We'll See Who Yelps!

The Yelp IPO is getting outsized attention, coming up third on my Google news page, right below civil war in Syria and the exposure of a bomb plot against the US Capitol.  Why does a money-losing user-review site deserve this level of coverage?  Obviously, the pending Facebook IPO has induced a sugar rush among business writers  that’s eclipsing war, politics, and taxes.  This fact alone has my bubble alert blinking yellow.  Then there are the facts of the offering itself, and the underlying company fundamentals.

The expected offering range of $12-14 values Yelp at over $800M, small potatoes compared to the juggernaut of Facebook at $100B but still a lot of money. Yelp is another “PayPal Mafia” production, kicked off by a $100M investment from Russell Simmons after he and CEO Jeremy Stoppelman wondered why it was so hard to find a good dentist. Around since 2004, Yelp has never made any money, but they’ve built a loyal cadre of followers, to the tune of 66 million unique Web visitors and about 6 million unique mobile visitors per month. Yelp lost over $16M on revenues of $84M in 2011, and has been candid in revealing to potential investors that it won’t make money anytime soon.

One of the most interesting elements of Yelp’s profile is its relationship with Google. While Google search visitors make up more than half of Yelp’s traffic, Yelp has not exactly gone out of its way to be grateful.  In fact, some would say Yelp has displayed something of a death wish by biting the hand that feeds it. Yelp’s  public tussle with Google started when CEO Stoppleman accused Google of scraping Yelp reviews and applying them to Google Maps’ local results without compensation.  Google’s reply was basically “tough luck – you benefit from us sending visitors to you.” When the Senate antitrust committee decided to investigate allegations that Google was using its search dominance to consolidate its clout, Yelp’s CEO Stoppleman was at the head of the line to testify that Google was rigging results to its own benefit. In a quote that might give potential Yelp investors pause, when Sen. Al Franken asked if, knowing what he knows about Google’s power in the internet space, he would start a firm like Yelp now, Stoppleman replied “"There's no way I would start fresh.  I wouldn't even consider it today."

A look at Yelp’s most obvious direct competitor, Angie’s List, is revealing.  While Angie’s list has a different model, based on paid subscriptions rather than advertising and free user access, it  still hasn’t been able to generate a profit.  ANGI opened at $13, started trading at $17,  surged to $18.75 and closed at $16.25 for a 25% first-day pop. Unfortunately it was downhill from there as ANGI slumped to a low of $10.75.  It’s since engaged in a roller-coaster ride that’s brought it to its current $14.92, not without making investors quite squeamish along the way.  While ANGI won’t release its first official SEC earnings report until Feb. 22, it’s well-accepted among analysts that profitability is still a long way off.

Bulls on Yelp cite a few factors that might augur well.  Yelp is only getting paid by about 16,000 of its potential millions of local business, so growth potential is huge, It’s already gotten lucrative buy-out offers from some of the big players, including, reportedly, its love-hate significant other, Google, so clearly there is recognized value.  Its user-generated content model keeps costs low, dedicated users (I’m a big fan myself) swear by it, and, as the action moves to mobile, its established footprint in that space could grant it an  immense advantage.

So, while the bubble warning system is starting to hum, and the recent price action of Groupon,  Zynga and Angie’s List may cause some indigestion, there are always the positive examples of LinkedIn and, hopefully, Facebook, to generate some hope. As the social media revolution moves from the innovation and startup arena, where experimentation and audience size are valued for themselves, to the public markets, where forgiveness is non-existent and the shorts are breathing down your neck every second, everything will be revealed. As the very public drama in Greece illustrates, you may be king, queen, prime minister or internet god, but the markets rule them all.

Zynga: so last bubble!

Looks like Zynga is jumping out ahead of some of the issues I noted in my last post. According to Bloomberg today, ZNGA plans to offer its prime game space on Facebook as an advertising medium to other game developers, a move that Bloomberg and its BusinessWeek publication are comparing to EA and Activision's roles as "publishers".  It's not too mysterious why a plan like this is attractive to Zynga; with Daily Active Users shrinking from 62 million this time last year to 59m the next quarter, 54m the next and 48m in the most recent, and with R&D costs exploding eight-fold, Zynga clearly needs to get creative on growth strategies.


I'm not sure that allowing other game developers to advertise on your games, thereby tacking themselves onto your name and risking the dilution of your brand, is the best idea - what if the games suck? Will Zynga be applying quality control to the games they allow to associate with their brand, as real games publishers like SEGA and EA do, or is this merely a 'billboard' strategy, with its attendant reputation risks?  Will Facebook gamers differentiate between Zynga-developed games, and games that advertise in Zynga's gamespace, or will they just lump them all together and blame Zynga for the lame funless games that pop up during their Farmville session?


Not to be too skeptical, let's note that Zynga is making some smart moves, like migrating from the Amazon cloud service to its own 'z cloud' infrastructure, thus ensuring that gamers won't be subject to slowdowns and outages that are outside of Zynga's control. With all the talk of exploding R&D, if it's a case of real investment in future blockbusters (versus the developers-run-wild scenario posited by some) this could also be a growth-sustaining move. The prospect of legalized online gambling has Zynga proponents ready to double down, as its popular Zynga Poker title could be the perfect platform for minting money.  And rumors of Zynga's plans to challenge Steam, the game engine gamers love to hate, could broaden Zynga's control of gamer mindshare, if they can overcome the annoying idiosyncracies of that competitor.  In short, there is a bull case to be made for Zynga, just not on the basis of the current numbers or their trajectory. 


And the back-of-the-napkin calculation that says that, if Facebook is worth $100B and Zynga generates 12% of that, therefore Zynga must be worth about $12B (close to its current market cap) is just so last bubble.

Zynga Takes a Hit

By now everyone that follows the market in tech IPOs has seen the shellacking that Zynga has taken since its earnings disappointment on Feb. 14.  Not only has the stock been pistol-whipped like a Mafia Wars stoolie, now down about 14% since its pre-announcement peak, but the analyst community has heaped manure on it, Farmville-style,  even going so far as to issue that rarest of Wall Street opinions, an outright sell (from Evercore). It wasn’t just this first quarterly report that raised the skepticism of analysts and traders; issued at $10 by lead underwriter Goldman Sachs on Dec.16, the stock, rather than exhibiting the customary upside explosion associated with hot tech IPOs, actually sunk to a low of $7.97 before earnings speculators bid it up to $14.55 in anticipation of a nice report. Instead they got ambushed. Granted, part of the revenue miss was connected to the costs associated with the end of the lock-up period, and even though stockholders got drubbed, Zynga founders and early employees got to cash out and get rich. Other elements of the report that set the hairs standing on investor’s necks was the slower-than expected growth in Daily Active Users, and the big jump in R&D costs, which suggest to some analysts an undisciplined development environment.

Just to twist the knife, a self-proclaimed ex-developer went public on Reddit to amplify some of these concerns. According to "mercenary-games", Zynga is intentionally re-jiggering their games to make them addictive, and their development teams are overrun with “brogrammers”, defined as “Silicon Valley/Harvard type douchebags who got into programming ... YCombinator drop outs with…no idea how to setup a build system  nor work in native code.” This sort of “disgruntled ex-contractor” stuff is usually self-debunking, but in this case it reinforces some of the concerns that have been pointed out by respected analysts like Ben Schachter of Macquarie, who said the numbers still were "not enough to make the stock work.” In a lovely understatement, Schachter said “The fact that R&D went up more than we expected is not a good sign.” In fact, R&D increased eight-fold, a jaw-dropping metric.


So we’ve got a company that relies on one partner, Facebook, for 90% of its revenue, and that partner skims 30% of Zynga's take for the privilege of that dependency. If the worst is believed, Zynga is having challenges managing its development environment, and is not experiencing anything like  the growth numbers required to meet expectations or justify its valuation. To veterans of the first internet bubble, these issues sound hauntingly familiar. And they have major implications for the mega-IPO everyone’s chattering about, Facebook. As Dan Lyons notes in his Daily Beast commentary, the $100 billion valuation that’s being posited for Facebook values it at about half of Google’s current $188B valuation, without much clarity on its eventual business model or revenue-generation capabilities, which are now around $1B to $1.5B. I find it fascinating that investors are not showing anything like the tolerance for “investing in growth” or “collecting eyeballs before monetization” that they demonstrated in the first ‘net bubble.  Will investors, who probably will have to sell their families and debase themselves to their brokers just to get on the list that gets you on the list to get an allocation of Facebook, have the tolerance for a $100B company that’s seven years old and still doesn’t really know what it does for a living? I guess we’re about to find out.

The Gestural Interface

While everyone is focused on high-profile IPOs like Groupon, Zynga, and, of course, Facebook, a stealthier IPO has made sharp-eyed speculators a bunch of money, and, more importantly, has some interesting implications for the direction of gaming, mobile, TV, and PCs.  InvenSense (INVN), according to their website and SEC filings, “designs, develops, markets, and sells micro-electro-mechanical systems (MEMS) gyroscopes for motion processing solutions in consumer electronics. The company delivers next-generation motion processing based on its advanced multi-axis gyroscope technology…”  INVN’s initial price last November was $7.50. While  it didn’t have a spectacular “first-day pop” like LinkedIn and, presumably, Facebook, it moved up steadily to a recent high of $19.34, and hovers around $18.50 now. 

So what’s interesting about InvenSense, beside the fact that it’s been a double for traders? InvenSense is one of the firms that’s providing the underlying motion-sensing capabilities that enable the “gestural interface” that’s driven some of the most engaging applications on Nintendo’s WII, Apple’s iPhone, and the next generation of digital cameras. The gaming implications are obvious, as gamers evolve from the 40-year-old joystick paradigm to a lifelike gesture-based interaction with games and virtual environments. The iPhone’s ability to sense the orientation of the device and adapt the interface in real time is a trivial example of coming attractions, as we see motion and gestures controlling image stabilization, application interfaces, and experience vast improvements in GPS navigation and location-based services. When your phone knows not only where you are, but whether you’re looking up, down or sideways, the possibility of true “Minority Report”-style navigation and marketing moves closer to reality. As both Apple and Google begin to plot their strategies in the Smart TV space, gestural navigation through menus, channels, and content can deliver real differentiation.

Whether you’re an investor looking for the next under-the-radar double, or a gearhead trying to predict what the next gen of tech toys will deliver, it’s often profitable to look beyond the hyped mega-offerings and explore some of the innovative firms, like InvenSense, that could form the foundation of the human-machine relationship to come.