For some time now we've been bullish on boutique investment banks. In the fall of 2007, as the current crisis began to unfold, we predicted a shake-up in the highly concentrated investment banking model. The crisis of the past 2 years has only served to underscore our belief (a belief shared by others) that the conglomerate model of investment banking cannot stand, and that smaller, more nimble, research-driven shops will be the winners.
One of the shining examples in this regard is JMP Group (JMP), a San Francisco-based boutique founded in 2000 by Montgomery Securities alumni Joe Jolson and Carter Mack. JMP went public in 2007, and as a result has had to build its business in one of the worst market environments of the past century. Nevertheless, JMP has survived, and in fact has thrived, capitalizing on the distress of its larger competitors, capturing talented managers fleeing ailing bulge bracket firms, and partnering with Qatalyst Group, a technology boutique founded by veteran tech banker Frank Quattrone.
JMP's recent financials are impressive. Having posted a net loss in Q4 of 2008, the company returned to profitability in the first quarter of this year with EPS of $.03. In the most recent quarter, the company posted record revenues, nearly doubling from $25.02 million to $49.63 million. Revenues increased in all core business areas with the exception of asset management, which actually fell by 50%. Quarterly EPS increased 667% to $.20. JMP's balance sheet is strong, with $55.7 million in non-deposit cash and marketable securities, and minimal debt (8.5% d/e ratio).
But can the company continue to post such numbers? We believe it can. Management has clearly proven itself by building and sustaining a viable investment banking franchise in the midst of utter turmoil and uncertainty in the global economy. In addition to being a beneficiary of the bulge bracket meltdown, we believe JMP stands to benefit greatly from increased M&A activity and, yes, the eventual return of the IPO market. The universe of venture and private equity-backed companies continues to grow with no end in sight, and will provide a healthy stream of dealflow by mid-2010.
Tuesday, October 20, 2009
Friday, October 16, 2009
Developing Your Acquisition Profile
First, you must redefine the profile of your core customer. While you should of course remain focused on your current user base (and growing it, if your value proposition involves increased market share or lead generation), your customers are now potential acquirers. Determine what industries your product would serve, then generate a list of customers in each. Recognize that you are now selling yourself as an off-the-shelf IT solution and, as is the case when contemplating an in-house IT project, you must justify the expenditure by demonstrating the ways your product can create value for the buyer's business. For each customer, place yourself in the role of CIO. How does your product fit into the customer's IT strategy? Will your product help to streamline operations? Increase market share? Lower the buyer's customer acquisition costs?
Once you have the answers to these questions you can begin to approach prospective acquirers. You may find that many will be receptive to your overtures, especially as the economy continues to improve and IT budgets increase. However, once your pitch is complete the response you are likely to hear is: "You've got a quality product, a great team, and we see the benefits you can bring to a company like ours. But why should we pay you what you're asking when we can build a comparable system for far less, or even outsource the development to India and get a comparable product for $50,000?" In other words, why should they pay you more than replacement cost for a non-cash-generating asset? For your response, you have several options:
Lower Total Cost of Ownership (TCO) /
Higher Return on Investment (ROI)
If possible, demonstrate how the all-in cost of acquiring you will be less than a custom-built application for the duration of a typical project length (five years). Point out that your costs are clear and are known upfront, whereas an outsourced or even an in-house build can suffer from significant cost overruns and result in outsize maintenance and support costs over time. If applicable, underscore how your product will deliver a pool of account leads or eyeballs for CPM purposes, and, preferably, that your acquisition will result in an increased conversion rate for the buyer. If the deal entails the transfer of human capital, underscore management's intimate bottom-up knowledge of the product as a key driver of value going forward.
Quality Control
Point out that, while an outsourced custom solution presents an attractive business option, it can be difficult to administer and, given the inherent complexity of software development, can often result in buggy code, sluggish performance, and an overall brittle application. Moreover, the identification and resolution of bugs occurs over time and in the live production environment. The result is at best an inferior product, and at worst additional costs in the form of lost productivity, lost customers and revenue, and additional capital outlays.
Evolving Functionality
Explain that custom-built applications tend to be rigid in their satisfaction of specific client requirements and do not provide the necessary flexibility to handle future changes. With your knowledgeable team in place, the customer will have the capability to regularly enhance the application with additional features, and to upgrade existing functionality. Conversely, upgrading a custom application will require a significant level of effort and expenditure.
Faster Time-to-Market
In addition to valuable resources, a custom-built application requires a substantial investment of time. Requirements analysis, design, development, testing, implementation, maintenance and support are all important factors when considering in-house or outsourced development. Acquiring your product, however, will enable the customer to deploy in a matter of days as opposed to weeks.
Obviously you will want more than replacement cost, but how can you justify this? In the absence of cash flows, you need to identify the unique value your product will bring to the acquirer over time. They key is being able to the quantify the value, and to demonstrate it in dollar terms. This is difficult, and will likely require customizing your product's value proposition for each buyer, but with a bit of research and reasonable assumptions, not impossible. In our next post we will focus on various methods for valuing your product as an asset acquisition.
Saturday, October 10, 2009
Wanted: Healthcare Finance Start-Ups
Like most industries, healthcare has embraced the Internet as a powerful communications tool, with scores of websites providing information, reviews, and recommendations. The healthcare industry has also been one of the early adopters of social networking, a technology which seems tailor made for individuals seeking valuable peer perspectives on providers and available treatments, as well as advice and support. Various digital media have recently emerged as a means for individuals to measure their "life stream data," to track their progress toward a healthier lifestyle. Yet, ironically, while never before have consumers been so empowered with respect to their own care, the ability to pay for such care has never been so uncertain.
We believe an enormous opportunity exists in the application of digital media to healthcare finance. A project of this scale would require as much financial as technological innovation, but we need look no further than P2P lending for inspiration in this regard. People lending money to complete strangers would have been unthinkable ten years ago, and yet today we find individuals lending millions of dollars to fund everything from a new business venture, to home improvement, to a master's degree. Likewise, we are (finally) seeing the first indications of P2P-type technology being applied to corporate finance (Sprowtt).
The democratizing effect of "Health 2.0" technologies has been shown to contribute significantly to administrative cost reductions, and this is an excellent start. But is time to take the larger step of revolutionizing healthcare affordability. The surprising success of the P2P finance model should provide ample incentive for financial technology entrepreneurs with unconventional ideas. The winner of this race will be rewarded . . . handsomely.
Wednesday, October 7, 2009
E*Trade Rumblings
Likely suitors include Schwab (SCHW) and TD Ameritrade (AMTD), both of whom have expressed interest in E*Trade's 2.7 million retail accounts. However, we disagree with the contention that larger institutions such as Wells Fargo (WFC) or Goldman Sachs (GS) could also make a play. While yes, these companies would be better positioned from a balance sheet standpoint to absorb E*Trade's mortgage portfolio, the synergy is simply not there, particularly in the case of GS. The bigger question still is whether ETFC would even want to sell. With the economy improving, and with the company still maintaining a highly competitive position, any offer would have to be at a considerable premium to the current price of $1.70.
Stripping away its balance sheet woes, ETFC is fundamentally strong. The company is successfully growing its account base, as well as its brokerage-related cash while keeping operating expenses low. In addition, ETFC continues to deploy cutting-edge desktop and mobile trading technologies, and remains one of the most recognized brands in online trading.
Apart from its takeover potential, we believe ETFC is a strong buy at current levels with a one year price target of $5.00.
Thursday, October 1, 2009
Facebook Credit Arbitrage
While exploring the Gift Shop shortly after Facebook's announcement, we discovered that this medium may in fact present opportunities for currency arbitrage. Facebook has since changed the process for Gift Shop transactions. Users now must choose their currency option under Account Settings - Payments, rather than make that choice at the time of purchase. In addition, it would seem that the option to purchase additional Credits (i.e. more than what is necessary to effect the current transaction) has temporarily gone away. Nevertheless, our conclusions still hold.
Facebook's local currency quotations are not in real time. In fact, they appear to be based on the previous day's closing value, and they apparently remain fixed for the following day. This means that Credit buyers have the ability to exploit this time distortion, and the pricing differential which may result. Depending on volatility, buyers could realize a substantial discount. Here's how it works:
1. Identify currencies experiencing a meaningful (i.e. 2% or more) intraday drop against the USD from the previous day's close.
2. Purchase credits in that currency (quoted at the previous day's close).
3. The purchase is converted into USD by your credit card company (for which you will be charged a conversion fee ranging from 1 to 3% of the transaction).
4. Enjoy your discounted Credits, or perhaps resell your Credits for dollars using Facebook's proposed transfer system when it becomes available.
Now, there are numerous caveats and assumptions here, not the least of which being that when using any of the myriad currency converters available to derive current exchange rates we are quoted the bank or wholesale rate - that is, the rate which applies to transactions sized in the millions of dollars. Whether credit card companies use this rate when converting your transaction is a bit of a mystery, thus transaction costs could substantially erode if not wipe out any discount. Also, this is of course not true arbitrage in the sense that (as of yet) Credits cannot be readily converted back into hard currency via Facebook. But to the extent that Credits can be used as currency in the Gift Shop and within a growing list of popular Facebook applications, it's as close as you can get. Should Facebook roll out its Credit transfer system (currently under private beta), however, things could get interesting. Theoretically, one could buy Credits in a currency experiencing a significant intraday drop against the dollar, then use the Credit transfer system to offer Credits in USD at less than the going Facebook rate. Using any number of payment providers to effect the transaction, the arbitrage is complete.
As with any arb trade designed to exploit tiny price differentials, in order to realize any meaningful return substantial sums would have to be involved. Transaction costs (the credit card conversion fee and the payment provider's fee) would have to be minimal, and the rate at which credit card companies convert purchases into your home currency would be a factor as well. Nevertheless, we find this to be an intriguing possibility, and as Facebook inches closer to full deployment of its virtual currency, we will continue to monitor. We hope that Facebook will be hedging their exposure.
As with any arb trade designed to exploit tiny price differentials, in order to realize any meaningful return substantial sums would have to be involved. Transaction costs (the credit card conversion fee and the payment provider's fee) would have to be minimal, and the rate at which credit card companies convert purchases into your home currency would be a factor as well. Nevertheless, we find this to be an intriguing possibility, and as Facebook inches closer to full deployment of its virtual currency, we will continue to monitor. We hope that Facebook will be hedging their exposure.
Friday, September 25, 2009
Asset Acquisition as a Path to Liquidity
Recent acquisition activity in the social media space indicates that start-ups may be increasingly viewed as attractive asset targets. In other words, given that many of these companies generate little (and in most cases, no) cash, they offer little value to a prospective acquirer outside of their ability to enhance the buyer's IT strategy. The target may bolster the acquirer’s top line by providing significant cost savings, faster deployment of new business initiatives, and, in many cases, talented managers who are compelled to stay on as part of the deal.
Nokia's recent acquisitions of mobile software maker Cellity, microsocial network Plum, and social travel site Dopplr are examples of such a strategy. Nokia is clearly seeking to buy a social network infrastructure rather than build one organically. Whether this strategy is viable remains to be seen (analysts have referred to it as rearranging deck chairs on the Titanic), but it is clearly warranted given the competitive threat from RIMM and Apple. Interesting note: The language of the Cellity press release actually states that "Nokia and Cellity have reached an agreement for Nokia to acquire the Cellity team" (emphasis added). Cellity is going away, and apparently Nokia values the 14 member team at somewhere between $10 and $20 million.
Intuit's acquisition of Mint, also motivated by competitive concerns, is an example as well. Intuit clearly was not purchasing a set of cash flows with Mint. Rather, Intuit saw an opportunity to buy an asset in the form of Mint's user base which could then be monetized via Intuit's current platform offerings (and dispense with a significant and growing threat).
As economic recovery takes hold, the popularity of these transactions will likely increase as businesses seek to develop a social media infrastructure, whether for internal efficiencies or for external growth. This is both good news and bad news founders and investors. The good news is that a path to much-needed liquidity is now opening for start-ups without much hope for an IPO. The bad news: valuations will adjust downward as they reflect the difference between a cash-generating enterprise and one which adds value as a strategic asset. A recent extreme example: Shutterfly's acquisition of Tiny Pictures for $1.3 million in cash. Tiny had raised over $11.2 million, and just closed $7.2 in series B in February, 2008. This is clearly not a happy exit, and is a cautionary tale illustrating the risk of valuing non-revenue generating entities.
The upshot: Rather than rely on faith (and burn cash) waiting for a market to appear (not everyone can be Twitter), start-ups and investors would do well to consider positioning their companies as attractive acquisition targets from the outset.
Sunday, August 30, 2009
Beijing's Attack on the U.K.
Recent revelations of China's state-sponsored cyber attacks on U.K. financial institutions underscores that strategic financial power is high on Beijing's list of priorities. Moreover, these attacks are consistent with "Unrestricted Warfare," a white paper published in 1999 by two PLA Air Force colonels, Qiao Liang and Wang Xiangsui, in which they argue that future wars will be fought on many fronts, and that in fact economic and financial warfare will become an increasingly necessary and accepted form of conflict.
Whether Unrestricted Warfare represents today's official view of China's strategic outlook is unclear. What is clear, however, is that from a risk-reward perspective, Beijing must believe that, as a matter of national strategy, a policy of infiltrating foreign financial systems provides great enough rewards to offset the risk of significant political fallout. China's zeal for financial power is clearly beyond the realm of licit transactions.
But what specifically are the Chinese after?
Proprietary technology? The need for cutting-edge financial infrastructure in China is great, but Beijing could quite easily purchase needed technologies (or the technology providers themselves) and forgo the considerable risks associated with cyber-espionage.
Data? Discounting a criminal motive, Beijing could be interested in gaining access to transaction or pricing data as a means to gain a competitive edge in the marketplace, particularly in the commodities arena. China's explosive growth rate means that even a slight edge could save China billions in natural resources expenditures.
While theft of data or trade secrets could be the primary motive, Beijing is also testing information defenses and planting back doors - in short, developing a formidable information warfare capability. Beijing views the global capital markets as the naval philosophers of the early 20th century viewed the sea - that is, as the lifeblood of national prosperity, and therefore a medium for the projection of national power.
Whether Unrestricted Warfare represents today's official view of China's strategic outlook is unclear. What is clear, however, is that from a risk-reward perspective, Beijing must believe that, as a matter of national strategy, a policy of infiltrating foreign financial systems provides great enough rewards to offset the risk of significant political fallout. China's zeal for financial power is clearly beyond the realm of licit transactions.
But what specifically are the Chinese after?
Proprietary technology? The need for cutting-edge financial infrastructure in China is great, but Beijing could quite easily purchase needed technologies (or the technology providers themselves) and forgo the considerable risks associated with cyber-espionage.
Data? Discounting a criminal motive, Beijing could be interested in gaining access to transaction or pricing data as a means to gain a competitive edge in the marketplace, particularly in the commodities arena. China's explosive growth rate means that even a slight edge could save China billions in natural resources expenditures.
While theft of data or trade secrets could be the primary motive, Beijing is also testing information defenses and planting back doors - in short, developing a formidable information warfare capability. Beijing views the global capital markets as the naval philosophers of the early 20th century viewed the sea - that is, as the lifeblood of national prosperity, and therefore a medium for the projection of national power.
Facebook and the Financial Analyst
Investing has evolved into a highly social activity, as evidenced by the countless chatrooms, blogs, and message boards populating the Internet. With the Facebook Platform API now available we would expect to see a rash of applications for investment analysis and portfolio management. By incorporating Amazon S3 or Rackspace for data storage, a scalable, robust, and fully virtual analytical capability is possible. To date, however, the majority of viable finance-related applications populating Facebook are payments-related: Send Money, justgiving, ChipIn, LendingClub, PayMe. Perhaps this is because the platform has only recently become available, or that Facebook is still very much a SOCIAL network, and as such would not provide a legitimate environment for an analytical application. The prototypical Facebook user is keeping track of people, that is, looking for fun, friendship and relationships - not p/e ratios and risk-adjusted returns (though the FSX - Fantasy Stock Exchange - claims 18113 daily active users.)
But the network-form has already been embraced by analysts in various disciplines as an efficient way to share and analyze information. Even the CIA has developed a social network for intra-agency intelligence sharing. We believe Facebook is an attractive environment for the deployment of financial modeling applications and would provide financial analysts - risk modelers, financial engineers, investment analysts, and portfolio managers - with a highly effective means of sharing data and ideas. The need for the cross-pollination of ideas is of paramount importance not only in the intelligence community, but in financial services as well.
But the network-form has already been embraced by analysts in various disciplines as an efficient way to share and analyze information. Even the CIA has developed a social network for intra-agency intelligence sharing. We believe Facebook is an attractive environment for the deployment of financial modeling applications and would provide financial analysts - risk modelers, financial engineers, investment analysts, and portfolio managers - with a highly effective means of sharing data and ideas. The need for the cross-pollination of ideas is of paramount importance not only in the intelligence community, but in financial services as well.
Opportunities in FinTech Localization
The globalization of financial services is accelerating rapidly, particularly in the emerging and pre-emerging market spaces. As the financial systems of G7 nations continue to evolve, these markets will need to undertake significant financial infrastructure reforms in order to achieve and maintain connectivity to the global economy. Chief among these reforms will be implementing systems crucial to credit access, orderly capital flows and liquid financial markets. At the same time, a shift is clearly underway from an aid-based to a market-driven model in global development. Recent deals to this effect include:
· The $250 million capitalization of two strategic African investment funds by the U.S. Overseas Private Investment Corporation which will, among other things, "enable companies in a variety of industries to expand and potentially to tap the capital markets," and "support financial instrument innovation and capital market development by expanding the pool of available investment securities in Africa."
· Citibank India’s deployment of biometric ATMs which assist microfinance customers in Hindi, Marathi, Tamil, and Telugu.
· Italian software vendor SIA-SSB’s contract to establish a new interbank payment system for the Egyptian market through a €2 million deal funded by the European Union.
· Dutch IT firm LogicaCMG’s contract to implement an interbank real time gross settlement (RTGS) platform for the Banco Central de la Republica Dominicana (BCRD).
· SunGard’s contract to provide its BancWare financial analysis technology to Beirut-based BankMed.
This shift will create opportunities not only for financial technology providers, but will generate significant demand for globalization and localization solutions in this space. As such, we recommend that both industry players and financial sponsors explore strategic acquisitions or joint ventures as a means to benefit from this emerging trend. Some attractive candidates include publicly held LionBridge, privately-held TransPerfect, and privately-held, Beijing-based CSOFT (all three of which maintain existing financial services practices), while publicly-held SDL, and privately held (venture backed) Idiom Technologies and Welocalize provide solutions which are readily applicable to financial services.
· The $250 million capitalization of two strategic African investment funds by the U.S. Overseas Private Investment Corporation which will, among other things, "enable companies in a variety of industries to expand and potentially to tap the capital markets," and "support financial instrument innovation and capital market development by expanding the pool of available investment securities in Africa."
· Citibank India’s deployment of biometric ATMs which assist microfinance customers in Hindi, Marathi, Tamil, and Telugu.
· Italian software vendor SIA-SSB’s contract to establish a new interbank payment system for the Egyptian market through a €2 million deal funded by the European Union.
· Dutch IT firm LogicaCMG’s contract to implement an interbank real time gross settlement (RTGS) platform for the Banco Central de la Republica Dominicana (BCRD).
· SunGard’s contract to provide its BancWare financial analysis technology to Beirut-based BankMed.
This shift will create opportunities not only for financial technology providers, but will generate significant demand for globalization and localization solutions in this space. As such, we recommend that both industry players and financial sponsors explore strategic acquisitions or joint ventures as a means to benefit from this emerging trend. Some attractive candidates include publicly held LionBridge, privately-held TransPerfect, and privately-held, Beijing-based CSOFT (all three of which maintain existing financial services practices), while publicly-held SDL, and privately held (venture backed) Idiom Technologies and Welocalize provide solutions which are readily applicable to financial services.
What About Personal Risk Management?
In 2003, Yale University professor Dr. Robert Shiller ("Irrational Exuberance") published his widely heralded tome, "The New Financial Order: Risk in the 21st Century." In it Shiller lays out his ideas for "radical financial innovation," and, specifically, the development of financial products and services which provide for the management of personal financial risk: retirement, home equity, job security. He also outlines his ideas for the development of "macro markets" wherein investors buy claims to economic aggregates such as national income and real estate.
Clearly there is merit to Shiller's ideas. Recent events in the housing marketplace suggest that there would be a large market for some form of product to hedge against adverse movements in home prices and interest rates. The market for a retail energy hedging product is enormous. Perhaps it is the complexity of financial risk management which makes such products unworkable in the personal finance marketplace, but surely the finest minds in marketing could devise a method for communicating such complexity to the masses.
The beginnings of such a project can be found in HedgeStreet, a trading venue which enables investors to take positions in foreign currency, Fed funds rate, precious metals, and energy markets. The system is based on binaries. At inception the underlying value of the binaries was only $10 but was raised to $100 about a year later. This platform is ideal for trading and speculating, but as for providing insurance or a true hedge against gas prices or home values, not so much. (The site currently only offers its "Mock Trader" platform for trading virtual cash. It appears to be undergoing some restructuring.)
It would seem that while there is a critical need for research and development in areas such as alternative energy to protect us from environmental ruin, there is also a need for research and development in alternative finance to protect us from personal economic ruin.
Clearly there is merit to Shiller's ideas. Recent events in the housing marketplace suggest that there would be a large market for some form of product to hedge against adverse movements in home prices and interest rates. The market for a retail energy hedging product is enormous. Perhaps it is the complexity of financial risk management which makes such products unworkable in the personal finance marketplace, but surely the finest minds in marketing could devise a method for communicating such complexity to the masses.
The beginnings of such a project can be found in HedgeStreet, a trading venue which enables investors to take positions in foreign currency, Fed funds rate, precious metals, and energy markets. The system is based on binaries. At inception the underlying value of the binaries was only $10 but was raised to $100 about a year later. This platform is ideal for trading and speculating, but as for providing insurance or a true hedge against gas prices or home values, not so much. (The site currently only offers its "Mock Trader" platform for trading virtual cash. It appears to be undergoing some restructuring.)
It would seem that while there is a critical need for research and development in areas such as alternative energy to protect us from environmental ruin, there is also a need for research and development in alternative finance to protect us from personal economic ruin.
A FinTech Opportunity in National Security
In July, 2003, the Pentagon's Defense Advanced Research Projects Agency (DARPA) scuttled an ill-conceived terrorism futures market. While the project was a political failure, the idea underscores the ongoing need for innovative thought in the area of indications & warning (I&W). The construction of a terror futures exchange wherein market participants bet on events themselves is perhaps politically unpalatable, if not in poor taste, but conceptually the idea is grounded in rational thought. But rather than create an artificial market where explicit outcomes are at stake, a better analytic approach for purposes of intelligence analysis might be to translate existing financial and commodity data into finished intelligence.
Markets behave in a generally rational manner, particularly when factoring in the economic and financial implications of geopolitical uncertainty, and valuations represent a proxy for the beliefs of market participants. Financial markets are a form of communication, with the myriad data, transactions, and instruments comprising a distinct language. The challenge is to understand and interpret this language in the context of global security, and to divine the trends within markets which might suggest an impending terrorist attack or geopolitical crisis.
A financial I&W system would involve a comprehensive monitoring of global financial markets to uncover anomalous trading behavior in various asset classes. The difficulty here, of course, is establishing a general model of price/volume behavior based upon historical data which would enable analysts to discern anomalies from the general noise. Given the difficulty of this and the inherent imperfections in forecasting security prices, such a system would be valuable not as a sole-source of I&W, but as a piece of the larger I&W infrastructure which draws upon a variety of disparate sources and types of data. Financial I&W would serve well to clarify existing intelligence, or perhaps, as was likely the case prior to September 11, send up a red flag and initiate coverage.
Financial markets can provide intelligence analysts with valuable insights. Data could be useful in determining whether a bias exists toward the potential for a major geopolitical event, or whether there is deliberate activity within financial markets indicating trading designed to profit from a future event, suggesting foreknowledge. How do we effectively parse market behavior in an effort to understand how valuations might reflect the risk of an impending terrorist attack? Unfortunately, markets often overshoot the target, sometimes quite dramatically. However, for purposes of terrorism I&W it would not be necessary to accurately predict the correct valuation for a given asset or asset class, only to divine the trend and the underlying reason for the trend, to strip away the drivers underpinning the movement.
It is generally accepted that prices reflect all information that is known or knowable. By the same token, then, it should be possible to discern the information which is factored into prices and, by process of elimination, identify those factors as they relate to potential geopolitical events.
Markets behave in a generally rational manner, particularly when factoring in the economic and financial implications of geopolitical uncertainty, and valuations represent a proxy for the beliefs of market participants. Financial markets are a form of communication, with the myriad data, transactions, and instruments comprising a distinct language. The challenge is to understand and interpret this language in the context of global security, and to divine the trends within markets which might suggest an impending terrorist attack or geopolitical crisis.
A financial I&W system would involve a comprehensive monitoring of global financial markets to uncover anomalous trading behavior in various asset classes. The difficulty here, of course, is establishing a general model of price/volume behavior based upon historical data which would enable analysts to discern anomalies from the general noise. Given the difficulty of this and the inherent imperfections in forecasting security prices, such a system would be valuable not as a sole-source of I&W, but as a piece of the larger I&W infrastructure which draws upon a variety of disparate sources and types of data. Financial I&W would serve well to clarify existing intelligence, or perhaps, as was likely the case prior to September 11, send up a red flag and initiate coverage.
Financial markets can provide intelligence analysts with valuable insights. Data could be useful in determining whether a bias exists toward the potential for a major geopolitical event, or whether there is deliberate activity within financial markets indicating trading designed to profit from a future event, suggesting foreknowledge. How do we effectively parse market behavior in an effort to understand how valuations might reflect the risk of an impending terrorist attack? Unfortunately, markets often overshoot the target, sometimes quite dramatically. However, for purposes of terrorism I&W it would not be necessary to accurately predict the correct valuation for a given asset or asset class, only to divine the trend and the underlying reason for the trend, to strip away the drivers underpinning the movement.
It is generally accepted that prices reflect all information that is known or knowable. By the same token, then, it should be possible to discern the information which is factored into prices and, by process of elimination, identify those factors as they relate to potential geopolitical events.
White Label Monetization for Financial Apps & Start-Ups
White labeling has long been an effective business model in the software industry and has taken on particular significance in the era of Software-as-a-Service (SaaS). As a form of licensing it offers a reliable stream of revenue for developers, and for customers it offers faster time-to-market, relief from the burden of maintenance and upgrades, and a lower total cost of ownership (versus in-house development). For financial technology start-ups white labeling is particularly attractive given the increasingly crowded field, and given that there is a race to social media within the financial services industry which will only accelerate as economic recovery takes hold.
To date, two companies have already adopted this model. Wesabe, an online personal financial management site, is white-labeling its platform, Springboard, to banks and credit unions, and it has signed on at least one customer, Delta Community Credit Union. CreditKarma, which provides consumers with free access to credit scores along with exclusive offers and deals, announced at Finovate2009 that it would be white-labeling its service as well.
Hedge Funds Turning to I-Banking
Hedge Funds Turning to I-Banking:
Last month Citadel Investment Group announced that it is launching an investment banking division. The company sees huge potential for transactions going forward, and given its outsize capital base, has the distribution network and liquidity at its disposal to execute. Other firms could follow suit, such as publicly-held Fortress (FIG).
But is this the best strategy? It's true that there has been perhaps no better time to be a boutique investment bank. Wall Street has been decimated by the events of the last 18 months, providing small shops with the dual windfall of talent and competitive advantage.
Rather than build an investment bank from scratch, there are numerous firms which could provide hedge funds with access to the coming wave of M&A and IPOs. Even in this age of advanced financial (yet impersonal) technologies, traditional investment banking remains heavily relationship-driven, and cultivating those relationships takes time and resources. We believe that hedge funds would do better to consider a strategic partnership or acquisition as this would provide a more efficient structure, and hasten top-line revenue growth.
But is this the best strategy? It's true that there has been perhaps no better time to be a boutique investment bank. Wall Street has been decimated by the events of the last 18 months, providing small shops with the dual windfall of talent and competitive advantage.
Rather than build an investment bank from scratch, there are numerous firms which could provide hedge funds with access to the coming wave of M&A and IPOs. Even in this age of advanced financial (yet impersonal) technologies, traditional investment banking remains heavily relationship-driven, and cultivating those relationships takes time and resources. We believe that hedge funds would do better to consider a strategic partnership or acquisition as this would provide a more efficient structure, and hasten top-line revenue growth.
Social Financial Media: Challenge and Opportunity
Bank Technology News recently highlighted how banks are reluctant to fully embrace social media as it remains unclear how this phenomenon fits into the industry's traditional approach to customer engagement. Financial management is an inherently antisocial activity, and as one might expect financial applications do not possess the broad appeal of other app verticals such as social games. Nevertheless, as we move into the postmodern era of financial services the winners will clearly be those companies who display an innovative approach to customer engagement, and we believe this starts with deploying a rich and engaging presence on the social web.
Many financials have already begun this process. Numerous regional banks (Arvest Bank, Shore Bank ) and credit unions (Amplify, Fairwinds, Travis), exchanges (NYSE-Euronext, CME Group), and even H&R Block (with over 1800 fans) have developed a social presence by skillfully leveraging the viral potential of the Twittersphere and Facebook Pages. But this presence has been limited to communication - i.e., few have explored the potential for richer engagement through the deployment of branded applications or by leveraging Facebook Connect to provide for a more integrated social web presence. Until now Twitter has been more appealing to financial institutions in that it provides a unique communications tool and readily augments existing marketing and customer service programs. But two recent developments may drive more companies to develop an outpost on Facebook: the ability to stream posted stories directly to fan news feeds, and Twitter integration via the Selective Twitter Status application.
We believe that as social media matures and becomes increasingly mainstream, financial institutions will be compelled to develop a more engaging presence on the social web. Building a Facebook or Twitter application is not particularly difficult, but the requisite programming knowledge does present a slight barrier to entry, and custom development can be cost prohibitive, even for larger institutions with in-house engineers. Buying an existing application is an attractive option as it provides for an accelerated ramp-up, but, like off the shelf software, can be rigid in design and functionality, and may still require tweaking.
In the end, it's all about ROI, and the benefits of investing in IT are notoriously difficult to quantify. This is perhaps even more the case when attempting to justify a large capital expenditure on emerging (read: as-yet unproven) technology. But we believe that companies would do well to consider some of the many innovative applications currently populating the Facebook and Twitter ecosystems. We believe that several of these applications present attractive acquisition opportunities and would provide for both rapid deployment and genuine ROI. In future posts as well as upcoming research products we will be discussing some of these targets as well as suggested valuations.
Many financials have already begun this process. Numerous regional banks (Arvest Bank, Shore Bank ) and credit unions (Amplify, Fairwinds, Travis), exchanges (NYSE-Euronext, CME Group), and even H&R Block (with over 1800 fans) have developed a social presence by skillfully leveraging the viral potential of the Twittersphere and Facebook Pages. But this presence has been limited to communication - i.e., few have explored the potential for richer engagement through the deployment of branded applications or by leveraging Facebook Connect to provide for a more integrated social web presence. Until now Twitter has been more appealing to financial institutions in that it provides a unique communications tool and readily augments existing marketing and customer service programs. But two recent developments may drive more companies to develop an outpost on Facebook: the ability to stream posted stories directly to fan news feeds, and Twitter integration via the Selective Twitter Status application.
We believe that as social media matures and becomes increasingly mainstream, financial institutions will be compelled to develop a more engaging presence on the social web. Building a Facebook or Twitter application is not particularly difficult, but the requisite programming knowledge does present a slight barrier to entry, and custom development can be cost prohibitive, even for larger institutions with in-house engineers. Buying an existing application is an attractive option as it provides for an accelerated ramp-up, but, like off the shelf software, can be rigid in design and functionality, and may still require tweaking.
In the end, it's all about ROI, and the benefits of investing in IT are notoriously difficult to quantify. This is perhaps even more the case when attempting to justify a large capital expenditure on emerging (read: as-yet unproven) technology. But we believe that companies would do well to consider some of the many innovative applications currently populating the Facebook and Twitter ecosystems. We believe that several of these applications present attractive acquisition opportunities and would provide for both rapid deployment and genuine ROI. In future posts as well as upcoming research products we will be discussing some of these targets as well as suggested valuations.
The Lure of Global Infrastructure
Fueled by the explosive growth of emerging markets and the never-ending maintenance curse in developed economies, infrastructure appears poised to be one of the main growth engines in capital markets for the foreseeable future. It represents an attractive opportunity for both the sell and buy sides.
Debt ceilings and political pressures have steadily eroded conventional approaches to public capital formation. Perennially cash-strapped states and municipalities have driven the development of innovative ways to design, build, maintain, operate and finance critical infrastructure improvements. One highly successful innovation is the Public-Private Partnership, or “P3" - a unique hybrid organization which provides a quasi-privatized approach to infrastructure challenges, enabling oversight by a public organization while benefiting from the market-based incentives and efficiencies of a private sector model. P3s have been particularly popular in Europe and Asia, and are gradually gaining legitimacy here in the United States. Notable U.S. P3s include Chicago's Skyway Toll Road, the Indiana Toll Road, Virginia's Pocahontas Parkway, and Texas State Highways 130 121.
Given recent market gyrations and the liquidity crisis in fixed income, we expect that in the near term we will witness a pullback in infrastructure-related deals. Long-term prospects, however, are bright, particularly in light of continued trends in public finance, and the need for pension funds and institutional investors to seek out higher yielding instruments while minimizing risk. A potentially symbiotic relationship exists between infrastructure funding needs and pension liability matching. The recent "repricing of risk" will drive institutions to find low-risk, cash flow-dependable investments and thus will encourage growth in the infrastructure space.
Debt ceilings and political pressures have steadily eroded conventional approaches to public capital formation. Perennially cash-strapped states and municipalities have driven the development of innovative ways to design, build, maintain, operate and finance critical infrastructure improvements. One highly successful innovation is the Public-Private Partnership, or “P3" - a unique hybrid organization which provides a quasi-privatized approach to infrastructure challenges, enabling oversight by a public organization while benefiting from the market-based incentives and efficiencies of a private sector model. P3s have been particularly popular in Europe and Asia, and are gradually gaining legitimacy here in the United States. Notable U.S. P3s include Chicago's Skyway Toll Road, the Indiana Toll Road, Virginia's Pocahontas Parkway, and Texas State Highways 130 121.
Given recent market gyrations and the liquidity crisis in fixed income, we expect that in the near term we will witness a pullback in infrastructure-related deals. Long-term prospects, however, are bright, particularly in light of continued trends in public finance, and the need for pension funds and institutional investors to seek out higher yielding instruments while minimizing risk. A potentially symbiotic relationship exists between infrastructure funding needs and pension liability matching. The recent "repricing of risk" will drive institutions to find low-risk, cash flow-dependable investments and thus will encourage growth in the infrastructure space.
The NVCA Four Pillar Plan
Pillar one calls for a reexamination of "ecosystem partners" - those institutions which currently make up the foundation of the IPO process - entrepreneurs, VCs, investment banks, buy siders, exchanges, law firms and accounting firms. NVCA recommends that boutiques step in to fill serve "No Man's Land" of IPO candidates raising up to $75 million and having a post-IPO valuation of up to $400 million. Other recommendations include greater cooperation between the bulge bracket and boutiques through joint book running and fee sharing, an emphasis on cultivating buy side interest in venture IPOS, and lower-cost accounting services for pre-IPO firms.
Pillar two calls for a reengineering of the liquidity process, with emphasis on alternative private equity platforms, innovative boutique advisors specializing in emerging technology, greater reliance on global funding sources and international stock exchanges, and VC-originated M&A which would roll up smaller portfolio companies.
We have blogged here before regarding such proposals, particularly with respect to the rise of boutique banking and alternative liquidity mechanisms. While the NVCA report cites wholesale institutions such as SecondMarket and InsideVenture as primary examples of "enhanced liquidity mechanisms," we continue to be bullish on such Web start-ups such as TradeVibes and Valuecruncher. We believe that social technology has the capability to transform the retail marketplace, to provide crowd-sourced price discovery, deeper liquidity, and access to a broad investor base.
We continue to be bullish on boutique investment banks. Companies such as Greenhill (GHL), Evercore (EVR), and Keefe Bruyette Woods (KBW) boast strong balance sheets, strong management, and solid core business strategy. We also expect a wave of consolidation in this space as firms seek to carve out or bolster current competitive positions. We see Thomas Weisel Partners (TWPG), JMP Group (JMP), and FBR Capital Markets (FBCM) as potential targets.
Implications of Facebook Credits
The movement away from an ad-driven monetization model toward one which relies on a high volume of tiny monetary transactions continues to gain significant traction. Companies such as Tencent, Zynga, and MyYearbook have recently posted multi-million dollar revenues derived largely from microtransactions in virtual goods, items which enhance user profiles or avatars within social networks, virtual worlds, or social games. We believe that Fb Credits will provide Facebook with equally outsize revenues and will produce even greater results as the company leverages the social graph. We believe Facebook intends for Credits not only to facilitate e-commerce, but to provide a form of communication, to augment the overall social nature of the site. That is, Credits could become a medium of user interaction which transcends simple pay-for-service transactions by encouraging a new social financial framework. Facebook’s recent beta test, while at first somewhat puzzling, indicates that the company may in fact have ideas for virtual currency which lie outside the mainstream. Fb Credits represent the tip of a much larger iceberg in terms of user engagement and activity within Facebook, and perhaps even across the social web.
Valuation 2.0
Valuing companies is always great fun. Ask 100 different analysts and you will likely hear 100 different numbers. Even with reasonably good transparency and sound forecasting methodologies, the final value is highly subjective. The short answer is simple: a company is worth what someone will pay for it. The end.
Things have become far more challenging in the era of Web 2.0 - an era characterized by Sarbanes Oxley, private equity, and "free." The challenge for the analyst nowadays is not only to provide the most objective articulation of underlying assumptions and data, but to essentially invent whole new methodologies. One example of such an approach is Adonomics, a portfolio company of Altura Ventures, the Facebook-centric venture capital firm. Adonomics provides valuations for Facebook applications based on a proprietary methodology which takes into account the number of installs, daily usage, and advertising potential of each app. The site provides a searchable database, and publishes the Adonomics 100, a valuation ranking of the companies behind the applications . The top company, Slide, founded by PayPal co-founder Max Levchin and maker of the popular FunWall, Top Friends, and SuperPoke applications, fetches a $322 million valuation.
The latest entrant in the valuation game is the Silicon Valley Insider, a blog founded by, among others, former Merrill Lynch star Internet analyst and dotcom implosion poster boy, Henry Blodget. The SAI 25 is a listing of the "world's most valuable digital start-ups." SAI's methodology is fairly straightforward, taking into account industry comparables, financials (when possible), market share, and growth rate. SAI fully admits the hazards involved in this exercise, particularly the effect of information asymmetry, but there is clearly some serious thought involved. For example, SAI values Facebook at $9 billion, versus the $15 billion based on Microsoft's stake. The rationale? As part of the transaction, Microsoft agreed to sell Facebook ads and bought preferred stock, thereby reducing the value of the common. Overall, the SAI 25 it is an interesting contribution to a growing body of work in this area.
Conspicuously missing from the list are Finance 2.0 companies, and an accompanying "Contenders" supplement includes only Mint ($50 million), and Prosper (<$50 million). This is hardly surprising, given that the valuations of the SAI 25 range from $250 million to $9 billion. Moreover, the revenue models for Finance 2.0 are still a bit uncertain - advertising, data aggregation, or premium services. The ad model is losing favor as users are increasingly tired of intrusive banners, preferring a cleaner, richer, and therefore more engaging (i.e. stickier) experience. Data aggregation holds great promise, but is both unproven and controversial. Premium services are perhaps the best route to "hard money" results, but it is difficult to justify fees when competing sites likely offer comparable services for free.
Things have become far more challenging in the era of Web 2.0 - an era characterized by Sarbanes Oxley, private equity, and "free." The challenge for the analyst nowadays is not only to provide the most objective articulation of underlying assumptions and data, but to essentially invent whole new methodologies. One example of such an approach is Adonomics, a portfolio company of Altura Ventures, the Facebook-centric venture capital firm. Adonomics provides valuations for Facebook applications based on a proprietary methodology which takes into account the number of installs, daily usage, and advertising potential of each app. The site provides a searchable database, and publishes the Adonomics 100, a valuation ranking of the companies behind the applications . The top company, Slide, founded by PayPal co-founder Max Levchin and maker of the popular FunWall, Top Friends, and SuperPoke applications, fetches a $322 million valuation.
The latest entrant in the valuation game is the Silicon Valley Insider, a blog founded by, among others, former Merrill Lynch star Internet analyst and dotcom implosion poster boy, Henry Blodget. The SAI 25 is a listing of the "world's most valuable digital start-ups." SAI's methodology is fairly straightforward, taking into account industry comparables, financials (when possible), market share, and growth rate. SAI fully admits the hazards involved in this exercise, particularly the effect of information asymmetry, but there is clearly some serious thought involved. For example, SAI values Facebook at $9 billion, versus the $15 billion based on Microsoft's stake. The rationale? As part of the transaction, Microsoft agreed to sell Facebook ads and bought preferred stock, thereby reducing the value of the common. Overall, the SAI 25 it is an interesting contribution to a growing body of work in this area.
Conspicuously missing from the list are Finance 2.0 companies, and an accompanying "Contenders" supplement includes only Mint ($50 million), and Prosper (<$50 million). This is hardly surprising, given that the valuations of the SAI 25 range from $250 million to $9 billion. Moreover, the revenue models for Finance 2.0 are still a bit uncertain - advertising, data aggregation, or premium services. The ad model is losing favor as users are increasingly tired of intrusive banners, preferring a cleaner, richer, and therefore more engaging (i.e. stickier) experience. Data aggregation holds great promise, but is both unproven and controversial. Premium services are perhaps the best route to "hard money" results, but it is difficult to justify fees when competing sites likely offer comparable services for free.
Deal Idea: PFM Acquisition of Billeo
We believe that a wave of consolidation could take place as those start-ups which have reasonably sound monetization models in place seek to expand their user base, and those which may be cash strapped but have a viable, innovative product seek to be acquired before failing.
One particular transaction looks increasingly attractive in the online personal financial management space. Personal financial managers (PFMs) such as Mint, Wesabe, Rudder, and Geezeo all offer the ability to track and manage personal finances from a single point. The aggregation of personal financial data is highly attractive for consumers, particularly in these economically volatile times, but as of yet there is no service which provides an integrated transaction capability. We believe there is substantial value not only in enabling consumers to manage their finances, but also conduct their financial affairs from a single environment.
We believe Billeo presents an attractive acquisition candidate for PFMs. Billeo provides users with the ability to shop and pay bills at company websites using payment and contact information stored in an online e-wallet. Users can also store, track, and search their receipts and payment confirmations. Billeo would enable an acquirer to strategically differentiate itself in what is becoming an increasingly crowded space.
From a usage perspective, a Billeo acquisition would offer a distinct competitive advantage for Wesabe, Geezeo, and Rudder, as Mint is clearly the frontrunner in terms of unique monthly users, which we may assume translates into higher user conversion numbers. Mint, however, boasts a high valuation ($46.3 million post money in Q1 of this year), and may be better positioned for an equity-based transaction.
No Exit
We believe one of the keys to restoring vibrant and liquid capital markets lies in the development of alternative means to liquidity. We believe that social technologies hold the key to the development of such alternatives, whether in the form of entirely new classes of financial instruments, or, in particular, a highly liquid, socially networked capital marketplace. We need look no further than the consumer lending space where P2P technologies are revolutionizing the way individuals gain access to debt capital. These technologies could be readily adapted to the development of an equity capital market.
Several ideas currently in their infancy offer a glimpse into future "socialized" securities markets. We see the movement toward a social, "wisdom of crowds" approach to investing currently underway. Companies such as kaChing and Covestor offer the ability for investors to establish track records and to leverage their expertise by managing actual portfolios. In addition, markets for "virtual shares" in start-ups, private companies, and even standalone applications have sprung up, and include TradeVibes, exchangeP, and AppBroker. We are also watching with great interest developments in the virtual goods/microtransaction space for potential capital market applications. We believe these ideas and others signal the beginning of a significant industry shift.
Given the current upheaval on Wall Street, the need for investor liquidity, cries for a new financial regulatory regime, and ongoing innovation in the social technology space, the stage is now set for profound disintermediation in capital markets.
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