"?> Davis Freeberg's Digital Connection » SA http://davisfreeberg.com Fri, 23 Sep 2011 19:32:38 +0000 en hourly 1 http://wordpress.org/?v=3.3.1 Did Motorola Get Caught With A Smoking Gun? TiVo Demands Source Code Access To Secret DVRs http://davisfreeberg.com/2011/07/28/did-motorola-get-caught-with-a-smoking-gun-tivo-demands-source-code-access-to-secret-dvrs/ http://davisfreeberg.com/2011/07/28/did-motorola-get-caught-with-a-smoking-gun-tivo-demands-source-code-access-to-secret-dvrs/#comments Thu, 28 Jul 2011 21:37:45 +0000 Davis http://davisfreeberg.com/?p=2195 TiVo’s Motion To Compel Source Code

(Above you’ll find a copy of a motion to compel that TiVo filed against Motorola on July 22nd, 2011. On July 25th, the judge in the case gave Motorola 14 days to comply with the order or to explain their actions to the court. To view all of the exhibits, associated with the complaint, you may click on the following links: Declaration By TiVo’s Attorney, Court order requiring production of all source code, Motorola dodging TiVo’s phone calls, TiVo’s initial patent complaint against Verizon.) As a friendly reminder, I am both a TiVo customer and shareholder.

TiVo’s love quarrel with Echostar may have just come to an end, but they still have two more elephants lined up in the crosshairs of their gun and while I always hate to read too much into the legal tea leaves, recent action on one of the dockets, suggests that they may have just stunned one of them with a tranquilizer dart.

As part of their patent lawsuit against Verizon, TiVo had initially requested access to Verizon’s source code on their FIOS DVR. This kind of data makes it easier for TiVo to identify any potential infringement and would certainly be a key piece of evidence towards proving any patent violations. Now there are many reasons why Verizon might not want to turn over this kind of data, but where things start to get weird is that instead of objecting to the request, Verizon claimed they weren’t able to comply with it because Motorola was the one that developed their DVR. This seems fair enough, so in good faith TiVo began working with Motorola to obtain the data.

Fast forward through three months of stalling and Motorola finally turns over two different copies of their database to TiVo. The problem with this is that once TiVo started going over all the documents that they collected, they discovered that Motorola had actually developed “many more versions” of the source code using secret codes names like Burbank, Carlsbad, Del Mar and Cardiff. In total, TiVo believes that there are over 30 different models that Motorola has out there and after being stung with delay after delay over “software modifications” in their trial against Dish, it’s easy to understand why TiVo would want to exercise extreme due diligence on this one.

Once TiVo realized that Motorola was trying to pull off the old fumblerooskie play on them, they dragged Verizon and Motorola back into court and clarified that they wanted all of the source code data on their DVRs. The judge agreed and in March of this year, he ordered Motorola to release “without limitation all Deployed versions of Motorola’s Del Mar source code and all Deployed versions of any predecessor to the Del Mar source code, as well as associated Broadcom code.” [Note: Emphasis added by me]

After the subpoena, one would have really thought that this would be the end of it, but instead Motorola continued to try and string TiVo along. In the attached exhibits, TiVo demonstrated that they contacted Motorola numerous times to discuss the deficiency, yet Motorola seemed only willing to reply whenever TiVo threatened to flex their legal muscle in the case. At one point, Motorola even set up a conference call to deter TiVo from filing this motion to compel, but then opted to ditch out on the call (without even having the courtesy to cancel.)

While these sorts of petty issues won’t actually impact the case, they can still provide us with insight into the case. Motorola’s lack of responsiveness suggests a certain squirreliness on their part. Instead of portraying a company that is confident in their legal position, the attachments paint a portrait of a company that is desperately trying to do anything to avoid turning over this evidence. The very way that Motorola has treated TiVo over the last 8 months could be a primer on how to maximize passive aggressiveness by only using your caller ID. After considering TiVo’s frustration with moving the case forward and the lack of any real justifications for the delays, the judge gave Motorola a final deadline of 14 days to turn over the evidence in question or to demonstrate why they seem to feel that they don’t need to comply with the court’s instructions.

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The Next Big Big Thing In Advertising http://davisfreeberg.com/2011/01/04/the-next-big-big-thing-in-advertising/ http://davisfreeberg.com/2011/01/04/the-next-big-big-thing-in-advertising/#comments Wed, 05 Jan 2011 05:41:03 +0000 Davis http://davisfreeberg.com/?p=1965 Clear Channel

I managed to get stuck in traffic during the middle of the day today and had the opportunity to listen to old people talk radio while I waited. There was some cranky guy on who was clearly worried about his own job in media. During the program he bemoaned Facebook’s $50 billion valuation, the demise of newspaper circulations and the end of the good old days when we used to have to pay travel agents $100′s of dollars to buy tickets for us.

Even though I didn’t agree with his bleak sentiments, it did make me reflect on how technology has managed to eviscerate one industry after another. Some of these trends caught on like wildfire, while other ideas were forced to lay dormant for years while the rest of the world caught up. Whether you’re talking about landlines, photo processing booths or Blockbuster Video, sooner or later good ideas have a way of replacing yesterday’s technology.

Normally, I expect to see new innovators challenging the status quo, but one industry that is experiencing it’s own “life changing” moment right now, is actually being led by the incumbents. Most people think of billboards are being somewhat of an eyesore. If you’re located in an area where you spend a lot of time, then you know what it’s like to have to look at the same old ad for months and months. By the time they do update the ad, the old one is usually halfway peeled off. Advertisers may be able to reach millions of people with a campaign, but it limits the value when they have to plan their campaign months in advance and when the presentation makes their brand look so tattered.

Over the last year, there have been two improvements in the signage industry that have impressed me a lot. The first has been how effective Lamar Advertising has been at using their digital signage portfolio to make a splash in social media. When Ashton Kutcher was trying to hit 1 million followers on Twitter, the company cashed in by giving away free exposure to @aplusk. When the goons at NBC butchered the Tonight Show by bringing Leno back, Lamar used outrage over the incident to reach the heart and souls of TeamCoco fans. While neither of these examples netted the company any serious cash, what they did prove was how much the internet/media/consumers will freak out over billboards that mention current buzz. With most companies clueless about ways to drum up buzz, Lamar’s portfolio offers an easy way for their customers to inject themselves instantly into any social conversation. Even if the sign is only up for a day, it will live forever online. With the TV advertising industry ready to pop, there will be a lot of money available to businesses that can provide this kind of immediate reach and response.

The other signage company that has really caught my attention is Clear Channel Communications. The company may be a dinosaur and burdened with way too much debt, but over the next 2 years, they plan on deploying 300 interactive displays that can only be described as life sized iPads. So far the displays have been a huge hit at San Francisco bus stops and I think that they are the real deal. Before the holidays, Digital Signage Insights posted a comprehensive behind the scenes view into how they work and their capabilities,

“The content management system, graphics processing unit, and real-time measurement application built into each digital bus shelter are capable of producing 3D graphics and immersive content the likes of which have not been seen in the digital out-of-home media sector. Clear Channel and its partners have just begun to scratch the surface of what these systems are capable of. The “Yahoo Bus Stop Derby” is a crowning example of what can be achieved at the convergence point of creativity and technology. San Francisco’s interactive bus shelters have been built with the future in mind. Owing to Clear Channel’s and Obscura Digital’s views on the expansion of the web into real world environments, the units allow for seamless scalability and back-end cloud networking. From supporting cinema-level 3D graphics, processing interactive 3D visualizations, to offloading real-time rendering to the cloud, San Francisco’s new bus shelters can do everything short of driving you to the office. On top of that, the shelters have been equipped with a real-time user-metrics collection system that provides advertisers with actionable intelligence throughout their interactive campaigns. The granular behavioral data that the units capture can be used to optimize applications in real-time, so to achieve the highest level of user engagement.”

The outdoor signage industry may seem as quaint as using your spare change for the payphone, but there’s no doubt in my mind that the industry is evolving. Whether either of these companies have the balance sheet or wherewithal to move past their debt issues is another story entirely, but I certainly can’t fault them for creating new and innovative ways where advertisers and consumers can connect on a more emotional level.

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Blockbuster’s Latest Drama Is Political Thriller http://davisfreeberg.com/2010/04/12/blockbusters-latest-drama-is-political-thriller/ http://davisfreeberg.com/2010/04/12/blockbusters-latest-drama-is-political-thriller/#comments Mon, 12 Apr 2010 15:09:21 +0000 Davis http://davisfreeberg.com/?p=1920 Political ThrillerThey say that a good captain will go down with their ship, but what can you say about the guy who climbs on-board after the ship has begun taking on water? Over the last few years, Blockbuster Video has hit iceberg after iceberg and while they’ve avoided capsizing this long, a $300 million looming debt payment may be the final torpedo that sinks the historic brand. Over the last few months, Blockbuster has seen board members flee like rats off of a sinking ship, but at least one shareholder wants to fight to save the company.

Last week, Greg Meyer fired the first shot in a proxy war by submitting paperwork to have his name considered for a position on Blockbuster’s board of directors. To win, he’ll need to take on board of director incumbent, James Crystal. In the proxy filing, Meyer makes a strong case that he is the more qualified candidate for the position.

-In 2001 Meyer started a DVD kiosk business at a time when most thought the idea was crazy. Eventually, DVDXpress was sold to Coinstar and later merged with Redbox. Mr. Crystal on the other hand has spent his career running an insurance company and doesn’t have any DVD industry experience.

-Over the last year, Meyer has put his own money on the line by purchasing over 600,000 Blockbuster shares on the open market, Crystal on the other hand has less than $50,000 worth of Blockbuster’s stock and only because it was given to him for serving on the board of directors.

-While Crystal’s full time job is his insurance business, he also serves on 7 other boards for various insurance companies. Meyer’s only other board position is with a non-profit that uses movies to help reach young kids.

-Perhaps most damaging of all though, is the related transaction between Mr. Crystal and Blockbuster. Last October, Blockbuster made Frank Crystal & Company their exclusive insurance broker for the company. At the same time, Mr. Crystal, who sits on the compensation committee, was helping to award over $1.5 million in bonuses to Blockbuster executives in a year where Blockbuster lost over a half a billion dollars. Given that Blockbuster CEO James Keyes was awarded $400,000 of that bonus, perhaps it isn’t all that surprising to see him come out against Meyer’s nomination.

In a press release, Keyes rejected the idea of adding Meyer to the board and wrote,

“While we have an appreciation for Mr. Gregory Meyer’s investment and interest in the company, those are not sufficient reasons for his candidacy for the board. We are disappointed Mr. Meyer is pursuing a costly and disruptive proxy contest. A proxy contest can only serve as a distraction to the company when attention and resources would be better used in creating value for stakeholders by implementing our strategic plan. We assure all of our constituencies that we remain committed, as always, to doing what is right for our shareholders, debt holders, employees, and customers,”

Distraction or not, it’s understandable that Blockbuster’s shareholders would be disappointed in the current board of directors. Since bringing on Keyes, Blockbuster has seen their stock fall from $4.46 to $0.29 per share. During that time, they’ve seen Netflix and Redbox take market share from them, while they were concentrating on trying to figure out a way to save Circuit City from bankruptcy. Instead of focusing on offering an all you can eat streaming service, Blockbuster spent their operating income on redesigning their stores. Meanwhile, they’ve continued to lose the confidence of both the stock and bond market.

Given that there aren’t many people who’d be willing to run into a burning building in order to save a video store, I reached out to Mr. Meyers to help better understand what he hopes to accomplish with his proxy run. Below is a transcript from our interview.

Davis: I guess the biggest question on my mind is that with Blockbuster clearly hurting pretty bad right now, why you would even want to get involved with the company. You’ve already proven that you can build a DVD business from scratch, what is it about the challenge of turning the company around that appeals to you, instead of using your time and capital to create another new business?

Meyer: When our team was building the DVDXpress business early on, we spent years struggling to make customers aware of the fact that it was possible to rent DVDs from a kiosk and encouraging them to do so. Blockbuster was such a dominant force at the time that we felt like we were constantly swimming upstream against this 900lb gorilla.

Fast forward to today and the tables have turned so that many people say ‘Why would I ever go to Blockbuster?’ I think the pendulum has swung too far and believe there is an enormous amount of intrinsic value within Blockbuster that can be realized with proper guidance and forward-thinking strategic insight. Love ‘em or hate ‘em, everyone knows that Blockbuster means movies, and having such widespread brand awareness is extremely valuable.

Davis: Having served on the front lines of the bond market, what insights does this give you into how the banks and hedge funds might be thinking about Blockbuster’s debt right now? Specifically, what sorts of things do you think that they’d like to see in order to be amenable to restructuring overtures?

Meyer: The perception in the market is that Blockbuster’s subordinated notes will be equitized at the expense of shareholders. I believe there are some intelligent steps that management can take to avoid this outcome, which would obviously be advantageous for shareholders- and I have recently apprised them of one such structure. The Company and its legal and financial advisors need to be thinking about creative solutions to bring the company back to health and not take the easy way out by converting sub debt
to equity unnecessarily. My impression is that the Company and its advisors are looking at this as a zero sum game instead of trying to figure out how to creatively increase the size of the pie for all constituents, which I think is doable. That’s why I think it’s so important to have at least one shareholder advocate on the board.

Davis: You also mentioned in your filing that you’d like to pursue a solution that results in the lowest possible dilution, if any, of shareholders. Given the burden of having to service almost a billion dollars worth of debt, can Blockbuster be competitive in an industry whose competition is cutthroat right now? Can you share any thoughts on your rescue plan for Blockbuster and what it might take to save the company?

Meyer: Blockbuster has some incredibly valuable assets and competitive advantages. In addition to huge brand awareness, the Company has very strong relationships with the Hollywood studios. These studio relationships have become more apparent in the last few months with the Warner, Fox, and Sony supply deals providing Blockbuster with day-and-date availability of new release titles vs. the 28-day delay for other channels. This is a huge advantage relative to Netflix and kiosks competitors, and it’s one that Blockbuster has never had in the past. I think the company has done a reasonable job of communicating this advantage to customers with the recent release of ‘The Blindside’ and ‘Sherlock Holmes’.

The studios are smart- they realize it is in their best interest to have a healthy Blockbuster. Blockbuster spends more money on DVD inventory each year than Netflix and the kiosk operators combined, so they’re a very important source of revenue for the studios. And Blockbuster’s a la carte rental pricing is not viewed to cannibalize sales like some of the other distribution channels. So I view Blockbuster’s relationships with the studios remaining strong over time and think the Company needs to continue to leverage these relationships going forward, particularly as digital delivery replaces physical distribution. Keep in mind that the First Sale Doctrine does not apply in the same way to the digital world as it does to the physical world, so having strong relationships with the studios becomes even more important down the road as the studios have stronger control over who gets their content.

For now, having closed many of its underperforming stores already and amid a significant reduction in overall brick-and-mortar industry capacity, Blockbuster’s physical stores represent a true asset if managed properly that can generate significant cash flow for years to come and act as a bridge to its various future distribution channels rather than an impediment.

Davis: Blockbuster released a press release urging shareholders to reject your advances, saying that they were disappointed that you were pursuing a “costly and disruptive proxy contest” at a time when their efforts should be focused on executing their existing turnaround plan. Do you feel that it’s appropriate for Blockbuster management to publicly respond this way and do you have any concerns that your actions could have any negative consequences by trying to shake up the status quo?

Meyer: The reality is that Blockbuster’s management is making the decision to perpetuate a proxy contest. I find it unconscionable that management would be willing to waste shareholders money to fight a full blown proxy contest to keep a qualified, industry relevant and highly motivated individual off the Board. If James W. Crystal is as valuable as James W. Keyes suggests then I would be happy to serve constructively with him on the board. This does not have to be mutually exclusive. Keep in mind the size of the board has shrunk from 9 to 7 over the past few months due to several departures, so having both of us as directors would actually return the board to a more normal size. But this is a decision that Jim Keyes and the Board has to make as it is out of my hands.

Davis: Beyond the finance side of the equation, is there anything that you feel Blockbuster should be doing to make their product more relevant to consumers?

Meyer: Yes, I think the value proposition to customers can be significantly improved. Look at the smart things that smaller brick-and-mortar video competitors like Family Video (rental) and MovieStop (retail) are doing. These companies have been growing rapidly over the past several years as they’ve figured out how to remain relevant with consumers despite growing competition from Netflix and the kiosk operators. These companies offer a variety of real services to their customers. As one small example, both of these chains offer a ‘Notification Service’ by which they will call or email their customers when a movie or game becomes available for rental or sale, either new or used. This builds goodwill and drives customer traffic. Sometimes a lot of small improvements at the margin add up to a much better experience.

Additionally, these chains have figured out intelligent pricing structures that appeal to the widest possible audience in a manner that still generates profits for the retailer. There is a lot that can be done with pricing to improve both customer satisfaction and profitability.

And of course there are many innovative steps the company can take to serve customers digitally, some of which they’ve started to take with Blockbuster On Demand. The combination of near ubiquitous brand awareness and strong studio relationships has the potential to make Blockbuster a dominant player in digital delivery going forward, but this path needs to be navigated intelligently to ensure success.

Davis: Finally, Carl Ichan previously spent a lot of time and money trying to win board seats and concessions from Blockbuster management. While he ultimately won, his actions haven’t seemed to help the company all that much. Even if you were to win a seat, do you think that you’d have enough influence to create the kind of change that Blockbuster needs in order to save their business?

Meyer: All I can ask for is the opportunity to have my informed opinions heard at the board level and hope that the other directors would act in a rational and objective manner in the best interests of the shareholders.

Since I’m not a Blockbuster shareholder, my vote won’t count in this contest, but I am interested in what other shareholders think, so feel free to share your thoughts in the comments. Will you be voting for Meyer? For Crystal or do you plan to kick all the bums out? While fighting a proxy war can be a distraction and could potentially interfere with Blockbuster’s efforts to restructure their debt, it can also bring hope to a weary shareholder base at a time when things seem hopeless. I don’t think that Meyer can turn the company around single handedly, but as Johann Wolfgang Von Goethe once wrote, “in all things it’s better to hope than to despair.”

Update – In an open letter to shareholders, Meyer calls out James Keyes for perpetuating the proxy contest and reveals that he encouraged Blockbuster to adopt DVD kiosk technology over five years ago. At that time he also pointed out that Blockbuster could have saved $140 million per year by cutting their store hours by three hours per day.

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TiVo Awarded Patent For Closed Captions On A DVR http://davisfreeberg.com/2010/02/11/tivo-awarded-patent-for-interactive-data-closed-captions-on-dvrs/ http://davisfreeberg.com/2010/02/11/tivo-awarded-patent-for-interactive-data-closed-captions-on-dvrs/#comments Thu, 11 Feb 2010 14:25:12 +0000 Davis http://davisfreeberg.com/?p=1862 The Hash Tag Patent

TiVo doesn’t know whether or not their injunction against Dish’s DVR will hold up yet, but that hasn’t stopped them from adding to their patent portfolio in the meantime. In a remarkable filing with the USPTO, TiVo appears to have now won an important patent for displaying closed caption information to DVR customers.

In addition to covering this important feature, TiVo’s latest addition to their portfolio, also appears to encompass enhanced TV services, including a “clip and sling” type technology, that could eventually allow TiVo users to automatically remove commercials from time shifted programs.

According to patent 7,661,121, TiVo now owns the right to use existing closed caption and Enhanced Television (ETV) signaling data to create an interactive experience for their customers. ETV data is metadata that content owners have started to embed into their programming. It’s been used by Cablelabs and is part of the fundamental architecture behind big cable’s sinking “Canoe” DVR advertising venture. While I would suspect that the cable companies also have patents related to how ETV data can be used, it will undoubtedly be another series of rapids that the long delayed project will have to maneuver through.

While the abstract for TiVo’s latest patent is a little vague, if you delve into the details, you start to understand why TiVo would try to seize this particular piece of intellectual property. Essentially, the patent allows TiVo to sync closed caption information (and metadata) from broadcast programs recorded on a DVR and then display that data in an interactive format. This data can be as simple as a menu or closed captioned text or can be as advanced as digital video and sound effects.

From the patent,

“A multimedia device may use closed-caption data patterns to recognize and synchronize to multimedia content streams. The types of data patterns available in closed-caption data are numerous. For instance, distinct data patterns may exist within the actual closed-caption text, the closed-caption control data, as well as well as any other event defined by the closed-caption data. By recognizing distinct patterns within the closed-caption data, a DVR may identify events within the multimedia content stream. One way of recognizing patterns within closed-caption data is by computing hash values representing closed-caption text and identifying patterns of hash value sequences. Thus, according to one embodiment, at a multimedia device, such as a DVR or server, the closed-caption data is parsed and hash values are generated corresponding to the closed-caption data. The hash values are then compiled into hash value sequences associated with particular video programs or segments, and further combined with metadata defining command and control information for processing at multimedia devices. These hash sequences and metadata are provided to multimedia devices such as DVRs in the form of hash value sequence data. The multimedia devices use the hash value sequence data for recognizing and synchronizing to closed-caption data. A matching algorithm is used by the multimedia device to sequentially compare generated hash values from the closed caption data with multiple hash sequences that the multimedia device has stored locally. According to one embodiment, the matching algorithm is implemented through a state machine that processes the generated hash values and reports whether or not a match has occurred with a hash sequence identified by the hash value sequence data. ”

While the patent was only awarded on February 9th, TiVo actually implemented part of this technology years ago. Not only do they already offer a number of different ways to view closed caption data, but if you’ve ever watched a commercial on TiVo from one of their corporate partners, you’ve probably noticed a thumbs up icon that lets you easily subscribe to a show or order more product information.

While TiVo’s current implementation of this technology is admittedly pretty limited, the patent hints that there may be more powerful features going forward.

“”A user can mark off sections of a multimedia program or place points of interest relating to content within the multimedia program. For example, a user may want to mark the best plays of a recording of a football game. Once the user marks the plays, he can send the resulting hash sequences to a friend’s DVR.” [Bold added by me]

One of the reasons why Dish was never able to launch their clip and sling technology was because the content owners threw a hissy fit and threatened to sue the bejesus out them, if they made it easy for consumers to share content. While I don’t know the technical details behind what Sling was trying to accomplish, my sense of the project was that they wanted to let users edit other people’s content and then redistribute digital copies of those clips. The genius behind TiVo’s method is that their method wouldn’t allow anyone to “share content” that wasn’t entirely owned by the customer or TiVo.

“DVR users can distribute their own sets of points of interest for programs to other users. Users can further attach metadata to each point of interest that may cause the DVR to display text to the viewer, e.g., “Isn’t this a great action scene?” The user may also attach metadata to a point of interest that tells the DVR to skip x seconds into the program from that point of interest or display x seconds of the program before skipping to the next point of interest. This allows users to create their own condensed versions of a program that they can distribute to their friends, family, classmates, students, interest group, etc.”

While TiVo uses the example of a clipping highlights from a football game in their patent filing, I’m much more interested in how TiVo customers could potentially use this technology to remove commercials from YOUR programs. If both you and I have already recorded a particular show, there is no copyright violation because we’re both recording content that we already own. By allowing their users to create hash tag data, TiVo would technically own that data and would have the right to distributed that hash tag data to other DVRs without having to worry about content owners accusing them of stealing.

This would make it easy for me (or more likely someone else since I time shift everything ;) ) to easily tag all the commercials in a program and TiVo would then know to auto-skip past the content (commercials) when it saw the tags. TiVo could also use this as a way for live subscribers to tag the end of football and basketball games, so that they wouldn’t get cut off if the game went to overtime.

Another interesting embodiment of this patent would be the combination of live information with time shifted programming. Whenever I watch something a few months old, I always see commercials for upcoming TV shows or movies that are way past their expiration date. Instead of advertisers wasting their money on DVR subscribers, they could use sponsored hash tags to replace an old ad with something more current. Alternatively, if you were time shifting the news, TiVo could use your internet connection to create a live scrolling ticker that could update you on any new developments in the story.

Other potential uses that appear to be covered by the patent would include shows that have choose your own adventure type storylines. Upset about Chuck and Sarah not hooking up? the producers could give fans an alternate storyline to explore and allow viewers to vote on how they want to see the story move forward or TiVo could use this patent to create Blind Date type pop-ups around recorded television. While I tend to prefer my TV clutter free, for events like the state of the union, I can see why people would be interested in having fun facts pop up, addressing the issues that are being discussed.

While we haven’t seen any of these implementations take place today, the mere fact that TiVo was thinking about these options when they filed the patent would seem to suggest that they’ve been quietly innovating behind the scenes. This new patent award won’t necessarily help them in their case against Verizon or AT&T, but it could offer the telcos yet another reason to settle their dispute with TiVo, instead of being forced to place limits on the future of TV.

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25 Stocks Under $250 Million http://davisfreeberg.com/2010/01/26/25-stocks-under-250-million/ http://davisfreeberg.com/2010/01/26/25-stocks-under-250-million/#comments Wed, 27 Jan 2010 00:19:24 +0000 Davis http://davisfreeberg.com/?p=1785 House Of The Rising Sun*Disclaimer – This post should not be construed as investment advice or a recommendation to buy or sell any of the securities mentioned. Small cap stocks in general tend to be much more dangerous than larger companies and investors are highly encouraged to speak with their own financial adviser and to perform their own due diligence before considering an investment in any of the companies mentioned. Full Disclosure, I currently own shares of Calamos and Lojack.

Many investors tend to focus on large well established companies, but I’ve always had a penchant for small cap stocks. It could be my masochistic tendencies, but I prefer the risk/reward of a long shot, over companies who already dominate their market. Typically, my investment style has been to seek out strong brands that have fallen out of favor with the market and then wait for their fortunes to improve. Sometimes this involves waiting for years, sometimes it involves taking a complete loss and sometimes I get lucky and other firms step in and buy them out or bid up the price. Since a few of my readers have inquired about what sorts of things I look for in an investment, I thought I’d present a list of 25 small cap stocks that I currently have my eye on. Most of the data has been taken from Yahoo! finance as of 1/26/2010, so it’s probably a good idea to double check the numbers.

1-800-Flowers (Market Cap = $136.47 million Ticker: FLWS) – Every since United Online purchased FTD, 1-800-Flowers seems to have lost market share, but despite their wilting fortunes, they represent a strong brand in a market with limited competition. After cutting operating expenses by $50 million in the second half of 09 and with Valentine’s day just around the corner, I wouldn’t count this one down and out.

Audiovox (Market Cap = $151.26 million Ticker: VOXX) – Despite having booked over a half a billion in consumer electronic sales over the last year, Audiovox doesn’t seem to get a lot of respect outside of the consumer electronic’s industry. With $361 million in shareholder equity, the firm is trading at half of their book value. While the company has lost over $50 million in the last 12 months, these losses are largely attributed to one time charges. With the firm having hit profitability in the last 3 quarters, a turnaround may be in sight for patient investors.

Bank Of The Internet (Market Cap = $87.61 million Ticker: BOFI) – While many local California banks made some pretty terrible loans during the housing boom, BofI was considerably more conservative with their assets. The market may have discounted them along with the rest of the financial community, but a closer look at their balance sheet suggests that this may be a hidden gem in all the rubble. With a charter that allows them to operate in every US state, there is a lot of potential for this little known company. With some of the highest interest rates on cash deposits, they’ve been able to attract deposits during a period where most banks have seen their customer base contract. For fiscal year 2007, they had revenue of $45.7 million, in 08′ they booked $64.8 and in 09′ they had $81.1 million. While I’m no longer a customer of the bank, from past experience I can personally attest, that they have the best customer service of any financial institution that I’ve ever worked with.

Big Band Networks (Market Cap = $205.92 million Ticker: BBND) – Since it’s debut in 2007, this content delivery network has seen their stock price fluctuate between $3 a share to $20.44. The company did lose $11 million in the last quarter, but had they not been investing in research and development they would have generated a small profit. While they do owe approximately $70 million in debt, with $161 million in cash and short term investments, they should have the stamina to make it through the market’s bust. Sitting at the epicenter of online video movement, there’s a lot of potential for this Silicon Valley company.

Calamos (Market Cap = $237.42 Ticker: CLMS) – When it comes to convertible bond investing, Calamos has set the gold standard for fund managers. While revenue is down over 20% since the market collapsed in 2008, I don’t believe that this is proper justification for trading at less than 1 times their trailing 12 month sales. With a strong management team, a fantastic brand and their recent return to profitability, I think that the company is undervalued. With their latest dividend reflecting a 2.4% yield, I’m willing to wait for their turnaround.

ClickSoftware Technologies (Market Cap = $200.88 million Ticker: CKSW) – ClickSoftware helps companies better manage their workforce. Since the beginning of 2009, they’ve seen their stock rise almost 400%, so they’re not exactly a secret. Nonetheless, this Israeli company has demonstrated some pretty impressive metrics. In fiscal 06′ they had $32.4 million in revenue, in 07′ this rose to $40 million. In 08′ they recorded $52.3 million in sales and for 2009, they are expected to report approximately $61 million. With the company having made three small acquisitions in the past year and realizing 67% gross margins, it would appear that they have a bright future ahead of them. With $48.6 million in current assets and only $22.2 liabilities, they should be able to survive for a very long time, especially if the continue to remain profitable.

DivX Inc. (Market Cap = $180.25 Million Ticker: DivX) – After making a huge splash in 07′ and hitting a billion dollar market cap following their IPO, DivX has been a huge disappointment for many investors. While there are long term questions about their business model and management has given no indication that revenues won’t continue to drop, with $139 million in cash and short term investments and only $25.6 million in liabilities, the stock is certainly priced at a bargain. Given their unique position in the digital media space, I can think of a number of large competitors who wouldn’t mind taking advantage of the market’s short-sightedness.

Double-Take Software (Market Cap $216.34 million Ticker: DBTK) – Even before cloud computing was a buzz word, Double-Take was working towards building remote solutions for businesses. After seeing their revenues rise over 50% between 2006 – 2008, the company experience some turbulence in 09′. For the first 9 months of the year, they recorded revenue of $60.4 million, compared to $71.3 million for the similar time period in 08′. Nonetheless, when you consider that they are still booking a gross profit of 89%, there is a lot here to like. With financial and insurance companies representing some of their biggest customers, it may take time for them to return to their highs, but with nearly 4 times as many assets as they have liabilities, the company should have no problem surviving.

Geek.net (Market Cap = $77.41 million Ticker: LNUX) – As a self professed Geek I may be a bit biased on this one, but with the company trading at just $10 million above their book value, I think that this could be an extremely attractive acquisition for the right partner. Through sites like Slashdot, Sourceforge and ThinkGeek, they’ve been able to build an audience of over 40 million unique visitors each month. When you consider that their core audience tends to be primarily male developers with a lot of disposable income, I’m not surprised that their revenue has grown despite a collapse in the online ad markets. Recent insider selling and the lack of profitability may be cause for concern, but I believe that their core brands are too valuable to be trading at such a steep discount.

IncrediMail (Market Cap = $77 million Ticker: MAIL) – Since hitting their bottom in late 2008, IncrediMail’s stock before has been nothing short of incredible. With the stock up over 400%, there’s room for it to take a breather, but based on their most recent dividend, investors are earning an approximate 10% yield. While it’s always possible that they could quit paying back returns to their shareholders, with revenues up 25% for the first 9 months of 09, the trend is headed in the right direction.

Jackson Hewitt (Market Cap = $101.27 million Ticker: JTX) – They say nothing is certain in life except death and taxes and given Jackson Hewitt’s past sins, it’s fair to say that both may still be in store for this company’s future, but with the stock trading at 10% of past valuations, there’s also room for an impressive “dead cat bounce”. After getting busted for issuing problematic refund anticipation loans there’s an unknown liability that hangs over this firm, but with the company trading at 0.40 times their 12 months sales, the risk/reward is attractive for the troubled tax preparer.

Internap (Market Cap = $247.71 million Ticker: INAP) – Like many of the CDN players, Internap has seen their stock price hit with a buzzsaw as investors re-evaluated the long term potential of internet delivery. While Akamai may have a firm grasp on this market, I believe that there’s a lot of untapped value in this company. With over $250 million in revenue over the past year and over a billion dollars worth of tax losses, this small little video provider is ripe for consolidation.

Lasercard (Market Cap = $75.85 million Ticker: LCRD) – After a history of losses, this Silicon Valley security company appears to have turned the corner with their business model. During 2009, they blew through their net operating losses and have once again begun paying taxes on their profits. While their revenue tends to be concentrated with a few customers, recent contract wins with the governments of Hungary and Angola should provide some much needed diversification over the next year. Their leverage is a little bit higher than I’d like to see, but with a successful underwriting early last year and a bright future for the global security market, they should be OK over the near term.

Lojack (Market Cap $74.57 million Ticker: LOJN) – Caught between the wrong end of a patent lawsuit and the collapse of the auto market, Lojack has been absolutely hammered over the last few years. With the stock down more than 80% from their all-time high, it would be easy to write this one off as a tax loss. Despite the challenges that they’ve faced though, I believe that their unique technology and brand can easily be ported into other industries and that their recent losses will only prove to be temporary. With sticky contracts with law enforcement agencies and the potential to once again realize strong earnings, I think the company has been undervalued by investors.

Motorcar Parts of America (Market Cap = $68.22 million Ticker: MPAA) – Despite their ticker symbol, MPAA doesn’t have anything to do with the entertainment industry. They’re a small firm that sells plain old boring alternators and starters for small trucks. While the auto industry has seen new car sales eviscerated over the last few years, it should provide an opportunity for companies who build replacement parts. With their current liabilities exceeding their current assets, it may be wise to wait until they raise more money before proceeding, but with the company trading at approximately half of their trailing 12 month sales, the market seems to have priced in the doom and gloom already.

OpenTV (Market Cap = $162.92 million Ticker: OPTV) – With the Kudelski group having already agreed to pay $1.55 per share, you won’t get rich off of investing in this set top box manufacturer, but there could be an arbitrage opportunity for those looking for a short term investment. Assuming that it takes them another 1 – 3 months to close the transaction, investors could expect an annualized yield of 10.75% – 3.22% respectively. While these transactions always carry the risk that something could derail them, I’d be surprised if the deal doesn’t get completed in the first quarter.

Primedia (Market Cap = $126.26 million Ticker: PRM) – From a high of $175 per share during the .com heyday, to it’s current price under $3 a share, it’s fair to say that the last decade hasn’t been very kind to Primedia investors. Despite their past performance though (and huge question marks about the ad market), there’s still life in this old dog yet. Over the last 12 months, they’ve been able to pull in approximately $270 million in ad revenue and while this is less than what they earned in 2008, it does suggest that their revenues are starting to stabilize. With an impressive portfolio of .com properties, once the ad market returns, Primedia is an a better position to recover than most.

Rentrak (Market Cap = $167.97 million Ticker: Rent) – DVD sales may be in a freefall, but Rentrak has done a good job of managing this decline. The company not only helps to distribute packaged media, but also sells industry data to the major studios. While on one hand, the current business trends would appear to be working against the firm, the decline in disc based media also makes that intelligence even more valuable. With the company trading at less than 2 times sales, it wouldn’t surprise me to see a firm like Nielsen try to buy them in an attempt to bolster their own portfolio.

Rocky Mountain Chocolate Factory
(Market Cap = $51.65 million Ticker: RMCF) – While this pick violates a rule I have about never investing in restaurants, I’m willing to make an exception when it comes to chocolate :) With $17.8 million in assets and only $3.7 million in debt, this small specialty retailer has a remarkably clean balance sheet. Sales may be down year over year, but thanks to a partnership with Cold Stone Creamery, there is potential for growth. Given the strength of their brand name, I could think of quite a few companies who would mind owning their brand.

Smith and Wesson (Market Cap = $235.94 million Ticker: SWHC) – Over the past two years Smith and Wesson investors probably feel like they’ve been shot in the gut. Despite revenue going through the roof, they’ve been sidelined by one blunder after another. With a messy balance sheet and company officials facing charges of bribery, this one may be dead on arrival, but with over $300 million in revenue and a terrific brand name I wouldn’t hesitate to take a second look once things get straightened out.

Sonic Solutions (Market Cap =$232.46 million Ticker: SNIC) – For a long time, Sonic seemed to be the little engine that just couldn’t. With a number of software products focused on digital media, success always seemed like it was just over the horizon, but delays from studio partners and the decline in demand for their DVD services put a crimp in their stock’s performance. After seeing a rebound of over 400% in 2009, investors may be setting themselves up for another disappointment, but recent agreements with Blockbuster Video and a successful stock underwriting late last year, have removed concerns about their near term future. While I still have doubts about their ability to execute, there’s no denying that the Roxio and CinemaNow brands have value.

SORL Auto Parts
(Market Cap = $205.64 million Ticker: SORL) – Chinese companies always make me a bit nervous because it’s hard to trust their financials, but given China’s investment in infrastructure, there’s a lot of upside to the industry that SORL operates in. As a supplier of auto parts for Chinese trucks and buses, they’ve been immune to the issues facing the US auto sector. With assets representing more than 4 times their debt, they should be well positioned to capitalize on China’s own stimulus plan.

Spark Networks (Market Cap = $62.77 million Ticker: LOV) – Every since I made a bundle when IAC bought out UDate, I’ve been looking for an internet dating site to court. While I may have missed the bottom when it comes to Spark Networks, I’m still attracted to their business model. Revenue, net income and their member base have both been heading the wrong direction, but if their new Spark.com domain can take off, there’s still a lot to love.

SRS Labs (Market Cap = $98.73 million Ticker: SRSL) – Compared to heavyweights like Dolby, SRS is a 98 pound weakling in the audio technology industry, but don’t let their size fool you about the quality of their technology. Recently the company announced that their partners have shipped over 30 million certified TruVolume devices. Perhaps even more impressive though is that the company operates at 99% gross margins. With their technology able to prevent the sound fluctuations between your programs and commercial breaks, I see a bright future ahead. When you also consider that the company has over $50 million in assets and less than $3.5 million in debt, I think it’s a steal at their current valuation.

Stamps.com (Market Cap = $140.77 million Ticker: STMP) – Over the last few years, Stamps.com’s revenue has been more or less stagnant, but with limited competitors they should be able to maintain a pretty good hold on their niche market. With the recent growth in home based businesses, the company is poised to capitalize on FedEx’s losses. With a balance sheet heavy on assets and light on liabilities all it would take is a dividend or a share buyback to make this stock attractive.

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How To Save Blockbuster http://davisfreeberg.com/2010/01/20/how-to-save-blockbuster/ http://davisfreeberg.com/2010/01/20/how-to-save-blockbuster/#comments Wed, 20 Jan 2010 22:25:34 +0000 Davis http://davisfreeberg.com/?p=1592 SuperBlockbuster

Ten years ago, Blockbuster video was on top of the world. They didn’t know it at the time, but it was the golden age for the video store. After years of reminders to be kind and rewind, consumers were adopting DVD players en masse and needed a source for their entertainment needs. For better or worse that source was Blockbuster.

With the internet buzz hitting a fevered pitch, Blockbuster was already hard at work creating a digital strategy. Given their dominate position in the video store industry, they even flirted with the idea of buying a small internet start up named Netflix for a mere $50 million.

With the entertainment world seemingly in the palm of their hand, Blockbuster was positioned to make the jump to digital better than anyone, but over the last decade they’ve made a series of blunders that now threatens to bankrupt them today.

Yet, in looking at their rise and fall, it’s easy to make the quick assumption that their problems were a result of technological innovation, but the truth of the matter is that they have no one but themselves to blame for the weak position that they find themselves in today.

Of all their missteps, the biggest blunder was assuming $1 billion in debt, so that Viacom could collect an obscene dividend payment when they sold the company to a naive public. That debt now hangs over them like an albatross across their their neck and has caused them to lose pace with their unencumbered competitors.

With revenues in steep decline, it will only get harder and harder for Blockbuster to continue to meet their obligations under this debt. Without the firepower to compete on a level playing field, their situation will only get worse

With the precariousness of their position becoming increasingly clear, Blockbuster has done everything from paying a high price to refinance their debt to hiring a bankruptcy specialist to help salvage what is left of their business.

Yet, despite the clear and present danger of their situation, Blockbuster has continued to keep their head buried in the sand. Over the years, I’ve offered my fair share of suggestions criticism for how they could improve their business model, but we’re now at a point where a tourniquet won’t save them, they must do massive surgery and Stat!

In an effort to try and preserve a dying part of the entertainment industry, I present to you, my plan to save Blockbuster.

With the future looking pretty bleak for just about any video store, how can a company like Blockbuster save themselves? By sacrificing their media business in exchange for an opportunity to reinvent their retail business.

What I’m proposing would be tricky and the devil really would be in the details, but with the right execution, Blockbuster could shed their legacy of debt, future proof their business and position themselves to take market share, instead of losing it.

Essentially what they’d need to do is create a “good Blockbuster” and a “bad Blockbuster” to isolate their problems.

On one side you would have their DVD by mail program, their DVD kiosks and their digital business. On the other side, you would have Blockbuster’s traditional video store business that so many are quick to write off.

Together, the two businesses are slowly strangling Blockbuster, but split apart, they could free them from the impact of years of stagnation and ineptitude on their part. What I’m proposing is that they spin off their good assets and use that money to pay off their debt.

In the past, Blockbuster tried to launch an aggressive initiative to boost their DVD by mail program, but by doing so, they only ended up cannibalizing their in store customers. As a result, they’ve all but abandoned the program and have allowed their future to slip away.

If an independent Blockbuster.com doesn’t have to worry about that cannibalization, they could focus on going head to head against Netflix. They could create a subscription program for their kiosks that could offer value that Redbox couldn’t match. They could be price competitive without having to worry about their legacy stores. The result would be a smaller Blockbuster with less meaningful revenue, but it would represent profitable revenue instead of losses.

Neither Netflix nor Redbox would be able to offer DVD exchanges at the kiosk level and through the mail, but Blockbuster could capitalize on both strengths. Yes, the company would be a mere sapling in the larger entertainment industry, but Netflix was once a sapling and they’ve been able to grow into a very large oak.

From the video store side of the equation, Blockbuster could focus on what they do best, maximize cash flow while transitioning their stores into a new business. Whether that means turning their stores into modern day Starbucks or a replacement for the now defunct Circuit City, there are still plenty of opportunities for smart and nimble retailers.

To date, Blockbuster CEO Jim Keyes has made this transition a priority for the company, but when they are forced to forgo tens of millions in capital expenditures, just so that they can service their debt, it limits how quickly they can make this jump. As a result, they continue to face pressure to close stores instead of turning them into cash flow producing machines.

Given all of the negative media attention, it may be hard to believe, but Blockbuster still does a ton of business. For the first 9 months of 2009, Blockbuster brought in over $1.9 BILLION in revenue. By comparison, Netflix brought in $1.22 billion during the same period. Yet, when you look at the differences in market capitalization, Netflix is over 20 times more valuable than Blockbuster.

Perhaps even more surprising is that Blockbuster would have turned a profit of $38.4 million during that 9 month period, had they been able to ignore their debt. Instead, that $38.4 million profit turned into a loss of $131.6 million for the company. Now you don’t need to have a Phd in math to know that losing over $100+ million per year starts to get expensive fast and perhaps even more damaging than the loss of the cash is the effect that these interest payments are having on their competitive ability.

Instead of being able to invest in their future, they’ve been forced to make cut backs. Instead of retrofitting their stores, they’ve been closing them instead. Instead of stepping up the marketing, they’ve been forced to dial back. The result is that more revenue shifts to Redbox and Netflix and their cost to acquire customers has plummeted. If this trend continues, you don’t need Dr. Doom to tell you that it will be curtains for Blockbuster. They must stop the bleeding and they must stop it now.

Now I know what you are thinking, if Blockbuster is a penny stock today, how are they going to come up with $1.6 billion to pay off their long and short term debt. Part of it comes from the assets that they are holding today. With $980 million in current assets, they should be able to keep a good chunk of their leverage in check. The remaining $620 million worth of debt would be paid off by spinning off their new media divisions.

According to the most recent data, Blockbuster currently has 1.6 million online subscribers. As of last September, they had deployed 1,000 kiosks, but were anticipating that they would have over 10,000 deployed by the end of 2010. While Blockbuster doesn’t break down their digital revenues, I think that it’s reasonable to suggest that this division would be worth anywhere between $25 – $75 million based on their market position and intellectual assets.

If you look at Netflix’s current valuation, it works out to be approximately $255 per subscriber. Assuming that you discount Blockbuster subscribers by 30%, it would value Blockbuster’s DVD by mail business at $285 million.

In February of 09′ Coinstar completed their purchase of Redbox at a valuation of approximately $350 million. At the time, Redbox had 12,500 kiosks suggesting a value of approximately $28,000 per kiosk. Assuming that Blockbuster can get to 10,000 kiosks, even at a 50% discount to what Coinstar paid at the bottom of the market, one could assume that this stake would be worth approximately $140 million without Blockbuster’s legacy stores or debt.

What these numbers suggest is that if Blockbuster were to do a spinoff, it’s easily conceivable that they could raise at least $500 million in the offering. Assuming that they start to market their DVD by mail and get it up to 2.5 million subscribers, it would value their new media business at approximately $660 million.

If they did the spin off in the form of a convertible bond, I believe that this number goes even higher, because bond investors could be given the option to return to their current position, if the spin off flopped.

While this sort of transaction would create a new competitor for Blockbuster Video, by getting rid of their debt, it would enable their stores to become profitable once again, which in turn would make it easier for Mr. Keyes to raise money for the marketing and store improvements that Blockbuster so desperately needs.

While I believe that this rescue plan could make Blockbuster competitive again, I don’t believe that their current management is willing to sell off their future, even if it means saving themselves. Despite all evidence of a dying industry, Keyes continues to insist that the video store is the cornerstone of what they do and has consistently defined Blockbuster’s competitive advantage as being able to offer entertainment across multiple channels. While it’s easy to point to Netflix and Redbox as the source of Blockbuster’s kryptonite, I believe that it is their own unwillingness to let go of the past that is preventing them from being a video superhero of the future. Only time will tell how indestructible they really are, but if they continue down the same path, they’ll end up as a mere footnote in the history of the entertainment industry.

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Coming Soon To A Store Near You http://davisfreeberg.com/2009/11/18/now-come-to-a-store-near-you/ http://davisfreeberg.com/2009/11/18/now-come-to-a-store-near-you/#comments Wed, 18 Nov 2009 16:51:03 +0000 Davis http://davisfreeberg.com/?p=1689 Hollywood DivXI know that I’ve been critical of DivX’s efforts to woo Hollywood in the past, but I’ve also got to give them credit for a win when I see one and I think they knocked it out of the park when it comes to Paramount.

Recently, Paramount announced that they were going to be distributing content on USB sticks. At the time, they didn’t say what format it would be in and even on DivX’s conference call there was no mention of this realization of their strategic vision, but Electric Pig is reporting that the Paramount movies will in fact be encoded in DivX.

With only 20,000 memory sticks for sale and at a price of approximately $33 US, Paramount is still clearly in the testing phase, but the fact that they choose DivX demonstrates the clear advantage that DivX has over all of their other digital competitors. They have the only real solution for brick and mortar retailers.

If Paramount tried to do this with a proprietary solution, it wouldn’t work because it wouldn’t give them a way to get that movie to the television. They could try to do it with Apple, but Apple doesn’t have the same reach to the TV, especially in Europe where this is being launched.

To date, most of my thoughts on DivX’s courtship of Hollywood have centered on the futility of trying to win enough support, so that online retailers could adopt their technology for digital distribution. If you can’t get a Disney or UMG to license DivX’s format, it makes it tough for someone like Netflix or Blockbuster to use their codec even with the other 80% of the content owners on board.

The beauty of the USB distribution strategy is that they won’t need 100% industry support in order to move their plans forward. Shelf space is limited as is, all they need is for a single studio to want to take advantage of this and there will be more than enough titles to tempt you with while you are waiting in line at the cash register.

Now I know what many of you are thinking, movies on USB are pretty lame. When Paramount made their announcement, there were more than a few commenters who zinged them for being out of touch with current trends. While there’s no doubt that the world will go digital, I also realize that the major studios aren’t going to abandon the retail partners that deliver the majority of their profits each and every year. It may end up becoming super easy to buy movies straight from your home, but if you have millions of consumers visiting a store each day, you can bet that the studios will want to reach those customers where they are hanging out. The shelf space is too valuable to be abandoned.

DivX on USB also opens up new business models for the studios. Instead of selling three DVDs, they could package all the Godfather films on one stick to justify a higher price tag or they could offer an entire season of television on an 8GB stick instead. If a retailer can sell something for twice the price, they will take smaller margins from the studios for the larger transaction. With the studios under pressure to develop new revenue streams, this will be too tempting for them not to exploit.

There’s no doubt that DVD is moving to Blu-Ray, but DivX memory sticks allow their Hollywood partners to reach consumers who may not have upgraded to high def just yet. With the industry in a state of flux, being able to sell a device that can be read by any computer and over 200 million devices gives DivX broad reach when it comes to the world of disconnected playback.

Paramount may be approaching this market cautiously, but I think people have greatly underestimated the size and the impact that USB films will have. It may not be cutting edge technology, but there are too many powerful companies who need it to succeed for it to fail. At the birth of this industry, it’s encouraging to see Paramount actively supporting their partnership with DivX, instead of just taking a licensing payment and then ignoring what their technology can offer.

USB movies won’t necessarily solve DivX problems with their shifting business model, but it does underscore the significance of the platform that DivX has built. As much as DivX is threatened by the obsolescence of the DVD, they can also benefit from the format shift. So far, they haven’t done a very good job of managing this transition, but this deal proves that even an old dog can learn new tricks. If retailers start asking for DivX as a weapon against Blockbuster and Netflix, other studios might also understand the benefits of using open and popular technology to make more money.

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Blockbuster Bleeding DVD-By-Mail Subscribers http://davisfreeberg.com/2009/08/21/blockbusters-3-million-subscribers-now-down-to-1-to-125-million/ http://davisfreeberg.com/2009/08/21/blockbusters-3-million-subscribers-now-down-to-1-to-125-million/#comments Fri, 21 Aug 2009 16:11:38 +0000 Davis http://davisfreeberg.com/2009/08/21/blockbusters-3-million-subscribers-now-down-to-1-to-125-million/ not-blockbusterPhoto by C-Bunny.

Just in case you think Blockbuster’s problems are isolated to a declining video store industry, I’d encourage you to take a closer look at their latest 10-Q filing. Despite there being clear growth in the DVD by mail category, Blockbuster is hemorrhaging subscribers. In fact, the percentage of people giving up on their by mail service is almost as high as the percentage of people giving up on their video stores. According to their 10-Q,

“Rental revenues decreased mainly as a result of: a $76.3 million decrease in by-mail revenues driven by a 30% average decline in by-mail subscribers, which was more than offset by related cost reductions described below under “Domestic—Gross profit;”

At one point in early 2007, Blockbuster had the pedal on the metal and was boasting of having close to 3 million subscribers. Since then, they’ve been understandably quiet, but I had no idea things were this bad until I read their most recent filing.

After piecing through other filings, I was able to come up with an estimate of 1 – 1.25 million current subs.

Here’s the math for those playing at home.

At the end of 2006, Blockbuster had 2.2 million subscribers and had brought in approximately $250 million in revenue. By the end of 07′, they were flirting with 3 million subs and had $525 million in DVD-by-mail revenue.

From a historical standpoint, this tells us that Blockbuster’s subscribers tend to average between $9.49 – $14.60 per month, but these figures are a bit skewed by their total access efforts. Since most of their subscriber gains were added at the end of 06′ and the beginning of 07′, it pushes both numbers to an extreme. Their actual monthly average is probably closer to somewhere in the middle.

By comparison, Netflix subscribers were averaging $12.84 per month as of their most recent quarter.

The information that Blockbuster discloses doesn’t allow us to get at an exact figure, but if we also dig through past filings, there is more than enough info to extrapolate a reasonable estimate for their current number of subs.

In December of 2006, they had just passed 2.2 million subscribers. Two months later, they were predicting that they’d be at 3 million subscribers by March 07′

A year later the first sign of trouble shows up when they disclosed that they saw “significant” subscriber losses after pulling total access in 07′. If we assume that 20% of their subscribers left after they cancelled the free in-store exchanges, it would bring you to an estimate of 2.4 million subscribers for midway through 07′.

By Oct 08′, Blockbuster admits that their by mail revenues decreased another 21.5%, so if you subtract another 500,000 subs you get a total of 1.9 million from 9 months ago.

Since we know that they’ve lost 30% of their subscribers over the last 12 months, it gives us an estimate of 1.3 million subscribers today. With some of these number being moving targets, I wanted to check to my math to see how reasonable this guess was and I actually think it’s a tad high. If you take a look at their most recent by-mail revenue number, it suggests that the total is slightly lower.

Since Blockbuster has plans that range from $9 – $17 per month, it gives us a range to consider. If a decline of $76 million represents 30%, it would suggest that they are currently earning $14.8 million per month from by mail subscribers.

If we assume that 100% of them were $9 per months subs, it would mean that the maximum number of subscribers that they could have at this point would be 1.64 million and if 100% of the subscribers were paying $17 per month, it would peg the minimum size of their subscriber base at 870,000.

Since $12 – $14 is a more reasonable estimate for what the average Blockbuster by mail subscriber pays each month, it gives us a ball park range of 1 – 1.25 million current subscribers.

I wasn’t surprised to see a drop in subscribers right after Blockbuster abandoned their total access plans, but to see them drop below TA levels has to be concerning for Blockbuster Execs. This is the one part of the company that should be firing on all cylinders, but clearly Netflix’s Watch Now service has been poaching their members.

Blockbuster may have put up a good fight in the DVD wars, but with nearly 10 times the number subscribers, Netflix is now threatening to do to them, what they did to Wal-mart’s DVD by mail program.

The smaller membership gets, the harder and harder it will become for Blockbuster to run their by-mail program at a profit. They could always raise prices, but that would only lead to additional defections. With Blockbuster on the ropes, don’t be surprised to see Netflix maintain the price war for another 12 months while they wait for Blockbuster’s bond owners to take control of the company.

In the meantime, this data only highlights the fact that Blockbuster’s problems aren’t because of a lack of opportunities, it’s an issue with their execution.

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Judge Denies Further Extensions, DivX/UMG To Be Resolved By Christmas http://davisfreeberg.com/2009/08/07/judge-denies-further-extensions-divxumg-to-be-resolved-by-christmas/ http://davisfreeberg.com/2009/08/07/judge-denies-further-extensions-divxumg-to-be-resolved-by-christmas/#comments Fri, 07 Aug 2009 10:35:01 +0000 Davis http://davisfreeberg.com/?p=1547 You Win Some You Lose Some

Additional ruling
3 good transcripts with background on case to date (1 , 2 , 3 )

It’s been nearly two years since DivX filed their “pre-emptive” lawsuit against Universal music group and so far, there really hasn’t been much to talk about. DivX’s original lawsuit was thrown out after UMG removed the overhanging legal threat against Stage6 by actually filing a suit alleging copyright infringement.

Given the hurry that DivX was in to have this case resolved, one would have thought that consumers would have had a digital betamax decision by now, but once DivX abandoned Stage6, their strategy towards the case took a 180.

With DivX seeking Hollywood approval, I’ve no doubt that they would like nothing more than to sign a content deal and settle the matter with a small token of goodwill. Last November, they tried to reach a settlement with UMG, but UMG seems out for blood on this one. If they were to actually get the $300 million in damages that they are seeking, it would not only bankrupt DivX but would give UMG control over their technology.

While it may still be in UMG’s best interest, not to establish a legal precedent on the DMCA safe harbors, there’s no doubt in my mind, that they’ll try to extract more than a pound of flesh, before they let DivX off the hook on this one.

Over the last year and a half, the case has largely been hung up over petty issues related to discovery. With DivX in stall mode, they tried to ask for a mountain of documentation from UMG. Specifically, they wanted the entire chain of copyright documents for all 2,600 allegations of infringement.

With some songs requiring over 500 pages of contracts, UMG was reluctant to help DivX on a fishing expedition, especially when they have “certificates” that certify their ownership of the works in question.

Meanwhile, UMG wanted to use Audible Magic, in order to detect every instance of copyright infringement on Stage6. DivX understandably wanted to make this harder for them. DivX argued that since UMG failed to use their voodoo technology, while the site was up, they shouldn’t be compelled to power all 750,000 videos back up.

Eventually, they gave UMG an index that let them search for the name of a video and then request a copy from DivX for review.

Of course the problem with this approach is that as anyone who used Stage6 knows, the studio files were never labeled with the proper titles. Search on Stage6 was always pretty terrible and this was made even worse by members trying to hide themselves underground.

Rather then using search, browsing through tags was a much more efficient way to find content ;) Since most visitors were coming from link aggregation sites anyway, it wasn’t all that necessary for the movies to show up in search.

Most of these differences could have been worked out pretty easily, but with DivX trying to let YouTube set the precedent, and with UMG trying to go after the lower hanging Veoh fruit instead, neither party has been very incentivized to move this case forward.

In fact, just last week, both UMG and DivX asked the judge to add on an extra 60 days before they would have to do battle, specifically so Veoh could go first. The judge, who has clearly been frustrated by the petty antics of both parties, finally put his foot down and denied the extension despite both parties being in agreement. Now, Veoh’s case has been pushed back while they wait to see if DivX walks away a free entity or facing an executioner.

Like a man on a mission, the judge has followed up his denial with two rulings, that settle a laundry list of squabbles and should make the rules of engagement crystal clear.

At one point, DivX may have been able to convince the judge to let them have wider access to the copyright records, but after failing to cite a single “widely distributed” modern act, he put an end to this discovery requirement.

Because a healthy part of the legal paperwork is obscured by sealed records, it’s not exactly clear what happened with audible magic, but from the way I read it, it looks like DivX was able to limit UMG to finding the content the same way that users had to. The judge did give UMG access to the search terms, (which will enable them to use the tags in order to find more potential violations), but he didn’t require DivX to turnover the metadata on the files.

DivX wasn’t able to get emails of record label employees, but did get an order for “actual or prospective policies or practices from January 1, 200o to the present.”

As part of their defense, DivX is trying to assert that they put in measures to help prevent copyright abuse. Specifically, they used technology that would prevent the same video from being uploaded, if it had already been subjected to a DMCA notice.

UMG is trying to argue that the copyright violations on Stage6 were so blatant that DivX would have had to have known that infringement was occurring (even if UMG didn’t complain about it first.)

The key issue here, will be whether or not the technology that DivX employed, was considered an “industry standard” for preventing infringement. If they can show that UMG had previously endorsed the technology that they were using, it would make it hard for them to argue that DivX wasn’t taking reasonable steps to prevent pirates from ransacking Stage6.

With the legal maneuvering, finally out of the way, the biggest obstacles to a trial have been removed and we should have a resolution before Christmas.

Of course, if you’re hoping that DivX is going to make a stand for consumers by establishing the legality of video sharing for a site that is all but dead to them, I wouldn’t get your hopes up too high.

DivX and UMG may have failed to reach an agreement last November, but they’ve “tentatively” agreed to go in for couples counseling and have a mediation date scheduled for Sept. 21st.

I don’t know that DivX will be willing to write a big enough check to satisfy the music conglomerate’s greed, but if UMG begins to doubt their case, it wouldn’t be hard to get a little bit of money and a passive admission that they can enforce whatever rule of law they want.

If we do get a trial, it will be a fun one to watch. Here is an estimated schedule based upon the most recent developments in the case.

August 17th – Non-expert discover cutoff/last day to conduct settlement conference
August 18th – 25th – UMG begins depositions of DivX employees and witnesses
Sept 29 – Last day to hear motions
October 26th – witness list is due
Nov 24th – Trial Begins
Dec 10th – Jury reaches verdict

Whether or not DivX will stick to their guns remains a question, but there is finally light (or darkness) at the end of the tunnel. We don’t know how this will get resolved, but it shouldn’t take much longer to find out.

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Rhapsody And The Art Of The Up-Sell http://davisfreeberg.com/2009/07/20/rhapsody-and-the-art-of-the-up-sell/ http://davisfreeberg.com/2009/07/20/rhapsody-and-the-art-of-the-up-sell/#comments Mon, 20 Jul 2009 20:48:37 +0000 Davis http://davisfreeberg.com/?p=1465 RealPhoto by Thomas Hawk

One of my very first jobs was working behind a concession counter for a big multi-plex cinema. It isn’t the sort of place where one would expect to learn a life skill, but early on I learned an important lesson in business, the art of the up-sell.

You see, movie theaters make very little from the box office receipts, so the concessions counter is the lifeblood of the industry. The setup is pretty much the same at every theater, but most people don’t tend to think about it. Because the actual cost of the popcorn and soda is so low, the theaters reap big profits from selling captive customers overpriced snacks and beverages.

One of the problems that theaters face, is that there are a ton of people who tend to order small sizes. It could be that they are trying to save money or that they don’t need oversized portions, but because the containers cost the theater more than the actual popcorn or soda, going from a small to a larger size, tends to be pure profit for the theater.

To help “encourage” movie goers to pay the max, theaters will price their small popcorns at ridiculously expensive levels and then have a minor jump in price from small to medium and medium to large. If you were to price the popcorn by ounce, a small would cost four times as much as a large, but because of the high cost at the small level, it makes it easier to convince consumers to pay a little bit extra for a lot more food.

When I sold concessions, the sales pitch would typically go “hey did you know you can get a large for only 50 cents extra?” That was all it took and at least 75% of the customers would go big.

In thinking about why my theater was so effective at up-selling, two things jump out at me. The first has to do with the way the pricing was set. Consumers got tremendously more value at the higher levels, then the lower ones. It might be tough convincing someone to spend $5 on a bucket of popcorn to begin with, but once they made that purchase, an extra 10% for 200% more, seems small. Secondly though, they had an actual human explain this value to the customer. Concession employees were expected to upsell or suggestive sell on every single transaction. It could be subtle, but management made sure that every employee was at least presenting more options to the customers.

What made me take this trip down memory lane is a recent experience with Real’s Rhapsody music service. Before the internet, napster, and digitization, I used to collect music with a passion. Records, Tapes, CDs, it didn’t matter. I would scour local garage sales and thrift stores looking for bargains, (not to mention all of the BMG and Columbia House memberships.)

When the internet first started to take off, my collecting habits intensified. I’d surf Ebay for favorite artists. I didn’t care about the singles or the greatest hits, I was after the rare B-sides that were released internationally. There is something amazing about listening to an artist’s entire discography in order, but back then, it took a lot of money to buy every single song that an artist produced.

Once MP3′s took off, I abandoned physical playback and spent many late nights digitizing my music. As time has gone on though, I’ve realized what a hassle it is trying to maintain a large digital library. Computers have a way of freaking out once you go over a certain limit, there are countless hard drive failures involving added expenses and I don’t even want to think about the amount of time I’ve spent dealing with buffer overrun errors while backing up my music. The bottom line is that if you’re trying to collect a couple hundred thousand Mp3′s, it’s not only cheaper to rent then it is to buy, it’s cheaper just to store it.

Because I had such a large music collection, I never gave Rhapsody a chance, but as one hard drive failure after another has taken large chunks out of my music library, I’ve found myself turning to the internet for specific artists or songs that I’m now missing.

Over the last year, I’ve signed up for Rhapsody three different times to listen to music that’s disappeared over time. Thanks to their free trial offers, I’ve been able to hear a lot of great music, but never kept my membership for longer than a month.

What surprised me so much about the experience was how much I enjoyed it. Not only can I get the latest top hits for a fraction of what I used to spend, but I also get access to the expensive b-sides that were never in wide circulation. The first time I logged onto the service, I was estactic after discovering an entire album’s worth of material from my favorite artist.

Given how much enjoyment I’ve gotten out of the service, one would think that it would be a no brainer for me to spend a modest amount of money for access to more music then you can even think about, but when it came down to becoming a paying member, Real Networks lost me on the up-sell.

You see, as a streaming internet music service, Rhapsody really is an amazing product, but its lack of a robust download solution, means that if you want to take your music on the go, customers have limited options. Since Real realizes that not every consumer wants downloadable functionality, they price their service in two tiers.

The first is the standard all you can eat streaming music of just about any song or artist you can think of (we’re talking stuff not even on Bit Torrent.) For $2 more though, you can download songs to “approved devices” and rock out using a portable device that doesn’t need to be connected to the net.

As an internet streaming service, I would have been happy to pay their monthly fee for all of the music that they provide, but by offering a download “upgrade”, it makes me keenly aware of a significant limitation to the service. As is, I can listen to Pandora via the internet now, so a streaming only service makes me second guess how much value Rhapsody really has. I wouldn’t even mind paying the $2 more per month just for streaming access, but don’t see enough value in the $2 upgrade to justify signing up for the downloading tier.

Part of this is because I’m not able to download a DRM free MP3. Even if you download your music, you still have to “refresh” your approved device once a month or your songs get disabled. You’re also limited in the number of devices you can play your Real files on.

As much as I prefer downloading over streaming, it simply isn’t worth an extra $24 per year for a weaksauce version of the real thing. Having to connect my cell phone to the net once a month is obnoxious and I’m not particularly fond of downloading music that I can’t play on all the electronic gadgets that I own.

If they eliminated the download tier, I’d probably be a customer right now, but by making me choose, they’ve persuaded me not to sign up for either package.

Not everyone purchased an up-sell when I sold concessions, but during my entire time behind the counter, I never had a single customer walk away without at least buying the small popcorn that they originally asked for. When it comes to Rhapsody though, the different pricing tiers have cost them at least one customer who would have paid, if he didn’t have to choose between streaming only or weaksauce downloading.

I don’t know if Real does consumer surveys, but I bet that I’m not the only one to agonize over this distinction. Instead of using the price difference to highlight their weaknesses, Real would be better off by either raising the price $2 on everyone and then including their downloading solutions with the service or eliminate the downloading tier entirely and focus on being an amazing and comprehensive streaming service only. By trying to straddle between streaming and downloading, they are only confusing customers and highlighting the limitations to their service.

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Vois.com – Golden Melody or Laryngitis? http://davisfreeberg.com/2009/07/09/voiscom-golden-melody-or-laryngitis/ http://davisfreeberg.com/2009/07/09/voiscom-golden-melody-or-laryngitis/#comments Thu, 09 Jul 2009 11:42:52 +0000 Davis http://davisfreeberg.com/?p=1441 MoneyOver the years, we’ve seen stock promoters use spam and junk faxes as a way to hype their securities and while these methods are still in use today, they lack a certain amount of credibility that most investors are looking for. With the masses growing increasingly numb to these tactics, the wolves of Wall St. have learned a new trick and have managed to hijack social media as a way to tout their shady opportunities.

For the most part, high profile bloggers have viewed these fly by night companies with the appropriate degree of skepticism, but over the last year and a half, one questionable company has managed to infiltrate the tech elite.

Vois.com’s first big splash on the innerweb occurred in November 2007, after TechCrunch highlighted the company as a publicly traded social networking site. In a quick post on the company they wrote,

“I can’t see VOIS winning any awards for its service, but those with a stock market fetish looking to play around with some investments in this space, VOIS gives you that option.”

Ironically, a mere month and a half later, Vois actually won Mashable’s Open Web Awards contest for best photo sharing site and finished at a strong 2nd to Facebook in the best large social network category. The win was so surprising that Mashable labled them a dark horse candidate.

In February of 2008, Mashable interviewed Vois Co-Founder Craig Agranoff and published another glowing review highlighting Vois’ efforts at raising $1 million. In the article, they wrote,

“Vois has gone in a new direction, giving its own users a piece of the pie, and it seems to be working out very well for the company so far.”

Maybe for the founders, but not so much for the other Vois shareholders. Mashable may have interpreted the $1 million in financing as a sign of Vois’ success, but the reality was much darker. Of the $950,325 that they raised, $95,033 went to the broker who did the placement. After they got their 10% commission, another $328,000 went to two former Directors and unnamed “consultants” that needed to be repaid because like today, Vois was in default on their debt.

If you had listened to the hype, you would have thought that Vois was the next Facebook, but behind the curtain, you’ll find plenty of skeletons waiting in their closet. Vois may envision their site as the new voice of social sourcing, but all I’m hearing is static.

Back To The Future

In order to understand the secrets locked inside of Vois, you must take a critical look at the footprints of its founders. While they may try to cast themselves as successful entrepreneurs, a closer inspection will reveal that they play the role of the villain in this tragedy.

To fully understand the events that led up to the creation of Vois, we’ll need to jump into the machine to 1985.

Gary Schultheis – President and CEO

After one year at the State University of New York at Farmingdale, a young Gary Schultheis left school and took a job with Airport Express International. He would continue working there until 1992.

During the 1980′s, Air Express International was a microcap shipping company. Their one claim to fame is that they tangled with the Lucchese crime family during the late 80′s. According to a 1986 RICO indictment against members of the family, Air Express management was being squeezed by the mob, in exchange for peace with their labor unions.

The crime family was interested enough in the corporate comings and goings, that they even went as far as to try and block a merger between Air Express and another air freight company that was also being shaken down. While it’s hard to blame Air Express for being a victim, one does have to wonder how they found themselves in this predicament to begin with. What did they owe the mob to make them think that they could try and get away with extortion? I don’t have the answers, but I suspect that the story goes much deeper than this.

After Schultheis left Air Express in 92′, it’s not exactly clear what happened to him for the next two years. Despite my best efforts, I wasn’t able to ascertain his whereabouts during this period. Not only are these details noticeably absent from Vois’ regulatory filings, but they also seem to have been suspiciously left out of other filings as well. There could be a simple explanation for this black hole, but I believe that investors deserve a full and complete bio from publicly traded CEOs.

In March 1994, Schultheis would show up on the radar again, this time as the President of a financial relations firm named Wall Street Enterprises (aka Wall St. Associates.) We don’t know much about Schultheis’ early years at the firm, but over the next two years, he would lay the groundwork for what would later become a lynchpin for future stock promotions.

Herbert Tabin – Secretary, Senior Vice President, Corporate Development and Director

In 1989, Vois Co-founder Herbert Tabin graduated from The State University of New York at Oneonta. In Vois’ SEC filings, Tabin doesn’t reveal much in the way of details, about where he began his career. Fortunately, he does tell investors that he worked for the American Stock Exchange and “three New York-based stock brokerage firms”, over a span of three years.

By doing a bit of digging, I was able to identify the three brokerage firms as Stratton Oakmont, Continental Broker-Dealer and Kensington Wells.

Stratton may not be well known outside of the finance community, but is a legend on Wall St. Before it was shut down by regulators, the company was the poster child for how boiler rooms operate. In fact, Martin Scorsese is currently making a big budget film about what happened at the firm, during the time that Tabin worked there.

Even if you can look past the wild tales of “shaving female sales assistants’ heads, tossing midgets and Ethiopian hookers, one cannot ignore this culture of deceit where Mr. Tabin received his formal Wall St. training.

The SEC consent judgment against Stratton describes exactly what this culture was like from 1989 – 1991,

“It is undisputed that, during that time, Stratton was operating a classic boiler room. The brokers sat “cheek by jowl” in a room the size of a basketball court. All of their desks were lined up side by side in rows. The firm held mandatory sales meetings every morning at 8:30 a.m. at which time sales techniques were demonstrated and scripts for the firms’s “house stocks” (i.e., those in which the firm made a market) were distributed. Brokers were expected to follow the scripts and only give customers the information they contained. Brokers were discouraged from doing any outside research, and told to rely on the firm’s research and representations. Aside from training in high pressure sales techniques, brokers received no instruction from Stratton management.

After the morning sales meeting, brokers were expected to spend the entire day (except for a lunch break) on the telephone.

The firm expected a high volume of sales, and if brokers did not stay on the phone, they were fired. Stratton was run like a “boot-camp”, with all of the brokers’ activities closely monitored and scripted by the firm’s principals. At the end of the day, a second sales meeting as held at which time each broker was required to report his production for the day.”

In case you were hoping that Continental Broker-Dealer or Kensington Wells might have a better reputation, I wouldn’t hold your breath. During the time that Tabin would have been at Continental, the firm was helping to financially engineer the fraud that inspired the hit movie Boiler Room.

In the case of Kensington Wells, things are just as bleak. After the company shut down, the NASD stepped in and charged 12 of their former brokers “with a wide range of sales practice abuses. The complaint alleges that the 12 brokers, who were based at Kensington Wells’ Mineola, NY headquarters, participated in or facilitated a boiler room operation through a series of fraudulent sales practices and other misconduct”

From September 1993 to March 1995, Tabin served as the vice president of HBL & Associates, a financial relations firm in New York city. There isn’t a lot known about HBL, but the rumor on the street is that it was being run by none then Larry Erber.

Erber is a recidivist stock felon who has had multiple run-ins with the SEC. In 1991, he pled guilty to securities manipulation and wire fraud. Despite being barred from the industry, Erber is rumored to have secretly purchased a stake in Paramount securities.

HBL & Associates didn’t have a lot of clients, but they did have one very important one. Between 1991 – 1994, Erber (and HBL & Associates), would tout a small company named Teletek. This is significant because the promotion would have been going on the entire time that Tabin was with the firm. As the scheme was unraveling, a short seller even went as far as to try and extort Erber into giving away free shares of Teletek.

“Carlson’s alleged misconduct occurred during a June 9, 1994 telephone call, in response to Carlson’s earlier call. Carlson initially “congratulated” Erber on the GLAD situation, because he felt that “there were strong similarities between the GLAD situation and Teletek,“and he wanted to let [Erber] know that I knew what he was up to, that he was up to another one of these stock manipulations, and that he wasn’t pulling the wool over my eyes.” Carlson then requested a block of Teletek stock at a discounted price in exchange for Carlson’s keeping silent about Erber’s alleged promotion and manipulation of Teletek stock:

‘Let me tell ya, we were intimately involved in getting GLAD delisted. OK? I am going to do the same thing to Teletek — unless I get some stock from you on a favorable basis. I am gonna do what’s called a magic trick – that’s where I take your money and I turn it into my money.’

Carlson repeated this quid pro quo later in their conversation: “so, on Teletek-either I get a block of cheap stock or I am going to play a magic trick on you-OK-I am going to get that stock delisted next.” Carlson then accused Erber of being an undisclosed owner of Paramount Securities, an act that would violate a federal court order restricting Erber’s participation in the securities industry. Carlson continued:

‘Ya, if you want me to serve you up and wrap your F***ing nuts around your head I will. So you decide what you want Larry, we either play hard ball or . . . I get some of this cheap stock that keeps on printing in this pig.’ Carlson concluded the conversations as follows: ‘[s]ave your breath-OK-buy me some stock or I’m gonna F***ing-I’m going to go after Teletek. Those are my terms-please get back to me-thank you.’”

Unfortunately for Carlson, Erber was recording the phone call and while Erber would ultimately face charges for manipulating Teletek, Carlson would end up being suspended from the industry as a result of his conduct.

After leaving HBL & Associates in 1994, Tabin would join a “merchant banking and venture capital firm” named LBI group. From April 1994 – Dec. 1996 he served as their vice president of marketing. While Tabin was working there, LBI provided consulting services to a fast food restaurant named Tasty Fries Inc.

Tasty Fries first hired LBL on May 23rd, 1996. You may not be able to buy a burger for a nickel anymore, but LBL learned an even better trick. In exchange for “certain business consulting services, including marketing for a 12 month period”, LBI was given an option on 4 million pre-split shares at .05 cents a share.

A little over a month after entering into the contract, employees at LBI paid $200,000 to exercise these options (despite only being 2 months into a 12 month commitment.) While we don’t know whether or not LBI was dumping their shares while they were performing their “marketing” duties, we do know that they were only able to return 1 million shares once the contract was rescinded.

Later, the SEC would deep fry the fast food restaurant and in 2004, CEO Edward Kelly would be forced to settle charges “for fraud, unregistered sales of securities, and reporting, record keeping and internal control violations.”

After Tabin left the company, LBI was accused of sending unsolicited pump and dump faxes to prospective investors.

Millennium Holding Group – Their Own Personal Death Star

Millennium Holding Group was created on February 27, 1996. Shortly after forming the group, Millennium would acquire Wall Street Associates, the firm that Schultheis had spent the last two years creating. This is the first known partnership between Schultheis and Tabin. In the 10-k Vois describes Millennium Holdings as a “financial consulting firm specializing in mergers and acquisitions.” On the surface, this sounds impressive, but take another look at the types of companies that they worked with and you can’t help but be aghast at the client list.

In April of 1997, American International Petroleum Corp. (AIPC) hired Wall Street Associates to “implement a five-part investor relations program, including stockbroker relations, media relations, shareholder/investor communications and Interent [SIC] coverage.” AIPC was a Kazakstan oil exploration company with refining facilities in Louisiana. In July 97′, Wall St. Associates/Millennium Holding Co. issued a press release letting investors know that “revised estimates of potential recoverable reserves in Kazakstan exceed one billion barrels.”

Of course those barrels of oil were never recovered and in October 2004, AIPC would be forced to declare bankruptcy in a Louisiana courthouse. Two years alter, the SEC would revoke AIPC’s stock registrations for failing to file current reports.

To get an idea of the type of hyping that Millennium Holdings was allegedly engaged in, just take a look at this Silicon Investor post where someone says that “Gary from Millennium Holdings” touted a potential $50 share price in an AOL chat session with investors. I’m not sure what the stock was worth then, but today you can buy a share on the pink sheets for only .002 cents.

I don’t know what it is about the name, but there must be something about Voice that Schultheis and Tabin like, because on June 23rd, 1997 they picked up over 300,000 shares of iVoice.com. A little over a year later, they acquired an additional 925,000 shares.

On November 15th, 1999, iVoice hired Integrity Capital to perform a laundry list of “investor relation” services. At the time Robert Pratt was a principal owner of Integrity. In February of 2008, the SEC finally caught up with Mr. Pratt and accused him of running a pump and dump scheme.

In August 1997, Millennium Holdings group acquired shares in a company named MDI Entertainment. A few years later, MDI would sue Oxford International (another “investor relations” firm), alleging securities fraud.

In August 97′, Millennium took an interest in TearDrop Golf Company. Four years and several “acquisitions” later, TearDrop was forced to file for bankruptcy protection.

On Sept. 15th, 1997, Millennium announced that they would be taking on Sled Dog as a client. A little over a year later, Sled Dog would file for bankruptcy protection in Minneapolis. Given the short time between when Sled Dog hired Millennium and the bankruptcy, one has to wonder what type of due diligence Millennium was doing before taking on clients.

In November 97′, Millennium helped Mark Fixler, President and CEO of Fix-Corp International, Inc. secure an interview on Fox News. In 2008, Fixler would be named in a civil lawsuit, alleging, yup you guessed it, securities fraud.

In January 1998, Millennium Holdings was pitching Advanced Media Inc (ADVI) to potential investors. In September 2005, ADVI had their stock registration revoked for failing to keep their SEC filings up to date.

On March 12th, 1998, Winners All International, Inc. sued Millennium Holdings Group Inc. for breaching “a consulting agreement, common law fraud and fraud in the purchase of securities.” The statement of claim sought rescission of the agreement, restitution of the stock shares issued and a claim for $200,000 in damages. Millennium would later settle the lawsuit by paying out the $200,000.

In Sept. 98′, Millennium took on NetMed Inc. as a client. Less than 6 months later, OxyNet sued NetMed alleging fraud. Approximately, 3 weeks after the lawsuit was filed, NetMed declared Chapter 11.

In Sept. 98′, Millennium was also providing investor relations support to Silverado Gold Mines, Ltd. As if this story couldn’t get any more surreal, Silverado’s CEO would later appear “in a staged interview with a TV host, previously sued by the SEC in a multi-million dollar fraud case involving live goats and goat carcasses.”

Ten years after hiring Millennium, Silverado would eventually get busted after a series of damaging articles by the legendary business journalist, David Baines :)

In November 1998, Millennium Holdings announced that they had been hired to provide investor relations support for Keystone Energy Services Inc. Six months before they began their marketing campaign, Keystone was sued as part of a class action lawsuit for issuing misleading statements to their investors. In March of 2001, two Keystone execs, were indicted on 114 different violations. This case is especially notable because it was the first time that the state of Minnesota pursued charges on a pump and dump that involved the internet.

International Industries / International Internet Inc. / Evolve One – The Gift That Kept On Giving

After being involved in so many companies at the investor relations level, it was only a matter of time before Schultheis and Tabin would want to set up a company of their own to run. In preparation for public office, On May 30th, 1997, they formed a company named Mr. Cigar Inc.

They were supposed to be a cigar kiosk company, but after learning about a patent on the concept, the company decided to just be a distributor instead. On Jan. 26th, 1998, International Industries Inc. acquired Mr. Cigar Inc. and gave control of the company to Schultheis and Tabin through a reverse merger.

8 months after the acquisition, Transmedia Consultants (another financial relations company) would try to get their pound of flesh by suing them over some kind of grievance. While the suit would later be withdrawn for an unknown settlement, what was so damning about the lawsuit was that Transmedia was after the equity in Mr. Cigar Inc. NOT International Industries. This would suggest that stock promoters were lined up, even before Mr. Cigar Inc was bought.

On Jan. 14th, 1999, Bloomberg wrote an article accusing International Industries of adding to the “internet stock market mania” by issuing a press release announcing their acceptance into the Amazon affiliate program. Of course, we know today that even small time publications like my own, can easily get accepted into the program. At the time though, investors were so hungry for growth opportunities that they bid up International Industries by 100% on the day the press release was issued.

With the old economy starting to look stale, International Industries would change their name to International Internet in 1999. Later the company would be known as Evolve One.

On May 10th, 1999 International Internet announced a drastic change to their business model. Going forward, they wanted to act more like an internet incubator and try to acquire various businesses. Later they would spinoff these investments which would create new public companies for them to feed off of.

A month after announcing this change in business model, they acquired Auction Concept Inc., in the first of what would be a series of acquisitions.

Running low on funds, International Internet took to the street to raise money. In March of 2000, with the market near its high, they received a commitment for $11.25 million from Avenel Financial Group. Avenel was a financial firm controlled by Michael Pruitt. Pruitt will drift in and out of the story as time goes on, but this investment was notable for two reasons.

First and foremost, International Internet had just made an acquisition of Reconversion Technologies. Inc. on March 8th, 2000. As far as I know, this transaction was never reported as the related transaction that it was. Only two days later, Pruitt would be appointed as a Director of Reconversion Tech (now known as Healthsport.)

Another troubling connection between Pruitt and International Internet occurred on Jan. 14th, 2000 when International Internet LLC acquired a minority interest in Vertical Computer Systems.

Nine months later, One Travel Holdings Inc. (a company where Pruitt was the CEO) would enter into a contract with Vertical Computer systems to have them provide “internet, e-commerce and software services.”

On March 16th, 2001, International Internet registered to sell 550,000 shares of EResources Capital Group, Inc. EResources was yet another firm where Pruitt served as the CEO. Again, I couldn’t find a single related transaction disclosure.

While it’s easy to say that the SEC fell asleep at the switch on this one, Schultheis and Tabin did show up on their radar while they were working International Internet. In 2002, agents from the SEC recommended that “the SEC pursue a federal injunctive action against EONE for violations of the antifraud provisions of the federal securities laws.” Specifically, they were concerned about two false and misleading press releases that were issued in February 2000. Despite my best efforts, I wasn’t able to find out how this was resolved.

International Broadcasting Corporation – Ground Control To Major Tom

I never did quite figure out how Schultheis and Tabin acquired their stake in International Broadcasting Corp., but like many of the companies in this article, it also has had a troubled history. The firm was a collection of internet radio stations that broadcast everything from Blues to stock market commentary. Before it was IBC, the company was named “Explosive Financial Opportunities” :roll: Feldman Sherb & company was the auditor.

In May of 2002, IBC filed an SB-2 that brought Tabin and Schultheis’ positions under 5% (meaning that after the offering, Tabin and Schultheis would no longer have to report their trades or positions.) In the SB-2, IBC claims that “none of the selling security holders has or within the past three years has had, any position, office or other material relationship with us or any of our predecessors or affiliates, other than Tyler Fleming, who is Daryn Fleming’s brother and Sharon Fleming who is Daryn Fleming’s mother.”

Daryn Fleming, who was the CEO of IBC, may have disclosed his family relationships, but what IBC did not disclose was that Arthur Dermer, who also sold shares in the offering was (and still is) listed as a Director of the Tabin Family Foundation. I don’t know what his relationship to the family is, but it represents yet another related transaction that was hidden from the public.

Even before Fleming took on his role at IBC, he had prior relationships with Schultheis and Tabin. In July 98′, Fleming was hired to provide marketing to International Industries. As part of the promotion, he issued a positive “research” report on the company.

Despite the controversial nature of Fleming’s business model, the man knew no shame. A mere two weeks after his report on International Industries, he was highlighting a company that “helps investors who have been victimized by fraudulent and corrupt practices of brokers.”

In 1999, the Wall Street Journal would take Fleming to the woodshed for hyping stocks on the internet without disclosing that his firm, Wall St. West, was being compensated for the promotions. In the article, WSJ reporter Jason Anders, took a critical look at Fleming’s client base and included comments from Schultheis on why they hired Fleming in the first place.

“Gary Schultheis, president of International Industries says he hired Wall Street West to get some exposure for his company, particularly on-line. “[Mr. Fleming] said that he is very active in the internet, and that he had lots of places to get us good corporate exposure.” Mr. Schulteis [SIC] says he never specifically asked Mr. Fleming to post on message boards.

Mr. Fleming created a Silicon Investor message board to discuss International Industries, a Boca Raton, Fla., company that manufactures cigars and cigar vending machines. Mr. Fleming has posted 11 of the board’s 27 messages. When some participants complained that the stock’s price appeared to be slipping, he responded, “We think mostly big time investors bought [International], which is why we want to do a Wall Street West style SQUEEZE. This is where none of us will sell. In light of increasing demand, the stock could soar!!!!”

In 2005, Mr. Fleming would find himself in a bit of hot water after going on “Stock Talk Live”, one of IBC’s radio shows and making false statements to investors about acquiring various radio stations. Two years later, the SEC would lower the hammer and would file a complaint against him for fraud.

Interactive Golf Marketing/WowStores.com – More Than One Way To Skin A Cat

A little over a year after joining International Industries, Schultheis, Tabin and Rakesh Taneja purchased Interactive Golf Management (IGM), through a company named Estores.com. The purchase occurred on February 16th, 1999. One day later, International Internet, (which was also controlled by Schultheis and Tabin at the time) made a $20,000 investment into IGM. In March of that year, International Internet would end up acquiring 16% of the company. While it has been over ten years since this transaction took place, as hard as I tried, I still couldn’t find where it was reported as a related transaction.

After taking over, the group must not have been very happy with their golf swing, because they promptly changed the name of the company to WowStores.com. A short 7 months later, Tabin and Schultheis would leave the company after selling their stake to StockFirst.com

StockFirst was an “unbiased” financial site dedicated to emerging opportunities. The president of StockFirst at the time of the acquisition was David Hirsch. Before Joining StockFirst, Hirsch was working for a boiler room operation named First United Equities Corporation. While there, he was caught pushing two different microcap stocks on investors. In a settlement with the SEC, Hirsch admited to engaging in manipulative trading, lying to his clients about not earning commissions from selling them the stocks and refusing to let customers sell out of positions, unless they purchased one of the other house stocks instead.

Network Systems International/OnSpan/Double Eagle – Make Sure To Look Out For Number One

Of all the stocks that I’ll discuss in this report, Network Systems International was by far the most damning. On July 25th, 2000 Millennium Holdings Group conducted a private placement where they sold approximately $1 million worth of stock to investors. In addition, Tabin purchased another 2.7 million shares for a cool $1.5 million. After the transaction, Tabin would become the CEO of the new company.

While it would take nearly 6 years to unravel, this transaction would end up haunting Schultheis and Tabin for a very long time. Two of the $1 million investors, Richard T. Clark and Joel C. Holt would end up suing Schultheis and Tabin after things didn’t quite turn out as planned.

According to their complaint against the company, on May 8th, 9th and 10th, 2000, Tabin held a meeting in the Bahamas with Clark, Holt and other investors to discuss the acquisition of a small cap stock. Tabin’s attorney for the deal, G. David Gordon would also attend. From the complaint,

“At the meeting, Tabin solicited Clark and Holt, as well as others, to invest $1,000,000 for an operating company which was publicly traded and listed on the Small Cap NASDAQ Exchange. Tabin told Clark and Holt that the money would be used by OnSpan to acquire some operating business with independent managements [SIC] that would enhance the value of OnSpan’s stock and render a profitable return to its stockholders. Tabin told Clark and Holt that he would be buying out the ONSpan insdiers and assuming the role of OnSpan corporate director. Tabin told them that if Clark, Holt and other investors invested $1,000,000, then the insiders’ stock positions that he acquired would give them as a group effective control of OnSpan so that the business plan he had outlined for OnSpan could be carried out.”

Later in the filing,

“Tabin’s representations and warranties concerning the investment strategy and business plan never included, or even contemplated, that Tabin would remain a long term officer or Director of the Company. Nor would he draw a salary or other cash remuneration after he had assisted OnSpan in located and acquiring an operating business with an independent management. When Tabin made his statements and representations to Clark and Holt at the meeting, he made false representations of material facts, and omitted and failed to tell them of certain material facts, which would have had a substantial impact on their decisions to invest in OnSpan, and the absence of which, when considered in the context of the information that Tabin did provide to them, mad Tabin’s presentation misleading. These false representations and omissions of material facts include without limitation, the following:

(a) Tabin did not advise Clark or Holt, that their money had to be committed and in escrow to enable Tabin to acquire his interest in OnSpan, and that therefore he was not undertaking any risk until Clark and Holt had already assumed the risk of the investment.

(b) Omission of the fact that he already had an agreement with the current directors and management of OnSpan to purchase stock at a lower price than to be paid by Clark and Holt

(c) Omission of the fact that he had an agreement with one or more other John Doe investors to acquire a controlling interest in OnSpan as a group, instead of voting his shares with the shares purchased by Clark and Holt, and any other Initial Investors, for purposes which were contrary to his representations and warranties made to Clark and Holt. Tabin actual purpose included taking control of the Board of Directors of OnSpan so that the Board would be under the dominion and control of Tabin so that Tabin could direct the actions of OnSpan as he saw fit, including the dissipation of company assets and opportunities and the conversion or misappropriation of its assets by paying himself a large salary, and possibly other compensation and benefits, at a time that OnSpan had no revenue and no business operations whatsoever and while Tabin was drawing full compensations from Evolve One, inc., another company for which Tabin raised funds under the same or similar circumstances as OnSpan

(d) Omission of the fact that he was associated with acquiring another company, Vertical Computer Systems, Inc., in much the same fashion as he did for OnSpan, which was under investigation by the Security Exchange Commission for possible violations of federal securities laws.”

While it’s easy to look at a complaint like this and claim that it’s just Clark and Holt crying over sour grapes, there is supporting evidence to suggest that something may have been up.

On February 10th, 2009 the SEC charged David Gordon with securities fraud. In their complaint, the SEC claims that Gordon was part of a shell creation group that derived over $41 million in illegal profits from their pump and dump activity. Richard Clark would also be indicted as part of the scheme.

“To execute their scheme to defraud, Defendants, acting in concert with other persons, obtained market domination in the target stocks; engaged in coordinated trading activity, including the use of illegal matched orders; and created and distributed to the public deceptive promotional materials, all of which generated the false appearance of investor interest in the Target Stocks thereby artificially inflating the prices of the shares. Defendants, acting in concert with other persons, sold shares of the same three Target Stocks they were recommending that the public buy. This scheme is commonly referred to as a “pump and dump” because the perpetrators artificially inflate or “pump” the price of a stock and then sell their own shares (the “dump”), at the artificially inflated “pumped ” price.”

In case you think that Tabin was actually looking out the interests of OnSpan shareholders, I’d like to point out that once he faced legal liability, he was quick to offload the risk to the shoulders of OnSpan investors.

In 2006, Tabin and Schultheis would eventually settle the lawsuit by giving up their shares in OnSpan/Double Eagle in exchange for the Vois.com domain name. When Tabin finally did leave, Michael Pruitt would replace Tabin as CEO and Chairman of the board.

Marc A. Saitta – Chief Financial Officer

In this report, I’ve focused most of my comments on Schultheis and Tabin’s career, but one character who jumped out at me was Vois’ CFO Marc A. Saitta. I’m not exactly sure what connections he had with Vois, prior to its creation, but I found his prior employment at Smithsonian Business Ventures extremely interesting.

It would take another 7,000 words to go into all of the details behind the conspiracy, but essentially the executives at SBV found a loophole in the Government that allowed them to loot one of our Nation’s treasures. While investigating SBV, Senator Charles Grassley had a most appropriate quote,

“It looks like the leaders of Smithsonian Business Ventures were living like Thurston Howell and managing like Gilligan.”

Unfortunately, Grassley would never pick up on the microcap angle to the story and this was never fully investigated. Instead, SBV would eventually trip themselves up by signing a 30 year exclusive deal with Showtime to produce historical films. When Congress found out about SBV, they were furious. The investigation produced several lengthy hearings and a report that is over 100 pages long.

I’m not a fan of the political thrillers myself, but if a journalist wanted to take a closer look at SBV’s licensing deals, I think they’d find a story that is eerily similar to Vois, only involving extremely powerful Washington insiders.

The Auditor – Second Verse Same As The First

Over the last 20 years, Tabin and Schultheis have appeared with a wide variety of supporting cast, but one bad actor who kept reappearing during my research was Sherb & Co., Vois.com’s auditor.

In looking at the history of the firm, one must conclude that these guys are either incompetent, actively helping to perpetuate stock fraud or are simply the world’s unluckiest auditors.

Recently, famed short seller Manual Asensio cited China Sky’s use of Sherb & Co. as a major red flag for the company. In 2007 (right before Vois first hired Sherb & Co.) the auditor was reprimanded by the PCAOB after they looked at 8 of their clients and found material deficiencies in the audits. Specifically, they cited one case that “included a deficiency of such significance that it appeared to the inspection team that the Firm did not obtain sufficient competent evidential matter to support its opinion on the Issuer’s financial statements.”

Whether we are talking about Smart Online, Spear & Jackson, China Sky, ProNetLink, Light Management Group Triton, or Optionable, Sherb & Company has consistently failed to catch problems before they happen. That may be a benefit to someone who is trying to hide illegal behavior, but shareholders deserve a higher level of performance from someone who is so crucial in identifying and preventing fraud.

Over the years, Schultheis and Tabin have worked with Sherb & Co. enough times, that I think it’s fair to question whether or not the firm is considered independent. While I understand how hard it can be to identify firms that are engaging in fraud from that ones who just make mistakes, I can’t but help find it frustrating that Sherb & Co. has been able to have such a high failure rate and yet they’ve received little more than a slap on the wrist by regulators.

Given that Vois has been fooling the blogosphere for over a year now, some may ask why I choose to speak out on this issue now. While deep down inside I really didn’t want to make enemies with people I don’t know, I became concerned that a trap was being set after Vois announced that they were doing a 1 to 100 forward split. Through this use of financial engineering, they’ve been able to dilute their shareholders.

Why do I think that Vois is doing the 1 to 100 forward split now? It’s pretty simple really, they are out of money and likely won’t make it through December, unless they can offload warrant debt onto public shareholders that is. TheRichArab from Yahoo! Finance explains this point best,

“WARRANTS ARE LIENS. the company is doing the split to cover the WARRANT. which EXPIRE IN DECEMBER OF 2009. IF the warrant is not covered by shareholder capitalization then THEY THE COMPANY must pay the outstanding amount. IT IS SIMILAR TO OPTIONS, VS. MMs and US (you cannot option a pinkie).

SO, what does the company do when the stock has moved south ever since the LIEN of the WARRANT ISSUE? THE offer a 100 to forward split! Look at VOIS it has not moved at all since the SEC Filing – WHY? Because NOBODY F*ING CARES. The only paper in play is the WARRANT. They want that CAPITALIZED in order not to have EVEN MORE DEBT than they already have.

The Strike price previously on the WARRANT was 18.50
with the forward split it will be .1850 – 100 X less.
you will not get more share (nor will your PPS holdings be 100X less). But VOISW can convert to common shares at .1850! that is the play for us holding! AND I guarantee that this stock VOISW will reach .185 before and beyond the split! the company wants everyone in the warrants to succeed. they could care less about the company they are diluting with the 100 to 1 split. they simply dont want to go bankrupt on the LIEN, which looking at their company they are very close to doing.

So what do you do as an investor. RIDE THE WARRANT AND F*K the COMPANY. My prediction, this split will cause the warrant will be worth more than company stock – look at VOIS vs VOISW and the 3200% VOISW has made in 1 month versus the NEGATIVE SPIRAL CONTINUING with VOIS.

this is from company you can email them too

From: CRAIG A [mailto:craig@scommerce.com]
Sent: Fri 6/26/2009 9:55 AM
To: richarab
Subject: investor question

Hi richarab!

In regards to your question about whether the split affects both VOIS
and VOISW, I just wanted to clarify something. The common shares of
VOIS will split 100 for 1, and the exercise price of the warrants
split. So instead of exercising at $18.75 they would split at an
equivalent of .1875.

Thanks!”

Former convicted stock felon Barry Minkow describes financial fraud as “the skin of the truth stuffed with a lie.” The best con artists must pepper their lies with truths in order to perpetuate their fraud for as long as they can. You have to have people believe in the legitmacy of what you are doing, if you want to do more than pickpocket them.

Vois claims that they are a legitimate web 2.0 company with a “strong” management team that has taken many tech companies public. What they don’t tell the public is that over the course of their careers, the founders have been exactly one degree away from businesses and individuals who have been directly involved in fraud on multiple occasions.

Whether or not Vois’ founders are trying to pull the wool over their investor’s eyes, I’ll leave up to you to decide, but make no mistake about what is at stake.

People who are victimized by stock fraud don’t tend to be the sophisticated investors that the big name VC firms are going after, they tend be be an unsuspecting and unsavvy web 2.0 public that doesn’t understand the first thing about investments. Hopefully, before recommending a company like Vois again, we’ll see sites like TechCrunch and Mashable do better due diligence to help protect their readers.

*Just in case you didn’t get enough of this story in the article, tune in on July 9th at midnight PDT for part 2 of my expose as well as a a podcast where I confront Vois Co-Founder Craig Agranoff on the air.

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Ask Davis: How Much Did Rim Pay For Dash? http://davisfreeberg.com/2009/06/28/ask-davis-how-much-did-rim-pay-for-dash/ http://davisfreeberg.com/2009/06/28/ask-davis-how-much-did-rim-pay-for-dash/#comments Mon, 29 Jun 2009 04:54:38 +0000 Davis http://davisfreeberg.com/?p=1265 Dash ManOne of the things that I love about publicly traded companies is the amount of information that they have to publish in their regulatory filings. Combing through the gaboolgook of business speak, legal disclaimers and operating results probably doesn’t sound all that exciting, but it can be fun when you find secrets buried in the tediousness of it all.

The key to unlocking most filings, isn’t so much what they tell you, but what’s missing. If you look at the numbers that they do give you from different perspectives, you can often get a rough outline of the ones that aren’t there.

With this in mind, I decided to dig deeper into Research in Motion’s latest 6K filing, to see if I could find clues to some of the questions that RIM left unanswered when they acquired Dash Navigation. Rim’s purchase of Dash has always been shrouded in a cloud of mystery. Normally, acquisitions make front page news (or at least the front of Techmeme), but Dash and Rim both kept quiet for nearly two weeks, until Boy Genius saw details leaked in an industry publication. Even in their most recent 6k filing, Rim doesn’t mention Dash by name once.

What Rim does mention though, are some hard numbers that can help to fill in the blanks.

In the filing they tell us the following

-During the 1st quarter they purchased two companies. A company named Certicom and “a company, whose proprietary software will be incorporated into the Company’s software.”
-The two businesses cost RIM $124.4 million
-Out of the $124.4 million, $111 million was spent on Certicom
-They also spent $4 million in financing costs as part of the transactions
-Even though they only spent $124.4 million, they actually had to redeem short term investments of $136.4 million in order to complete the transactions.
-Part of the cost of the Certicom transaction was reduced by the $10.9 million in cash that they picked up as part of the transaction.

Since RIM admits to only making 2 acquisitions during the quarter, it is relatively easy to determine the purchase price of the company.

$124.4 million – $111 = $13.4 million
$13.4 million – $4 million = $9.4 million

In order to make sure that we take into account any cash that Dash may have had, you have to look at the difference between what RIM actually paid for both companies and what it actually cost them.

$136.4 – $124.4 = $12 million

Since Certicom had $10.9 million, it would suggest that Dash was left with a mere $1.1 million when they were acquired.

$9.4 – $1.1 = a purchase price of $8.3 million

When you consider that Dash raised $71 million in three rounds of financings, it’s easy to understand why they wanted to keep quiet about an 88% loss for their VC investors.

What is a little surprising though, is how good of a deal RIM seems to have gotten out of the transaction. One of the more interesting figures that caught my eye was an entry for a $26 million dollar tax credit picked up in “one” of their acquisitions. That’s right folks, by buying Dash for $8.3 million, Rim will get a $26 million haircut on their taxes. They actually had to book over $8 million in revenue during the quarter to reflect the immediate gain on their investment. The tax loss alone represents a 300% (overnight) return on the acquisition. No wonder RIM doesn’t want to talk about it, Dash seems to be more of an accounting adjustment then an actual play at their technology.

While I can understand why Dash and Rim wouldn’t necessarily celebrate this transaction, lets hope that they are being honest with us about implementing Dash’s technology into their products. Allowing consumers to share information, in order to better understanding real time traffic could really help to push GPS technology ahead. It would be a shame to see Dash’s legacy relegated to an unnamed footnote in a business filing.

If you’ve ever wondered what my opinion on something might be, here is your chance. Contact me through the tip line and I’ll consider your question for a future column.

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Fear Of A MiKrosVft Planet http://davisfreeberg.com/2009/06/02/fear-of-a-mikrosvft-planet/ http://davisfreeberg.com/2009/06/02/fear-of-a-mikrosvft-planet/#comments Wed, 03 Jun 2009 03:56:26 +0000 Davis http://davisfreeberg.com/?p=1002 Microsoft Planet

“I need not fear my enemies because the most they can do is attack me. I need not fear my friends because the most they can do is betray me. But I have much to fear from people who are indifferent.” – Russian Proverb

Now I know that most people don’t really care about the mechanics behind playing video files and I can’t say that I blame you for caring more about your content than the technology behind it, but while this post will get into some of the more mundane mechanics of the codec industry, I ask that you stick with me because behind the scenes a war is being fought for control of your very television.

This particular battle has been going on for over 10 years now and centers around something called a codec.

When J.D. Rockefeller set out to monopolize the oil industry, there were several crucial areas where he attacked. He knew that he couldn’t control all of the oil fields because it was literally bubbling out of the ground, but what he could control was the distribution method for getting oil to the end customer.

In building his monopoly he seized assets used to transport oil from raw material to the end consumer. Whether it was owning all of the oil pipelines, so that he could control what oil cost him, owning the railroads so he could dictate how far his competitors could reach or owning the distribution points where consumers bought kerosene to light their homes, he made sure that he had control over every aspect of it. This was good for Standard Oil investors, but wasn’t very good for competitors or consumers.

Online video may not seem like it has a lot to do with the oil industry, but if you look at it’s early development, there are many similarities. So much content is bubbling up that the real challenge isn’t finding video oil, it’s getting it to consumers. Instead of pipes, now we have internet access, instead of railroads there are CDN networks, instead of gas stations, there are operating systems ready to serve us 24 hours a day.

In all of these industries, competition has been limited to a handful of big companies, but the industry that I’m most interested is much smaller than any of these. In the grand scheme of things, codecs (and the filters that go along with them) are the refineries of the video world. They take digital signals and convert them into the flickering magic that appears on our screens. Consumers may not understand the technical details behind it, but they are a crucial chokepoint in your digital video experience.

This battle has been fought on many fronts, but in the end it always comes down to one issue. Those who think consumers should have a choice and those who think they know better. It’s about control over your entertainment experience. Who, What, Where, When, and How you are allowed to consume YOUR media. On one side, well funded corporations with huge financial stakes, on the other, an unorganized patchwork of misfit companies and an army of guerrilla volunteers desperately fighting for a better entertainment experience for all of us.

The war over how video is transmitted may not make it to the front pages, but how it turns out will be important for the success of digital video. In order to better understand how this battle is going, I reached out to interview one of the Colonels in this digital revolution.

Dan Marlin is the CEO and Co-Founder of CoreCodec. His company has built many of the tools necessary to play video files. Before starting his company, he worked for DivX and over the years has contributed extensively to the open source codec movement. He also sits on the board of the Matroska Foundation, an organization dedicated to enabling high definition digital video support for as many consumers as they can.

In our interview, we discussed the growing momentum behind the MKV format, his thoughts on DivX and the competitive landscape of the codec industry and had a passionate discussion around a controversial decision by Microsoft to prevent outside developers from using alternative filters in Window’s Media Player.

In regards to MKV, Marlin had many positives things to say about the momentum that they are seeing. When I asked him about interest in the format, he said that over the last 8 months, they’ve seen a “20 fold increase in the inquiries in regards to more details, about usage about enhancing the current feature set.”

This interest should mean good news for consumers. As more and more customers ask “where’s the MKV?“, hardware companies are starting to respond. When I asked Marlin about how long it would take before we see MKV reach critical mass he said,

“If you look at the adoption scale, you’d probably have to say that we’re at the Ubber Geek stage right now. It will probably take 2 – 3 years. We’re just starting to see the penetration now and it’s been three years since our last release. I would probably have to say two years. Not this Christmas, but the following Christmas you’ll probably start to see more devices.”

One of the more interesting things that came up during our conversations was some of the trends that Marlin is seeing in the MKV adoption curve. It’s no surprise that the anime community was one of the first ones to start using the technology, but I was surprised to learn that countries in Asia and Europe have been more enthusiastic in adopting MKV then in North America. In fact, the trends for MKV adoption mirror the original DivX adoption curve exactly. It’s almost as if the people who’ve been long time DivX users are the first ones to upgrade to an HD experience.

“Absolutely, as a matter of fact it’s mirrored exactly. You could look at DivX in the early days when I was there going back to 2001 and you can actually see the same adoption happening, the anime, the ripped releases from the AV heads, it’s mirroring it, but you have to ask why they are doing it? They are doing it because of the flexibility that it brings to what they’re doing. They can add, especially when it comes to some of the guys that rip DVD and the like and Blu-Ray, they kind of make it their own. They can add menus, there are menus out there that even though they are text, they do very basic things, but there can also be a ton of files inside the container itself, there are info files and pictures you can group.”

While Matroska was technically created by CoreCodec, Marlin told me that he has plans to spin it off into a foundation similar to Mozilla. They plan to offer sponsorships to companies that want to tap into their early adopter customer base. One of the things that I found fascinating throughout the interview was the openness behind such a transformative piece of technology. Instead of monetizing their creation, CoreCodec is building a business around the open source eco-system. Big media companies that believe you can’t build a business around “free”, would be well served in looking at how Core Codec has been able to position themselves by giving a good portion of their technology away.

“we looked at it not looking to make money and that wasn’t really the intention, but even what has been proven now and maybe not so much back then, open source and the ecosystem around open source, there can be profit. Even in a non-profit foundation or a not for profit foundation I should say, which the Matroska Foundation will eventually become, you know is pretty much the same thing. You still can be profitable and make money to support what you developed.”

When I ask Marlin about his thoughts on DivX and how they are positioned in the codec industry, his thoughts were bittersweet, “it’s a love-hate thing.” On one hand, having DivX adopt the MKV container does a lot towards making it a standard. It also helps to speed up the amount of time it will take to get into hardware devices. On the other hand, not a lot has changed since DivX and XviD split paths and now that the open source movement has taken the upper hand, he doesn’t like to see confusion between X.264/MKV and DivXHD.

“Obviously they’ve rethought what they had to do with H.264 which is a migration, but they’re not providing anything of value to what’s already out there. As a matter of fact, it brings more confusion than anything else and that’s the frustrating part because they have their own eco-system with certification and us as a solution provider like with CorePlayer or the CorePlayer platform itself is working with third party OEMs and they are asking questions in regards to DivX and DivXHD and we say the same thing we’ve been saying all along. DivX is Mpeg video and DivXHD is AVC video.”

Of all the topics that we discussed though, the most controversial was the decision by Microsoft to restrict how third party filters work within Windows media player.

To fully understand the issue, you need to know how your computer reads media files. When you click on your file, filters take a look at that data and tries to figure out what to do with it. If it’s audio, they’ll send the data to an audio decoder so your soundboard can play it. If it’s video, then it gets sent to a splitter where the audio stream and video stream are separated. From there a decoder looks at the video data, decodes it and sends it to a renderer for display on your screen.

The controversy revolves around how Microsoft prioritizes filters when you play back content. Currently, if you have several filters installed that can all handle the same job, WMP will look at the merit value of each filter and give preference to the highest one. Since you have the ability to prioritize which filters you want your computer to use, it allows you to create the ideal settings based on your hardware.

This comes in handy if you’re trying to play H.264 video in WMP and it happens to conflict with your video card. Since the user has control over the priorities, you’re able to create a better (more credible) configuration.

With the Windows 7 RC, Microsoft has taken away your ability to prioritize which filter you can use. From their perspective, they get a ton of complaints about filter problems and by making it a closed system it improves the experience for their customers. For the codec industry though, it will reduce the incentive for engineers to continue to work on filters because Microsoft has just essentially seized the entire filter market.

Microsoft will argue that because they allow people to install whatever filters they want on their own media players, that this restriction is somehow reasonable. After all, they’re not preventing customers from downloading another media player and configuring the settings anyway you like, they’re controlling their own product.

The problem with this argument though, is that while consumers have shown that they’re willing to download a codec, by and large, they’ve been very reluctant to download an entire media player. It’s a big commitment to mess with the default settings on Windows and because Microsoft bundles a copy of Window’s media player into every operating system they sell, it drastically minimizes the potential market that companies like CoreCodec, DivX and Nero can serve. This ultimately leads to less investment in codec technology and lower quality video for consumers in the long run.

Take a look for yourself at a real life comparison between video played using Media Foundation’s preferred filters and an open source combination. While the differences may be subtle, there is clearly better focus and definition in the open source solution. It might not be much, but it makes a huge difference when you put it on a 60″ screen. Today, you’d have the option of recreating the ideal settings in WMP, but with Windows 7 Microsoft is now in control.

While Marlin wouldn’t go as far as to accuse Microsoft of using their dominance over the operating system as a way of stifle third party codec competition, he did agree with me when I suggested that this may have more to do with preventing competition then securing their media player for consumers.

“You said it I didn’t, but essentially when it comes down to it, that’s what it is. It’s just frustrating that we all have to go through what we have to do and they could have provided an integrated solution without having to lock out third parties. Period.”

Now we can argue over whether or not Microsoft had an evil intent when they choose to shut down part of the codec industry, but regardless of the motives, competition is hurt by their decision to close media player to third party vendors. When I asked Marlin whether this would hurt his company or whether it was a dam in the river that would fork around the issue, he had conflicting thoughts.

““I think it’s going to be both. Microsoft will probably tell you that there is no problem and then the Core people will fork around it, but you’ve got to question the value of it though. You could still have embedded DirectShow filters, why have them under media foundation?”

Later on in the interview he extrapolates,

“I would say that as long as the default decoders are not set as the default and can be overwritten, I think we’re OK. The question is what steps will you have to go through and will Microsoft allow those steps. Right now you can edit it, they posted the solution online, but Microsoft could bypass that solution with the next RC. So that’s kind of like a wait and see thing. It does affect our business though, it does affect DivX’s business, it affects everyone’s business. “

Now Microsoft is free to run their business in anyway that they see fit and while the issue over filter compatibility within WMP may be an inch in the grand scheme of things, with each inch consumers lose a little bit more control. What’s so surprising to me about Microsoft’s behavior though, is how bold their actions are given the current regulatory climate.

Someone should nominate them for Alpha Dog of the Week because it takes giant brass balls to use your ability to bundle software, in order to shut down an entire industry, while you’re being accused accused of abusing your monopoly by bundling software within the operating system. If the EU understands even a little bit about codecs, I would expect them to be up in arms over this issue because it essentially proves the argument that they’ve been trying to make. Microsoft’s dominance in the operating system is having a detrimental effect on competition in other areas of the software industry.

It could very well be that Microsoft has good intentions here, but given their long history of doing whatever it takes to gain control of the codec industry, I can’t believe that this is by happy accident. This is a company that just spent a ton of money to exclusively webcast the Olympics in their Silverlight codec. The lack of MKV support in Windows 7 prompted the Hack 7 MC blog to write that “Microsoft’s support of the format is borderline neglectful.”

The decision to interfere with the priority filter settings is so Machiavellian I still don’t know what to make of it. My cold banker heart says yes! yes! yes!, but the consumer in me says dear God no. While I understand that these issues are hard to figure out and that there are many ways to look at them, I hope, for the sake of the entire codec community, that Microsoft will rethink their decision to exclude third parties from Windows media player.

For a complete transcript of my interview with Dan Marlin, please click here.

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Why Is Redbox Afraid Of The Big Bad iPhone? http://davisfreeberg.com/2009/03/25/why-is-redbox-afraid-of-the-big-bad-iphone/ http://davisfreeberg.com/2009/03/25/why-is-redbox-afraid-of-the-big-bad-iphone/#comments Wed, 25 Mar 2009 23:17:05 +0000 Davis http://davisfreeberg.com/?p=891

Over the last few years, Redbox has been able to build an impressive DVD rental network by being innovative and flexible while their competitors were still laughing at the concept of kiosk rentals. Over time they’ve added features to the Redbox website that allow customers to browse and reserve titles online. They’ve linked their kiosks together so that unlike competitors (ahem: Blockbuster), you can actually rent a movie from one location and return it at another. Redbox’s core business may ultimately be, plain old boring DVD rentals, but there’s no denying that they’ve been an innovator in their industry. This is why I am so perplexed by their most recent decision to go hostile against iPhone owners.

Given the company’s reputation for thinking progressively, I was disappointed to learn that they’ve decided to take a technological step backwards by putting pressure on the Inside Redbox blog, to kill their Inside Redbox iPhone application.

I haven’t jumped on the iPhone bandwagon myself yet, but I can understand why some people think of their phones as an extra appendage. The apps store was a brilliant move by Apple and has created all kinds of interesting software programs that wouldn’t have existed if people had to rely on big companies to build them.

By taking advantage of the GPS features inside the phone, Inside Redbox was able to give iPhone customers the ability to look up which Redbox was closest to them at any given moment. It also allowed customers to find out whether a specific title was available before wasting time visiting the kiosk in person.

The best part about the application though, was it’s ability to reserve movies directly from the iPhone. This means that if you’re standing in line at a Redbox and the person ahead of you is taking too much time selecting a movie, you could theoretically use your iPhone to digitally cut in line and reserve the last copy of Harold and Kumar instead of having to wait impatiently.

When you consider that one of the biggest customer service complaints about Redbox are the long lines when customers try to return DVDs, it blows my mind that Redbox would discourage consumers from using their own mobile device by having them monopolize a kiosk instead.

Whether a customer prefers to order their movies from the internet, a kiosk or the middle of the store while shopping for groceries shouldn’t make a difference to Redbox. No matter what, they are still making a sale, even if they don’t have 100% control over the purchase.

Inside Redbox is mum on details and calls to Redbox’s PR agency didn’t shed any light on the situation, but the two most “controversial” features included in the app is a list of codes for free Redbox movies and the fact that the app relies on Redbox’s website for most of the content.

One theory for why Redbox doesn’t seem to care about iPhone customers is that while they’ve been able to get a lot of buzz using their free movie offers online, consumers haven’t been all that aggressive about redeeming the promotions. Since iPhone customers have access to the most recent free offers while they are actually standing in front of the Redbox kiosk, it makes it easier for customers to take advantage of their specials.

If this is the reason why Redbox killed the application, my response would be that Redbox hasn’t solved their problem, they’ve just made it more difficult to work out a reasonable compromise with their customers. It won’t take consumers very long to figure out that they can bookmark Inside Redbox’s list of free codes or RedboxCodes.com on their iPhones and still have access to the same information.

Rather then fighting progress, Redbox should be using the relationships formed through the application to streamline their movie promotions. They already restrict some of their offers to new customers only, so why can’t they work out a deal for iPhone promotions? Wouldn’t it be better for Inside Redbox iPhone users to have a 10% chance at “winning” a free movie instead of killing the app and forcing these customers underground? By trying to lower the wham hammer on this neat little application, they’ll only end up upsetting customers instead of addressing a weakness in how they’ve choosen to promote their service. Just because the iPhone app doesn’t fit into their mold of what marketing should be, doesn’t mean that killing it is the best solution.

A second theory for why Redbox may have requested that the app be pulled is that Inside Redbox uses Redbox.com’s website for a healthy chunk of their content. Some businesses may object to this and want to have 100% control over how their customers are “allowed” to use their product, but smart companies see the benefits of being open. In fact open API’s are becoming increasingly common in the tech industry. By allowing third parties to mashup and repurpose your data, entirely new creations are possible. This is why some of the most successful companies have business models that encourage outsiders to partner with them. The Inside Redbox app may repackage content from Redbox’s website, but when push comes to shove, it’s really no different than an internet browser. Is it really better for Redbox to force their customers to have a subpar experience using the Redbox.com website on the iPhone instead of an app that is specifically designed to be viewed on the small screen? I don’t think so.

Asking Inside Redbox to pull their program is a bit like asking Microsoft to not allow Redbox’s website to be shown on Internet Explorer. If Redbox really objects to how their content is being used, they have the power to change it. Instead of trying to kill the third party programs that tap into what they’ve already created, they should be encouraging their fans to mix, mash and experiment to create new experiences for their customers.

To date, Redbox has managed to stay ahead of the competition by being nimble and by nurturing a passionate and dedicated fan base. Their decision to now turn on the very fans who cared about them long before their mainstream momentum, says a lot about how fickle their business decisions really are. Instead of acting like the innovator that I know they are, they are acting like a big media company. Hopefully, Redbox comes to their senses and “authorizes” the use of an app that only makes their service more valuable to their customers.

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Night Of The Living DivX http://davisfreeberg.com/2009/02/25/night-of-the-living-divx/ http://davisfreeberg.com/2009/02/25/night-of-the-living-divx/#comments Wed, 25 Feb 2009 21:35:58 +0000 Davis http://davisfreeberg.com/?p=755 Night Of The Living DivX

The last couple of years may have felt like a bad dream to most investors, but for DivX shareholders it’s been nothing short of a nightmare. They don’t hand out Oscars for businesses, but if they did DivX would have won hands down for best horror flick.

When the company first went public, expectations were high. YouTube had just been sold for $1.6 billion, DivX was demonstrating 75% gains in their high margin core licensing business, and their unique business model looked like it offered a very strong moat from competitors like Apple and Microsoft.

At one point DivX’s market cap exceeded $750 million, today it barely closed above $150 million. Over $600 million dollars in capitalization wiped out by one misstep after another. Admitedly, the tough economic environment can be partially blamed for DivX collapse, but the sad truth is that much of the value destruction could have been avoided.

Suicide Kings

Shortly after DivX went public, Jeran Wittenstein wrote “DivX was founded just before the dotcom bust in February 2000 after Greenhall managed to convince Jerome Rota — a French software engineer who created DivX’s founding technology — to join him in building a company. Including Greenhall and Rota, eventually there would be five co-founders, all of whom are younger than Greenhall and still with the company.” (Note: bold print added by me)

They may have been able to survive the dot com collapse, but DivX’s founders weren’t able to survive the success of going public. In December 2007, Jordan Greenhall, Darius Thompson, & Tay Nguyen all left the company after DivX’s board of Directors made the inexplicable decision to cancel their spin off of Stage6. Joe Bezdek officially left the company 10 months later and now I hear that Jerome Rota, DivX’s original creator, resigned from the company on February 6th of this year.

While Rota remains on the DivX board of Directors, the loss of his day to day influence can’t be understated. I only had the opportunity to meet him once, but was impressed by his remarkable vision. These five individuals may not have had the spit and polish that Wall St. expects from traditional executives, but they weren’t afraid to take risks and knew how to motivate the troops beneath them. The impact from the loss of these employees goes well beyond their individual contributions and investors have already seen shockwaves from these loses ripple through DivX’s employee base.

Two and a half years later, investors have voted with their feet, all five of the founders have now left the company, cracks are beginning to form in their moat and their franchise is very much in danger. The company has gone from being an innovative risk taker to a zombie of her former self. DivX now stands at a crucial crossroad. Are they willing to risk potential annihilation to save consumers from their zombie masters or do investors have Dawn of the DivX in store for a sequel?

“Affliction comes to us all, not to make us sad, but sober; not to make us sorry, but to make us wise; not to make us despondent, but by its darkness to refresh us as the night refreshes the day; not to impoverish, but to enrich us.” – Henry Ward Beecher

There are many instances where management has stumbled, but the end result all comes down to a loss of confidence. They’ve lost the confidence of their shareholders, the analysts, their employees and most importantly, the consumers who drive demand for their products.

Without a dramatic turnaround, I fear that this lack of confidence will spread to their manufacturing partners and we’ll see DivX lose their digital video franchise. While there is still plenty of cash flow left to milk from the DVD market, without aggressively expanding their market position, DivX’s influence will be over before they have a chance to finish the revolution they started.

Barbarians at the gate

When DivX went public, investors were willing to pay a premium to get exposure to the stock. At one point investors were paying more then 10 times sales, a P/E over 30 and over five times DivX’s book value. Based on the midpoint of DivX’s 2008 guidance, DivX is now valued at 1.15 times book, 1.66 times sales and a p/e ratio of 9.5. When you consider that DivX is holding $120 million in cash and short term investments, investors are pricing them more like a blank check IPO, then a strong growing company. You can argue that this is a result of the poor financial markets, but I think it speaks volumes about the lack of confidence that shareholders seem to have in management.

DivX’s response to their problems has been to try and slash and burn their way out of it. When they closed Stage6, they also layed off approximately, 10% of their staff. After Yahoo! backed out of their toolbar arrangement, DivX fired another 10% of their staff. If DivX was struggling to get by, I could accept these types of sacrifices, but the reality is that these cuts are only designed to boost earnings for the company.

I believe that DivX’s management is under the impression, that if they can increase earnings enough, investors will reward them by returning to their stock. The problem with this strategy is that it may be easy for DivX to position themselves to feed off of years of hard work, but without continuing to invest in the business, they have little chance of realizing meaningful growth. When DivX presents their 2008 earnings in early March, I believe that their focus will be on strong earnings results. This may look impressive from a distance, but don’t be distracted unless it’s accompanied by strong revenue growth. Earnings are certainly nice for investors, but if DivX has stopped growing, then investors won’t pay a very high multiple.

When DivX presented at the Thomas Weisel technology conference earlier this month, they used the following graph to illustrate their past growth. On the surface, it’s hard to criticize the progress they’ve made.

DivX Revenue Company Perspective

While there’s no doubt that DivX has accomplished a lot in a very short time, where they are going is more important then where they’ve been. Sadly, over the last year they’ve seen their progress come to a screeching halt. Another way to illustrate, the same information that DivX used in their Thomas Weisel presentation, is to graph the percentage that revenue has grown each year. Even if we exclude things like the Yahoo! toolbar fiasco, the trend for DivX’s core business doesn’t offer a lot to get excited by.

DivX Historical Revenue Growth

In 2003, DivX grew their core licensing business over 700%, in 04′ they saw 184% growth, in 05′ they saw 84% gains, in 06′ they almost experienced a 76% increase in growth. In 07′ signs of danger started to appear, but they still realized 40% growth from their core business. If we use the midpoint of their guidance for 08′ revenue, DivX should see a 13% increase in core revenue for 08′.

As DivX’s business has grown, there is an expectation that the law of large numbers will start to kick in, but if current trends continue, it would appear that DivX’s core licensing revenue will hit near term maturation sometime this year.

Jordan Greenhall said that 2007 would be a building year for DivX, Kevin Hell said the same thing about 08′. With the company in self destruct mode, how optimistic should investors be for 2009?

Trouble In Never Never Land

Some investors may cheer the savings in earnings, but make no mistake, it has had a tremendous cost. The coup to get rid of Greenhall, the divisive nature of current management and the layoffs have all had a tremendous impact on employee morale. DivX may claim that their employee relations are normal in their SEC filings, but there is too much evidence to suggest that DivX now suffers from Yahooitis! These creative individuals are the soul of the company. If DivX continues in their zombie state, more and more employees will leave, feelings will become even more bitter and the company’s progress will be stalled.

If you want to see proof of how bad employee relations have become, take a look at DivX’s reviews on Glassdoor.com. Kevin Hell’s current approval rating is 15%. That’s worse then GW’s numbers, when he left office. To put this into perspective, Hell’s ranking gives him the dubious distinction of being the 18th worst CEO of the 7,185 companies that Glassdoor is tracking.

If you read the comments on the site, it’s very revealing about what’s going on behind the glass curtain.

“It’s party time…if you are a VP or above…”
Pros
It’s a fun atmosphere and very social if you are of the right mindset. Lot’s of cool people and talent…
Cons
Watch your back…I didn’t trust any of the management at all after seeing my boss’ team cut without her knowing beforehand. Very closed, “open environment”… If you are looking to complete a project to add to your portfolio…think again…my projects changed scope every 3 weeks. The strategic direction changes everytime the wind blows.
Advice to Senior Management
Hire new management that cares more about the company’s success than their cushy compensation packages… Layoffs in 2008 were taking place while senior management was cashing in on millions of $$ in stock…even at very low strike prices….Something very fishy is happening here…”

or this one from a current employee who goes by the name anonymous

Anonymous in San Diego, CA: (Current Employee)
“Great company, TERRIBLE management.”
Pros
You get a chance to work with a lot of cool, talented people.
Cons
All the cool, talented people are getting laid off/fired/quitting.
Advice to Senior Management
DivX had so much energy and drive but the management seems to have succeeded in beating that out of the company almost completely.

Here’s one that calls out DivX CFO Dan Halvorson

Developer in San Diego, CA: (Past Employee – 2008)
“DivX was a fun place to work…. at one time”
Pros
DivX has a wonderful group of bright engineers. The camaraderie in my team was superb and we made the best of the otherwise dismal situation. The HR department is better than most in that they truly seem to care about the needs of the employees. There is an opportunity to do something big, and that can be exciting as well.
Cons
I’m not sure where to start! The CFO Dan Halvorson has a reputation for layoffs and cash-outs. He was rumored to have said, “I love it when people quit”. It’s gotten to the point where Halvorson avoids the office and never sticks around at company events. I suppose he knows he isn’t welcome. The constant layoffs and lack of openness to employees gives people an sense of uneasiness and all you can really do is speculate what they’re upto. At least with Jordan, he would be straight with you. The Hell regime seems pretty secretive and sometimes dishonest most times. The Stage 6 debacle was a train wreck. So much of the company’s resources were thrown at this pig and look what came of it? Nothing. A number of long time employees left around this time? Coincidence? Maybe, but not likely. I am guessing the founders got tired of the games and politics.
Advice to Senior Management
Get rid of Halvorson, he is dragging morale down all on his own. No one likes him or wants him there. Be more honest and forthcoming with employees.

The most accurate of them all though, is the bittersweet summary of DivX’s short history.

Anonymous in San Diego, CA: (Past Employee – 2007)
“Good While It Lasted”
Pros
The culture, when it first started was remarkable. There was a great vibe in the office and you constantly felt that you were being challenged and motivated.
Cons
After they went public, and Stage 6 launched, there was a massive series of mistakes that killed morale.
Advice to Senior Management
Listen to your employees.

It may be tempting to write off comments like these as disgruntled employees, but there’s obviously friction between labor and management. Shareholders may not want to acknowledge it, but they would be foolish to ignore it.

If DivX’s reign of Hell is allowed to continue, labor problems will only get worse. Lower payroll may be good for the bottom line, but it does nothing to boost their revenue, long term potential or the health of the underlying business. Going into zombie mode may be the safest way for management to keep their jobs, but zombies move slow and now is the time for action, not caution.

DivX’s digital eco-system is shifting like quicksand beneath them

Like the DVD, DivX’s codec is being made obsolete by high definition. To DivX’s credit, they saw this trend earlier than most and had the foresight to buy MainConcept to help manage this shift, but even there we’ve seen talented defections.

Support for H.264 doesn’t automatically mean that their codec won’t be skipped over in lieu of generic HD certification. The biggest threat to DivX’s business model is that CE makers will use the DivX to HD transition as a way to build support for generic certification. If consumers aren’t demanding DivX support, it will make it easy for them to cut DivX out of the equation. Managing this change to their eco-system, should be the company’s top priority. If DivX can’t convince device makers, that consumers really want their product, more and more manufacturers will leave DivX for cheaper alternatives, creating a downward spiral on their licensing business.

Winbox COO, Niklas Samios shares his rationale for choosing to skip DivX certification

Since Hell took the helm of the company, DivX has been focused on licensing premium content from the major studios. They have scored agreements with Sony and Time Warner, but between their P2P reputation and their Stage6 experiment, one can understand why some of the studios would be reluctant to dance with them.

Last August, they announced a partnership with Cinema Now for showcasing DivX content. While it’s unclear as to when their collaboration will start, it sounds like they are working on creating some kind of new entertainment destination.

According to CEO Kevin Hell DivX is “actively working with retailers to launch sites that can sell content leveraging our DRM in the marketplace. We announced Cinema Now last year and we are actively working to launch a retail offering with Cinema Now and other parties that are out there. The whole idea being that we want to bring content and allow that content to move to all the different devices out there that have our DRM inside.” (Note: Bold added by me)

While I’m of the belief that there can never be too many internet video sites, I did find it curious that Hell used the word “launch” to describe their initiative. When you consider how difficult it’s been for businesses to gain traction in the online video space, it’s a little surprising that DivX wouldn’t be using Cinema Now’s own flagship website as their distribution system.

What the need for a brand new site reveals about DivX content initiatives is a fatal flaw in their Hollywood ambitions. Even with a third tier internet video provider, they can’t convince Cinema Now to incorporate DivX into their main site, because they’ll never be able to get a license from all of the content providers.

Even if they could get a couple more studios on board, their lawsuit with UMG will effectively torpedo any hope of them ever being able to offer a comprehensive catalog to consumers. If you think UMG has any intention of backing down on this one, take another look. Read through DivX’s latest dust up over whether or not UMG should be allowed to use Audible Magic on Stage6′s 60 terrabyte database and form your own conclusions as to how far UMG seems willing to take this.

In the past, DivX management has argued that access to premium content was a key component to their growth, but at the Thomas Weisel investor conference, Hell backed away from previous comments.

“this space does I think take some time to play out, I think that there’s a lot of interesting opportunities out there right now in the premium space, but they’re taking time to really play out, so we’re making sure to pace ourselves in this space and not get ahead of the market”

Going after the studio content is a mistake in my opinion, it’s like ditching the girl you took to the prom for the cheerleader that all the jocks are already trying to make a move on. If DivX had a clean record and was bulging with cash, they might have a shot at some of that hot mainstream content, but when their P2P ex-girlfriend is more horrifying then Carrie to the content providers, it seems foolish not to stick with the girl you took to the dance.

DivX doesn’t need Hollywood content, they need consumers to DEMAND support for DivX in their consumer electronics. Supporting the dark side of the content business wouldn’t earn them any friends in Hollywood, but it would win them the hearts of consumers and would rebuild their moat in high definition.

One of the biggest challenges that Blu-Ray players have faced, isn’t so much the high cost of the hardware device, but the extra money that studios are insisting for Blu-Ray content. DivX could turn themselves into a recession play if they’d be more vocal about advertising the “free” content that people can use on their devices. As Paul Sweeting so aptly put it earlier this year, “hardware makers are adding all sorts of other gimmicks to their Blu-ray players, too, from wireless connectivity, to portability, to, wait for it…VHS playback. Yep, anything to try to avoid slashing the price of players. And anything to try to give consumers options beyond paying $30 for Blu-ray movies.”

Instead of promoting their latest licensing scheme as an H.264 solution, DivX should be pointing out that DivX Plus certification offers “Blu-Ray quality” high definition without this $30 cost. Again, it wouldn’t help their content negotiations, but it would help drive consumer demand back to DivX Plus devices, which is what ultimately drives CE interest and powers DivX’s business.

Content deals make sense as a way to extend their eco-system, but only if it’s on DivX terms. Instead of begging studios for access, DivX should be developing their consumer pipeline and rewarding the content companies who recognize the benefit of being able to access millions of consumers at their television sets. DivX greatest opportunity is the caos caused by Hollywood’s licensing terms. If they go through official channels, it will be years before they can reach their core fans, but if they fight against the system, they will be the only international solution for a very long time.

How much buzz could DivX get, if they actually spoke out about their lawsuit against UMG or if they ran some kind of “pirate” friendly promotion like giving free ISOhunt toolbar installations, while trying to find a replacement for Yahoo! These moves wouldn’t make them any money, but it would be a clear signal about who their end customer really is. DivX does almost zero marketing because their consumers have built their brand. By going hostile against Hollywood, DivX would magnify the strength of their signal. When consumers show passsion for the DivX brand, CE companies will quickly fill the void.

Fat Tube and little DivX

DivX other big “growth” initiative has also turned out to be a flop. Despite two years of pitching the concept, DivX has yet to see Connected integrated into other consumer electronics. The sad part is, that I believe Connected could radically transform DivX’s value proposition.

Currently, if you want to play a DivX movie on a DVD player, consumers must find the content, transfer it to a portable storage device (i.e. burn a DVD or move the file onto a memory stick) and then physically transport the media to their DVD player. If you’re a hard core fan, it’s worth going through all this trouble to get access to your media, but I’d be shocked if more than 5% of users were taking advantage of this feature.

The beauty of the Connected business model is that it dramatically simplifies the process. If consumers buy a TV that is powered by DivX Connected, they’ll get curious as to how to take advantage of the functionality. Not everyone will adopt DivX, but if even 25% of those customers plug their television into the internet, it would drive mass adoption for DivX content.

Compared to their DVD licensing, DivX Connected could have an atomic impact on the content industry. Make no mistake about it, if Connected takes off, it will be a weapon of mass piracy from the studio perspective. Because Connected makes it so easy to access your content, it has the potential to turn mainstream customers into rabid file sharing animals. Why it hasn’t already taken off remains a mystery to me, but it could have a serious impact on the demand for DivX, if they can ever get it released into the wild.

Last fall, I had the opportunity to meet Hell in person and I asked him whether or not he felt that the premium they were asking for Connected had anything to do with manufacturer resistance.

His response was “I wouldn’t attribute it to the pricing, I think it’s more an issue of implementation and the fact that a lot of these guys are still trying to figure out what they’re doing there. They either have their own initiatives or they’re confused about it, they want to try X, they want to try Y, anything that’s out there to figure out what it’s all about and in my mind it’s a lack of coherent focus and understanding by the CE partners.”

Since then, CES has come and gone, but it looked pretty clear to me that the CE industry isn’t all that confused about their connected television plans. The fact that DivX hasn’t been able to get their product in the door may or may not have something to do with their pricing, but deep discounting may be their best option for jump starting the program again.

In 2002, DivX was struggling to convert their company into a licensing business. Manufacturers were skeptical that consumers would pay extra for the support. To prove the value of DivX certification, DivX signed a licensing agreement with a little know third tier DVD maker known as KISS. It was officially certified in August 2003. The product, immediately began to pick up buzz and less than six months later, Phillips signed on to have DivX included in their own DVD players as well. After Phillips made their move, other CE companies were forced to follow and by mid 2004, DivX DVD players were pretty much available anywhere on the globe. To this day, the Phillip’s DVP642 remains one of the most reviewed DVD players on Amazon.

A couple years after DivX helped to put Kiss on the map, Cisco bought them out for over $60 million. I would argue that there are many similarities between Divx’s initial efforts to convince DVD player manufacturers to licensing their technology and their current struggles in the Connected market. Rather then continuing to hold out for a premier deal, DivX would be well served in signing a teaser deal with a small television provider. When large CE companies see proof that DivX Connected can move TV sets, they’ll quickly begin signing contracts to ensure that they remain competitive. While heavy discounting is less than desirable from Divx’s perspective, getting more Connected devices in the wild, would at least give them an opportunity to prove that there’s still value in the DivX brand.

Death of a Salesman

While I support discounting when it helps to secure DivX’s moat, it’s hard to be encouraged by the cracks that we’re seeing in their value proposition.

To help take a closer look at DivX’s pricing erosion, I reached out to Jack Wetherill from Futuresource Consulting for data on global DVD player sales. According to Mr. Wetherill, “DVD players in their broadest sense (ie set-top players, recorders, integrated home theatres, DVD/VHS combos and portable DVD players) totaled 122m in 2006 and 127m in 2007. We expect the market to level off at 127m in 2008, although year end numbers are still being finalised.”

When DivX first went public, the company said that they had a 25% penetration rate in the DVD player market. This translated into approximately $47 million in core licensing revenue for 2006 or approximately $1.54 per DivX certified device.

In 2007, DivX grew their global DVD player market share to 37%, which translated into approximately $66 million in core licensing revenue or $1.40 per unit.

At the Thomas Weisel Technology conference, DivX said that they’ve now captured 50% of the DVD player market, but according to their own projections they are only expected to grow their core licensing business by 13% in 2008. With core revenues around $75 million, this would suggest that DivX is now earning a unit licensing fee of $1.18 per certified device. A decline of approximately 23% in pricing power since the company went public.

When you consider that consumer trends have been much kinder to upscaling DVD players (where you almost always find DivX) vs. traditional DVD players and when you consider that DivX’s core revenue numbers include other electronic categories and Main Concept revenue, one could argue that these calculations are much more conservative then the actual results.

DivX has always said that they provide volume discounts to partners, but with over half the market now captured, it would appear that DivX’s DVD upside is somewhat limited.

Saving Private DivX

Along the way, DivX has made their fair share of mistakes, but they’ve also achieved tremendous wins as a result of the risks that they’ve taken. Compared to the mainstream studios they may only be a tiny mouse, but when you look at affect that their technology has had on the media landscape, it’s clear that they’ve been able to frighten the Hollywood elephants.

The good news is that it’s not too late to turn DivX around, but without some kind of action, I fear that DivX will remain in cruise control while their franchise continues to lose value. What does DivX need to do in order to return to their glory days of growth? It all comes to restoring confidence in the company.

First and foremost, DivX must put a stop to the bleeding from employees leaving the company. Given their labor issues, I don’t believe that this can be accomplished without replacing their management team, so I believe that new leadership needs to be a top priority.

Once a new team is in place, I would take .25 cents worth of earnings and commit to investing it in DivX’s growth. DivX’s employees are more accustomed to the culture of a start up then a publicly traded company. DivX should be playing to these strengths. Spend $500k per month building out new businesses. Adopt a Google model where employees are encouraged to spend 15% of their time thinking outside the box. Become a technology incubator with the long term goal of spinning off divisions when the markets recover. Start funding a profit sharing contribution to the company’s retirement plan, so that DivX’s success is shared by everyone instead of those lucky enough to get options. Take the time to listen to your employees and address their concerns.

Secondly, DivX must restore faith to their investor base. New leadership could help to accomplish this, but it will likely take more than promises of growth, to soothe the rattled nerves of their investors. Reinforce DivX’s long term commitment to shareholders by paying a .25 cent dividend as a way to reward investors while they wait for evidence of a turnaround. Taxes on a dividend would be better avoided through a buyback, but further buybacks would only reward short term shareholders and would increase volatility by reducing an already low share count. With a 5% yield, a dividend should help to establish a floor on DivX’s share price until earnings multiples expand back to growth levels.

Finally, restore confidence in your consumer base by speaking out for consumer rights. Use the UMG trial as a way to create passion in your fans and to drum up support for digital rights. Squeezing marketing leverage from the lawsuit would at least help to justify the costs involved with going to trial. Focus on Divx Plus’ quality advantage for HDTV consumers. Instead of throwing good money after bad, abandon your content plans until you have better leverage. Use small independent content providers to show how powerful DivX user base can be to progressive studios. Sign a sweetheart deal with a small CE television manufacturer to put pressure on the rest of the market.

If investors do nothing, DivX won’t necessarily go bankrupt, but it will torpedo their brand and market position. DivX CFO Dan Halverson said that their #1 goal in 09′ is to protect the balance sheet. This may seem prudent during such difficult economic times, but sleepwalking through a format change won’t position DivX for the long term. There will be a time for Divx to cash in on all of their hard work, but to try and do so at such a crucial point in the digital transition seems foolish and short sighted.

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The Nuclear Option http://davisfreeberg.com/2009/02/11/the-nuclear-option/ http://davisfreeberg.com/2009/02/11/the-nuclear-option/#comments Thu, 12 Feb 2009 03:58:48 +0000 Davis http://davisfreeberg.com/?p=766 Radiation AreaUnless you’ve been living under a rock, you know that a housing boom enhanced by risky leverage has caused an implosion within our very financial system. What was first contained to the real estate and financial markets has now quickly spread into mainstream job losses.

While the panic may have subsided, the pain that people continue to feel is very real. Businesses continue to fail and the very health of some of the largest financial institutions still remains in doubt. There have been a lot of solutions proposed for getting ourselves out of this debt ridden mess, but most agree that it’s going to take some kind of investment to break the vicious downward spiral. Some argue that this investment should come from the government through stimulus spending, while others have argued that we need tax breaks and incentives for the market to properly function. Some say we should do nothing and let the market figure it out. There are even those who argue that the tax revenue from legalizing marijuana could be the solution to our problems.

While every argument has it’s pros and cons, even at $3 trillion dollars, I can’t help but wonder if these solutions aren’t radical enough. Now bear with me, because I’m still trying to flesh out the impact that this kind of idea would have on the financial markets, but here is my own proposal for an economic recovery plan.

Eliminate the creation of any new derivative investment.

When you look at the cause of the financial crisis, it’s easy to blame real estate, but the reality is that it was over leverage that created the tsunami after the quake. Because of the lax regulation surrounding CDOs and other leveraged investments, banks and institutional investors were able to create a side market where they could bet on the success or failure of the marketplace.

From 02′ – 07′ the derivative market grew from $100 trillion to $516 trillion in size. When the bubble burst, this side market took the real market down with it. Considering that it was leverage that led us into this, forgive me if I can’t help but wonder how beneficial this stuff really is.

While derivatives do allow for businesses to hedge risks that they’ve taken, they are also used to speculate on everything from the price of gold to the weather in New York city. The problem is, that I don’t think they actually create jobs, at least not directly.

If a company wants to raise money so that they can hire staff, expand their business or just stay alive, they’ll typically either borrow the money (debt) or will sell off ownership in their company (equity). While there are many other ways to raise money, the important point is that the debt or equity that is created goes towards helping the business succeed.

When a big bank writes an option contract or an interest rate swap and links it to the price of something else, none of the money goes to the business or underying asset that investors are betting on (or against for that matter.) Instead the money raised is passed between investors and financiers depending upon the final result.

So what would happen, if the captains of industry weren’t allowed to underwrite derivatives any longer? This $500 trillion market would be forced to find other investments. Instead of being able to borrow money and make 10 – 1 long shots, they’d have to invest in the real assets or buy that debt and equity off of the open market. Instead of a $3 trillion injection, we would see $500 trillion redistributed to businesses as more and more contracts expired.

Now I’ll be the first to admit that there are some serious risks to my proposal and that such a drastic action could potentially cause an even greater collapse. I’ll also concede that any possible attempts at banning derivatives would have so many loopholes that it wouldn’t be effective. I won’t even pretend to know how the financial behemoths would react if they lost access to these types of investments. Certainly a few of them would likely go under. I’m also not sure what type of contraction effect something like this could have on the money supply. The last thing we’d want is for people to have to pay back $500,000 mortgages earning 1980′s level wages. Yet despite all these misgivings, I can’t help but wonder how important this extra layer of investment really is. By not allowing derivative investments, it would remove a middleman from the finance system and allow private money to go directly to job creation.

The cure may end up being worse then the disease, but if we end up finding ourselves in the great depression 2.0, I think that the nuclear option should be left on the table.

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Comcast Targets Innocent Customer In P2P Dragnet http://davisfreeberg.com/2009/01/29/comcast-targets-innocent-customer-in-p2p-dragnet/ http://davisfreeberg.com/2009/01/29/comcast-targets-innocent-customer-in-p2p-dragnet/#comments Thu, 29 Jan 2009 20:45:43 +0000 Davis http://davisfreeberg.com/?p=736 The Barbed Wire Keeps The Bears OutCNET reported this morning that AT&T and Comcast are planning on adopting a three strikes and you’re out policy for P2P users. The move is yet another desperate attempt by the media industry to try and regain control over content distribution. Because most broadband providers have government protected duopolies, they hope to use the MSOs as a chokepoint in their war on privacy piracy.

If you don’t actively engage in P2P sharing, you probably don’t think you need to worry about this, but I think there are already reasons to be alarmed. Even before the program’s launch, we are seeing reports of innocent customers being targeted by Comcast’s DMCA enforcement division.

Recently, John Aprigliano received a letter from Comcast asking him to take down a torrent that he was allegedly seeding. As if hitting him with a bogus DMCA takedown request wasn’t bad enough, Comcast had to insult his taste in movies by accusing him of sharing Cadillac Records, a movie that he had never heard of BTW.

When he called Comcast to figure it out, he got the usual run around. After 4 different telephone calls and an hour of hold time, he was finally able to determine that Comcast sent him the notice because of an old modem that was now being used by someone else.

I find this scary because I tend to move around a lot. Over the course of my life, I’ve easily used ten different modems. Considering how popular Bit Torrent is, there is more than a good chance that one of my former modems is being used pirate media. Why should I now have to worry about getting kicked off the net, just because Comcast can’t tell the difference between an IP and MAC address?

In John’s case, he was fortunate to be tech savvy enough to catch this, but what happens when some little old lady loses her broadband just because of a Comcast screw up? Are most people really going to know that they need to ask Comcast, what they have down for their Mac address? Somehow, I doubt that my Mom would have been able to prove herself innocent in the same situation.

During the RIAA’s lawsuit blitz, there have been plenty of examples where they filed lawsuits against innocent “infringers”. Now the media industry wants to exploit government granted monopolies, in order to take away high speed internet from those same victims. Forgive me, if I’m more then a little pessimistic. Why Comcast or AT&T would even consider such an anti-consumer proposal is beyond me, but the whole scheme is doomed for failure.

The pirates will eventually figure out even better ways to encrypt their traffic and the end result will just be a bunch of ticked off consumers feeling like big brother is breathing down their neck. It’s hard to get excited about having Comcast monitor P2P activity, when they already have a history for screwing these things up.

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Netflix And Walmart Accused Of Illegally Cornering DVD Market http://davisfreeberg.com/2009/01/07/netflix-and-walmart-accused-of-illegally-cornering-dvd-market/ http://davisfreeberg.com/2009/01/07/netflix-and-walmart-accused-of-illegally-cornering-dvd-market/#comments Wed, 07 Jan 2009 19:29:22 +0000 Davis http://davisfreeberg.com/2009/01/07/netflix-and-walmart-accused-of-illegally-cornering-dvd-market/ Netflix Walmart Anti Trust Complaint

Over the last few years, it’s been no secret that Netflix has become the dominant force for DVD by mail rentals. There may be plenty of other ways to watch films, but when it comes to renting through the mail, Netflix’s laser like focus has put them in the enviable position of being able to assert a large degree of control over the economics of their market. While there is nothing wrong with a company being so successful that they become the dominant player through skill, there are laws against abusing that power to prevent competition.

A few years ago, Wal-mart created a copycat DVD rental service in order to try and get their own piece of the DVD rental market. Their results were disastrous and despite significant financial and retail advantages, the service never caught on with consumers. Eventually, Wal-Mart realized that it was foolish to spend as much time and money focusing on such a small part of their core business, so they threw in the towel and essentially sold their membership base to Netflix. While we know that the agreement included some cross promotional advertising, the actual terms of the deal weren’t ever publicly revealed.

While some would argue that Netflix’s agreement with Wal-mart was just another example of their business acumen, nearly four years after this transaction took place, Walmart and Netflix both stand accused of engaging in anti-trust behavior over the deal. While Netflix does see its fair share of bogus lawsuits, after reading through the complaint, I think that this case may end up having more teeth to it then most of the frivolous lawsuits that are filed (warning, I’m not an attorney, just my uneducated opinion.)

Because the overall DVD market is so much bigger then the online component that Netflix pwns/operates in, I think they’ll end up getting past this, but the complaint which was filed by Andrea Resnick, does do a good job of framing the debate and raises some prickly questions for Netflix/Walmart. Had Resnick tried to seek an injunction blocking the transaction back in 2005, most courts would have brushed aside any anti-trust arguments in a heartbeat, but by shifting the focus of their complaint beyond Netflix’s control over the DVD by mail category to Wal-Mart’s domination of the DVD sell through space, Resnick does a decent job of making his case.

According to the complant, “Prior to and at the time of the agreement, Netflix and Walmart.com were actual competitors in the Online DVD Rental Market. In addition, Netflix, on the one hand, and Wal-Mart Stores and Walmart.com were actual participants and Netflix was a potential participant, with the means and economic incentive to sell new DVDs–in the absence of the Market Division Agreement. Defendants shared a conscious commitment to a common scheme designed to achieve the unlawful objective of dividing the markets for online DVD rentals and new DVD sales. The Market Division Agreement allocated the Online DVD Rental Market to Netflix, with Wal-Mart Stores and Walmart.com agreeing not to compete in that Relevant Market. The agreement also allocated new DVD sales to Wal-Mart stores and Walmart.com, with Netflix agreeing to refrain from selling new DVDs in competition with them. In addition to explicitly or de facto agreeing not to sell new DVDs, Netflix also obtained the Market Division Agreement by providing potentially valuable promotion to Wal-Mart Stores and Walmart.com.”

(Note: bold and italics provided by me)

I don’t know whether or not there was specific language in the agreement preventing Netflix from selling new DVDs to their customers, but I am looking forward to finding out more details during the discovery phase of the trial.

Feel free to read through the complaint yourself, but when push comes to shove, it’s hard for me to believe that the courts will side with Resnick on this one. For one, as Techdirt aptly points out, Netflix doesn’t have a monopoly on the market, they just have the fortunate luck of competing with a neutered Blockbuster for that space. I also would argue that Netflix or Walmart for that matter, doesn’t have the ability to corner the home entertainment market as alleged. If Resnick is successful in arguing that the DVD by mail industry is a unique market they may end up having some luck, but the reality is that the home entertainment market is a helluva lot bigger then DVD rentals via the internet. If the FTC didn’t have problems with Sirius and XM combining to create a single satellite radio company, it’s hard to accept the argument that Netflix’s actions prevented competition on an anti-trust scale.

Since 2005, we’ve seen a radical transformation occur in the VOD and video over the internet markets. During that time, we’ve also seen Redbox install over 10,000 DVD kiosk locations throughout the US, including a large percentage of those in Walmart locations. When you consider that last year, Blockbuster had more then four times as much revenue then Netflix, it begins to illustrate how small Netflix’s slice of the movie rental industry really is.

Only time will tell how far this one will go, but I think it’s worth keeping an eye on. While I’m confident that neither Netflix nor Walmart did anything wrong, the suit isn’t as black and white as I would like. If Netflix does end up having to make compromises as a result of their success, it could have a serious impact on their ability to transition to digital delivery without any turbulence.

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CBS Facing Tribal Council On The Next Survivor: Goodwill Island http://davisfreeberg.com/2008/05/23/cbs-facing-tribal-council-on-the-next-survivor-goodwill-island/ http://davisfreeberg.com/2008/05/23/cbs-facing-tribal-council-on-the-next-survivor-goodwill-island/#comments Sat, 24 May 2008 00:44:05 +0000 Davis http://davisfreeberg.com/2008/05/23/cbs-facing-tribal-council-on-the-next-survivor-goodwill-island/ Laugh FactoryJonathan Weill with Bloomberg news noticed that CBS’ market cap is currently lower than their book value. When a stock is trading under it’s book value, vulture value investors tend to start getting interested, but in CBS’ case this may have all the makings of a value trap.

The problem, most of the assets on CBS’ balance sheet are attributed to goodwill.

If the market is right, they are expecting CBS to write down about $6 billion in assets. This would mean that the disconnect between the balance sheet and the stock price may not last for very long. Worse yet, if they did have to do a write down, it would also mean that their financial performance hasn’t been strong enough to justify their own internal valuations. Lower earnings + massive multi-billion losses tends to = unhappy investors, hence the dismal stock performance.

“So, on paper, this single, pneumatic intangible supposedly is more valuable than the company as a whole. As they used to say on CBS’s old show “The Twilight Zone,” you are now traveling through another dimension. If CBS’s audits were an episode of “Survivor,” a bunch of that goodwill would have been voted off the island by now.

And what is goodwill? You’re breathing it.

Goodwill is nothing more than a ledger entry, representing the premium that one company pays to buy another. Specifically, it’s the difference between the purchase price and the fair value of the acquired company’s net assets. The more you pay, the more goodwill you get. It can’t be sold by itself, either. Hence, the term’s synonym: air. CBS acquired the bulk of its goodwill through its 2000 purchase of — strangely enough — CBS.”

With CBS planning to purchase CNET, Weill notes that they’ll be adding even more goodwill to the balance sheet. While his article raises some tough questions for CBS, Weill does offer some help to CBS management by giving them a top 10 list of excuses that that they can use, for why they haven’t taken their medicine.

Top Ten CBS Excuses for Avoiding Big Writedowns:

10. Shh! You’ll wake Mr. Redstone.

9. We get our figures watching “The Price Is Right.”

8. Ben Bernanke is letting us swap goodwill for Treasuries.

7. Our CFO is busy watching “American Idol” on Fox.

6. You mean that’s $18 BILLION? With a B?

5. We put the cast from “Numb3rs” in charge.

4. Ratings boost: We’re dumping Andy Rooney for Britney.

3. Moody’s and S&P rate Katie Couric AAA.

2. Bear Stearns says the worst is behind us.

1. Dave’s got a turnaround plan!

Weill’s article was written tongue in cheek, but he does raise some pretty serious questions for CBS investors. There are times when large goodwill is justified, but there are also a lot of companies who use this line item as a way to make their financial condition appear more healthy than it really is. Goodwill is a tricky asset to put a number on because it’s so intangible, but there does need to be a legitimate justification for keeping that value on the balance sheet. If the market is valuing the entire company at less than goodwill alone, then CBS needs to rethink how much that goodwill is really worth or provide an explanation for how they are valuing the asset.

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DivX Looks Outside The Codec For The Future Of Web Video http://davisfreeberg.com/2008/05/07/divx-looks-outside-the-codec-for-the-future-of-web-video/ http://davisfreeberg.com/2008/05/07/divx-looks-outside-the-codec-for-the-future-of-web-video/#comments Thu, 08 May 2008 02:33:39 +0000 Davis http://davisfreeberg.com/2008/05/07/divx-looks-outside-the-codec-for-the-future-of-web-video/ DivXDivX reported their 1st quarter earnings on Monday and while I’m still waiting to read the actual 10k before digging too far into the numbers, I did want to comment on what I see as a significant shift in strategy. Over the last 7 years, DivX has done an impressive job of building an eco-system around a single file format. The first time that I came across a DivX file, I actually thought that it was some kind of a virus. It took me two weeks before I worked up the courage to download the DivX media player so that I could play the movie, but once I did, I realized that my fears were unfounded. The file not only offered a superior video experience, but it was a lot smaller than the MPEG files that I was used to downloading. Since I was on a dial-up connection at the time, every little byte made a big difference.

As the P2P networks developed, DivX and it’s open source cousin XviD, became an important resource for file sharers. Initially, my own interest in DivX was driven by it’s technological advantages over other video formats, as well as the wide availability of DivX content on the grey market, but as compression technology has evolved, my reasons for using DivX have changed as well. Since I’m no longer on a dial-up network, compression is less important then what I can actually do with my videos.

As DivX gained in popularity, they were able to forge agreements with consumer electronic manufacturers that allowed you to play DivX files on a wide range of devices. Even though, H.264 is a superior standard for internet video, I still prefer DivX files because I know that I’ll be able to play them on the hardware devices that I own.

By creating an eco-system that supports portability, DivX has been able to lock me into their format in the same way that Apple has been able to use iTunes to keep their customers buying iPods instead of mp3 players.

As H.264, Microsoft, Apple and Adobe all continue to creep into DivX’s territory, there has been a lot of concern over how DivX would respond to these competing threats. Microsoft’s approach has been to batten down the hatches by developing their proprietary Silverlight codec. By retaining full control over the video format, they are able to convince people to buy as many Microsoft supported products as possible. These extra restrictions increase the appeal of Silverlight for DRM hungry Hollywood studios, but it also frustrates their customers in the process. Incompatible file formats are the reason why services like Netflix’s Watch Now doesn’t get along with Apple. Since Microsoft (and Apple) refuse to open up their codecs, it gives them a monopoly on the hardware that is allowed to support their video files.

Apple has at least opened up their system a little bit by adding support for the H.264 format, but they’ve still chosen to wrap their h.264 files inside of the Quicktime container. This prevents other companies from supporting Apple H.264 content, without obtaining a license for Quicktime first. This helps to open up Apple’s eco-system to alternative video formats, but still gives Apple control over the companies that are allowed to play nice with their your media.

Similarly, Adobe has also forged agreements to support H.264 inside of flash, but if you want to take your Flash H.264 files portable, you’ll need a device that can support the Flash format. To their credit, Adobe has done a good job of building momentum for downloadable flash by supporting open source initiatives, a new DRM system, and by removing license fees for mobile providers, but despite their early traction with these efforts, there are still very few hardware devices that are actually capable of playing portable flash content.

With so many companies pursuing proprietary video strategies, one would expect DivX to be focusing on locking consumers into the DivX format, but like most things having to do with DivX, their strategy for dealing with the next generation of codecs is also built on a system of openness.

We got our first real glimpse of this strategy last November when DivX announced that they had acquired Mainconcept for $22 – $28 million. The Mainconcept acquisition gave DivX an immediate footprint in the H.264 space, but it also raised some important questions about how DivX could maintain a monopoly on their community, while supporting a format that is widely available to competitors.

Interestingly enough, while discussing H.264 on their latest conference call, DivX CEO Kevin Hell pointed out that the current state of H.264 really isn’t all that different from the MPEG-4 standard that DivX was built on.

“Looking forward, a real opportunity exists for DivX to emerge as the consumer face of H.264, serving as a trusted brand for users who don’t want to concern themselves with underlying formats or technologies. In fact, the current H.264 market resembles in many ways the early stages of MPEG-4 market.

When DivX first emerged seven years ago there were number of different and incompatible MPEG-4 implementations available. Through our strong consumer adoption and the creation of the DivX certification program, we were able to simplify the experience for consumers and provide a solution that just works across any device. We plan to repeat that strategy by incorporating broad H.264 support into both our software and consumer electronics offerings under the DivX brand. We are on track to release a new version of our software in 2008 that supports H.264 and then extend that support to consumer electronic devices that are likely to hit the market in 2009. We believe that this development will help move the DivX brand beyond one single format and toward promise of support for any video content, on any device.”

DivX’s evolution towards H.264 won’t be a clean and easy transition, but it is the right direction for the company. If they can successfully integrate H.264 into their certification program, it will reduce the threat of their codec becoming obsolete and will highlight their certification process as being the real value added for consumer device manufacturers.

Instead of trying to educate consumers on the differences between MPEG-4 Part 2 vs. MPEG-4 AVC (H.264), CE manufacturers can slap the DivX label onto their devices and consumers will know that it will support their digital video libraries without complications. In fact, during the Q&A section of their conference call, DivX discussed the possibility of pushing this envelope even further by adding Flash support to their certification program.

“In terms of how we think about Flash more broadly, the vast majority of content that is downloaded today is in DivX format or variations of the DivX format, so we don’t see that as being a threat in terms of the use case that we’re really providing, which is high quality content delivered through the internet and then played back on a variety of devices. To the extent that Flash starts to get traction in terms of files that are downloaded at high quality and based on the terms, it would be something that we could actually extend into and offer into our certification program as well and that’s what we’d be looking to do.”

Part of what makes DivX such a difficult company to pin down, is their ability to take competitors and turn them into partners. On one hand, Microsoft is one of the biggest threats to DivX, but if they can get them to extend DivX support to the Xbox, they could become an important customer.

Adobe is currently using Mainconcept to power their H.264 support, but they are also trying to establish their own format as the new standard for internet delivered video. These complex relationships are enough to make anyone’s head spin, but DivX has a way of getting their partners to look at the glass half full side of the equation.

On one hand, It’s hard for me to believe that Adobe would be all that enthusiastic about giving up control over their flash content, but on the other hand, a DivX partnership would create a powerful competitor to Apple and Microsoft’s closed systems.

Adobe would gain access to an established community of video fans and would have one more platform that could drive demand for Flash content. Instead of having to worry about the lack of downloadable flash content, they could leverage DivX’s popularity, while slowly introducing their own standard for web video. While I doubt that older DivX devices would be able to support Flash with a firmware update, any new DivX devices would be able to support their content.

For DivX, they would be able to increase the appeal of their brand by offering support for the next generation of internet video. They could also use Adobe DRM as a way of bypassing studio approval for DivX content. While DivX did mention plans to update their DRM later this year, getting in through Adobe’s backdoor could be a lot easier than buying off the studios. According to DivX’s 4th quarter 10k filing, they paid Sony $1.5 million and gave them 100,000 warrants at a strike price of $16.14, in order to get the studio to bless the DivX format. While it’s possible that DivX plans on buying off all of the studios, this could get expensive really quick, if DivX is serious about going legit.

For consumers, it would be the biggest win of all. Instead of being locked into a single file format, they would have the flexiblity to adopt alternative standards without having to abandon their current media libraries. This would pressure Microsoft and Apple to open up their hardware, instead of maintaining data silos.

It’s hard to judge how serious DivX is about adopting flash support from just a few comments, but even beyond flash, having support for multi-formats adds real value to their brand. As new forms of digital transmission unfold, DivX is in a position to attach their brand to a much larger category of web video.

Some of the niche video formats don’t have the ability to negotiate partnerships with the device manufacturers directly, but through DivX could gain access to a much larger audience. If DivX certification suddenly meant that Matroska containers could play on DivX devices, it would open up another community that DivX could tap into and it would change how Matroska fans think about the DivX brand.

Bringing other formats into the DivX program, would add to DivX’s cost of revenue, but it would make DivX certification more valuable to their CE partners. I may enjoy dissecting the nuances between the various competing video formats, but most consumers don’t want to think about it. They want to be able to play whatever file they have without converting it into a single format. By focusing on supporting as many formats as possible, DivX may end up competing with their own eco-system, but they’ll also expand their reach in the process. By taking DivX beyond the codec, it allows their community to move forward with the future, while hanging onto the treasures from the past.

Disclosure – I own shares of Netflix

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