The media, technology, and telecommunications industries are in the middle of a tectonic collision, one that is creating vast new businesses and destroying entire industries.In the past few years, Google and Facebook have built humongous global companies, Internet pioneers like AOL and Yahoo have withered, and the newspaper industry has gotten gobsmacked.
So what’s next? And how should investors play it?
This week’s INTERVIEW OF THE WEEK is with David Siminoff, the chief investment office at Thompson Peak Capital, a long/short equity hedge-fund based in Silicon Valley.
Thompson Peak invests exclusively in technology, telecom, and media companies. And no one has a better view of the collision of these three industries than David Siminoff.
A Silicon Valley native, David was the media analyst at mutual-fund giant Capital Research for most of the 1990s. Earlier this decade, he was the CEO of a public Internet company called Spark Networks and a partner at venture capital firm Venrock. In the past few years, working with his wife Ellen Siminoff (who was employee No. 6 at Yahoo), David founded a digital education startup called Shmoop, which is off to a spectacular start.
David and his partners Michael Hourigan and Gustavo Miguel launched Thompson Peak earlier this year. The firm aims to use its partners’ industry experience, Silicon Valley relationships, and advanced trading techniques to provide ~15% annual returns with low volatility. The firm’s flagship fund launched in February and was up 10.9% through October.
In the following interview, David weighs in on the future of the TV industry, Netflix, Google, Yahoo, the cable stocks, and several of the amazing private companies that are taking hold in Silicon Valley.
DAVID SIMINOFF: Thompson Peak is a technology, media, and telecom-oriented hedge fund based in Silicon Valley. We take advantage of the collision of the haves and the have-nots with a keen eye for the fact that there are always two kids in a garage, with nothing to lose, throwing stones at mature company union-filled Goliaths.
BLODGET: Back in the 1990s, you were at mutual-fund firm Capital Research, and you were probably one of the best informed and best investors in the media sector. Are you relationships in Silicon Valley critical to what you're doing now? Do they inform your feel of the media world?
SIMINOFF: Yes I think the world has grown and merged on so many levels. If you don't live in the middle of Silicon Valley, and aren't an active investor in private companies, it's very hard to have a sense for what public companies are doing. There are an enormous number of people in New York City and Los Angeles who follow the traditional media business, and there are a lot of people who follow technology in Silicon Valley. But very few follow from both ends. And the world that we live in is a collision of old and new media. So, we think we are pretty well positioned here, to have a deep sense of what's going on from 30,000 feet and below.
BLODGET: So, given that--what's going on?
SIMINOFF: Margin destruction.
What I mean by that is--the world we lived in in 1985 was a pretty static world, with soft global growth. The Internet in 1985 was called home video export. And the big export was VHS tapes that American studios shipped to London, Australia, and Brazil and collected rents, and it was all incremental margins.
Then there was then an echo-boom with DVD's. DVD created a better viewing experience. They required consumers to upgrade to better hardware, better TV sets, better cable bills, and it was a virtuous cycle for a long, long time.
Then along came the AOL chat room. And things began to change. The demand elasticity for experiencing interactive media or media in general became something that was a gradual thump, sucking away the time consumers spent on traditional media properties. The Internet in general began to intrude in a meaningful way, in various pockets in and around verticals.
The most violent collision we have seen thus far, comes in the form of the newspaper industry and classifieds. Which have all but disappeared from the traditional newspaper business, and certainly the margins are dramatically different today for newspapers, versus what it was in 1985.'
BLODGET: And so what's next? Most of the talk is about the TV industry. A lot of people think TV is right where newspapers were in the early 2000's, where you've been hearing warnings for years, nobody paid any attention to them, and then suddenly everything collapsed. Is that going to happen to TV?
SIMINOFF: I would say the TV industry is more analogous to the music industry than the newspaper industry. As you know, piracy killed the music industry in a very short period of time. And technology has been the gating factor that has allowed television a bit of more resilience here.
The music industry sells a core unit that's about roughly three or four megabytes in size. Meaning the download of an average song, in an average template is around three or four mgs. The download of a 22-and-a-half-minute Simpsons episode, depending on how you download it, is 50-500X that size. Because cable pipes and storage, and RAM, and rendering, and 50 other technology-oriented things were not yet ready for flash downloading of high-definition movies, the TV business has had a kind of respite from the piracy that was rampant, and is still rampant in the music industry.
Now, we are entering a new world of 4G Wireless spectrum allocation and usage, and simply faster Internet connectivity, and that likely spells bad things for the margins of the television business. I don't think TV is dead by any stretch. I just think the margins will go down as viewership continues to fragment and the TV distributors and producers and other pieces of the television ecosystem have to fight harder to retain audiences that they currently have.
And this maps interestingly to 1975 when All In The Family, was the dominant show on television, and there were only three networks. There wasn't even a powerful UHF spectrum. You only really had three choices for viewing.
Today the world is dramatically different, and the world that Mike Ovitz described as 'n-thousand channels' is today n-million channels, if you think about the verticals in and around Youtube to xtranormal and some of the other products that are starting to proliferate at scale.
BLODGET: I think what the TV folks would say is that the music industry got completely blind-sided but the TV industry has had 10 years to get ready. There are now many other alternative ways TV can get paid for its content, and not have it get stolen. So does that save TV, and does that offset some of the margin destruction that you're talking about?
SIMINOFF: I think it slows down the destruction, but you can't fight gravity and you can't fight the need for entropy to be very high to keep castle walls fixed around your proprietary content.
To back up a little, the music industry was destroyed from a margin perspective in large part not from the piracy itself. The piracy was a violent, vicious wake-up call, but it was the unbundling of forced bundles of albums that destroyed the structural elements of the business.
What i mean by that is that when a hit record would come out there were two, three maybe songs that you wanted to buy. And instead what happened, you had to buy all thirteen songs for $14.95. Today, iTunes lets you buy just the three hit songs that you want for $0.99 each, and while the unit margins are higher to the music producers meaning on the $0.99 there's no physical product, they receive a check from Apple n-days later, and they collect their $2.14 compared to the $14.95 record album sale, the music industry suffered greatly.
By the same token, there is an odd kind of analogous bundling that happens in the TV business where groups of programming are sold down channels as 'networks.' This messier distribution process that will give the television margin challenges to take longer to truly take effect.
But I do not understand how television can have higher margins, or even equivalent margins, selling Internet product that is almost free, versus the a la cart unit sales that grew the industry from the early 1940's to maybe five years ago, when the diaspora in video viewing really started to take hold.'
BLODGET: So Time Warner Jeff Bewkes was hallucinating earlier this week when he said Netflix is toast?
SIMINOFF: Well there are different questions here. One is about the future of Netflix, and the other is the future of the margins of the television business.
The margins of the television business are one of simple gradual erosion over periods of time, and maybe a tweaking in the way products get made.
And to finish on that, another allegory to think about is the number of movies made each year. 20-five years ago there were 4-20x as many movies made each year, depending on how you do that maths, as there are today. It was a combination of no growth in theatre attendance to union strictures to the way labour was agglomerated by the agencies and the cost of talent that changed that dynamic. So there are a lot fewer movies made now, but also a lot less waste, and the margins of the movie business are low, but they continue to survive, and to go along.
The consideration of Netflix is a different issue...
BLODGET: And what about the cable networks? The issue there is the huge fees the cable companies pay to networks, like ESPN and others. The threat is that those will disappear if everything goes a la carte or to Netflix or something. It's important to both parties, the cable companies and the networks themselves, to maintain the status quo. Will they be successful in doing that?
SIMINOFF: So a cable network is not a cable network is not a cable network.
If I told you I have a truck full of food, you would ask 'is it caviar or is it potatoes?' ESPN is caviar chilled at 58.5 degrees, with warm blini ready for serving.
It's $4.50 a month, I believe, in fees that the cable companies pay to ESPN. And, frankly, if you polled most of my friends, we would pay $20 a month for ESPN. And there's probably a meaningfully higher set of packages that we would pay for the NFL premium services, and otherthings, where there's deep emotional connection in the viewership.
But if you asked me how much I would pay to watch C-SPAN--I would pay money to NOT have that on my system.
So you have vast differences in the demand elasticity for viewing different channels.
ESPN is in a very interesting position competitively now in that I believe someday Disney will look at the video landscape and will want to stream ESPN from its own servers. Because the video revenues that it is now being paid by the cable companies will be trumped by what it can collect from guys like me. I would pay $20/month just for ESPN, $30/month for the NFL package, $40 for the premium golf package or whatever, and ESPN would want to actually know its customer--know my IP address, send me my bill and so on.
Whereas today ESPN sells to cable companies who then own the end customer. In other words, ESPN is now a wholesaler, and I think there will be a lot of pressure on ESPN to go direct to the customer.
Could C-SPAN do that? No. But I think ESPN could, and that then is a game-changing entity for a lot of the other video producers in this ecosystem.
BLODGET: And Apple?
SIMINOFF: You know, I think I'll be the 6.8-billionth person to say 'yeah, there's more upside'. Normally you know, I like to be a contrarian on things, but here the story just looks really good to me.
I'm keen on a number of different numbers, like Apple (AAPL) being a relatively small part of the overall PC universe, the fact that Apple isn't even yet integrated into Wall Street where they're just starting to use iPads to open doors there. I look at volumes on the app ecosystem, where Apple smokes everybody 10 or 20 to 1.
I look at how hard it is, what Apple has done. The melding of hardware and software in the way that they've done it is ungodly hard at scale. I just don't see anyone else remotely close to knocking them off. At a Netflix valuation, or a Netflix equity multiple Apple would be a $1,000/share stock price or more. I also think they're going to do something smart with their balance sheet, and likely not just buy back stock. So they've got all kinds of interesting things coming.
I would think Netflix is thinking a lot about iMovie, why doesn't Apple do to the movie and television business what they did to the music business. If there would be one thing I would worry about if I was Reed it would be competing against Steve Jobs, who is another amazing athlete. I don't think he's too worried about the athletes on other fronts.'
BLODGET: And Google?
SIMINOFF: Google (GOOG) is the greatest direct marketing company in history. They think of themselves as a technology company, but they're the technology of direct marketing. And direct marketing kind of goes with the advent of commerce migrating from real estate to the web, meaning the move from Walmart to Amazon that we're seeing. Google has been the weapons, picks, and shovels supplier to the core miners and warriors who are fighting that battle.
I think Google will continue to grow nicely from here and it doesn't trade at a high multiple, and the stock should be just fine at least for a while. Until there are two other Stanford Ph.D. students who are somewhere in a garage, five miles from here in Palo Alto who are coming up with some new cool thing that Google couldn't possibly even know about. And like all other predecessors who eat their young in cannibalistic Silicon Valley fashion, Google will likely miss whatever platform shift will happen in n-years and that will be the end of that story, in the same way we've seen the gradual end of everything from the old payday of IBM to Microsoft to AOL, Netscape, Yahoo, go down the list.
BLODGET: But didn't that garage invention already get made in a dorm room at Harvard, by someone named Mark Zuckerberg? And isn't Facebook the biggest threat to Google going forward?
SIMINOFF: We're in a climate where all tides are rising. If this were the long distance business and it was market share that was up or down 1% year after year, like 1985 MCI and AT&T, and Sprint's wars, that would be a different discussion. But in my mind, search and Internet commerce is a boat that's rising.
Will Facebook grow faster than Google? Arguably. But, does that mean it's the end of Google trading at whatever it trades at--13X cash earnings, something like that? No, I mean I don't think that's where the world heads at all.
Five years from now, when maybe they're in parity for revenues or some other element, maybe it becomes a threat. But, I don't see people leaving Google to use Facebook to search for tooth whitener.
BLODGET: Any hope for AOL or Yahoo at this point?
SIMINOFF: As you know I'm emotionally invested in both companies from the beginning of my career.
AOL (AOL) I don't see a good outcome there. I think it just continues to end like a whimper, not a bang.
Yahoo (YHOO) I think of as a Chinese holding company. Most of the value of Yahoo today derives from Alibaba and all the other Chinese investments that it has made. If you are bullish on China and the Internet in China, which I think I am, most of us are, then those assets are worth dramatically more than Yahoo's operating business today. So I think of the operating business as a kind of a workout or work-off.
You talk about Facebook beating Google, Facebook killed Yahoo. It was the resident homepage and email addresses on Facebook that sucked all the volume growth out of Yahoo. The operating business I think, Carol Bartz was brought in to just milk-off the remaining parts. She sold off search, she's downsized the company, and it's just quietly producing cash and doing its thing as it slowly probably goes away.
BLODGET: We seem to sort of be in the latest, greatest Yahoo management change. Carol was just supplemented by Ross Levinsohn. Maybe Levinsohn takes over in a year or two. Does this new addition give Yahoo new life in the core business?
SIMINOFF: I think Yahoo News is great. I still use it, I love their homepage. I spend a lot of my own time on Yahoo. I think there's a nice opportunity for Yahoo entertainment to be a meaningful player.
I think Yahoo entertainment could become one of the key properties of the web. Ross is a great guy to be brought in for that space. He comes from the boxing licensing arena, and he knows the entertainment business as well as anyone. His big weakness is his putting and chipping, where he could really use some work, but the rest of his game is very good. I think he'll be a good complement to Carol for a while.
I have no idea what Carol wants to do at Yahoo. When I think about the right melding for someone trying to save Yahoo, it's someone who has a highly ingrained opinion, is clearly identifiable and narrow. So, if you think about a Tim Burton movie--you know what a Tim Burton movie with Johnny Depp is going to be--you know it's going to be weird, it will be compelling, and it will be something that lasts with you long after you leave the theatre.
In the same way, Yahoo after trying to be everything to everybody, now has to commit to being one good thing to everybody. I think that thing will be something in and around the entertainment business, and that's why Ross makes a lot of sense to me.
BLODGET: So let's quickly touch on a few stocks that had their moment in the sun a while back, and have now been pretty much left for dead--Research In Motion, Microsoft, and eBay.
SIMINOFF: Let's start with RIM (Research in Motion, RIMM). Blackberry was the bomb eight years ago, and for a whole host of reasons, they sort of ran out of innovation gas. I think that's the thing that distinguishes them from Apple.
Also think about Nokia (NOK). Remember a decade ago Nokia was one of the largest market caps in the world, it was awesome, it was unassailable, it was the global brand. Today, it's a shadow of its former self. Why did it get there? It got so big, it stopped taking risk. It simply made more of the same thing.
Let's talk about the old Motorola (MOT) in the heyday of its early cell phone days. Companies get successful, and they stop killing themselves.
So you have different beasts with Apple and RIM. Apple has Steve Jobs. I don't think he's too worried about paying his mortgage, and I don't think he cares about short term things, and I think he's willing to fail a lot. So the RIM guys stopped taking risks, and the RIM product today looks very much the same as I saw eight years ago. So is it a surprise that consumers got tired of this product? No. It would shock me if the iPhone of today, looks like it will five years from now. There will be some whole new revolutionary thing that will make phone calling more intimate and easy and clear and everything else that will come.
So I think RIM suffered from that in a big way, and you hear about rumours of a take-out every other week, maybe that happens maybe not. But will Blackberry be a huge market moving entity 10 years from now? That would surprise me.
SIMINOFF: Microsoft (MSFT) is an interesting duck in that it was probably the most dominant technology company that we will ever see from its heyday in the early 1980's until when the Internet really started--maybe 94' or 95'. But then there weren't enough people on Earth to keep consuming operating systems, growth mitigated, and the economic rent that Microsoft could charge for an operating system began to diminish because there were alternatives.
There are many famous examples of roadkill in its way, but I think the ultimate poison for what has killed, and what will continue to kill Microsoft's growth is that people have the Internet as an alternative. A very lightweight computer, and some DRAM, and Google Gmail really replace a lot of what Microsoft offered.
Microsoft I think is on Word and Excel version 196, and I'm a professional financial modelling person, and I don't think I could use much more than the top eight or nine buttons on Excel. People don't need those upgrades anymore, and the open source equivalent of those things are just fine. Frankly my 'compose' button on Gmail is plenty good as a word editor for 98% of what I do.
So, I think the process there of becoming a monopoly, and not having people upgrade anymore or need to upgrade anymore, sucked that growth out of Microsoft's marketplace. Then you map that onto a different culture of innovation and a completely failed Internet effort that should have been a monster hit.
People criticise Yahoo for not acquiring Google and Facebook and a bunch of other things. Well, guess what--Microsoft had a lot more cash than Yahoo or anyone else combined, and where were they? I mean Amazon was in their backyard. I bet you they could have written Jeff a check for $10 billion eight or nine times and he would have been thrilled to go work for Steve.
So the process of the way they invested has been their killer because they didn't cannibalise themselves fast enough, and were convinced that the operating system was the be-all and end-all of the computing process. And this notion of owning the computer or owning the customer is what eluded them and will eventually bring their downfall. Then couple that with Gates leaving and kind of his innovation style and his ability to take risks, with Ballmer who's more of a business guy than really a product guy. Then with losing Ray Ozzie, and some other people, I think that company will be very challenged for a very long time.
BLODGET: When we heard that Google had a $6 billion offer for Groupon on the table the other day, immediately a chorus of commentators rushed to say that this PROVES were in another tech bubble. From your seat in Silicon Valley, do you think its tech bubble 2.0?
SIMINOFF: Well, based on the Groupon offer--no.
Groupon numbers are not public, and I only know what's whispered about at the grocery store, so I actually don't know what their numbers are. Last I heard, Groupon has something like $300-$400 million of EBITDA this year, going to $750 million or something next year. So a $6 billion offer is only 10x current 12-month period EBITDA. That's not some crazy high number, 10x EBITDA. In the bubble in 1999 things were trading at 100x revenue. So, those aren't bubble kind of multiples. The rumour mill was that the Groupon deal fell apart based on the kill fee that Google would have had to pay if the Hart-Scott-Rodino Act nullified the deal.
The bubbles that I see are more for the two kids in a garage with a PowerPoint whose business used to be funded at $2 million pre- with angel money of $500,000. And those would fail often, only half-million dollars was being lost of a billionaire's money. In in the angel world, that makes sense: In a hundred tries I'll find something where they make 100x or 500x my money. But today angel companies are getting funded with $6 million pre-money valuations for a million dollars, where the Angels are buying just common stock, not even preferred stock. That to me is a bubble, where it's a great time to have a PowerPoint in a garage.
BLODGET: Thanks, Dave.
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