengthen the firm’s position as a business partner, rather than a line item in the budget.

We are hoping that law firms will also recognize their role in bringing the economy back, by offering legal services to startup companies which hope to rapidly grow their business on a discount basis, or in exchange for some equity (where this structure is allowed by the bar) or structured on growth basis. By sharing in the risk with the entrepreneurs, the law firms are creating a network of grateful and loyal entrepreneurial customers and their referrals, but also are investing into ensuring the survival of their own future client base.

This is an opportunity for lawyers to help out seed and early-stage companies by giving them some basic services and business contract forms cheap or free, instead of charging heavy fees later by telling the company about the damage done to the valuation, money lost to overtaxation, or intellectual property lost because they could not afford lawyers and failed to use proper legal forms.

wall streetThe startlingly honest and straightforward admission by President Obama came under questioning by Steve Scully during the C-SPAN interview. President Obama cites the failure to fix the US health care system as the long term reason for this fiscal crisis, and in the short term the extreme demand for money to rescue the financial sector, the auto industry and address the “huge recession.”

The current US national debt of $11 trillion comes out to$36,000 pear each living US citizen, and has continued to increase on an average at the rate of $3.8 billion per day since 2007. Of course US is not alone in this situation as IMF has calculated that average government debt for the richest G20 countries will exceed 100% of their GDP in 2014, compared to 40% in 1980 and 70% in 2000.

The growing debt burden has been mainly financed by printing money (technical term – quantitative easing) as we have reported in our previous posts here and here. However, the concern for rising debt has now pushed UK and US creditworthiness to the brink and put their AAA national debt credit rating very much at risk. However, tough budget cuts must still wait a while, as current stimulus spending is necessary to bring life back to the US economy. This creates for a very tough challenge for any world leader.

Full transcript of President Obama’s interview is available from C-Span here, but the relevant portion of the interview went as follows:

SCULLY: You know the numbers, $1.7 trillion debt, a nationaldeficit of $11 trillion. At what point do we run out of money?
OBAMA: Well, we are out of money now. We are operating in deep deficits, not caused by any decisions we’ve made on health care so far. This is a consequence of the crisis that we’ve seen and in fact our failure to make some good decisions on health care over the last several decades.
So we’ve got a short-term problem, which is we had to spend a lot of money to salvage our financial system, we had to deal with the auto companies, a huge recession which drains tax revenue at the same time it’s putting more pressure on governments to provide unemployment insurance or make sure that food stamps are available for people who have been laid off.
So we have a short-term problem and we also have a long-term problem. The short-term problem is dwarfed by the long-term problem. And the long-term problem is Medicaid and Medicare. If we don’t reduce long-term health care inflation substantially, we can’t get control of the deficit.

layoffsI read from Uri’s blog (written in Estonian language) today about his banker buddy from Southern Europe commenting on people getting laid off all over Europe due to the economic crisis.

The banker suggested that in Europe, where laying off people generally is very costly and involves potential law suits, several (big)companies are using crisis as a perfect scapegoat for letting people go. He also added that in most cases, these people would have been fired long time ago, but these companies just did not have a plausible and safe enough reason to get rid of them until the meltdown. The key for the downsizer is to blame it on external reasons, globally applicable if possible!

“World markets are all down. We can’t possibly afford to keep you around anymore.”

“Our revenues are down. It is sad, but we are forced to let you go.”

“Our export clients aren’t buying anymore. Your department needs to be shut down despite your great personal performance.”

“Everybody is talking about cutting costs and staff. So, letting you go now is only fair, right?”

Rather interesting observation I would say. It certainly makes (brutal)sense when considering how hard it is to fire workers in normal conditions due to inflexible socialist regulations that make it prohibitively expensive to adjust staff  according to changing market conditions.

Printing money is hard work

Printing money is hard work

When writing my March6 blog entry I wondered when we would the United States be added to the list of countries resorting to printing money to boost the economy.  That day has already come.

In the words of Goldman Sachs analyst Jan Hatzius, the Fed is going to the “kitchen sink” strategy of throwing everything it had to jolt the economy out of its downward spiral.

The Federal reserve is dropping a $1.15 trillion money bomb into the bond markets to boost lending. Yes this money will literally be eased out of the printing machine in major quantities (official term being “Quantitative Easing”). Ok maybe I am not using  exactly the proper description they teach in the MBA program.

Wickipedia defines QE as follows:

The term quantitative easing refers to the creation  of a pre-determined quantity of new money ‘out of thin air’ through open market operations by a central bank as the start of a process to increase the money supply. It can, more simply, be understood as an indirect method of printing money.

Traditional papers are closing their doors, drastically reducing staff, and shifting all their operations online. This week the Seattle Post-Intelligencer, Seattle’s oldest business publishing papers since 1859, closed its doors after losing $14 million in the


Employee commentary on the wall of Seattle Post

last financial year. This follows on the heels of Rocky Mountain News, Denver paper founded in 1863, publishing its final edition after losing $16 million last year. This April the 100 year old The Christian Science Monitor closed the print operation of the paper and moved all of its content online. The Miami Herald, San Francisco Chronicle and Minneapolis Star-Tribune are on the verge of bankruptcy and are up for sale. The New York Daily News is losing 7% of its readership per year and took a $30 million loss in 2008. Four owners of 33 U.S. daily newspapers have sought Chapter 11 bankruptcy protection in the past 2 1/2 months. Similar trends are seen in the magazine industry with a significant reduction in paid advertising pages.

The old media revenue streams (read – advertising) have dried up significantly over the past two years, and it is simply not possible anymore to keep a staff of 150 professionals and carry the cost of physically printing and distributing newspapers and magazines. Online versions of the publications require a staff of less than 20 employees and distribution is fully scalable with very low costs. Moreover, the advertising views are quantifiable and traceable providing useful metrics and targeting tools impossible to achieve with traditional media.

Zimbabwean taking home his daily pay

Zimbabwean taking home his daily pay

As US (0.25%), UK (0.5%), Japan (0.1%), Canada (0.5%) and other key Central banks have reduced their short term interest rates to near zero. With that economic stimulus tool’s effectiveness exhausted, countries around the world are now having to turn to radical last ditch solutions like – printing money.

Yes, exactly the same thing we all learned in high school economics class is very bad idea. Printing money can lead to hyperinflation at some point taking the form of Zimbabwe’s daily additions of zeros to the prices.

Bank of England has now announced that it will be applying “quantitative easing” (QE) to add to the supply of money in the UK banking sector. In plain English this means that it will print  £150bn (10% of the annual output of the economy) extra money. The extra cash will be used to purchase government bonds and commercial assets to quickly inject money into the economy.

International Monetary Fund IMF may have to use its Special Drawing Rights (SDR) to create money. IMF is simply running out of money, as it has already committed 25% of its Reserve funds to bail out Iceland, Ukraine, Pakistan, Belarus, Serbia and Hungary. IMF needs another $600 billion to address the growing crisis as the Baltics, Romania and Turkey are all teetering on the verge of economic catastrophe.

Economists claim that it is possible to do QE successfully pointing to 2000 Japanese experiment. There is a debate whether QE actually worked. Regardless, QE is a sign that central governments are beginning to use their emergency parashutes and other than the umbrella there is not much left after QE to guarantee a soft landing.


Wolves are circling the prey

I have been asked several times in the past six months – if and when will the mega-rich start buying up the best of the distressed assets. I must admit having heard rumors about local business tycoons and groups of wealthy Swedish business sharks hoarding piles of cash, ready to pick the low hanging fruits. But my honest answer is – I am not sure if Estonia has that much of valuable assets to buy up at all, distressed or not. In Estonia and its neighboring countries there is little to no transparency to determine the actual purchasing power and liquidity of the rumored buyers. 

In US however, the wolves are ready for a moose hunt and their preys know it. Kara Swisher pointed out that high-tech giants are sitting on a huge amount of shiny acquisition dollars. Take a look at these enormous reserves:

  • Microsoft (MSFT): $20.7 billion
  • Cisco (CSCO): $29.5 billion
  • Apple (AAPL): $25.6 billion
  • Intel (INTC): $11.8 billion
  • Oracle (ORCL): $10.6 billion
  • Hewlett-Packard (HPQ): $10.2 billion
  • Google (GOOG): $15.9 billion
  • Yahoo (YHOO): $3.5 billion

To continue the fauna analogy, this wolfpack (clearly on steroids) is patiently following the moose herd (i.e. start-ups) to go after the ones that show sings of weakness and can’t keep up with the pace of others (i.e. run out of money). It is clear that the wolves could already make their move right away, but they are holding it back to maximize their gains. They bet on the dire economic landscape that will become even harder to pass for the moose, allowing the hunters to optimize their attack when the prey is completely exhausted.

Thanks to the internet, we have front row seats for witnessing the brutal outcome of this hunting season. Stay alert and let the chips fall as they may because there is little hope for the moose.