Research 2.0

We've Moved!

2006-11-28T07:03:00.000-05:00

In addition to consolidating our URL we are going to WordPress after evaluating it side by side with Blogger. Come on over!

Virtual Amazon?

2006-11-23T10:33:00.000-05:00

Bezos has created some buzz and head scratching with his infrastructure initiatives lately. Last year we explored and wrote about A9 and Mechanical Turk which have not really taken the world by storm. So it is with some trepidation that investors greet initiatives like EC2 and S3. However it's hard to believe that Bezos is just being unfocused or distracted into a sideline business as the CEO of a major company.

We've been provoked by the idea that Amazon can go much further and offer a very complete array of outsourced services that might represent the kind of turn-key virtualized company often conceived and seldom realized.

Despite the efforts of eBay, Yahoo and Google it's still not very easy to instantiate a robust online business of any sort, digital or physical.

To get an inkling and have a little fun we decided to build Our Bookstore using Amazon's new store tool. The point of it is to get thinking about what Amazon could do if they really deliver on the vision of being able to offer a complete solution for a business. Although this simple example uses existing Amazon products it could be extended and generalized easily enough to support custom products or even just designs which are then sourced from global suppliers (think Alibaba), delivered to Amazon and ultimately shipped to end customers.

There's an open question about the shape of the big wave of innovation and investment around virtualization and open source. One possibility is that it will take the form of typical business process outsourcing but with much more disruptive price points and cycle times. If this is true and Amazon can execute, it would provide a real opportunity for them.

Right now it's mostly rhetoric so we're going to push on EC2, S3 and their other services with some force and see what we find. Combined with some margin analysis it will give us a foundation for measuring their progress and determining whether or not it will make a difference for the company and investors.

Beginning to revisit BEA.

2006-11-16T09:38:00.000-05:00

We haven’t covered BEA for many years but did follow them pretty closely during their ascendancy back in the 1999’s. Ironically their very success made them somewhat uninteresting to investors for a few years because they reached $1B in revenues so fast they were left with few meaningful growth prospects and had to work hard to replicate the same level of success each year.

Recently we just started to become a bit more interested in the company and started to look at them more closely again. They company just reported and the results disappointed most of the analysts who have been recommending the stock the last few quarters.

We’ve been out of the loop for some time so all the minutiae are lost on us. From our point of view the results and near-term guidance was pretty much inline with what we would have expected. BEA is a fairly large and complicated company with enough moving parts to defy easy analysis. A few million dollars either way should not make much of a difference.

During their call management talked about SOA moving out of the experimental phase and into mainstream enterprise deployments. We agree that SOA is au courant but disagree that this is a recent fact. We would observe that mainstream market adoption started a few quarters ago in our view and has probably been driving BEA results since then.

Claims about the business of SOA being driven by the business rather than I/T seem doubtful to us. BEA has fielded a BPM product that might be touching there but we have yet to look at it in detail.

Analysts are out today with downgrades citing a range of reasons including the point that BEA is losing market share to Oracle and IBM. We can’t refute the claim but we don’t believe it. BEA does have a challenge in that customers have limited resources and Oracle has forced many of them to allocate a significant portion to navigating the Fusion path to reach some converged application architecture. IBM, Oracle and BEA have all failed to attract new generations Web 2.0 technology developers into their fold.

They company spent quite a bit of time talking about their new generation products like SOA360 and Workspace360. They are also focused on creating fine-grained components of their functional products that sounds sensible. The idea of unifying endeavors of development in Eclipse, business process management and application management with OpenView is interesting but hard to visualize without more concrete information and code.

Management touted new technology (Guardian) that sounds very similar to the IBM autonomic computing initiative which as been around for quite some time with limited impact.

One emerging thing that is interesting is the increasing SOA and related software content in the network layers. BEA talked about some deals and has been working in the communication area for some time. Their micro service architecture is said to allow very small implementations of SOA to be driven all the way to the edges of intelligent networks.

So what’s for real in this network infrastructure area? Does it help explain why Oracle bought Portal Software? We know SIP is becoming real and creating new disruptive applications. Plenty of work is going on to drive 3G and IPTV application networks.

We believe software infrastructure that reaches out from behind a virtualized infrastructure behind the firewall to deliver service-enabled applications out to devices at the edge of the network will be a very promising place to be. We just can’t yet say that what BEA doing is going to really get them there.

So what is BEA worth? We took the time to punch some rough numbers into our long-term valuation model and came out to about where the stock is trading now, $14. We will publish the model later on but our assumptions included a 15% long-term growth rate, operating margins of 12-15%, a 30x earnings multiple and a 15% discount rate.

In conclusion we can see people got ahead of themselves on BEA, which seems like a company that only just now is hinting at some interesting things. Corporate portals and the Plumtree acquisition certainly did nothing for us. We have yet to delve into many of the newer products but our nature is skeptical. For us this is something that could be an interesting situation a few months from now depending on what the company does.

So we would advise people to focus on other things now and stay tuned for more informa-tion on BEA as we figure it out. Our best bet on the M&A side is that HP buys the company and puts Alfred in charge of their overall software business much as IBM has done with Steve Mills. (HP are you listening?)

Powerset as Bubble Indicator?

2006-11-08T11:52:00.000-05:00

So all it takes to grab headlines is a bold claim that you are going to be the next Google by providing a better search and have raised $10M?

Powerset has been featured in notable technology blogs and profiled by reporters. Without going into great detail they talk about looking at words in context to get superior search results.

Although I've commented on a few of these blogs already since this situation reminds me so vividly of the Zitel fiasco in 1999 I had to post it here. This was a company also in "stealth mode" that supposedly had a secret powerful technology invented by a PhD in China that could solve the Y2K problem easily in all cases. They promoted the solution (although it didn't exist) and even developed the idea into an trailer-based implementation plan so they could drive their specially-equipped datacenter to parking lots outside of desperate companies who would pay them a ton of money to fix their crisis. The stock zoomed and created many a fool as it turned into a poof and went to zero. We were amazed at how many people took it seriously.

Powerset isn't a public company and it's only going to lose the $10M it has raised so far. But still 22% of a poll being conducted on GigaOM thinks they will "reset Google" in the market.

I'm not sure we are in a real bubble but there is certainly a healthy amount of froth in the market place with respect to valuations. Silicon Valley is probably in bubble mode now but the public markets still seem somewhat grounded. If Powerset gets acquired for anything more than their remaining cash you know we are getting into some trouble...

VC goes lightweight...FINALLY!

2006-11-02T09:10:00.000-05:00

Charles River announced a new program to give $250K venture loans to entreneurs who send them an email (quickstart@crv.com) with their idea.

We give them credit for recognizing that many Venture Capital firms have amassed so much capital that they look more like Private Equity firms. Angel investors abound they can be hard to work with and demand a reasonable chunk of equity in exchange for a small investment.

This area has been championed by Paul Graham and his crew at Y Combinator but this move by Charles River certainly ups the ante and investment resources for building companies fast with a minimum of friction.

Overall the terms and conditions look pretty fair. Complete information on the program and the ability to apply can be found at the Charles River Website.

Virtual STDs

2006-10-31T14:24:00.000-05:00

A recent BBC article brings to light some of the more covert and malicious dangers of social networking and the YouTube phenomenon. The increasing popularity of video sharing destinations on the Internet have provided crackers (as an ex-software engineer, I refuse to use the word "hacker" to denote black-hat activities) and unscrupulous marketers the opportunity to proliferate malicious video codecs that install ad-ware and other viruses and trojans, often without providing any of the actual expected functionality.

This highlights the underbelly of Metcalfe's law, which states that the value (danger?) of a network is proportional to the square of the number of users of the system (n²).

So remember, when watching an online video passed on to you from a friend, you have now videoed with everyone that they have ever videoed with. Erstwhile online Johns had best be on their guard.

Calendar 2.0?

2006-10-24T15:52:00.000-05:00

We're tired of new calendars. Each one coming with a slightly different assortment of features and improved eye candy. When we ask about advanced functions and smart calendar behavior we are told they are all "tough use cases" and not planned in any future releases.

A calendar knows where I am going. It's easy to map it to my address book by location. It's easy to transfer a travel reservation automatically. It's not hard to deliver time and location-aware advertising to me based on my interests and plans.

Hopefully we are moving to a stage where developers will focus on adding these functions to existing calendar interfaces, be they Google Calendar, Outlook, iCal or what have you.

There's plenty of buzz around Scrybe which does indeed look like a nice implementation of a number of personal applications. While it is worth taking a look at and considering, the issue most people have now is that they are not really looking to ditch their existing calendar. Adding advanced functions in an integrated and seamless fashion seems like a way to win users.

We moved to Google Calendar some time ago for basic features and easy sharing. There's no offline capability and data import/export is a drag. These are problems we think will be solved soon. Generally speaking there is still too much focus on building the "next thing" and not enough on making what we have work much better by implementing those "tough use cases."

Open source usability still challenging...

2006-10-16T14:30:00.000-05:00

I know, I know... open source applications are typically used by people who really know what they are doing.

However as things like Firefox and Thunderbird become more mainstream and talk about the "Linux desktop" continues it's worth observing that even brand new (and excellent) add-in features require far too much brainpower to figure out how to use.

A recent case in point is the nifty little signature control add-in for the Thunderbird email client. We needed it badly and were surprised how much work was required to set it up. In fact we noticed that even many of the early open source adopters had run into the same problems and fortunately posted their solutions to the support pages.

Instead of being able to click on a simple "Install" button one must download and save the file, go into the Thunderbird extension manager, give the location of the file to the install dialog, restart Thunderbird and *then* it gets tricky!

You have to add the icon by going to toolbar customization. But when you try it the first time you don't see the option. Turns out you have to add it to the toolbar that comes up when you are in the sending mail context.

After you've spent the hour or two to figure it all out at least it makes logical sense. We were willing to work through what were two or three real obstacles to getting the functions working.

Most users would have stopped after 15 minutes if they even made it that far. This is the kind of thing that sends people to terrible programs like MS Outlook.

We are huge open source fans and supporters but continue to wonder why it seems so much harder than it should be.

Alcatel talks video, WiMAX steam powering ALVR?

2006-10-11T07:15:00.000-05:00

During the current broadband networking conference being held in Paris, we had a few moments to pop into hear Mike Quigley, President and COO of Alcatel (ALA), talk about their current plans around wireline networking. We also were able to soak up some general observations from walking the floor and talking to vendors.

Not surprisingly, Alcatel is focused on the growth of broadband subscribers and the need for their customers to find ways to reduce churn and operating expenses with new services and infrastructure.

There were a few interesting highlights from an annual customer survey which indicated that 9 of the top 10 opportunities are in personalization, rather than accessibility or interactivity. Although few details were shared, it was clear that quite a few had to do with video. In fact, Quigley did say that it appeared that customers were making their initial provider choice on the basis of video and then making decisions regarding other services like VoIP. No doubt based at least in part on these results the key aspects of future platforms include being optimized for video services.

More broadly it was clear from the myriad vendor presentations that every single one of them was spending a great deal to drive their own flavor of triple-play solutions into the market with improved performance and lower pricing. One thing for sure is that software and services companies like Google can rest assured that the broadband network will be in place to support the kind of software as a service architecture core to their approach.

Motorola (MOT) was mildly surprising for us although we admit to being easier to impress in networking than software. The company was showing a very impressive fiber networking platform that Verizon (VZ) has chosen to deploy as their solution. We don't normally think much of Motorola in this space but it appears that they have a pretty compelling offering here.

One of the benefits of the system they showed includes the ability to support a 20km+ distance to the end node delivering 2.4GB/sec (1.2GB upstream). Not yet single wavelengths of light into the home but pretty good from a practical standpoint.

There was also far more WiMAX deployment activity than we would have guessed, especially in Europe which seems to be a little 3G focused. Apparently WiMAX will have a major role here with some large players like France Telcom who owns the fixed market and has purchased the WiMAX spectrum to compete more effectively with the cellular providers.

A small public company, Alvarion (ALVR), has an pretty good portfolio of WiMAX technology products and early deployments. They company has a good deal of legacy non-WiMAX business, but if the excitement continues to build around WiMAX being a simpler alternative to the seven radios in every phone the Qualcomm guys power, talk about the stock will continue to do well and stand a good chance to be bought out by one of the larger networking players.

Petrie Parkman IPO - just okay at $200M or below.

2006-09-14T07:24:00.000-05:00

Another boutique investment bank has filed for an IPO. Petrie is in the energy sector so given the current market dynamics everyone will agree that "now is the time!"

Having worked at firms like this for years one can't resist having a look to see if they have an innovative business model that would actually suggest that outside equity holders could earn strong returns.

Petrie looks to be actually far worse than average. At first glance one is struck by their stunning growth - revenues were up 79% YoY for 1H06 to $62.3M. However expenses were up 81% to $62.2M wiped out any profit for the period. (We understand that typically this is a high period for compensation so overall profits will be better for the calendar year, as they were for the full year 2005, see below.)

Aside from the fact that the company revenues are all directly linked to the red-hot energy sector they are even more concentrated with a full third coming from just one client in 1H06.

For the full year 2005 the company generated a 5.6% net margin. Looking at 2006 we can use $125M as full year revenue and suggest a 10% margin target to guess at a $12.5M net. Putting a 10x multiple on what could be peak earnings for the company and adding the $60M in cash we get to about $200M.

There are plenty of expansion opportunities for the firm in related areas and geographically but they will all involve investment. Due to the compensation overhead ($1.2M/employee in 2H06) the outcome will depend on a sustained level of high activity in energy.

On the surface Petrie looks to be an excellent company in their niche and provides excellent value for their clients and employees. The risk/reward for outside equity holders doesn't look very good unless the stock is priced at a very reasonable valuation. Investors need to price in the likely case that revenue in a future year will be down and given the business model and compensation structure they are not likely to fare well then.

[UPDATE - Well the company was acquired by Merrill for what was reported to be $500M or so. Even though it's a rich valuation the deal is good for both sides. Merrill has the banking, trading and fixed income operations to make the $500M pay off quickly in what will always be a big sector and the company is spared from the misery of being a low-profit, low-multiple public company.]

Sun has the "dot" wrong again...

2006-09-13T06:24:00.000-05:00

Jonathan Schwartz rang the bell to open NASDAQ today and is holding their customer day in NYC today.

After six years of losing money post the "putting the dot in .com" era Sun is talking about how well all parts of the business are doing and that "all signs are pointing to the right." Despite that the company is not yet sure they will be profitable this fiscal year.

Last year at this time Schwartz stated that the profit opportunties from utility-style service-oriented computing from arrays of servers would be vastly better than what they were experiencing selling discrete servers. The suggestion was that gross margins would be 30% or higher.

Did he have a price point in mind? Yes, just $1/CPU hour. Since it was pulled out of the air we shouldn't be surprised when the actual price being charged by companies like Amazon today is $0.10/CPU hour.

Imagine what that does to your gross and net operating margin assumptions!

The bottom line is that Sun probably will be successful driving more units into the market at much lower prices and take some market share but still seems to have their head in the clouds (or sand) with respect to a profitable business model.

Galbraith on meetings.

2006-09-04T01:19:00.000-05:00

As an aside in his book The Great Crash, Galbraith writes a wonderful little riff on meetings before he discusses the tactics that President Hoover used to appear busy in the aftermath of the stock market crash of 1929.

"Men meet together for many reasons in the course of business. They need to instruct or persuade each other. They must agree on a course of action. They find thinking in public more productive and less painful than thinking in private. But there are at least as many reasons for meetings to transact no business. Meetings are held because men seek companionship or, at a minimum, wish to escape the tedium of solitary duties. They yearn for the prestige which accrues to the man who presides over meetings, and this leads them to convoke assemblages over which they can preside. Finally, there is the meeting which is called not because there is business to be done, but because it is necessary to create the impression that business is being done. Such meetings are more than a substitute for action. They are widely regarded as action.

The fact that no business is transacted at a no-business meeting is normally not a serious cause of embarrassment to those attending. Numerous formulas have been devised to prevent discomfort. Thus scholars, who are great devotees of the no-business meeting, rely heavily on the exchange-of-ideas justification. To them the exchange of ideas is an absolute good. Any meeting at which ideas are exchanged is, therefore, useful. This justification is nearly ironclad. It is very hard to have a meeting of which it can be said that no ideas were exchanged."

For me this is a little gem. If you haven't read the book you can buy The Great Crash at Amazon.com.

What is Larry Kudlow on?

2006-08-17T19:38:00.000-05:00

Being largely out of public equity markets for the summer and coming back from a couple of weeks of family vacation I was caught off guard by Larry Kudlow during his regular show today. He was crowing about the best ever stock market ever! Stocks are at 5 year highs! We are proving again that capitalism is alive and well!

I started wondering what could have happened these last two weeks?! True there was a small technical bounce from oversold conditions but with little volume and no change to the underlying fundamentals. Most stocks seem to be flat to down of late and realistic concerns about the economy and inflation remain unresolved.

It's hard for anyone to be perfectly objective but Larry reminds me of the worst when it comes to repeating sins of the past when "experts" regularly explain with authority that investors will be "just fine" no matter what the data suggest.

We read plenty from far smarter people out there on the macro economy and the markets and can find absolutely no clear agreement or compelling reason to try and outguess them. It's embarrassing to watch someone like Larry Kudlow distort information and offer conclusions with zero research behind them. Thankfully we rarely watch anything on CNBC due to the pain it inflicts.

Openwave (OPWV) and the research providers...

2006-07-06T08:41:00.000-05:00

Interestingly we have watched this situation develop as this company had a nice rise in stock price into the low-20's followed by a huge ramp down to $8 this morning.

The consensus among the 20 "real analysts" that cover the stock is for a moderate buy versus the nearly unanimous opinion of black box analytics firms of "Strong Sell" all the way down.

In the case of OPWV the financial numbers were a better predictor of future stock price than the industry expertise afforded to active analysts who write on the company.

We will be publishing our overall software universe in the next few days as a prelude to doing some of this numbers-driven analysis to identify situations where our informed and reasoned opinions, positive or negative, may be at odds with reality.

OPWV
Openwave
Finance
Investment

Vista...is that really it?

2006-06-14T04:20:00.000-05:00

We only did the walk through on ZDNet but it was a big disappointment. It's true the new 3D looking icons are cool but that can't be it right?!

There is better integration for pictures, audio and video but it doesn't even catch up to what you have on OS X today so it's just more me too stuff.

Improved integrated security is probably the only thing that we nodded at; thinking that customers will very likely want these features and security is often enough of a reason to upgrade to a new software release, at least in the corporate world.

On the whole disappointed but not surprised. Corporates hooked on Windows will upgrade and the rest of the world will probably yawn.

We will take the Beta later and play some more but the walk through was all that could be managed today.

MSFT
Microsoft
Finance
Investment

Bank of France warns on risk....

2006-06-04T10:16:00.000-05:00

The FT carried the story on May 31, 2006 that the "Bank of France warned that the tools used to measure risk had been made obsolete by the rapid growth of complex financial products, such as credit derivatives and structured investements in hedge funds."

The article goes on to emphasize what the BoF was most concerned about the "value at risk" computation which could be much lower than the actual risk if market volatility and/or interest rates increase.

Interesting the "value at risk" measure which is the item most investors focus on assumes that positions can be liquidated in 10 days. Beyond being just arbitrary this assumption seems quite inconsistent with what can reasonably be expected in the market today, let alone a panicked market where liquidity is severely tested by hurding market participants!

In a related article JPMorgan noted that the amount of funds invested in the collateralised debt obligation (CDO) market is now about $1 trillion and may reach or even exceed the $1.2 trillion estimated for the hedge fund industry.

Another chapter in our continuing exploration of systemic risk in the global financial system.

Cramer
AIM
Euronext

A reasonable OpEd from Cramer.

2006-05-27T07:38:00.000-05:00

We wince when we think about Jim Cramer and his "Mad Money" success but his WSJ OpEd yesterday regarding Euronext and the NYSE was spot on.

Jim points out what we already know: The regulatory burdens and lousy industry fundamentals for the US Equity business hurt more than just Wall Street paychecks.

He goes on to point out the more effective structure of the overseas markets and the fact that all the profits in US exchanges have migrated to areas where there is some pricing power and a better structure, namely derivatives.

We see no quick fix for the situation in the US which has definitely piqued our interest in focusing more of our research efforts abroad.

WSJ now charges for their content online but you can find his OpEd in the May 26th edition.

Cramer
AIM
Euronext

Private Equity Full Circle?

2006-05-24T15:00:00.000-05:00

When KKR "went public" recently to raise another huge buyout fund a little bell went off in our head.

We have noted the multi-year shift away from public markets that started with hedge funds and then these massive increases in private equity activity around the world. It has been a situation that simply reflects the reality of the marketplace and the power large cash buyers have to dictate terms away from public markets.

Then KKR went to the public markets with enough success that there appears to be a line forming for the other major players to do the same thing.

This completion of the circle combined with announcements about upcoming $25B technology company buyouts and $100B funds just seems surreal.

Are the markets that broken?

Private Equity
KKR
Stock Market

Corporate Apple Polishing.

2006-05-09T04:53:00.000-05:00

We were very surprised to see the results for Apple published late last year by CIO Insight in their December Issue.

Nobody expects Apple to gain much share in the enteprise yet this survey seems to indicate otherwise. The survey itself seems legitimate with 884 qualified responses. More information on how it was conducted is in the report.

The highlight is that Apple is now #2 on the overall list versus #5 last year and #9 the year before. (Red Hat is #1 and was so last year when it first made the list.)

This survey was conducted *before* the announcements about MacBook Pro models being able to run XP and Microsoft delaying Vista.

We'd also note that the corporate favorite ThinkPad has a new owner that may have more consumer-oriented ambitions and Michael Dell musing that he'd like to sell computers running OS X.

So the opportunity for Apple in the corporate space may be greater than we had thought. It's time to do a little survey of our own.

[I wasn't able to post a direct link to the PDF of the survey on their site so you have to dig it out. If anyone else manages to find one feel free to add it as a comment.]

AAPL
Apple

Turning research departments into hedge funds?

2006-05-05T03:58:00.000-05:00

[This was previously posted on another blog and I moved it here where it fits better.]

This my response to a recent FT article that talked about taking all the research analysts producing currently useless content and putting them to work doing proprietary projects for investment banks and hedge funds.

James,

I am responding to your column on April 18th. I've been in equity research for years and a DoR for the last few when I worked for investment banks. (I left to start my own research business.)

You observations regarding the astonishingly vapid quality of what is passed off these days as "research" is spot on. It's embarrassing. One just has to look at the Barron's listing of research report summaries because so many of them read "Company XYZ is doing very well. We remain neutral however because the stock is fairly valued. If the company continues to show strong and improving results in the future we would be more positive." And wouldn't that then be reflected in an even higher share price? Ever hear the idea that the market is a *discounting* mechanism?! It's really ridiculous.

It has always difficult to produce investment research that actually focused predicting the future events for companies and stocks, backed it up with real data and enabled investors to make money. We did it back at SoundView in the 1990's. Of course at the time there wasn't much to get in the way. Analysts were free from logging hundreds of client calls, marketing to be II, playing compensation politics, navigating complex compliance and regulatory requirements and all other forms of wasted effort. Furthermore analysts like myself could "put our money where our mouth was" and invest our own money in our best ideas (after giving our clients all the information with a waiting period.) Analysts were driven to find real investment opportunities instead of covering the news and pushing spreadsheets around.

I could go on enough to fill a book about what it takes to do this right but I can let you know that the conclusion is that it can no longer be done within the structure of a broker or investment bank - at least none that I am aware of.

Your idea about hedge funds makes sense... however: the truth is less than 5% of equity analysts are really stock focused enough to make that work. The vast majority of analysts leave it to others to manage their money or actually put the bulk of their cash in bonds. A few I know invest in blue chip stocks and actively right calls on their positions with a view towards income versus risk. In fact when they are allowed to few analysts actually invest in their own sectors. Many are also terrible portfolio managers and investors when given the chance. Of course there are a few that are and I suspect those are the ones that have migrated to hedge funds.

My biased view is that the way to fix this is to create a wholly new approach to research outside of the broker-dealer, investment banking, regulatory world. If you want research analysts to focus the bulk of their time finding and figuring out great investment opportunities they just need everything else taken off their plate. This includes client marketing, sales and trading support, research reports on news items and earnings releases, meetings with regulators whenever a rating has to be changed, etc.

It's already been a nasty five years but I believe it will still take several more years for such firms (hopefully mine will be one of them) can really demonstrate highly effective research of this ilk and make an impact in the market.

Kris Tuttle
Founder & CEO of Research 2.0

Research
FT
Investment
Equity
Hedge Funds

Microsoft frustration.

2006-05-04T07:11:00.000-05:00

So wanting to be fair I went to MSN AdCenter today to set it up in a similar fashion to how our company uses Google AdWords. Unfortunately I didn't get to square one because they don't support FireFox.

Yes we could it but it's a poke in the eye before you even get started. It's one thing to say "some of the nifty features will only work with IE."

It seems that the entire opportunity focus for Microsoft resides in their installed base rather than new users. It's a big base to be sure but we'd still insist that investors will afford them a lower multiple for milking the imprisoned user base rather than doing something that attracts new business.

MSFT
Microsoft
Google
Finance
Investment

Is MSFT a value trap?

2006-05-02T04:07:00.000-05:00

The software still counts.

A fresh 10% decline in Microsoft last week gave everyone the chance to wonder if the valuation on MSFT was just too compelling to overlook despite their seemingly dim prospects.

Many investors are thinking and some analysts are suggesting that buying the stock at these levels will give them attractive returns. Just give Microsoft the chance to turn the crank a few times on product development and delivery, make some acquisitions and the multiple will expand from from current depressed levels. After all this is a very profitable company with huge cash reserves and a massive installed base of users who can not easily migrate to another platform.

Windows and the Office Suite seem to be pretty safe notwithstanding inroads from Apple and Google. Apple's success will probably double their market share to 6%, say 10% if you want to be aggressive. Firefox is doing extremely well but IE continues to have 70% share. Gmail is growing way faster than Hotmail but still has only 10% as many users.

All that said we have seen these tempting situations end up in disappointment. It's been hard to recover once on the wrong side of the technology curve, particularly in software. We wrote in an earlier report that given the years of development effort required for Mozilla to recast Firefox, it might require a decade or more for Microsoft to recast their own software content, at least at the application software layer.

It feels like Microsoft is still in a secular downtrend but money can be made by picking spots. Given their installed base the potential for a Vista/Office upgrade cycle the stock will probably see a decent rise at some point. To us all these are opportunties to buy and sell the stock but not enough to suggest a secular uptrend.

Investors have plenty of reasons to be skeptical of where the $2.5B will be spent. Many acquisitions in the past may not have been total failures but didn't seem to change much. Many Microsoft products outside of the core Windows, IE and Office have faded from memory.

We played with Windows Live and came away pretty disgusted. What we created easily and simply in Google was slow, non-intuitive and burdensome in Windows Live. When Steve Ballmer jokes that his kids don't use Google or iTunes we feel that it speaks volumes about the real problem at Microsoft. These products represent the new baseline for what people expect. If you don't know them well, how do you do a better job?

Ray Ozzie seems to be the face of future innovation at Microsoft these days. So far we are pretty unimpressed. We have used Lotus Notes and Groove. Both definitely had visionary elements in their functionality but operationally left a good bit to be desired. In fact Groove reminded us of Outlook in terms of the vast resources it consumed relative the functions delivered. (We don't use any bloated products anymore in this shop...) Ray has been a trooper and introduced concepts like the Live Clipboard that some like, we think it treats the symptom and not the disease.

From a pure numbers standpoint it would seem that Microsoft at these prices is a trading buy (we did purchase stock on the dip but would sell it at $27.) Beyond that the question to us remains open. Because the installed base is so huge and has limited ability to migrate there are plenty of reasons to believe that financially Microsoft can rebound and give investors a return. But will it seem like a CA-style return or something more inspiring?

Maybe the company will get aggressive and acquire a handful of companies that show some clever thinking about leveraging their position?

Maybe there will be a change in the kind of insular brute force thinking that comes from Steve Ballmer?

Either one of these could be a real sign of encouragement for the longer term but without them it's hard to expect a major change in the culture and operating style of the company to fit a true Web-focused approach to software and computing.

Everyone has their 2c on Microsoft but since we took the time yesterday to put our hands on Windows Live, we figured it was worth noting our opinions here. If Windows Live is the flagship of the USS Microsoft it's riding pretty low in the water.

We'd love to see some comments on this one!

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AOL gets the idea!

2006-04-28T06:35:00.000-05:00

We have no idea how successful they will be but AOL today announced that they are launching a number of stock-focused blogs. The bloggers will have editorial freedom it is said and be able to invest freely in stocks so long as they disclose their actions and positions. We feel this validates our view of the value of putting investment content out in unconventional ways and shows that publishing in this manner does not constitute activity that needs to be regulated by the SEC or NASD.

We'll be interested to see how these properties evolve and what sort of content ends up here. The track record for such open social commentary sites is not great. For more information on that see work by Clay Shirky at NYU.

Research 2.0 Blog is Born

2006-04-27T14:14:00.000-05:00

As we have continued to develop our online brand it has become clear that we needed a blog that was purely aimed at Research 2.0 topics versus our far more varied posts on our personal blog. This is the place to focus on research and the impact of the lightweight business model on traditional Wall Street and institutional publishers.