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July 28, 2005
About InfoSpace
This Stock Price Does Not Reflect Their Opportunity
INSP just plunged 30% to a new 52-week low of 24 and change on lower than expected guidance for the year. Sounds pretty bad, but don’t be too quick to judge. I would point out that before Jim Voelker there was Naveen Jain, who had taken the stock down to a near delisting. Things could be a lot worse, and it’s not like the business is in the toilet – it is growing respectably. I have always thought INSP is just one of those ultra-volatile stocks that the street hates mostly because of history. After Naveen made his “we’re going to have a trillion-dollar market cap” statement then proceeded to tank the company but still emerge a billionaire, I think the legions of daytraders who lost their asses still feel compelled to punish them for anything less than stellar results.
I will point out that in the mobile space, JMDT is trading at a P/E of 101 and EPS is .29 and in the search space, GOOG is trading at a P/E of 87 and has roughly the same EPS as INSP at 3 and change. Compare these comps to INSP’s 6.4 P/E. INSP is trading at 2.79x, whereas JMDT is trading at 16.12! This with a profit margin around 8.4 vs. INSP’s 48!
It is absolutely ridiculous to me that this company should have less than a 3x multiple. With more than $300 million in the bank still, it just doesn’t make sense even given the guidance for the year. Nevertheless, the guidance is softer than what analysts would have liked to have seen.
I would like to explain why I think this is happening and what should have and still can be done about it. This is bad enough for InfoSpace shareholders and employees with stock options who just saw their value evaporate, but I would like to explain why I think it is really really bad for our industry and why it has much deeper implications.
The Importance of Ringtone Revenue
I was previously president of Moviso, a successful ringtone company that was sold to InfoSpace in late 2003. The success of the subsequent hockey-stick revenue growth from Moviso (now InfoSpace Mobile) was largely responsible for propelling INSP upward. But the revenue model we built for Moviso was a series of overlapping S-curves with decreasing margins over time. Imagine three growth curves for ringtones: monophonics, polyphonics and what we tried to get the industry to call “TruTones” or songtones or whatever you want to call them.
Monophonics cost a dollar to consumers and we paid a licensing fee of about $.10. That’s a pretty healthy gross margin. (We also paid a distribution and billing fee to the carriers at various rates, but that is probably confidential information to InfoSpace, though I doubt that it has stayed the same.) But monophonic handsets were quickly being replaced by polyphonic handsets, so the expected lifespan of that revenue curve was predictably short, but overlapping it and exceeding it over time was the polyphonic revenue curve. This was the sweet spot of the market because we still had to pay only about 10% to publishers for a mechanical license but polyphonic ringtone pricing was generally higher, so now we could sell a ringtone for $1.99 and still only pay $.20 or so, dramatically increasing margins. To make things even better, this was happening at a time when ringtone sales were increasing at an increasing rate. So that revenue curve, while it still had a sunset, was much longer. We knew the next big thing would be TruTones, so we added that to the model, intersecting polyphonics the same way polyphonics intersected monophonics. Here’s the problem with TruTones: You have to pay the publishers the same rate previously mentioned, but then you also have to pay the record labels, and they didn’t just want parity with publishing, they wanted HALF of gross. So the margins go through the floor, but you still make a profit – you just have to sell them for more ($2.99, which starts to limit your market) and dramatically increase volume.
To InfoSpace’s great benefit, the ringtone business became a faucet of money that was impossible to turn off. Now maybe it is waning a bit. Why? Competition in a commodity market. As the owners of the intellectual property rights upon which ringtones are based become more sophisticated, the companies that make money as middlemen become marginalized and a more direct relationship between content and distribution renders the middle-of-the-value-chain technology transparent or even irrelevant.
If you look at InfoSpace Mobile’s fundamentals, the basic economics of their core mobile offering, ringtones, had a lot to do with last year’s nice ride but also with getting them to where they are now. Frankly, they should have seen it coming. Which brings us to...
The Importance of Vision
All product-driven businesses have a similar series of curves in their projections – no one product revenue line can keep going up forever. So the most important thing you can do is to continue to diversify and invest in new products that will continue to capture market share. At the time of the Moviso acquisition, the mobile division of InfoSpace was run by someone with an engineering background, Kendra Vandermeulen.
This was a critical point in history for InfoSpace.
They had a low-margin but highly defensible service business built around infrastructure that they sold to network operators. With the acquisition of Moviso, they had the opportunity to turn their business into a high-margin but hit-driven product business built around entertainment.
They had to choose one option and do it very well. Instead, they chose to sort of do both as well as possible, and that was their biggest mistake, in my opinion.
About a year after the acquisition of Moviso, Kendra separated from InfoSpace (around October of 2004) and no successor was publicly announced. Taking the position internally was one of the nicest and most professional guys I have ever met in business – Steve Elfman. Steve is apparently a fair and seasoned manager, but my experience with him was so brief that I cannot comment on his vision. What I can say objectively is that I have never seen any press release from an InfoSpace senior executive apparently in charge of the mobile division stating any kind of compelling vision. Since Kendra’s departure, InfoSpace has been looking for a more media-focused leader for the mobile division from the entertainment space. Finding the right person can take a long time, but it is now mid-2005. That’s a very long time.
I know there is management in the mobile division, and it is strong. But what is the vision? My mental image of the current financials is that they got to the end of the last overlapping revenue S-curve provided by Moviso and didn’t add several more upward-moving curves and that is what is affecting guidance now. If someone would depict the vision for InfoSpace Mobile translated into a series of overlapping upward-trending revenue curves, I would have great confidence in the financial future of INSP.
You will know there is a turnaround at InfoSpace when Jim makes the following bold statement: “Nobody understands local directory search like InfoSpace, and nobody can bring it to the mobile consumer like InfoSpace. Google? Yahoo? Morons compared to us. With our extensive assets in this area combined with our deep reach into the worldwide mobile space, we are well positioned to be the market leader in this burgeoning multi-billion market. As the lines are blurred between the web and mobile worlds, we will leapfrog ahead of the competition by tightly integrating our media assets with our local search and directory business to create a powerhouse media experience that gives consumers value that nobody else can give them. Let me be crystal clear about our vision: Mobile Search and Directory is the future, and it belongs to us.”
Now that would invigorate analysts, shareholders, employees, reporters and consumers. This statement could have easily been made in late 2003, and they could have been off and running over a year ago with a truly compelling consumer offering that really would have kicked some serious ass. Only today is AOL announcing something along the same lines.
Whatever. I don’t think it is too late, but I really would like to see some clear trailblazing vision rather than a fast-following mentality that has them buying game companies occasionally and watching their market share erode to competitors along with their margins on products that have not really been refreshed in years. There are some smart people there – I wish them all luck and I am sure that Jim will pull it off.
The Importance of Role Models
The real story here hasn’t been written yet. Look at what is happening in the mobile space today. A lot of value is about to be created on the backs of investors confident that the mobile space is a hot growth area. Mforma is gearing up for an IPO, For-Side is on an acquisition spree for the same reason, WiderThan has strong fundamentals and now has a toe-hold in the North American market and they have plans for an IPO. M&A is heating up, too. You can’t swing a dead cat in this industry without hitting a VC planning a roll-up of small companies with run rates in the $1mm - $2mm range.
There are precious few currently publicly-traded players in the mobile space in North America, and everyone is watching them. I think JMDT is going to beat the street on their earnings call on August 11. Is that stock too hot? Is the multiple too high? Dunno. But I do know that INSP isn’t hot enough, given it’s performance, and the multiple is too low given their leadership position. When institutional investors look at the newcomers on their roadshows, they will be looking at two primary comps: INSP and JMDT.
What conclusion would you draw? Is it as simple as “games look hot, ringtones look dead, and infrastructure kills your margins”? Because all of the would-be newcomers are basically roll-ups, they look more like INSP, which has their finger in a little of everything and less like JMDT which is basically a pure play. The implication is that analysts, with little else to go on, will draw conclusions based on the comps they see now. And if they draw the same conclusions they are drawing now about the future of INSP, what conclusions will they draw about more entrants to the space? Will it look dilutive to the overall opportunity? The worst thing that can happen is that analysts look at the performance of the precious few companies that are currently publicly traded and they yawn at the prospect of new entrants into the space. It could mean the difference of billions of dollars of shareholder value if the mobile opportunity is not correctly perceived.
Keep this in mind: We are barely at 1.0 of the opportunity in the mobile space. The biggest native brand our industry has in consumer applications is JAMDAT Bowling. Think about that. (Yes, it’s very fun - you should buy it.) But we haven’t seen our industry’s EBAY, YAHOO!, GOOGLE or AMAZON. Those brands were built in their space for their space. The mobile equivalents are right now on white boards and in pitch decks. To not understand the massive upside that companies like InfoSpace have at this stage in the game is myopic at best. To not understand that the future of mobility is so bright that there is room for a thousand more InfoSpaces could only be the perspective of someone who has not heard of the internet.
Posted by Shawn Conahan at July 28, 2005 07:08 AM
Comments
Great insight and analysis of INSP's quarter and of the challenges and opportunities facing the company. I particularly agree with your view that a "vision refresh" is needed. But beyond talk, I still wonder ultimately how successfully a mobile search product from INSP would be. That market appears to be as competitive, if not more competitive, than ringtones -- with GOOG, YHOO, MSN and AOL all making significant investments in product, and all of these large, multi-product players attempting to leverage their relationships with carriers. I still need to be convinced of a truly competitive advantage there. In terms of vision, I've been surprised at the lack of vision from mgmt in the area of mobile gaming, where investor sentiment is quite high (just look at JMDT's valuation, as you pointed out). The three mobile gaming companies INSP purchased may be small today, but they are growing quickly (in fact, the only portion of INSP's business growing now) and appear to have strong technology/development foundations.
Posted by: Comment Guy at July 28, 2005 08:26 AM
What sets INSP apart in search is that half of their business is local, mobile-relevant 411-style search. Nobody else you mentioned have such assets. (Citysearch comes to mind, though.) Google on my mobile phone is frankly not that interesting to me. I don't want to be able to search the internet, I want to search the neighborhood. INSP has a huge advantage there. Furthermore, the big 4 have legacy web-based businesses that require attention, whereas INSP is already in the mobile space. Most outsiders don't really understand the value of a relationship with a network operator. INSP should have been leveraging these relationships more than they have. Lastly, I would have to agree on your comment about games - it is low-hanging fruit, but the clear vision has not materialized. This may be partly because JMDT "owns" the mobile gaming mindspace. I think mostly it is because the INSP management team was brought in to turn the company around, and they have done so with great aplomb. It is possible that a turnaround team is not also the vision team, but this is more about ARTICULATING the vision than having it, which seems fairly obvious to me. If the vision doesn't exist at the highest levels, maybe they should think about hiring someone who has it at the highest level in the company. That, I think, has been in the works as I mentioned. It will take a heavy hitter to make it work, and when it does, it will work in a big way.
Posted by: Shawn at July 28, 2005 09:34 PM
Good comments, Shawn. It's noble of you to sketch out a vision that could rescue Infospace from their plight. But then again, it's a little pathetic that nobody on the management team at the company has the ability to articulate such a view. Vision isn't just for Wall Street: vision is what inspires the staff to get out of bed in the morning and change the world. Without a compelling product vision that inspires and motivates personnel, most of the crew is just punching the clock. That is, if they bother to show up at all (each day it appears that fewer Infospace employees bother). That might be okay in a mature industry where market share is largely determined. But in an utterly volatile field like mobile entertainment and mobile data, it's not good enough. Such a firm will shrink. For the disruptive startups in mobile will extract their market share out of Infospace's hide.
The leader's job is to lead. Employees demand direction, and they have a right to question the leader's judgement if the direction is not crystal clear. Today, there is no compelling product vision at the top of Infospace. There appears to be no investment in original content made for the medium. There is no standout hit product in the pipeline, just a series of singles and doubles. How much longer will "Pub Pool" be milked on Vodafone until it fades? The organization is a mess. And there appears to be no ability to structure or maintain a longterm partnership with a major media company whose brands stir up consumer passion and loyalty.
Without these things, Infospace looks like tiresome old news compared to nimble startups whose revenue may be tiny but whose vision captures the imagination of investors and consumers... and imagination of the talented engineers and designers who create the products. No wonder Infospace is losing its most talented staff.
The widely cited attrition in the senior ranks of Infospace's mobile content group is not limited to your fellow Moviso alumni. Their peers, and the guys they hired, and the guys who work for them, are all seeking opportunities at new companies whose management can share a vision which reminds the employees why their hard work matters. How do I know they are seeking new jobs? Because their resumes are in my inbox.
Meanwhile, senior management at Infospace seems to take comfort in the ancient telecom mythology that says infrastructure is good because it's clean, solid, predictable and reliable, but content is bad because it's complex, messy, unpredictable and deals with yucky human emotions. This is a management team that laughs openly at the entertainment companies and the people who manage the creative process, deriding them as flaky and silly. They don't deserve to have talented creative professionals in their organization until they learn to celebrate and respect this precious skillset.
At the end of the day, consumers don't care about infrastructure, and they don't care about search with any deep loyalty. However, consumers do care deeply about the stories and characters who touch their lives and who inspire them. Entertainment speaks to consumers on an emotional level that is irresistable: it bypasses the intellectual filters. Consumers emulate their heroes and aspire to be like them: they crave more and more from the people they admire and they are willing to part with their hard earned cash to pay for the experience. Successful mobile entertainment comapnies, like all entertainment companies, must tap into this sensibility. What's required is more than mere vision: empathy and self awareness are necessary to tap into honest emotion, and these seem to be in woefully short supply in Seattle.
Infospace's weakness is rooted in their inability to make the transition from infrastructure provider or purveyor of commodity information to a packager/producer/publisher of compelling, thrilling, stimulating and emotionally interesting consumer content. The result is a company that bores consumers with commodity products, and which leaves its employees cheerless and disoriented, and which leaves investors yawning and reaching for the remote control. Next.
Posted by: Robert at July 28, 2005 11:19 PM
Robert -
I think your criticism is a little strong, particularly given the fact that revenue and profit are increasing fairly substantially. The objective of my post was to point out that InfoSpace has a huge opportunity and it is wallstreet that doesn't get it.
With a minor shift in focus, as I suggested, InfoSpace could dominate an important area of the mobile content space. I am not suggesting an overhaul. When you think about it logically, they have all the pieces in place already - they just have to articulate the vision and start beating the drum. If they do, they will run circles around their would-be competition. I say this because I worked with the engineers who are ultimately responsible for making it happen and they are some of the smartest people in the world. They can pull it off. It is the street that has to understand that they can and value the company accordingly.
Posted by: Shawn Conahan at July 29, 2005 09:24 AM
Shouldn't the Mobile division be already doing this for it's clients?
http://www.usatoday.com/money/advertising/adtrack/2005-07-31-track-cingular_x.htm?POE=click-refer
I'm not sure if they are or ever plan to.
Posted by: Who knows at August 1, 2005 01:10 PM
Wow. I like that blog. It is so different than the message board of Infospace on Yahoo. It is so great to read the opinion of someone (Shawn Conahan) who really knows something about Infospace.
I have two questions for Shawn. Where do you see Infospace in 5 years from now and at what price do you think it will be trading?
Posted by: Gaston at August 1, 2005 09:12 PM
Gaston - I am not a financial analyst so certainly could not peg the stock at a certain level, but I can say that the current stock price seems exceedingly low to me, just based on InfoSpace's fundamentals and strong management team. That said, it looks like an acquisition target to me. In 5 years, I don't expect INSP to exist.
Posted by: Shawn Conahan at August 3, 2005 06:13 AM