Sarah Lacy Takes Tom Friedman to Task - No Gov't Money for VCs - I hope someone in Israel is Listening

Anyone in the Israeli Ministry of the Treasury and on incoming Prime Minister Netanyahu's staff should read Sarah Lacy's fantastic post on why the US government should not step in and give money to Silicon Valley VCs. 

Lacy takes Friedman to task for suggesting billions go to fund cash starved VCs so they can invest in the new wave of innovation while applauding him for suggesting that the auto industry bailout is a bad idea. We have a similar and related problem in our country with the Office of the Chief Scientist. For years the Chief Scientist has funded job preservation at money-bleeding companies like Tower Semiconductor, wasting wads of taxpayer shekels on uncompetitive industries.  We do not need floods of government money coming into Israeli VC funds today, much like we do not need government to prop up marginal innovation at large companies who do not want to fund it with their own cash.  

The Government should be funding innovation strategically. It should invest in research. It should invest in post-docs staying in Israel. It should invest in infrastructure that lets entrepreneurs and Universities test that research, like real broadband and solar energy farms and desalination. I made some of these comments in a Globes (Hebrew) interview I gave with Boaz Dinte and Eyal Kishon last week.

**Update: I just saw my partner Bill Gurley did a great roundup of responses to Tom Freidman and post on the topic as well.

Here are two money paragraphs from Sarah's post but do yourself a favor and read the entire post. It is very well-argued. 

"Before we get into the economics of his argument, let’s start with the facts. Friedman writes, “Call up the top 20 venture capital firms in America, which are short of cash today because their partners — university endowments and pension funds — are tapped out, and make them this offer: The U.S. Treasury will give you each up to $1 billion to fund the best venture capital ideas that have come your way.” Um, venture capital firms are not short on cash. Far from it. The precise problem with the venture industry is too much cash in fact, especially given increasingly paltry returns.

Most shocking to me, Friedman invoked one of the most repeated Valley mantras to prove his point when he wrote, “Some of our best companies, such as Intel, were started in recessions, when necessity makes innovators even more inventive and risk-takers even more daring.” Mr. Friedman: Read the second half of your own sentence again. The reason recession-born companies are so inventive and daring is because founders are forced to work within constraints, precisely because it is harder to raise capital. Nothing kills a great idea like too much cash. Unless it’s a flood of too much taxpayer cash, because then we all lose."

Marc Andreesen Must Have Been Reading My Blog Posts on Banks :)

Marc argues for brand new banks ("Software can be a bank"). In my terminology and previous blog post, I do not think we need banks at all but the point is the same. See about minute 50 in the video interview with Charlie Rose Below.

Bad Banks? Why Do We need Banks at All?

I was reading Andy Kessler's excellent piece suggesting a different route for bank bailouts. Kessler's key point is this.

"What we need are healthy banks with clean balance sheets and enlightened risk assessment to provide consumer and business loans that will generate returns to shareholders. And to this end, Mr. Geithner wants to create a public-private partnership to buy toxic securities off bank balance sheets. This is a truly worthy goal, but I don't think his plan for doing so will work. Banks are more than able to sell these toxic loans today. They just don't like the price...

Mr. Geithner should instead use his "stress test" and nationalize the dead banks via the FDIC -- but only for a day or so. First, strip out all the toxic assets and put them into a holding tank inside the Treasury. Then inject $300 billion in fresh equity for both Citi and Bank of America. Create 10 billion new shares of each of the companies to replace the old ones. The book value of each share could be $30. Very quickly, a new board of directors should be created and a new management team hired. Here's the tricky part: Who owns the shares? Politics will kill a nationalized bank. So spin them out immediately."

I agree with Andy but I think the current banking crisis begs a salient question: Why is banking immune from creative destruction or, more pointedly, why do we need banks at all? If it sounds crazy, a world without banks, it is not.

We have become so used to storing money in banks and talking to our banks that we have forgotten what they do. Simply put, banks borrow money from YOU, and lend it out to borrowers at a higher rate than they pay you in interest. That is it: Banks are lenders. They provide credit.  Everything else is window dressing.

Don't believe me? This is the Wikipedia definition .

"A banker or bank is a financial institution whose primary activity is to act as a payment agent for customers and to borrow and lend money. It is an institution for receiving, keeping, and lending money.^[1]"

You think banks provide safety? Wrong. That is the government and FDIC. Buying stocks, bonds or currencies? Just an added service.  So why do you go to a bank? Because your brain has been trained to believe that you can trust them. Their brand means safety to you. You assume that their risk management is better than yours and therefore will protect your money and enhance its value.

Now, what if that assumption is wrong? What if we cannot trust banks to protect and enhance our assets? We would be left with one function for banks: lending money or providing credit. If we could replace that credit function or if we believed that our own risk management was better than the bank's then we could do without Banks (someone else will give you a free mousepad). Technology and the internet is going to provide that.

Sound farfetched? It is not. In fact, the financial world has been evolving in this direction for a while. We just chose not to pay attention. 

Today, you can open an eTrade account and do all your brokerage online for less cost than going through a bank. You can transfer money using Paypal. You can trade currencies through endless online options from EasyForex and SaxoBank for experts to eToro for novices. Think you need advice on investments or consumption patterns and fees? Forget your banker and try Seeking Alpha or Mint.com (full disclosure: Benchmark companies).

Which brings us back to lending. There are numerous efforts around P2P lending from Zopa to Prosper (Benchmark company). There are other nascent efforts around commercial lending (which anyway the banks are not doing now). Essentially, startups can use the web to provide risk management tools and investment opportunities that disintermediate banks and thereby make credit available to borrowers.  One of the things that got banks in trouble with mortgages was that they were divorced from their borrowers. The FDIC has a long procedure around Know Your Customer regulations but banks do not really know them or their customers' creditworthiness.  They were buying sliced and diced mortgage paper at a distance (it is why some community banks are in better shape since they really knew their customers).

Think ahead: You can imagine a world where there are local social community lending tools that enable person to person or company to company lending where you can really know the borrower. Banks use technology for risk management and asset allocation. Why can't we put those tools in consumer's or business' hands? Are banks really experts? Are they bigger experts than crowd-sourced wisdom on creditworthiness or risk management?

Here is the kicker: one of the other roles banks play is they intermediate between the government (Treasury) and consumers and businesses to keep liquidity flowing in a risk-managed way. In the age of the internet, why can't consumers buy currencies directly from governments/central bank or currency trading platforms (answer: they already can) and access that liquidity directly? Businesses could as well.  It is just a technology question. Like always in creative destruction, it will happen from the bottom. clunky tools like P2P lending will grow up and become full-fledged lending platforms with appropriate risk management that might disintermediate obsolete banks entirely. If you go back to Andy Kessler's piece, the banks have simply become a filter that robs consumers of 90% of their money. That is a recipe for creative destruction of Banks. Not A bank but Banks in general. Andy's suggestion:

"Each taxpayer would get about $100 worth of stock for each $1,000 of taxes paid. Of course, each taxpayer has the ability to sell these shares on the open market, maybe at $40, maybe $20, maybe $80."

Why give $1000 of hard earned savings to the government that routes it back to banks so you can get shares at a lower value? Maybe banks should be obsoleted and disintermediated. This is not a perscription for a "Bad bank" but a suggestion that maybe all banks are or will be bad in this day and age of direct online trading, online risk management tools, P2P lending and government-provided liquidity.

Twitter Overload! Twitter Overload

What the heck is this? Tried to tweet just now and got this error!

3+ Conclusions From the Israeli Election Roundup

1. The Right and Netanyahu clearly won this election

Even though the Likud will finish in a tie or one Knesset seat behind Kadima, the Right has won a clear majority. The radical left represented by Meretz and parts of the Labor party was decimated. The hard core Right gained strength. Netanyahu can form a right wing government or, if he can convince Livni to subjugate her ego, he can form a broad government with Kadima, Yisrael Beteinu, Shas and Bayit Yehudi. I think it is also not-unlikely that Ehud Barak, at age 67 and facing a revolt from within his Labor party, could peel off and join Netanyahu in a government as Minister of Defense. He may bring a couple of others with him.  I think  it is also useful to point out that had there been direct election of the Prime Minister, Netanyahu would have won by a safe margin. In my opinion, he was clearly the most worthy candidate.

2. The election system is completely broken. Completely!

This sounds like a broken record but the horse trading Netanyahu will likely go through to form this government will exact a huge price and likely lead us back to elections soon. This is very unfortuante. One advantage to forming a broad government with Kadima and Yisrael Beteinu is it might give us a chance for the electoral reforms we so desperately need. An even more historical move would be to set aside Right/Left peace issues since they are irrelevant now and build a Likud/Kadima/Labor government that will guarantee four years in government and let Israel build itself. Netanyahu will need a broad coalition to tackle the huge issues facing the country including Iran, Hamas, The economic meltdown and the new Obama administration.

3. The electorate is still disillusioned

Despite the joyous reaction over "high" voter turnout, we should recall that it was "high" compared to the last election and not by historical standards. Beyond that, Livni managed to drag out a lot of voters who were panicked that Lieberman and Yisrael Beteinu were gathering strength.  There is no clear leader to rally behind in Israel. The electorate is not excited and is searching for leadership and a clear platform. 

A few mini items:

This election saw a few important firsts:

1. 31 NEW Knesset members. This is very welcome. For too long, politics has been a career in this country from student unions to the Knesset. Politics should be public service and people should go in, serve the people and get out after 4-10 years. The 31 new Knesset members are a breath of fresh air.

2. The internet was the most important media battleground in this election. The left wing media is generally harsh on Netanyahu and he skirted it by using the internet and email effectively. However, the internet did not reach the level of influence that it did in the US Presidential election.

3. I cannot figure out how the Haredi parties stay around 5-6 seats despite the fact that their percentage in the general population keeps rising.

4. The Bayit Hayehudi/Ichud leumi split did not finish off both parties, although they both limped into the knesset instead of riding in as a big unified party.

Israeli Leaderships Lack of Perspective - The Need for A Liberal Arts Education

Ariel Beery of Presentense Institute penned a great op/ed in Friday's English Version of Haaretz Newspaper. I wish it had been in Hebrew as well. It rang so true because so often Israelis ask me what I studied in university and when I respond that I studied political science in often elicits the response "what does that have to do with venture capital or technology?"  For the answer, read Ariel's piece in it's entirety.

I spoke this summer at a Presentense institute event and the fellows there are pursuing some really interesting social engineering projects. It is amazing what happens when you put smart, social minded entrepreneurs together. Read the entire piece but here is the money quote from Ariel's article:

"This leadership void poses a systemic challenge, which has weakened Israel in past decades and will worsen as time passes and faith in the political establishment diminishes. As the Israel Democracy Institute's 2008 Democracy Index found, trust in our elected Knesset representatives dropped to 29 percent - whereas 71 percent of the public trust our unelected army generals. To reverse this trend and to grow a crop of new leaders, Israel will have to go beyond the Israel Defense Forces' officers training course, to locate individuals able to lead in a world of grassroots movements and fast-moving companies, where creativity and entrepreneurial drive are valued more than obeying orders and strict hierarchies.Under the circumstances, it might be useful to examine one key reason why the U.S. is able to produce social and political leaders who can handle the complex requirements of public life: a liberal arts education. 

Israel's university system is based on the German model, developed to meet the needs of an industrial economy. To fulfill this system's requirements for specialized labor, students choose their discipline early, and stick to it during their studies. A student studying law, for example, is trained solely as a lawyer - and will not be exposed to, say, computer science or theology. Students are chosen entirely on the basis of their grades and test scores, regardless of extracurricular activities. 

The American system follows a different ideal - and evolved in a dissimilar manner. American students generally apply to colleges rather than particular faculties, and are judged by several standards - grades being only one criterion in the admissions process. Students then have up to two years to decide on their "major." Only then do they specialize in a field. 

This system has proven especially adept at preparing individuals for the information age, which demands creativity and nonlinear problem-solving skills, so they can develop new ideas and open up new possibilities. Contrary to Israeli start-ups, which are the product of enormous specialized expertise, American businesses are often of a more robust nature, because the people behind them have a more diverse set of skills, due to their educational backgrounds. "

The Israeli Baby Googles

Looking for a way to play Google's decent results, look at the public Israeli internet companies whose business models are driven by Google. Looking for a way to play it safe, look at these same companies that are trading at cash or close to cash.

Incredimail (MAIL), Answers.com (ANSW) and Babylon (traded on TASE BBYL) have significnat amounts of revenue driven by Google's adsense or toolbars. In addition, these companies are trading at pretty low multiples and in at least one case is sitting on plenty of cash relative to Market cap. These are all thinly traded stocks so it is tough to build a position but I think they can all be interesting.

Incredimail (MAIL)

Incredimail has traditionally been a provider of email clients.  The company monetized this in two ways, graphic packages and paid search. The company was put on ice by Google earlier in the year due to purported abuse. I believe that the time in the penalty box is keeping the MAIL's stock down. The stock is trading at slightly above cash today and is pretty illiquid.  The company has cash of over $21,000,000, TTM revenue of $21,000,000 and a market cap of approximately $25,000,000. 

Another item that has seemingly weighed on the stock was the shakeup in the management team earlier in 2008. Yaron Adler left the company and his cousin Ofer Adler, the company's founder, is now running the company.  As far as I can tell, Ofer has decided to invest in growth of the top line at the expense of profitability and has succeeded in doing that.   I believe that the investment phase is behind MAIL at this point and the company will reap profits form it 2008 investments beginning in 2009.  Their search volume is growing as they have rolled out Google search to more users as users upgrade the mail front end. 

In addition, the company has launched two new products. One is an IM add-on and the other a desktop photo manager. Each of these a profitable small niches to monetize Google search. Another Israeli company I know is running quite the profitable business with smiley on steroids products for MSN messenger.

Answers.com (ANSW)(Full Disclosure: I was on the board of Answers.com when the company went public but have been off for years)

Answers.com is growing incredibly fast. According to this Seeking Alpha article, it has grown 58% in the last year, which puts it in the top 20 growth sites. Its WikiAnswers site is gaining momentum.

Answers.com's stock (ANSW) has appreciated over 300% in the last 7 months and ANSW is now valued at around $90MM.  Answers.com has been at this for a while and seems to have finally hit its stride.  The Company does a little above $3M in quarterly revenue so it is now trading at roughly 7 times revenue. Based on my knowledge of salaries in Israel (where the Comany is headquartered) and factoring in the site's rapid growth, with a slight increase in revenues from where it is at, the company probably broke even or was profitable in Q4 (not yet announced).Answers.com has about $1.20 per share in cash on the balance sheet. So the price/revenues is a about 7 (net of cash).

Babylon (TASE BBYL)

For years, Babylon has been selling its world leading translation software. It has been a pay for product business. That business remains and continues to grow. However, since Noam Lanir of Empire Online (online gaming) bought a controlling interest in the company, he has worked hard on conversion to sale and added a Conduit-powered toolbar (full disclosure: Benchmark is invested in Conduit) to his products. Therefore, Babylon has also began making money from Google searches via the toolbar and the Babylon products. As far as I can tell, Lanir and the CEO he appointed are focused on generating more revenues from Babylon's business by increasing conversion and adding revenue generating product lines.

Babylon's stock currently trades on the Tel Aviv Stock Exchange at 4 shekels ($1) per share, reflecting a Market Cap of 165,000,000 Shekels ($40 million).  Babylon did a little shy of 17MM Shekels in revenue in Q3, reflecting about 50% growth from the same quarter in 2007. Babylon had net profits of 3.6MM Shekels in Q3 (approximately $900,000) and has cash and cash equivalents of approximately 40,000,000 Shekels. In addition, it has approximately 13 million shekels in accounts receivable. (full financials in Hebrew can be found here). 

The stock price reflects an enterprise value around 120,000,000 Shekels for a company growing 50% per year and earning 3.6MM shekels per quarter. The P/E is about 8.

In addition to the attractiveness of investing in companies at or near cash, these small cap companies represent three different ways to play the Google ad platform:

Full disclosure: I am long MAIL and Babylon and wish I had been long ANSW 7 months ago.

New additions to the blog

I added a link on the upper right hand corner to follow me on Twitter. And I updated the new button to get the Sixkidsandafulltimejob toolbar from Conduit.

I am certainly no old pro at HTML and each of these changes is painstaking for me. urgh.

Netanyahu's Daily Message from the Mount of Olives - The Election is About Jerusalem

As people get ready to vote in the upcoming Israeli election, the following video (in Hebrew) from Netanyahu's website is worth watching.

Are In-Text Ads a Good Idea? Peet's Coffee In Gaza

I have often wondered about the efficacy of in-text ads. Although Vibrant Media and Israel's Kontera seem to be growing nicely, i have seen a few in text links that made my hair stand on end. The below screen shots from Today's Jerusalem Post speak for themselves. 

I clicked on food coupons in the second line of the article on Gaza and got to a landing page for Peet's Coffee. Now I love Peet's teas (especially Pride of the Port) but somehow I think Gaza is a little out of context for upscale teas and coffees. (update: I managed to upload 3 screenshot)