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A Call for Quality Content in 2012: Investment Research Must Evolve

I've been off the grid for the last two weeks, out in Fuerteventura, one of the Canary Islands off the coast of Africa. During my time, I had the chance to catch up on some reading, specifically Michael Lewis's Boomerang. What can I say, Lewis has been an incredible writer, telling the story in a way that is both entertaining and educational, with a morality check to boot. Interesting read for anyone who's missed it. One of the themes that came out both in "Boomerang" and "The Big Short" involved the negligence of the ratings agencies and the analysts and managers of CDO portfolios who willfully bet on the music not stopping. Lewis argued that many of these folks were just mismatched and didn't remotely understand the securities they were reviewing or investing in - the others were just out to manipulate the markets (and probably should be put in prison). Lewis also notes that the market was fairly aware that the market was frothy and that analysts were probably putting out reports that were overly optimistic.

Why Research is Needed

The fact is, the research and analysis market is still very robust for one very specific reason - due diligence is hard to do in a vacuum and expertise is always valued in making investments (as my dad used to say "its important to 'buy a little brain' from time to time).

As a VC at Greylock, we relied heavily on the greater Greylock network to better understand the startup's team, the market, competitors, potential acquirers, and the quality of the product. Since our investments were in the private markets, and often in new industries, our 'experts' were bloggers, executives from potential acquirers and related firms, and technical experts. We rarely used investment bankers, as valuation was loosely structured on industry comps (from VentureSource or some equivalent service). We always included legal advisors in constructing the right term sheets for the investments once we agreed to move forward.

The same approach is applied in the PE world and the public markets, but with different data sources. In the PE world and Public Markets, buy-side firms have hard-data to construct valuations in a smarter way, resulting in a heavier emphasis on internal and external analysis on that front (think investment bankers on the PE side and sales traders on the public side providing pricing guidance). Additionally, there is a larger market of information and comps to draw insights from, namely the company's executives (think investor relations / corporate access), market research analysts from the likes of Gartner and Forrester, experts from the likes of GLG and professional analysts from large investment firms (sell-side) and independent shops.

But Research has Changed

Sadly, for our friends in Investment Research, the last 15 years have seen major changes. During the dot com bubble, a variety of analysts became superstars on CNBC, including folks like Henry Blodget, Mary Meeker, and Jack Grubman - these guys and many of their colleagues were incentivized to be bullish on securities that were issued by firms doing lucrative investment banking business with their firms - e.g. in exchange for a positive rating, the firm got larger allocations of IB fees. After the bubble burst, Spitzer went after the Sell-Side Research firms, and made several key changes to the industry, namely:

  1. Institutionalized a chinese wall between Investment Banking and Research to ensure that analysts were more objective
  2. Create pools of resources for these firms to allocate and promote independent research content, coming from firms who did not have investment banking or a broker-dealer in-house, again ensuring a wider array of opinions and objective analysis
Investment Research, generally a 'soft dollar' or 'loss leader' business, conducted to induce investment banking and trading revenues, now would be forced to either go 'hard dollar' (charge a fee for research directly) or rely on the latter only.
A few years later in 2006, 'best execution' requirements further solidified the shift to 'hard dollars' in mid-market and smaller shops, as it forced the buy-side to conduct the most efficient trade at the given moment, not the right trade within a 'soft dollar' arrangement (e.g. trading off a few bp in exchange for the research that induced the trade). This further decoupled research as a stand-alone offering, ideally situated as a hard-dollar business line.
These changes  came precisely during the decade of exponential information sharing and growth - retail investors on retail sites were getting access to real-time research and ideas shared from numerous sources. Consensus data, analyst projections,  and research reports were openly available or passed around with relative ease across historical and newfound communications channels (think of the big Lazard report for Carl Icahn that became a web sensation in February 2006, and still shared all over the web).
During the same time, traditional publishers had their content tested by the general and financial public to determine its value - certain brands thrived (think WSJ, FT, NYTimes, The Economist, and several smaller, leaner web-based offerings) while others struggled heavily or fell apart (think nearly everyone else). Clearly, people were willing to pay for the best available content, but the bar had risen to determine who would succeed in this new information-rich world.

Value In Information

In the publishing world, firms like the NYTimes and organizations like Dow Jones were able to win the digital dollars by creating a lucrative new model in cyberspace - giving away a portion of content for free and supplementing such services with advertising. Their best writers leverage social media to build notoriety to encourage more eyeballs to look at the content to drive those two business models (subscribers and ad traffic).
In the research world, firms on the sell-side push their research reports to both clients and potential clients (basically the bulk of the buy-side) for free, with the hope that clients will reach out to their analysts for both corporate access (opportunities to meet management) and analysts access (opportunities to pick the brains of the analyst over the phone or in person).
Today, most top-tier sell-side shops, who can ensure 'best execution' via their trading desks, can still afford to manage their research business via soft-dollars, but the rest of the sell-side and the independents make all of their money through hard-dollar arrangements. To be successful in a hard-dollar environment, analyst insights need to be considered highly valuable and essential to investment decisions - it can no longer be reliant on 'relationships' or some intangible connection for other business.

Selling Valuable Content

Again looking to the publishing business for answers, we can see a variety of approaches, namely the freemium model vs. the walled garden approach. In the freemium model, a taste of the content is shared with the potential customer to entice them to buy - sites actively push their best writers and content to be accessible to this audience, as it will encourage subscription and ad dollars rolling in. Alternatively, in the walled-garden model, the firm relies on its existing reputation to sell their content, generally sight unseen - this requires the very strongest of brand names in the market.
In the research world, a large amount of content is produced and shared through a variety of private channels (e-mail, databases, brokerage firms, and through financial news agencies), with the intent of building brand with existing and potential clients. The goal is to build enough credibility around specific securities, industries and macroeconomic areas to be worthy of client research budgets, which can easily be in the seven or eight figures for the larger firms.

Social as a Distribution Channel

Again, the publishing industry has largely embraced Twitter to push content to the masses and establish/extend the brand of the firms and their individual writers. It has been able to expand empires (think Thomas Friedman) and build new ones (think Mashable, HuffPo and BusinessInsider), particularly in the smaller and less-established firms.
On the research side, embracing StockTwits as a distribution channel is a modern alternative to the traditional research freemium model of database and dissemination through the news agencies - allowing the firm and their analysts to own the content being shared, how it gets shared, and follow the engagement from the community. With the research community sharing their basic thesis and analysis with the greater investment community on StockTwits, they will ensure attribution with the firm and analyst, and enabling fully-trackable engagement from both market influencers and potential clients. The result is a highly effective, yet simple way to be a part of the more transparent information market (actively, as apposed to being dragged into it, kicking and screaming), building clout and brand with the right audience who can be long-term clients.

Seems like a smart approach to me.

Look for it in 2012...

Rethinking Expertise, or Why Expert Incentives Can Create Chaos

Maybe i'm easily shocked. Like many of you, I've been spending the better part of the last year and a half reading and learning about the underpinnings of our most recent financial crisis, trying to make some sense of it all. Most recently, I've read Too Big to Fail, A Colossal Failure of Common Sense, and No One Would Listen (Markopolis on the Madoff Scandal). I've also had the chance to watch Inside Job, the documentary on the crisis narrated by Matt Damon (whom I have trouble taking seriously). In nearly all the key elements of the crisis and the Madoff scandal, one can find a deluge of experts from top business schools, top think tanks and the highest institutions in the world (including non-profit and government thinkers) rallying behind some of the most wrong-headed, short-sighted, and dangerous positions we've ever held. What lead them astray?

Let's start out by clearly pointing out that experts are not always going to be right, and often we pay for the vision and insight they can provide on a topic, whether the outcome matches their predictions or not. Clearly, predictions for nearly anything are difficult to put together with any reasonable accuracy, and its easy to look back and identify flaws in the underlying argument.

However, there is also a growing inclination by the expert class to take cash payouts to help determine which side of a position they lean towards. At this point, 'expertise' is not really expertise, but rather a 'paid for endorsement', no more reputable than George Foreman selling cooking equipment or Katy Perry touting acne medication. The irony is, George and Katy actually need to clearly state that they're paid to tout their products on those infomercials, while experts in situations with much higher stakes, do not need to do so.

The Blow Up

This week, there's been lots of talk about Quaddafi's consultants from Michael Porter's Monitor Group, to help clean his image around the world. As BusinessWeek reports, over $3m exchanged hands in this deal, involving the design of a massive marketing and advertising effort, intended to encourage world governments and large corporations to look at Libya differently. However, the 'experts' hired to build this marketing effort were very outspoken in the media about their feelings on how Libya had turned around and become a moderate and friendly place to do business.

Benjamin Barber, a professor from the University of Maryland, wrote an op-ed piece in the Washington Post in 2007, titled "Qaddafi's Libya: An Ally for America?", claiming that we might have been to harsh with the guy. Unfortunately, his 'about the author' section only states this:

Benjamin R. Barber, the author of "Jihad vs. McWorld" and "Consumed," is a senior fellow at Demos, a New York-based think tank focused on the theory and practice of democracy.

Glad to see he left out the Libya and Monitor Group-sponsored trips that helped sway his 'opinion'.

How Do We Solve This: A Look to Finance

How do we as a society solve this problem? Perhaps with a quick look to finance...

When you watch any financial broadcast, particularly on CNBC, Bloomberg, and Fox Business, you'll find a very clear list of disclosures when a guest commentator comes onto the program. This is used to help investors understand the agenda of the individual sharing their idea at that given moment.

Much like George Foreman, Jim Cramer's Mad Money show literally mentions his material relationships with any security Jim chooses to discuss in a given show (can easily be more than 50+) which allows the watcher to know his incentives. The irony is, Jim Cramer is still a big deal and a champion of the retail investor, even when his advice is far from perfect - part of that has to do with the transparency he provides (which is actually required by the SEC and FINRA).

In the business sphere, white papers and research are often written on behalf or with funding from individual companies. These documents are still incredibly useful, even if they have an underlying bias within them. Why can't this level of transparency be applied across the board?

In the political realm, this same concept should apply. I'd like to see CSPAN list the 'material contributions' the speaker at any given point has received from lobbyists and institutions, so that the voters and general public can take that into context.

In the consulting and think-tank universe, it's about time for proper disclosures on who's paying the bills. It would've helped us better understand the testimony these 'independent folks' might be giving to Congress, to students in a classroom, or to other influential bodies. Much like Mr. Cramer and the white-paper business, I'd expect their expertise to be duly noted and leveraged accordingly.

Robert Rubin, Larry Summers and Hank Paulson are still experts in Finance, even if they have clear biases. The Monitor Group is filled with smart people who have studied the science of business, and can provide some thought and guidance to the rest of us at times, but within the context of their biases. It's time we all accept that biases are out there, make them more visible, and give the people the chance to make a decision with that information.

It will surely help us make better decisions in the future.

Twiddle me this... On the Twitter protocol, ecosystem and the company's business

First, a must-read - Twitter CEO Dick Costolo's interview with the WSJ this wknd --> The Twitter ecosystem has really exploded over these last 12-18 months, with numerous companies building interesting tools, functions and adaptations of Twitter's underlying architecture. Many of these companies have even built robust and sustainable business models as well, which bodes well for the future of the communication platform. For a reasonable snippet (but by no means the entire list) check out this TwitterVerse graphic from Jesse & Brian Solis:

The eye opener from the Dick Costolo interview, and their actions over the last few months with 'the new Twitter' clearly indicates the battle lines that Twitter seems to be setting for many of these 'ecosystem' participants.

The key to the puzzle is business model - Twitter believes that it has a very robust advertising business, in which a sponsored tweet, sponsored 'trending hashtag' and sponsored username will support a company with a $2Bn+ valuation. Given the investors and the intelligence of Dick, I'm sure they have made a very conscious decision on this front, and they probably do have a bright future in this business model.

Implications of the model are quite clear:

  1. 3rd Party Clients / Communication Management / Mobile Applications- Advertising will either need to be 'passed through' to 3rd party platforms, e.g. sending sponsored Tweets through the Twitter API, or Twitter will need to make a very strong effort to get people to experience Twitter on (or Twitter-developed mobile apps). While the former is really a good stop-gap solution, that they will probably be able to push through quickly because of their immense influence, the latter is easier for them to model, as they seemingly have unlimited resources at their disposal as well as access and significant influence over some excellent engagement models built by 3rd parties (think Tweetdeck, Seesmic, Hootsuite, etc.). Twitter has the ability to build/enhance the best features from these platforms in their new experience, if they so choose, enhancing their user engagement (and ultimately advertising impressions) as they do it. The question will be whether they choose to build or buy, as i'm sure they've considered both.
  2. URL Shorteners - I stand in awe of the brilliant execution of the small team at that built a powerhouse out a simple consumer-facing idea that solved a problem (giving us a few characters back in that limited 140), an immense backend capturing nearly every detail of the link and its history, and the insights that only come from aggregation. There are many companies that were built, based on the basic premise of collecting data, then selling intelligence on top - think Hoovers (company data), Bloomberg (bond data), Facebook (personal interests), Linkedin (personal resumes), etc. - has done it remarkably well, offering a 'relevancy-based' web search by topic that is just phenomenal. Unfortunately for and the other shorteners, Twitter has realized the power of this data and is actively pushing users to use their own tool. Once again, much like #1 above, Twitter seems interested in actively competing with their ecosystem players, instead of buying them.
  3. Trends and Analysis / Twitter Marketing Tools / Search - Lots of companies in this space, many with questionable business models. As Twitter becomes more aggressive on the ad side, these will be critical core competencies of Twitter. I'd be shocked if they do not build through acquisition here, simply because I do not see any independent companies in this space, and frankly, i'm not sure I see any other logical buyer here. If you need a guide to how this will all happen, take a look at Google's acquisitions around the Adwords/Adsense/Doubleclick ecosystem.
  4. Influence - I find it hard to believe that Twitter won't actively pursue an acquisition or build here, since Influence is a very critical measure on the platform - as an advertiser, I want to get impressions and in front of the right people, but I also care where the message comes from. Tracking which messages are being sent by whom will better granulate 'impressions' by quality, which allows for more focused campaigns.
  5. Relationship Management - Tools that are further away from the Twitter core, and frankly compliment it, will likely survive and be given the chance the flourish. Of course, larger relationship management tools, like and other CRM tools will add more and more Twitter connectivity, and may pick of some of the guys in this category.
  6. Message Origination - Tools that encourage more messages on twitter will continue to thrive, particularly places like Facebook, LinkedIn, Yelp, OpenTable, the geo services like Foursquare and Gowalla, and firms like StockTwits. Firms that encourage their users to push messages to Twitter help the Twitter equation, as they make Twitter's message platform more robust, and allow Twitter to generate revenues from advertising based on the content of those messages from within the (and Twitter mobile platforms). Obviously, not all companies in this broad category will survive for various reasons, but by and large, i'd expect Twitter to be comfortable with the existing arrangement...

2011 will be a massive year for the Twitterverse, and I do expect that many of these 6 categories will look dramatically different by year end...