The Ponderings of Woodrow

Jeff gets the Microsoft/Facebook transaction exactly right...

Jeff reflects on a recent VC industry event he attended, and addresses the Microsoft/Facebook transaction; getting it exactly right.

Lot’s of grumbling about Facebook being valued at $15 billion and “how could Microsoft do this to us?”. Let’s be clear about something, Microsoft didn’t pay $15b, they paid $240 million out of their well stocked bank vault for pole position and, as Jim Long speculated, it doubtful they spent much time on the valuation. Will Price made the most salient point about this in questioning why FB would do this to themselves considering they have made their future employees options worthless.

Think about that for just a minute, if you already have options in FB the news that the company is worth $15b in that calculation (and it’s unavoidable irrespective of what people think FB is really worth, company valuation insofar as options calculation is a rigid event driven process) is great. I would imagine there were a lot of private wealth managers descending on FB HQ to tell employees how they could collar their options even though there is no market for them at the moment.

If you have yet to be hired by FB this news is no good news because it’s not like FB is going to give you $10m in options for being a senior product manager. I can only imagine some of the awkward conversations FB has been having with prospective employees about options these days. Basically, FB made it a lot harder for themselves to hire good people who understand cap table math.

I was on a blog hiatus at the time of the Microsoft's investment in Facebook but I can tell you that I was baffled at how many people were looking at that transaction through the wrong lens. I kept hearing about the "absurdity" of the $15B valuation as though that valuation has any real-world value. As Jeff says so well, the REALITY is that Microsoft used an infinitesimal amount of its cash hoard to secure:

• A relationship with the fastest growing social network
• A call option on potential future negotiations with Facebook
• A much needed "win" against Google

Now, there are also plenty of reasons why Facebook agreed to the deal, but Jeff (channeling Will Price) does bring up an interesting point as to what this does for Facebook's ability to hire in the future. Then again, that's a problem that all companies face that scale. I'm not a VC, but intuitively it strikes me that it's rare for employee #500 to get rich on stock options at any company. Maybe my VC friends can put some meat on those bones?

Note: This is not a recommendation to buy or sell MSFT or any other security, but is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over, did maintain a long equity position in Microsoft but reserve the right to alter our holdings at any time. We also may, at times, carry derivative options on underlying positions as a hedge.

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Dennis Howlett on software's Phoenix(s)...

Dennis Howlett is a rare breed.  He's a straight shooter with the tenacity of a beat reporter but the perspective of a seasoned industry executive.  One of the most enjoyable outcroppings of the development of the Enterprise Irregulars has been getting to know him and becoming familiar with his perspective.

In a three part missive, he gives his views on Microsoft and SAP, and the challenges they face as the software industry paradigms change around them. I don't always agree with Dennis, but I always feel smarter for having hashed out a topic with him. Hopefully you will, too.

1. Microsoft/SAP need to become phoenixes (Part 1)
   
2. Microsoft/SAP need to become phoenixes (Part 2)
3. Microsoft/SAP need to become phoenixes (Part 3)

Note: This is not a recommendation to buy or sell MSFT, SAP or any other security, but is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over maintained a long equity position in MSFT but did not maintain a position (long or short) in SAP . We also may, at times, carry derivative options on underlying positions as a hedge.

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Musings on the Google + Doubleclick Deal

By now you're well aware of Google's acquisition of DoubleClick for $3.1billion.  Few things get the blogosphere buzzing like a juicy Google story, and this one was no exception.  With Techmeme being taken over by this deal, there isn't much new I can add to the conversation for now. Instead, let me highlight some of the coverage I found most interesting:

• Fred Wilson on banners being the new black
• Brad on the 10x return on equity Hellman and Friedman generated in two years time
• Matt Ingram on the irony of Microsoft's antitrust claims
• Paul Kedrosky on why focusing on valuation is pointless in this deal
• Eric Savitz on the sell-side reaction to the deal
• Phil Wainewright on the difficulties of serving two masters [publishers and advertisers]
• Larry Dignan on why Yahoo! comes away looking good from this deal
• HipMojo with a contrarian take on why this deal makes little sense
• Will Hsu on Google-DoubleClick coming full circle

So where do I stand on the deal?

1) The big winners here are clearly Hellman and Friedman. They made a smart, ballsy call that was met with a LOT of cynicism at the time; and came out with enormous returns for themselves and their LPs
2) This wasn't a defensive move on Google's part, it was an offensive one
3) Regardless of whether the purchase price was egregious, I don't want to hear that Microsoft is better off for having not made the deal. There was a time, not so long ago, when Microsoft wouldn't have been outbid for a strategic asset. The fact Microsoft was in the bidding, and by most accounts initiated the talks, speaks volumes
4) The inevitable "myth of cascading M&A" was in full effect today, with 24/7 Media (TFSM) and Aquantive (AQNT) up sharply as traders tried to find the "next" deal in the space. My bet? None of the above

Note: This is not a recommendation to buy or sell GOOG or any other security, but is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over, maintained a long equity position in MSFT and YHOO but did not maintain a position (long or short) in AQNT, GOOG or TFSM . We also may, at times, carry derivative options on underlying positions as a hedge.

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Testing: Writing this directly from Word 2007

Just installed Word 2007 on my laptop and am testing the new feature which allows me to post directly from Word to my blog…

How does it look?

Bored to tears over the Microsoft groupthink...

Maybe I'm just getting crotchety in my old age but I find myself bored to tears over the conventional group think I'm seeing this week regarding Microsoft.  A look at Techmeme yesterday would have you believe that Paul Graham's declarative was somehow enlightening. Graham posited that Microsoft is dead. Wow, that's ground-breaking stuff, I can see why it elicited so many parrots squawking into the fray.

Then, as if that weren't enough, the stock made news today because Goldman Sachs, long the king of Microsoft supporters, removed the company from its America's Conviction List [but maintained its Buy rating].

Listen folks, I understand that Paul Graham is a super smart individual and he was trying to make a point with his missive. But what did he tell us that isn't already considered the status quo? Is there anyone with even a passing interest in the technology market that doesn't recognize Microsoft's challenges?

• Yes, Vista and Outlook 2007 took forever to hit the market
• Yes, Vista has been buggy and uptake hasn't lit the world on fire
• Yes, MSN is struggling while Google thrives and Yahoo! claws back market share
• Yes, open source continues to make headway in the browser, desktop and server environments
• Yes, the Zune appears to be a failed effort at dethroning the iPod
• Yes, the Nintendo Wii is doing well
• Yes, more startups are trying to emulate and/or steer clear of Google than the House that Gates Built

But guess what? THAT IS ALL FULLY UNDERSTOOD. How is any of this new news? The stock has been effectively flat lined for a half decade folks.

If Graham and his mimics really want to write something thought-provoking, why don't we talk about how impressive Microsoft continues to be on so many levels? Or how they might turn sentiment around?

• Hat tip to Dennis Howlett for recognizing that Microsoft's applications customers aren't the dissatisfied bunch the herd would have us believe
• Hat tip to Brad Feld for acknowledging the potential for Sharepoint; and how it's already an amazingly effective service
• Hat tip to Charles Zedlewski for bringing to light some of Graham's most egregious errors
• Hat tip to Larry Dignan for one of the few balanced reactions I read today

You know what I would like to hear about?

• Microsoft's phenomenal returns on equity
• The fact that Microsoft is trading at 17x forward earnings, virtually identical the S&P 500 despite having a more attractive overall financial profile
• The strong reviews on the functional improvements in the Office 2007 suite
• The strength of the XBox 360 [which is the real PS3 killer, not the Wii] and the profit leverage that comes in the next few years as the software/hardware ratio skews away from consoles
• The success of BizTalk and SQL server
• The fact that Microsoft is forecast to generate more than $19 BILLION in operating cash flow this fiscal year [by Goldman Sach's own model]
• That Microsoft has been at the forefront of technology companies in finding ways to return incremental cash flows to shareholders [e.g., huge cash dividend, quarterly dividends, massive buyback]
• The fact that large cap fund managers are underweight Microsoft [hint: you generally don't outperform by owning the stocks they're already overweight]
• That Microsoft's mobile and embedded group will more than double to $575mm+ this fiscal year from 2005 levels
• The launches of Longhorn and Katmai

If people want to draw a critical eye toward Microsoft, more power to them. I've taken the company to task plenty of times. But let's not praise someone for effectively telling us what an astute observer has known for years. Let's recognize that despite plenty of challenges and more uncertainty than we shareholders would care for, Microsoft remains the financial envy of virtually every technology firm and has a deeper technical and operational bench than all but a handful of the world's leading organizations.

Beware "Group Think" when it comes to large cap technology investments

• You know when the best time to build a position in HP was? When the world hated it, and no one knew if Hurd had the chops to turn around the situation he inherited from Carly Fiorina.

• You know when the best time to build a position in Apple was? When the iPod just launched and there were dozens of articles about how the music download business wasn't large enough to move the dial for Apple proper.

I'm not going to tell you Microsoft is a great investment; that's not my place. Nor am I going to pretend the company doesn't have its share of challenges. A disappointing quarter or two this year could easily send the stock back to its mid-2006 lows. But folks, please, please, please try to look beyond the rhetoric that often permeates the blogosphere.

Note: This is not a recommendation to buy or sell Apple, Google, Hewlett Packard, Microsoft, Nintendo, Yahoo! or any other security, but is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over, maintained long equity positions in MSFT, NTDOY and YHOO but did not maintain a position (long or short) in AAPL, GOOG or HPQ . We also may, at times, carry derivative options on underlying positions as a hedge.

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A Tale of Two Board Seats: Cisco and Microsoft

It wasn't long ago that Microsoft and Cisco were coincident power brokers with little real competitive overlap. As their businesses mature, and their reach expands beyond the scope of their core offerings, the next ten years may be more defined by how they successfully compete against one another in areas like unified communications. Regardless of where you sit on the Microsoft vs. Cisco debate; it's clearly that their fortunes have long been tightly correlated.

This week, both bellwethers announced the appointment of new board members. I don't think they could've gone in more different directions if they tried.

• Cisco appoints Michael Powell

Powell, a Republican and former member of the armed forces, was a high-profile FCC Chairman, maintaining an active media and web presence during his tenure. Powell (the son of Colin Powell) is a career politician, having served stints as an adviser to Dick Cheney, as well as a stint with the Antitrust Division of the DOJ prior to his seven-year run with the FCC.  His supporters would point to his support of VOIP proliferation and the distribution of spectrum; while his detractors would point toward his all-too-public run ins with Howard Stern and his support of expanded punitive actions in the fight against "indecency" which cropped up after Janet Jackson's Nipplegate. He resigned from his post in January 2005.

• Microsoft appoints Reed Hastings

Hastings, a Democrat and former member of the Peace Corps, is the CEO and founder of Netflix; the internet-based DVD rental service.  Prior to founding Netflix, Hastings founded Pure Software, which was ultimately acquired by Rational Software. Hastings is a mathematician by background, but has proven himself as a serial entrepreneur. The success of Netflix is a testament to his willingness to take risks; Netflix has completely reshaped the rental industry.

Will Hastings, who clearly understands how to build a disruptive service that captures mindshare of media consumers, help Microsoft push further into the home? Can Powell, who knows his way around the regulatory environment in Washington, help position Cisco as they continue to expand their reach and move further toward the edge? Time will tell.

Note: This is not a recommendation to buy or sell Cisco, Microsoft, Netflix or any other security, but is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over, maintained long equity positions in CSCO and MSFT but did not maintain a position (long or short) in NFLX. We also may, at times, carry derivative options on underlying positions as a hedge.

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Vista goes gold...and it's ABOUT TIME

Long-time readers of this blog know that I'm a Microsoft investor, and that it's been more frustrating than rewarding over the last few years.  And while Microsoft continues to have plenty of issues to deal with, it would be disingenuous of me not to express a long-awaited sigh of relief at the news that Windows Vista has gone gold and will actually ship to the masses in January.

Note: At the time of this writing I, and/or funds I maintain discretionary control over, maintained a long equity position in MSFT. We also may, at times, carry derivative options on underlying positions as a hedge.

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Zany for Zune...

OK, I generally try to stay out of the consumer electronic blog frenzies that so often take over techmeme. But today I have to make an exception because I'm feeling giddy about the Zune. I'm a big consumer of music and podcasts (and have a looooonnnggg commute each day) and am a rabid iPod user. But I'm also a rabid radio listener. And I love to share music (hence my love for Pandora).

So Zune appeals to me. Because I can do all three in one device. Obviously the proof is very much in the pudding. It's not going to be easy for Microsoft to put a dent in the Apple iTuneopoly, but I have to give them credit for going big. They're trying to differentiate in multiple ways: wireless, embedded content, subscription pricing, different form factor.

Now, things like form factor (Zune is big), battery life (supposedly 12 hours but we've heard such claims before from other devices only to be disappointed) and the user interface of their music downloading service are all gating factors out of the gate potentially. Apple is on version 7.0 of iTunes, and has more versions of iPod than Disney had dalmatians.

But, at first blush, count me in as intrigued. Being a bit of a gadget guy, I'll certainly buy one with an understanding that I could end up back in the iPod universe in short order. But before today's launch, I would've given Microsoft's Zune about a 5% chance of luring me away from Apple. Now it's up to 50%.

Among the 1,000s of reviews on the Zune, I personally found stereogum's analysis the most comprehensive. stereogum was one of a handful of bloggers invited up to MSFT HQ last week for an official briefing, and he covers all the bases.

Note: At the time of this writing I, and/or funds I maintain discretionary control over, maintained a long equity position in MSFT but did not maintain a position (long or short) in AAPL. We also may, at times, carry derivative options on underlying positions as a hedge.

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Don Dodge on Microsoft M&A and the Myth of Synergy...

Don Dodge has an interesting post on his blog discussing Microsoft's M&A activity and how some of the more recent, smaller investments have born fruit and a easily quantifiable ROI whereas some of the larger acquisitions of the past haven't lived up to expectations. Read Don's views in their entirety here:

Synergy and leverage are descriptive words that always come out when a company overpays for an acquisition. I started my tech career at Digital Equipment. At DEC whenever something was "strategic" what they really meant was, it is not profitable. I think synergy and leverage often fall into the same category. Fancy words for "this acquisition will pay off somehow at some point" and that "1+1=3".  Remember AOL and Time Warner? Or Compaq and DEC? Years later they are still looking for the synergy.

Long-time readers know this is a view I share passionately. Consider Symantec, which has experience on both sides of the ledger: Veritas (big) and IMLogic (small). It's great to see someone on the inside of a behemoth admit that to the potential pitfalls of the uber-acquisition. We all would do well to keep this lesson in mind as the M&A market for enterprise software vendors, large and small, continues apace.

Note: At the time of this writing I, and/or funds I maintain discretionary control over, maintained a long equity position in MSFT but did not maintain a position (long or short) in SYMC. We also may, at times, carry derivative options on underlying positions as a hedge.

don dodge m&a synergy microsoft software woodrow

XBox 360 gets a huge endorsement...

Like many people my age, I consider myself a "gamer." I grew up on never-ending cascade of "personal entertainment systems":

• Pong...
• Atari 2600...
• Colecovision...
• Commodore 64 (played a huge role in me being the tech geek I am today)...
• Nintendo...
• Turbografx 16...
• Sega Genesis...
• Playstation...
• Playstation II...
• and now???

But while I consider myself a gamer, like many people my age I'm now a heckuva lot busier than I used to be. For the first time in my gaming life, I'm no longer obsessed with being a first mover. I didn't clamor for the PSP when it hits the shelves. I didn't pay 3x the asking price on eBay for the Xbox 360 when it came out. And, yes, I do have several unopened PS2 games received as Christmas presents that I look forward to playing "when I have the time."

Busy or not, I'm still interested in gaming, consoles in particular, and will certainly buy one of the next-gen consoles (Wii, PS3 or 360) at some point. For me, given my time constraints, it's really a question of the best flagship titles. The first console with three or four "must have" games is probably the one I end up buying and sticking with.

But I'm also an investor, and like many technology-focused investors, the gaming world is of keen interest. Gaming is eating up an ever-increasing portion of people's free time. Gaming is becoming more immersive, more interactive, and yes, more complex. Meanwhile Microsoft and others view gaming as part of a broader basket of home entertainment services; and view a killer game console as a trojan horse into capturing a unified, home networking environment.

So it was with great interest today that I saw this blog post by Dana Jongewaard (via Om's blog). Dana is the editor of the U.S. Playstation Magazine, a publication officially endorsed by Sony (and published by Ziff-Davis). Dana, who makes her living thanks to the Playstation, has DECIDED TO BUY AN XBOX360 INSTEAD. Wow...I realize no one should overreact to anecdotal data points as a rule, but this is one I might make an exception for:

Contrary to popular belief, editors of the Official PlayStation Magazine don't get free hardware for their own personal use. So I've been having an ongoing debate with myself about the PS3 since E3. After Kaz announced that the price would be $600, I found my enthusiasm sagging.

It's not that I find the concept of a $600 console insulting. Inflation happens, and it's natural that eventually inital prices will be higher than they used to be. But when I know that a console's direct competitors cost two-thirds or half of that price, it becomes harder for me to justify shelling out that kind of money--especially when I can probably get the Wii and the 360 combined for the cost of a PS3.

$600 might be worth it if there were several huge titles on the near horizon that were PS3-exclusive. But for the first year at least, there are very few big titles that are PS3 exclusive. GTA4 and Assassins will be available for the 360 at the same time. And most of the big guns--FFXIII, MGS4--won't be hitting for quite some time after the launch.

The other big reason for people to shell out $600, BluRay, is frankly something I don't care about. I have a crummy 12-year-old 21-inch very-non-hi-def TV sitting on my stand at home, and while we've been talking about upgrading it for the past three years, we always end up walking out of stores TV-less. And I don't buy movies; I rent non-BR discs from Netflix. Much like I've never been an audiophile--as long as I can hear it, I don't care if it's mono, stereo, 5.1, 7.1--I really don't care how high-res the picture is. My bottom line is that as long as it has color and is free from static, I'm good to go.

So ultimately, I can't justify it. $600 is a lot of money, especially when I can get what--for me at least--will be a very similar experience for $400. I would like to own a PS3, and I hope that the price drops soon so I can consider it. But until then, this Official PlayStation Magazine editor will have to join the dark side.

All you can say is, kudos to Dana for her honesty. This kind of editorial comment would never have been possible prior to the blogosphere. Perhaps that sounds like hyperbole but I firmly believe Dana and others like her wouldn't have felt empowered enough to disaggregate her role as a professional writer about Playstation with her personal qualms with the PS3 as a consumer of gaming peripherals.

Dana's point about Blu-ray is especially illuminating. Sony is trying to emulate the success it had with the PS2; which enjoyed major uptake in no small part due to its ability to act as a DVD player in addition to a gaming console. This was particularly effective in Japan. Sony would have you believe the Blu-ray angle is similar; but I disagree. In the PS2 instance, DVD players were entering the peak of the consumer lifecycle, moving well beyond first movers. The economics had become compelling enough that average American and Japanese households wanted, and were willing to pay for, DVD players. PS2 offered consumers two devices for the price of one. In the PS3 case, Blu-ray is far too new to have the same kind of pull through effect we saw with PS2, in my opinion. Not only do you need an HDTV to enjoy Blu-ray to its fullest, but you also have to wait for an appropriate level of Blu-ray formatted media (movies, et al.) Blu-ray is at a much ealier stage of the consumer lifecycle. People will happily do without a Blu-ray player; so PS3 has to compete more directly on a) the quality of available titles, b) the feature set of the game player, and c) price. At $600 proposed MSRP, that's a hard pill to swallow.

As a Microsoft shareholder, anything that makes XBox 360 more ubiquitous or more likely the winner in the next-gen console wars is welcome news. XBox, in and of itself, has cost billions and the ultimate payback only comes if Microsoft can carve out a large share and then rake in the profits through subscriptions to Live as well as high tie ratios from higher-margin game titles. If Dana's reaction is right, Sony needs to re-cast the go-to-market strategy for PS3 out of the gates. Her point about Blu-ray is especially telling.

Note: At the time of this writing I, and/or funds I maintain discretionary control over, maintained a long equity position in MSFT but did not maintain a position (long or short) in Sony (JPN: SNE). We may also, at times, carry derivative options on underlying equity positions as a hedge.

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