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In 2003, following on the footsteps of years of dot com success, flashy TV ad campaigns,  and boom time excess, Brobeck, Phleger and Harrison, a major Silicon Valley law firm with a heavy focus on the technology industry and an 80 year history of practice,  imploded and shut down.  The liquidation ended up in Chapter 7 Bankruptcy and what remained of the firm ended up at the disposition of Bankruptcy Court.

In August, 2006, the court authorized the Library of Congress’ National Digital Infrastructure Preservation Program to begin archiving Brobeck’s digital records which contain a significant volume of contracts, drafts, memos and documents crafted by Brobeck staff.  It was argued that material is historically significant.

From the website :  “even if research access to these records is decades away, preservation demands intervention now” and “the artifacts left in the wake of Brobeck – including digital materials documenting the operation of the partnership and the work it’s lawyers did on behalf of more than 10,000 clients – [contain] a wealth of historical information.”

Over the past five months news of the decision has slowly spread and unfavorable reactions have grown from a whisper to a grumble.    In December several articles and blogs referenced the Archive.

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This is Part 2 of a 2 part report

Yesterday I picked out 3 of the many issues facing eBay as it grows – issues of customer retention, ROI on investment and Staffing.  Today, I am going to focus on 2 more issues that relate explicitly to size. I will also briefly mention a 3rd unrelated area:

The Rule of the Monkey:

The saying goes that “The higher up the ladder a monkey climbs, the more monkeys there are behind it trying to climb up its butt.” The same logic often applied to ambitious employees, applies to companies too.  The larger a company is (and the broader its focus is) the more competitors, who are often (but not always) smaller and able to move more quickly, try and grab market share.  eBay is as susceptible to this as any other company.  In eBay’s Payment Segment there is increasing competition from Google Checkout which is a threat even with Paypal’s expansion to 103 markets and 10 currencies.  In the Merchandise Segment it faces competition, domestically and internationally, from companies focusing on niche areas of the marketplace .  This competition can come from traditional retailers for new products, or even exist in the secondary markets that auctions suit so well.  The event ticket category is one such example.  Resale of tickets has the potential to do well in auction; scalpers have known the secondary market was lucrative for years.   But eBay has competition from classified listing services (Craigslist etc), or online secondary markets like ticket vendor Stubhub, and even auctions of tickets in the  primary market  sellers like Ticketmaster (which can decrease the likelihood of resale by adjusting their prices or model).  eBay will always face this risk, but the broader its focus gets, and the more it proves the viability of different business areas (categories and segments), the more it will be grabbed from those below.

The Law of the 800lb Gorilla:

This second maxim for large companies is largely a rule of simple math: the bigger your revenue numbers get, the harder it becomes to maintain the same kind of year over year growth you might have had earlier.  Generating 35% year over year growth is one thing when your gross revenues are $20m, but 35% of $100m, or $5b is totally different altogether.  It can be partly attributed to this that eBay’s international growth rate (36% for 9 months ended Sep 2006) is larger than the domestic rate of 28%).  But as the international revenue catches up, maybe even passes, the domestic numbers, its only natural that the year over year growth will slow unless other divisions grow, or other business lines are introduced.   All large companies face these issues; all also face pressure from Wall Street to find a way to maintain growth. Sometimes under the pressure, good people do bad things (and I don’t mean illegal things though that happens too, obviously) – maybe a risky strategy is made, or the company tries to hard to please and loses its focus, or gets stuck in analysis paralysis.  EBay’s heavy investment in China is suspect. It may pay off (I don’t think it will, personally) but the law of the 800Lb Gorilla should remind investors to be cautious in evaluating growth opportunities for large companies.

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This is Part 1 of a 2 part report

At 11-plus years old, a lifetime in both dot com and dog years, is Ebay a vigorous and healthy company or are they a pharmaceutically enhanced geriatric patient?

As of September 2006, Ebay had almost 13k employees worldwide, more than 50k categories of merchandise and over a million dollars of goods trading daily.

But how is the company really doing?  Approximately 10 of the 30 odd analysts covering Ebay rate it neutral.  I’m more or less with them (and not because there’s strength in numbers).  This would-be Corporate Geriatrician thinks the company is sound but has some real issues to sort out to truly be healthy. 

A 40 or more page analyst report could be written breaking down the issues.  that is way  too much space for this format, so to hit on just 5 of the issues (3 today, 2 tomorrow):

Heavy Reliance on relatively small number of customers:

Ebay has more than 1.3 million global sellers but various accounts suggest a small percentage of global “Power Sellers” account for a substantial amount  of the revenue in the company’s Merchandise Segment (which itself represents about 75% of net revenue). Click to Read More

Yesterday, I commented on the size of the M&A market for 2006 and promised a more detailed analysis of what it might mean for 2007.  I’m still thinking about that and I’m not ready to take the side of the Bulls or Bears nor am I sure how it will impact the entertainment, media and technology crossover companies that are the  focus of Metue.

Instead of making an unfounded prediction, in the spirit of being cautiously optimistic, I’m going to focus on what happens when money follows money because it represents a risk factor for what lies ahead.

Money follows money: taken literally, the statement is an often unstated, but nevertheless, common behavior in investing.    It makes sense in a simple way – if an investment is providing a good return you’d want to put more money in it and derive even more gain.   It’s the nature of riding the wave.  People follow the trends that are successful.  It’s also part of how investment bubbles are built, and how they burst.

Within the Venture Capital world, or more broadly, within Private Equity markets, there is a limited amount of deal flow that can be managed by Fund Managers in a given time period.  A Venture Capital Fund with 4 Partners might not have the capacity to intelligently invest in more than 5 deals per year (these investments, after all, may take several years of ongoing commitment before liquidity or failure).    If demand for the partners’ investment management services increase, however, something has to change.

Imagine a firm called Bubble Limited Investment Partners (BLIP).  BLIP’s first fund, Bubble I, had the leading Internal Rate of Return (IRR) among similar funds over its lifespan.  The performance was so good, in fact, that other investors want a chance to participate.

So, when the partnership pitches a new fund called Bubble II to their investors, the investors, happy with the return on Bubble I, increase their investment with the partnership, through Bubble II, by 50%.  Additionally, a whole new group of investors that didn’t participate in Bubble I want in on Bubble II.   If Bubble I was a $300m fund, Bubble II is now oversubscribed at $700m. 

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Some will say 2006 was the year of Mergers and Acquisitions.  The big five Wall Street investment banks (Merrill Lynch, Bear Stearns, Goldman Sachs, Lehman Brothers, and Morgan Stanley) had record profits.  The total value of acquisitions topped $4 trillion, easily besting 2000’s record $3.3 trillion according to tracking firm Dealogic.  Private equity firms accounted for more than 18 percent of that total by spending more than $720b to take companies private.

As news and analysis of the year trickles out, some are reporting that these same firms have more than $2 trillion in buying power going in to 2007.    

A small sampling of deals from the past year:

Two Tech infrastructure giants bought themselves greater involvement in Internet media distribution:

• IBM acquired Micromuse for $865 giving it additional software for managing video on the web. 
• Cisco acquired set top box maker Scientific Atlanta for $5.3b, thereby positioning Cisco for IPTV markets.

Old school animation and new digital methods officially married:

• Disney acquired Pixar for about $7.4b thereby increasing its resources for digital animation and providing it with a stronger footing to compete against companies like Dreamworks Animation and Imagi.

Newspaper publishers considered consolidation strategies as online services continue to encroach on their traditional offerings:

• McClatchy acquired Knight Ridder for approx $4.5 plus assumption of $2b in debt, thereby significantly increasing its newspaper publishing

Internet video got competitive and Google went shopping for…just about everything?:

• YouTube (for $1.65b)

• dMark (radio advertising platform for $102m)
• Measure Map (blog analytics)
• @Last software (Sketchup c.a.d application)
• Jotspot (wiki’s)
• Neven Vision (biometric identification- for use with Picasa photo archiving)

Privacy makes management easier: Radio and Major media ranking and review companies went private:

• Private equity firms including KKR, Thomas Lee Partners and the Carlyle Group acquired the shares of Dutch conglomerate VNU with the intent to privatize the company and improve its performance.  VNU holds, among other properties, media research and ranking firms ACNielson, Billboard and Net Ratings.  The company also publishes the Hollywood Reporter, Adweek, Billboard and other magazines.
• In a separate, but huge, pending deal, private equity companies are trying to acquire Clear Channel, owner of over 1100 Radio Stations among other entities for over $18b

It’s not unlikely that in 2007, private equity firms will play an even larger role in the media and entertainment sector than they have in the past few years.  Established companies will continue to have to evaluate what represents core and strategic businesses amidst changing technologies and may seek to divest non core, or under performing, areas, or acquire other pieces for the future. 

Areas that generate solid cash flows like gaming, publishing, broadcast and content catalogs are likely to get some speculation and scrutiny.

Tomorrow, after I’ve had more time to think about it, I’ll have some analysis about what this might mean besides the obvious prediction that there will be a lot of M/A activity in 2007 and at least a few large private equity investments.