September 22, 2006

ICE was Accomplice in Amaranth Blowup

posted by MR WAVETHEORY at 9/22/2006 09:20:00 AM
Rumors has it that Amaranth used ICE, an electronic commodities exchange, to cover its tracks and avoid regulations that would have helped avoid a blowup. You may recall that Amaranth amassed a huge natural gas position that led to its implosion. Well, it turns out there are regulations in the US that limit idiots from buying too many gas futures. To get around things, Amaranth went offshore. Trades on ICE, the InterContinentalExchange Inc, are not subject to CFTC regulations in US, but instead are regulated by the FSA in the UK.
It was the relative lack of oversight at the ICE that let Amaranth make the high-risk natural gas trades that ultimately turned sour, critics charge. Because of its heritage as an overseas exchange, the ICE is exempt from reporting trading data for over-the-counter trades to regulators at the Commodities Futures Trading Commission. Critics say the loophole permitted Amaranth to aggressively add to its high-risk bet that natural gas prices would rise at a future date
Looks like there may be trouble ahead for ICE. Its bad behavior might torpedo the NYBOT deal which is subject to regulatory approval. Sound like another Refco? Anyone? Bueller? Anyone?

Fidelity Screws Over Customers on DivX IPO

posted by MR WAVETHEORY at 9/22/2006 08:13:00 AM
I am hearing from several sources that Fidelity is not letting customers sell the DivX IPO shares which they were allocated. That means Fidelity retail customers who were allocated shares at $16 per share have been unable sell them. Instead, they are getting error messages on their online trading screens. I do not know Fidelity but this sounds pretty devious and an untransparent way of doing business, particularly since institutions have been furiously selling while retail investors have not been able to sell their shares. The DivX IPO has been trading down the entire morning since the opening price of $19.50, so Fidelity customers must be furious. DivX Inc is trading at $17.60 as of 11:10AM.

DivX Inc Opens at $19.50 UP +21%

posted by MR WAVETHEORY at 9/22/2006 07:33:00 AM
Looks like DivX Inc has a pretty decent open.

DivX Inc IPO Going Crazy

posted by MR WAVETHEORY at 9/22/2006 07:22:00 AM
The message seems to be this: Online video is hot. There is now a bid at $25. It's now $25-27. Given the dearth of tech IPOs recently, DivX Inc might also be attracting some daytraders.

To put things into perspective, at $25, DivX would be up 56.25% higher than its IPO price of $16. The company would be worth $835 million! YouTube, eat your heart out!
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DivX Inc Pre-Open at $21

posted by MR WAVETHEORY at 9/22/2006 06:30:00 AM
It looks like it will have a nice pop to around $21 at the open according to ARCA. Having an IPO is the dream of every entrepreneur and investor. The VCs behind DivX Inc must be happy and uncorking the champagne screw. DivX IPO press release.

Always remember, an IPO is a new beginning. To everyone who has put in so much hard work, congratulations DivX!

Update 10:10 am: An offer just showed up at $27 at ARCA. DivX Inc still hasn't opened.
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Company Admits Backdating Options of Dead CEO of Cable Vision Systems

posted by MR WAVETHEORY at 9/22/2006 05:54:00 AM
CableVision admitted that it backdated options for a deceased CEO.
Cablevision Systems Corp. awarded options to a vice chairman after his 1999 death but backdated them, making it appear the grant was awarded when he still was alive, according to a company filing and people familiar with the matter.
This is just bizarre and morbid. I wouldn't blame the CEO. After all, he's dead. I blame the idiots who forgot that the CEO was dead. Maybe they felt their fearless leader was running short on cash, and just needed an extra boost of wealth in the underworld.

Related: High Tech Executives Create Volatility In Their Stock to Enable Options BackDating

FaceBook is On Sale ! Was $1 Billion Now Just $800 Million. Yahoo! Bidding?

posted by MR WAVETHEORY at 9/22/2006 01:43:00 AM
Yahoo! Inc offered to buy FaceBook for $1 billion a month ago. But after several months of slow growth, Yahoo has retracted its bid and FaceBook is now worth "only" $800 million. If the price of FaceBook is so volatile, why not just wait until the end of the year? The trends are looking pretty awful for the site as traffic is going down. I did a comparison of the traffic of the second tier social networking sites (Friendster, Bebo, and FaceBook) and it shows that FaceBook's traffic is really slowing down while Bebo is growing the fastest, see What's the Hottest Place to Hangout: Facebook, Bebo, or Friendster and FaceBook is Worth $2 Billion?

Bill Allen says Yahoo! Inc would earn 3.5% on its money if it made a $1 billion offer. Now, I'm not a financial engineer, but last time I checked with my local bank, I can get 5% on a time deposit. Sue Decker, you may want to give them a call.

And Mark Zuckerberg, if you read this, my advice for you: If you can get anything in the 9 figures, take it and run to the bank. Do not walk. Do not stop. Run! And tell Sue that you'll only take cash.

September 21, 2006

DivX IPO Fees

posted by MR WAVETHEORY at 9/21/2006 11:26:00 PM
Bankers love IPOs because they get lots of fees. It looks like the DivX Inc IPO fees were 7% on this deal - pretty normal. The gross spread is $1.12 which means the underwriters are getting the stock at $14.88 per share ($16.00-$1.12). That means selling shareholders and the company only get $14.88. This may not be apparent to the average investor who thinks the company and the selling shareholders are getting the full $16. More details:

Offering Price: $16.00
Underwiters: JP Morgan, Bank of America Securities, Canaccord Adams
IPO Gross Spread: $1.12
Selling concession: 67.2 cents
Management Fee: 22.4 cents
Underwriting Fee: 22.4 cents
Reallowance: 10.0 cents
Deal Settlement: Wednesday September 27, 2006

For those who are unfamiliar, below is the definition of the gross spread from Wikipedia:
Gross spread refers to the fees that underwriters receive for arranging and underwriting an offering of debt or equity securities. The gross spread for an initial public offering (IPO) can be as high as 7%, while the gross spread on a debt offering can be as low as 0.05%.For example, if a company sells $100
million of shares in an IPO and the gross spread is 7%, the underwriting syndicate will receive fees of $7 million. These fees will be divided among the underwriters arranging the offering.

The standard contract is to divide the gross spread as follows: 20% management fee, 20% underwriting fee, and 60% selling concession. In the DivX deal, the underwriters made $10.192 million. The math is very simple.

$1.12 per share (X) 9.1 million = $10.192 million

Now you know how the IPO process works.

Zecco - Is "Free" a Business Model?

posted by MR WAVETHEORY at 9/21/2006 06:12:00 PM
The hot startups today all seem to have one thing in common today - they all have "FREE" as a business model. That is why when I read about Zecco.com, the free online stock trading site backed by the funder of Skype, my eyes rolled over. Have I heard this story before or what? Once and for all entrepreneurs, I would like to address the question that is on every Web 2.0 entrepreneur's mind: Is "FREE" a business model?The History of "FREE" as a Business Model
Going back about to the annals of venture capital, one of the more spectacular Internet businesses that I can remember offering "FREE" as a business model is NetZero, a free ISP. NetZero offered users free dial-up Internet access at a time when AOL was charging $19.99 a month for a 28.8 kbps connection which then became 56 kbps. NetZero was going to crush AOL by offering you free service and take away all of AOL's subscribers. In return for free access, NetZero would download a client onto your computer and serve ads. Watch advertising, get free access. Does that sound familiar to the "ad-supported" offers being hawked by Zecco today?

Fast forward roughly 5 years, and what has happened to NetZero? Check out the NetZero homepage and you barely hear a peep from them about free dial up. In fact, you have scroll all the way down to the bottom of the page to find the free Internet access offer. Instead of free Internet, NetZero is trying to hawk you dialup at $9.95 per month.

Can FREE Ad-Supported Services CoExist with NOT SO FREE services?
When two services, one free and another not so free, compete head to head, I would bet that the one which is not so free will win out in the end. The service that is free cannot afford to invest in a high quality user experience, because it is not generating revenue and income. The service that is charging users can afford to constantly upgrade, hire, and invest. Even free services like Skype are not so free - they charge for calls too.

What does FREE mean for Zecco?
I commend the investors and entrepreneurs behind Zecco to have the courage to launch a free online trading service. It certainly has gotten alot of press for a service that has yet to launch. However, the financial services business is rife with costs. Trading, unlike IP telephone calls ala Skype, is not free. There are clearing fees, exchange fees, quote fees. Everything around trading as service costs money. Furthermore, these are costs than cannot be controlled - they are externalities - costs which you cannot cut. That is not all.

Where the F*CK is my MONEY?
When it comes to handling financial information and money, customers demand accountability. If a trade is misprocessed or needs to be reversed, you can be sure the customer will be calling you non stop until the problem is resolved. Take a service like Paypal. It's not free. Guess what is the most frequently comment to customer service representatives when they call. You got it. It's the subtitle of this paragraph. Customer service fees can kill Zecco whether it wants to address it or not. If not, then litigation and regulation will kill it. Peace of mind is a big selling point for customers of Charles Schwab, E*Trade Financial Corp, and TD Ameritrade.

So, is "FREE" a Business Model?
As a venture capitalist, I think Zecco is an interesting concept. However, I don't think "FREE" is a business model. It is a great marketing pitch, but at some point, I expect Zecco to become a service you have to pay for one way or another.

Link: Frank Barnako' Zecco.com to offer free online stock trading
Blog: Morten Lund Talks About Zecco , More about Zecco

DivX IPO Prices at $16.

posted by MR WAVETHEORY at 9/21/2006 05:55:00 PM
According to Reuters, the DivX IPO has priced at $16 per share which is above the range of $12-14 per share. As I speculated previously, there would be euphoria on the deal, but for the average investor, it may trade so wildly out of range of true value that chasing it would be hazardous to your financial health. There are still issues about its business model.

I believe that much of the strong pricing has to do with online video sharing and YouTube. After all, it was no coincidence that an article was planted in the New York Post today saying YouTube was forth sale for $1.5 billion on the same that the IPO would be priced. Any financial professional who read that article would have bought any video related deal! For those you who are lucky to get an allocation, I expect this issue will trade strongly. However, price has nothing to do with value. If you get a good price, it may be a good time to sell at the open.

NEW YORK, Sept 21 (Reuters) - Media software maker DivX Inc. on Thursday raised $145.6 million with an initial public offering that priced above its forecast range, according to an underwriter.

The 9.1-million-share offering, which represents about a 27 percent stake in the company, sold for $16 per share compared with a $12 to $14 forecast.

Existing stockholders sold about 1.6 million shares while the company sold about 7.5 million shares, according to a filing with the U.S. Securities and Exchange Commission.

The offering price gives the company an initial market capitalization of about $535 million.

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How to Save Iraq - Borrowing an Idea from Venture Capital

posted by MR WAVETHEORY at 9/21/2006 05:23:00 PM
Recently, I wondered how venture capital concepts can be used to save Iraq. I struck upon an idea which I think works very well in growing venture backed companies. I think it will work for Iraq too. It is called giving Iraqis equity.

What is equity?

Equity is ownership. In venture backed companies, everyone from founders, managers, employees, and even administrative assistants get equity in the form of stock options. Options are like a kicker that can make you very rich. For instance, between the time of Google's first investment to today as a public company, Google stock has appreciated a over 10,000 times. Yes, that is 10,000! Not 1,000. Not 100. Not 10. But 10,000 times.

Why does equity motivate people to do the right thing in venture backed companies?

In venture backed companies, equity is not tradeable which means the owners of stock in a start cannot sell it, because there is no one who wants to buy it. There is only one way in which employees and founders and investors can sell it. That is when the company becomes public or a company is sold. So, everyone works in the best interest of the company. After all, an extra million or two would be nice in the bank account!

How can equity incentivize Iraqis?

Think about Iraq as a mini version of Google. There are lots of resources. In the case of Iraq, there is oil. Lots of it. In the case of Google, there was talent - smart people, and lots of it. Google gave equity to all its employees so everyone shares in the wealth.

Pop quiz: How do you give equity in a country?

It turns out, in the case of Iraq, there is a lot of wealth already. Give everyone a share of it. In fact, we were the first ones to figure it out in Alaska. Alaska, like Iraq, has lots and lots of oil. And what do Alaskans do with it? They give all that money from oil to themselves in the form of an annual check. Every Alaskan resident is eligible. Last year, everyone in Alaska got about $845.76. In 2000, it was even higher - $1963. Alaska has perfected equity ownership in the country. They even set a fund called the Permanent Fund.

The Iraqi Solution - Setup a Permanent Fund for Iraq

Distribute wealth to Iraqis and watch what happens. In 2005, average Iraqis took home $3,400 according to the World Fact Book. If they got an extra $800 in the mail every year for being good citizens, imagine what they will do to the oil pipelines. Blow them up? I don't think so. Given the fact that Iraq has alot more oil than Alaska, the check would probably be more than $800. It might even be a couple of thousand dollars. Now, that I am sure will make a difference.

So, next time you think about Iraq, think about it from the perspective of a VC or a true entrepreneur. Think about how to motivate people to do the right thing. Venture capitalists are notorious for having perfected it. Now, reuse the concept of equity ownership and use it to create wealth, not just for a few Googlers, but for an entire country!

Amaranth Update: Lost $6.5 Billion - Not $2 Billion

posted by MR WAVETHEORY at 9/21/2006 01:10:00 AM
Bloomberg now says Amaranth Advisors lost $6.5 billion in one week. It looks like my previous post underestimated the losses which until yesterday was estimated at $2 billion. This is turning into a very amazing story and will certainly deserve a mention in the Guinesss Book of World Records for most amount of money lost by a hedge fund. It certainly beats Long Term Capital.
Amaranth's main funds fell 65 percent, or more than $6 billion, this month through Sept. 19, founder Nicholas Maounis said in a letter to investors late yesterday. That leaves Greenwich, Connecticut-based Amaranth with less than $3.5 billion in assets.
Amaranth has few friends but they do have them. JP Morgan and Citadel are assuming Amaranth's positions. JP Morgan may be bailing it out more out of enlightened self interest. The rest of Amaranth will probably become a part of Citigroup.
Yesterday, Amaranth was pursuing the cash infusion it may need to stay in business. New York-based Citigroup was in negotiations that may give it control of Amaranth, according to the people familiar with the discussions. Should a
deal be reached, Amaranth would become part of the Citigroup division that oversees $42 billion in hedge-fund, private- equity and real estate assets, said the people, who asked not to be identified because the talks may still break down.

Amaranth's blowup will certainly cause investors to rethink hedge funds as an asset class and perhaps even consider investing more money into venture capital funds. As much as people hated the tech bubble, at least you didn't have billion dollar blowups at a single fund. It looks like this one blowup could be as much as the venture capital firms lost back in 2000. The losses are much smaller and the speed is also more prolonged. At least in venture capital, you don't have one fund blowing more than $1 billion - in a single week.

September 20, 2006

Is Yahoo! Inc Being Conservative or Is It Time To Sell Internet Stocks?

posted by MR WAVETHEORY at 9/20/2006 04:31:00 AM
The big question on every Internet investor's mind today is this: Is Yahoo! Inc being conservative with its guidance or is it time to sell internet stocks? Papers like the San Jose Mercury News reported that Yahoo's growth is slowing down. But that is hardly a surprise after last quarter's earnings miss. The Mercury news reports:

Yahoo's stock plunged more than 11 percent after Chief Executive Terry Semel and Chief Financial Officer Susan Decker told analysts at a New York investment conference that the Internet firm had started to see ad sales fall in economically sensitive areas like autos and financial services over the past few weeks.

``They are still growing, but they are not growing as quickly as we would have hoped at this time,'' Semel said.

Meanwhile, the FinancialTimes is predicting gloom and doom in Internet land.
Yahoo dealt a blow to the internet advertising sector on Tuesday as it warned that demand weakness from economically sensitive sectors such as automobiles and financial services would hold back its earnings in the latest quarter.
And Forbes is predicting the demise of portals and the rise of social networking.
Entire new categories of Web properties--social networks like News Corp.'s MySpace and video portals like YouTube, for instance--have emerged in recent years to attract the interest of advertisers.
Is this the end of Yahoo? I don't think so. Terry's recent downard guidance yesterday is awfully similar to what happened to Google's stock 2 quarters ago when George Reyes, CFO of Google, said at a financial conference that growth at Google will not be nearly as fast as it has historically been. In one day, Google lost about 20% of its value.

I don't think this comes as a surprise, but more of a delayed reaction from Internet investors who have finally come to accept that Internet stocks won't be growing as fast. After all, it's no secret that autos are not doing so well. Not a day goes by without news of a GM or Ford plant shutdown. Similarly, in financials, the housing market is cooling and therefore mortgage companies are spending less on advertising.


Should you be surprised? Not if you read the paper every day. Yahoo's warning is old news. Investors need to pay attention to upcoming news such as the launch of Panama - Yahoo's impending upgrade of its search system.

I suspect that Terry and Sue may have released the bomb so they can grant themselves cheap stock options. After all, if the stock falls to a lower strike, that just means their options are cheaper and they can make more money when the stock recovers. Read my article on how tech executives fatten their wallets by bring down their stocks - High Tech Executives Create Volatility In Their Stock to Enable Options BackDating. The incentives created by stock options are so very perverse!

So stop looking in the rear view mirror and start looking forward to the road ahead.

September 19, 2006

Amaranth Advisor Sent to the Gas Chamber - Hedge Fund Loses $2 Billion

posted by MR WAVETHEORY at 9/19/2006 05:36:00 PM
According to Barron's, Amaranth Advisors, a hedge fund, with $7.5 billion lost 35% of its value on a natural gas bet that went wrong. That's $2 Billion. By the way, an amaranth is a weed in case you were wondering.

Amaranth Advisors, a $7.5 billion hedge fund, in the genteel terminology of trading desks, Monday became the latest to blow up. Appropriately enough, the explosion came as the result of misplaced bets on the direction of natural gas prices.

The losses may exceed 35%, said a letter to shareholders from Amaranth founder and president Nicholas Maounis, according to wire-service reports. The stunning reversal came as gas prices plunged last week amid a growing surfeit of natural gas and crude oil at the end of the summer driving and air-conditioning seasons and the absence of hurricanes the likes of which sent prices soaring last year.

Here's what the WSJ had to say. It doesn't sound like he was doing any hedging.

Of all the traders gambling big sums on energy, a 32-year-old Canadian named Brian Hunter made some of the brashest bets and the fastest money.

Last week, he fell hard, proof of how quickly fortunes can reverse in gyrating commodities markets.

Here in this bustling new energy frontier, Mr. Hunter headed the energy desk for a Connecticut hedge fund called Amaranth Advisors. At the end of August, trading natural gas, he was up approximately $2 billion for the year. Then Mr. Hunter lost roughly $5 billion, in about a week.

Microsoft MSN Unveils YouTube Competitor

posted by MR WAVETHEORY at 9/19/2006 03:16:00 AM

Microsoft MSN is entering the video sharing game with SoapBox. Here's what Microsoft had to say:

The site, now in beta testing, will eventually be integrated with other properties in the Windows Live Network. Ultimately, users will be able to watch videos together through the messaging program--and with Windows Live Spaces, users will be able to tie their uploaded videos to their profiles and control who can see which videos, said Rob Bennett, MSN's general manager for entertainment and video. For now, the site is open only to a select few beta testers.

I like MSN's spirit and spunk - to be such a fast follower in this space. It really seems to have gotten its web strategy back together!

The SoapBox site looks pretty good. What is striking to me is that the service is based on Macromedia Flash rather than Windows Media Player. Could this be a sign that Microsoft is finally embracing technology that is not built in Redmond?

Opposing ViewPoints on YouTube

posted by MR WAVETHEORY at 9/19/2006 01:26:00 AM
In the greatest irony, Mark Cuban blogged YouTube will turn out like Napster - out of business - on the same day that YouTube CEO Chad Hurley strikes a deal with Warner Music to prove Cuban's wrong. Cuban's article is deftly entitled, "The Coming Dramatic Decline of YouTube" (via). Hurley's deal is based on sharing ad revenue with Warner. Whether Cuban is right or Hurley is right, it will be interesting to watch. I bet this will turn out to be an execution game. It will be hard for Hurley to keep trumpeting these mega-deals without delivering something of value. If the revenue share paid to Warner proves insignificant, YouTube will be out of luck, out of allies, and out of business.


September 17, 2006

Will The ShutterFly IPO Fly?

posted by MR WAVETHEORY at 9/17/2006 10:34:00 PM
ShutterFly, Inc.'s pending IPO proves that dot-com IPOs are back. ShutterFly enables consumers to upload, share, and print & print photos online. ShutterFly, Inc. is trying to sell 5.8 million shares at between $13-15 per share in an IPO worth roughly $73 million. With the excitement over photo sharing and the growing popularity of services like FlickR, I took alook at the ShutterFly prospectus to see for myself whether to snap up some shares on the IPO.

Market Opportunity

ShutterFly is going after a very broad market opportunity.
We are an Internet-based social expression and personal publishing service that enables consumers to share, print and preserve their memories by leveraging our technology, manufacturing, web-design and merchandising capabilities. Our vision is to make the world a better place by helping people share life’s joy. Our mission is to build an unrivaled service that enables deeper, more personal relationships between our customers and those who matter most in their lives. Today, with the evolution of digital cameras and technology, millions of people around the world are capturing their memories and communicating in more meaningful ways. We provide a wide range of products and services that allow consumers to upload, edit, enhance, organize, find, share, create, print and preserve their digital photos.
What I like about the photo sharing market is that it takes an existing business that used to be offline and transplants the entire industry online. The company's market is very large and that is why the company has shown some great numbers.
We have experienced rapid growth since launching our service in December 1999. Since inception, we have fulfilled more than 12 million orders, sold approximately 370 million prints and stored approximately one billion of our consumers’ photos in our image archives.
Business ModelBroadly speaking, ShutterFly is an online photo print business. ShutterFly believes that the market will grow from $424 million in 2005 to $1.9 billion in 2009. This implies a compounded annual growth rate of 45% per year! That is very impressive. But is this a good deal? ShutterFly cities a viral network effect as one of the keystones of its business. I think this is hogwash. People share photos, but the growth of ShutterFly is hardly exponential. I do concede that they have a very attractive customer demographic.
Based on our periodic customer surveys, we believe that our current customer base fits the following profile: approximately 84% female, approximately 63% in the 25-44 age range and approximately 53% with children. Our surveys also indicate that the average household income of our customers is greater than $75,000.
Females tend to do most of the shopping and 84% female is a great skew in demographic. It is also a slighly older crowd which means disposable income to spend.

Growth Has Been Consistent But Is Slowing


ShutterFly grew revenues from $31 million to $54 million to $84 million in 2003, 2004, and 2005 or roughly 74% between 2003 and 2004, and 55% between 2004 and 2005. Profits grew from $2.1 million to $3.9 million to $4.4 million in 2005 or 85% and 12% sequentially - indicating profits haven't been growing as fast as revenues. This implies declining margins. The slowing sequential growth rate is alarming, because it demonstrates that the market is maturing. Judging from ShutterFly's estimate of market size, it owns $84 million of a $424 million market (20%). It will probably be hard to grow at an able market rate.

ShutterFly may own such a big piece of the online printing market that it may have grown slower than the market. According to the S-1, the company grew revenues from $27.7 million in the first half of 2005 to $36.5 million in the first half of 2006. That is a growth rate of only 31%. When the market is estimated to grow at 45% and ShutterFly is growing at 31%, that is a cause for concern.

Growth Has Not Been Cheap

In order to achieve its revenue growth, ShutterFly has had to double sales and marketing spend every year from 2003 to 2005 from $3.9, $7.7, to $15.2 million. Part of the reason that growth has not been forthcoming in 2006 is that sales and marketing spend only increased by 58% from $5.1 million to $8.1 million. There is no doubt, that if marketing spend had doubled, then it would have lost even more money.

Capital Expenditure Plan Is a Concern

One particular item to note is that this business seems to require a lot of capital expenditure.
We expect to have ongoing capital expenditure requirements to support our growing website infrastructure and to meet production and manufacturing requirements. We expect capital expenditures to be between $30 million and $35 million in the second half of 2006 and through 2007.
Growth is great, but $35 million is not a small number considering that it generated $36 million in revenues in the first six months of 2006. It does bring into question the scaleability of the ShutterFly model. After all, the best type of business to invest in is one that costs less to run after adding additional customers - not more! ShutterFly doesn't seem to have economies of scale.

Business is Highly Seasonal

The biggest concern with ShutterFly is that it is a highly seasonal business. Q4 is the make or break quarter.
We generated approximately 49% of our net revenues for 2005 in the fourth quarter of 2005, and the net income that we generated during the fourth quarter of 2005 was necessary for us to achieve profitability on an annual basis for 2005. In addition, we incur significant additional expenses in the period leading up to the fourth quarter holiday season in anticipation of higher sales volume in that period, including expenses related to the hiring and training of temporary workers to meet our seasonal needs, additional inventory and equipment purchases and increased advertising. If we are unable to accurately forecast and respond to consumer demand for our products during the fourth quarter, our reputation and brand will suffer and the market price of our common stock would likely decline.
It also means that it must hire lots of temporary workers.
A majority of our workforce during the fourth quarter of 2005 was seasonal personnel hired on a temporary basis. We have had difficulties in the past with finding a sufficient number of qualified seasonal employees.
Don't Forget There is Pricing Pressure

If there is one reason not to invest, it is that this business is undergoing significant pricing pressures. Its biggest competitor cut prices by over 50% recently!
In the second quarter of 2005, certain of our competitors reduced the list prices of their 4×6 prints from $0.29 to $0.12. In response, we lowered the list price of our 4×6 prints to $0.19 in order to remain competitive. A drop in our 4×6 prices without a corresponding increase in volume would negatively impact our net revenues. Our larger competitors could elect to further reduce the list prices of their 4×6 prints or use lower pricing of prints as a loss leader. If this were to occur, we might not be able to
remain competitive on pricing for 4×6 prints, which could result in a loss of customers.
ShutterFly's biggest competitors are Kodak (Ofoto) and SnapFish (HP) so the game of lowering prices could go on for a long time. A quick check shows that ShutterFly has recently lowered the 4x6 to as low as 12 cents!

It's a Shipping Company - Not a Photo Printing Business!?

As if pricing pressure were not enough, a quarter of ShutterFly's revenue come from shipping.
We generate a significant portion of our net revenues from the fees we collect from shipping our products. For example, these fees represented approximately 19% of our net revenues in 2005 and approximately 22% of our net revenues in the first six months of 2006.
Valuation

ShutterFly will have 23.6 million shares outstanding after the offering. At a price of $13-15 per share, the market cap will be $306 to $354 million or roughly 3.6x to 4.2x sales in 2005. I won't speculate on revenues in 2006 or even the earnings. The company earned $28.4 million in 2005 (but that included a $24 million benefit for tax provision). Assuming $4.4 million of normalized earnings in 2005 (backing out the $24 million), the trailing P/E is 69 - 80 times trailing. Very expensive!

Conclusion

Given the pricing dynamics and commoditization of this market, the huge seasonality, the slowing growth of the business, and the lack of profitability, ShutterFly is vertically challenged. I am sorry to say that the ShutterFly IPO will not fly.

Update Link: ShutterFly RoadShow Presentation

High Tech Executives Create Volatility In Their Stock to Enable Options BackDating - Elan Corp, Microsoft, Sandisk Corp, Apple Computer Inc

posted by MR WAVETHEORY at 9/17/2006 09:28:00 PM
ISS, the Institutional Investors Service, has put together a wonderful overview of the options backdating scandal. What I find very egregious is the way some of the companies have exploited investors - particularly technology companies - by fattening the wallets of executives at the expensive of individual investors. I will discuss
  • what is options back dating, providing examples of high tech companies that back date options.
  • how options back dating may be the reason why high tech stocks are so volatile
  • why high tech executives purposely create volatility in their stock so that they can backdate their options.
What is Options Back Dating?

An option is the right to buy a stock at a given price. As ISS explains,
Almost all U.S. companies grant options to their top executives “at the money,” i.e., by setting the options' exercise price (purchase price) equal to the stock price on the grant date. That exercise price often is set at the closing share price on the grant date, or at the average of that day’s high and low. Under Section 162(m) of the Internal Revenue Code, at-the-money options are generally considered performance-based compensation that is deductible from corporate tax returns, even if an executive earns more than $1 million a year.
Options back-dating is the process of choosing a favorable date to grant options to executives, oftentimes when the trading price of a company's stock is at its lowest price. As a result, executives get to buy their stock at a low price. The most egregious form of executive greed is spring loading.
A company can also “spring-load” a grant by setting the exercise price right before
the release of news that would cause the company’s shares to rise, or right after the announcement of news that led to a share decline.
Take the example of Elan Corporation, a drug maker, who egregiously practiced spring loading. Elan Corp had a drug candidate called Tysabri which was supposed to be a blockbuster. On February 8th, Elan Corp released earnings and CFO Shane Cook declared triumphantly that Tysabri was going to be a hit,
While it is early days, the initial take-up since launch of Tysabri is exceeding all our expectations and we remain optimistic that we will return to profitability by the end of 2006.
Unfortunately for shareholders, Cook, true to his name, was cooking the books, because less than three weeks later, the company announced that it would be s
uspending trials of Tysabri due to deaths due to 2 severe adverse events that happened in clinical trials. Tell me that they didn't know about the 2 severe adverse events just three weeks earlier! Elan stock cratered from $26.90 to $3 - but not before executives had unloaded several million shares at prices above $20 per share in the three weeks between the earnings announcement and the suspension of Tysabri.
Elan is just one example of spring loading. Take for instance the example of Microsoft which is leading blue chip technology stock. Microsoft consistently practiced options backdating for 7 years according to ISS.
Microsoft awarded stock grants to employees at monthly lows from 1992 to 1999. A spokesman for the software giant said the practice was legal and did not constitute backdating because the grant prices were set at the lowest price in the 30 days after the grants. Also on June 16, Home Depot disclosed three instances before December 2000 where executives received stock options with exercise prices that were below the market price on the day they were approved.
How can this be legal? How could it have gone on for so long? Let's cut to the chase: Springloading is insider trading.

How Options Back Dating May Be the Reason High Tech Stocks Are Volatile?

Every investor knows that high tech stocks are very volatile. It is not unusual to see stocks like Apple Computer Inc, Google, SanDisk Corp can go up or down 20-30-40% during a period of several months and end up at the same place they were at, at the end of the year. Individual investors who buy high tech stocks at their high and sell their stocks at the low lose lots of money due to volatility.


Many people believe high tech stocks are volatile because technology is hard to understand or predict. I disagree. They are volatility because executives want cheap options. Executives of high tech companies are incentivized to create volatility in their stock prices so that they can take advantage of options back dating. The process is simple. Release bad news, make the stock go down, grant yourself options. Release good news, make the stock go up, exercise your options. Think about it. This is free money. If you were awarding yourself options, why not create volatility? If Microsoft stock stayed at the same price all the time, then how would a Microsoft executive make money?

When executives know they can get away with spring loading and backdating, investors lose money and suffer from inefficient markets.

Why does volatility benefit executives? Why do investors lose?

Volatility benefits executives by allowing executives to grant themselves cheap options. It's that simple. When a stock is mispriced due to misinformation in the markets, high tech executives are implicitly stealing from shareholders who paid a fair price for their stock. They are granting themselves stock at a discount to fair value. In any rational sense of the word, this is theft. The list of high tech companies that are back dating offenders is very long. Calpers sent letters to some of the best known companies in Silicon Valley regarding backdating.
Affiliated Computer Services Inc, Altera Corp, American Tower Corporation, Analog Devices Inc, Brooks Automation Inc, Caremark Rx Inc, Comverse Technology, F5 Networks Inc, Jabil Circuit, KLA-Tencor Corp, Maxim Integrated Products, McAfee Inc, Meade Instruments Corp, Medarex Inc, Openwave Systems, Power Integrations Inc, RSA Security, SafeNet Inc, Semtech Corporation, Sepracor Inc, Sycamore Networks (Nasdaq SCMR), Trident Microsystems (Nasdaq TRID), UnitedHealth Group Inc, and Vitesse Semiconductor (Nasdaq VTSS).
The Cure
When all is said and done, options do not align the interests of managers with shareholders.
Options incentivize managers to create extreme deviations between price and value of a company's stock, so that managers can benefit from a stock's recovery to fair value. In order to cure this problem, a solution must be implemented that makes options backdating and spring loading crimes with steep penalties. I propose the following 3 steps to be taken retroactively on perpetrators of backdating and spring loading.

1) Fine CEOs and board members of companies who approve back-dated stock options grants. The source of the problem of backdating is oftentimes the lack of board control over the compensation process or board members and executives turning a blind eye on the process. Nailing the source will cure the problem. While recent improvements in financial securities law like Sarbanes Oxley have placed stricter guidelines around public reporting companies, Sarbanes Oxley only requires CEOs and CFOs to sign off on the the accuracy of their financial reports and financial controls, not the integrity of their compensation programs. A law similar to Sarbanes Oxley should be created to create standards around companies that are granting executive stock options.

2) Fine the grant recipients treble (3x) the value of the options granteed. Make recipients disgorge not only the options granted but 3X the value of the grant. This will reinforce a corporate ethic that alerts executives to the fact that employees work for shareholders and not the other way around. They serve at the pleasure of shareholders.

3) Set strict federal sentencing guidelines around options backdating. When the laws are clearly set, there is no way to dispute that someone is breaking the law. When insiders act on their on behalf to benefit themselves using material non public information, it is insider trading. Backdating is insider trading.

Conclusion
Shareholders and investor have a duty to protect their rights. When simple insider trading laws are not strictly enforced by organizations like the SEC, the government has failed to protect shareholders and investors who lose their hard earned money. We are in an era where the value of information has increased so significantly that backdating and spring loading must be eradicated.

Sunday Reading from IBD: Gen Y Workers, ICE, and Multimedia E-mail

posted by MR WAVETHEORY at 9/17/2006 03:29:00 AM
I've been flipping through the IBD this weekend and noticed some interesting articles.

1) ICE, previously backed by TA Associates, is acquiring NYBOT, the New York Board of Trade, for $1 billion. I think it's a great deal and really expands the scope of the ICE business which today is so petro focused that the diversification which NYBOT brings makes a lot of sense.

2) Managing Generation Y Worker talks about how 20 somethings want a independent flexible work environment and are contributing greatly to many professional firms and taking on responsibility very quickly and faster than the boomer generation.

3) Multimedia E-mail. I think actually think this article is somewhat inappropriate. It talks about Fun Web Products, owned by IAC InterActive, and HotBar as e-mail special effects companies that add cool pictures and images to your emails. Wrong. Ever wonder why you get popups after you install their software? Answer: Fun Web Products and HotBar are spyware vendors!