Seth Goldstein

Today, Saturday May 22 2004, Howard Hintze, an important teacher of mine from high school, is retiring from teaching English at Interlochen Arts Academy.

The following is the note I wrote earlier for a book of recollections to be presented to him at graduation. It addresses the notion of learning in an age of the Internet that I thought would be appropriate to share in this context.

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I met Howard Hintze at the beginning of my first and only year at Interlochen, in September 1987.

I was 17 from Newton, Massachusetts and decided to come to Interlochen to study theatre for my senior year. I brought a lot of academic baggage as my public high school was a suburban feeder to the ivies. As intense as the theatre program promised to be, the academics were going to be easy for me.

In the classroom Mr Hintze was always energetic. He sat, perched upon his desk hungry for our hunger to devour the classics. Despite his passion when introducing us to Shakespeare, Sophocles, often for the first time, he could not hide a certain pathos. I always felt like we were letting him down, that we would never achieve the kind of perfect intellectual clarity that he valued.

I remember the thrill of seeing him outside of campus, when he invited me to share dinner with him at his home, I think on duck lake in grawn. Everything was perfect. The food was simple, the books were organized clearly on the shelves, the climate was cool (he told me how he liked to sleep in the cold which I follow as a practice to this day).

I took his classes on Shakespeare, Man & Destiny, and probably a few others. I remember the curriculum for each, typed in clear times roman. Numbers and letters, his own decimal system. We tackled books with a head start. He would coach us into the subject. When we got to Macbeth we really tried to break into the witches and the symbolism. The hor-ror. His sheen of disappointment could not alway contain his bounding joy in the face of great literature. It was as if he lept into the middle of the circle exposing himself in the midst of students who were gifted artistically, and therefore sensitive to art and culture, but who also mainly lacked scientific discipline and therefore couldn’t analyze the classics.

I wish I could have given him more as a student. For my final paper in Man & Destiny, I wrote of a spiralling suicide leap off of a fiery inside balcony, which flashed memories of my life that sped up as I got closer to the ground. I wanted to give Mr Hintze the systematic approach to self analysis that he challenged us to provide. I think I succeeded. I am not sure what I wrote (Mr Hintze, if you still have a copy please send to me) or even what he said, but I felt that I finally did the work.

At the end of my senior year, I was directing a Pirandello play for one main actress and two men called the Vise. It was an tense drama in which a wife becomes ensnared by her husband into admitting an affair. Just as we were about to perform, the lead actress had become so frail and thin (Eating disorder? Depression? Genetics?) that her mother came to school to take her home. I knew I needed to cancel the show. Mr Hintze begged me to at least stage a reading. He felt we had put in so much work that we at least needed to share certain decisions with him and an audience. I decided not to. This was the first indicent where we did not agree. It was telling, as I felt like I was growing up. I took responsibility as an author.

A few years ago I had my 10th reunion. This was right around the time that my wife had given birth to our first son Jacob.

By then I knew that he was sitting at computers at school after hours. He was always angry at their practicality. Grudgingly, he accepted that they were useful, but he granted them no mystical powers.

I on the other hand had begun to distinguish myself based on my creative uses of technology. I stopped reading books and started making web sites. Instead of Rilke or Beckett, I was interested in banners and venture capital. I think he found it humorous when I tried to describe what I was doing. For me, it is part of the whole intellectual exploration. But to Mr Hintze it was both incredibly interesting and horribly lax.

And so I decided that my gift on my 10th reunion to Mr Hintze was going to be a computer. I found the closest Circuit City and bought an all in one PC and delivered it to his car in the school parking lot. He really was speechless, almost gasping for air. He looked at me like I was some sort of Faustian devil, tempting him to bring technology into his perfectly analog home.

I never got an email from him although I did receive a nicely handwritten thank you still trying to figure out what he was going to do with a computer in his house.

In my day to day world in New York City, I help professional investors make sense of the internet. That basic search engine that we all use all the time, Google, is worth close to $20 billion dollars. To a certain extend, it puts a teacher capable of answering any question directly on your desktop at all times.

The idea that Mr Hintze is retiring is pretty hard for me to take. The pursuit of perfection in learning is idealistic, inconvenient, inefficient– quixotic; these are some of the only values that we put up with for the things that we love.

So how can you understand what Mr Hintze was like as a teacher?

Imagine a Google search that doesn’t return any results quickly, but just asks more questions.

Imagine a presence that forces you to justify exactly what you mean in excruciating detail until you are so frustrated that you want to knock over a desk and rip down the Stratford on Avon posters from the 70’s.

Imagine a teacher that cares so much about the English language and about world historical literature that you cannot ever become satisfied that you have learned enough.

This is Mr Hintze in the classroom. He trained my mind to always ask for more than I was getting. He will be missed by all of us, and it will be upon all of us to demand more searching than any new technology can ever hope to resolve.

- Seth Goldstein. May 22, 2004. IAA 1987-1988.

Google Circa 1998:

“The whole thing. Now which keyboard do I use?”

Tonight Majestic is hosting a dinner for its investor clients and select industry executives focused on Paid Search. John Battelle will kick the evening off. In preparing for this dinner I have had the opportunity to think back a bit over the past 10 years (!) since I first became involved with Internet marketing.

With the imminent public offering of Google, many investors see search engine marketing as the next great frontier for the Internet. The fact is that as early as 1995, advertisers were looking to connect to consumers through the search medium. At the time I was helping out my friend Scott Heiferman to connect advertiser’s web sites to media web sites through what we called “link marketing.” We spent a lot of time managing Excel spreadsheets that listed various media sites and the formats that they accepted for “banner” advertisements. This was before there were keywords to buy, much less common banner standards to run.

One of our first media clients was Kevin Ryan at United Media which ran the Dilbert Zone. There was no standard media format or pricing methodology, not to mention agreed upon traffic metrics, at the time. I remember calling up one of Intel’s advertising agencies, DSW in Utah, and negotiating a $10k monthly placement fee on top of the Dilbert strip. This was in July of 1995 and clearly shows how far the web has come in terms of accountability. Marketing on the web is now far more science than art.

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In terms of the emergence of Paid Search as a discrete phenomenon, I was fortunate to be an innocent bystander at its inception. It was the middle of 1996 and Bill Gross had recently sold Knowledge Adventure to Cendant and had then launched a new kind of Internet company that was going to incubate his ideas called Idealab! It was modeled after a company outside of Boston called Thermo Electron that pioneered the concept of corporate incubation.

Steve Glenn introduced me to Bill when I was the CEO of SiteSpecific and we were developing some innovative Internet marketing techniques using syndicated content and direct response. I remember going to visit Bill in Pasadena, and when I walked into his office he was standing at an large 20″ monitor using AltaVista. This was early, when Digital had just released AltaVista as a speedier version of a search engine. I remember Bill raving about how good the engine was, before we hunkered down to business and tried to figure out a way for Idealab! to invest in SiteSpecific. While I was not able to figure out a deal that would work for the rest of our shareholders, I remained in touch with Bill.

In the middle of 1998, after I had sold SiteSpecific to CKS and was winding down an outsourced concierge service that didn’t scale properly (ie www.root.net) I met with Bill and Idealab! again in Pasadena and discussed getting involved. Bill was raving on and on about wanting to reinvent search and had this crazy idea for allowing advertisers to pay for having their search results appear first. How crass, I thought. Bill asked me if I wanted to help him run his new search engine company and I politely declined.

As it happened, Bill found another (albeit longer haired) entrepreneur named Scott Bannister who had created a nifty little app called SubmitIt. SubmitIt was a simple web page where one could list a web site and have it registered at multiple search engines. Bill partnered with Scott to create the underlying business model and pay for placement algorithm that became Goto.com and later became Overture. As far as I can tell, this was the genesis of Paid Search.

It took Goto.com/Overture a few years to prove that consumers’ interests in high quality results could be served alongside of the commercial interests of advertisers. Insofar as advertisers only pay for the clicks, in a traditional direct response fashion, this made the model that much more enticing than the banner model where advertisers were paying on an impression basis.

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When I look back to 1998-1999 and the advent of Goto.com as a business model and Google as an emerging search monopoly, it now feels as if this was the tipping point between the Web as a publishing medium and the Web as an advertising medium. Not that the two aren’t interrelated, but simply that what was once implicit (commerce drives content) was now being made explicit. At SiteSpecific in 1996 we worked with a number of our advertising clients (Travelocity, N2K, NECX) to buy media on a pay-for-performance basis. We ourselves felt that we should be paid commissions on success, not guarantees for placement. We were young and fiscally reckless, I guess, and thank G-d that the online media outlets wanted CPM guarantees and would not go for performance based pricing. In retrospect it is pretty clear that if SiteSpecific were around today, we would be a SEO optimizing keyword campaigns as opposed to an agency creating interactive advertisements.

It is now mid 2004 and the Web seems to be about to move through another key phase. Only days ago Google began offering image ads. Key word prices are going up across the industry. Large consumer package goods companies such as P&G are reported to be getting re-engaged in web marketing in a big way. All of this points to a shift away from direct response and towards branded impressions as a driver of online value. In the same way that the best investors “buy straw hats in Winter,” it would seem that the equivalent is true online. Some of the more successful online commerce businesses (ie Netflix, Expedia, EDiets) succeeded in recent years because of the inefficiency of key word prices for their categories. Now that the Paid Search marketplace has become more efficient, that arbitrage opportunity is gone and yet at the same time the perceived value of an impression (not a click) is at a lowpoint. With the massive adoption of broadband, the free impressions offered by the search engines and some of the innovations in multimedia advertising, it would not surprise me if a new group of lifestyle brands (as opposed to commerce engines) take advantage of the opportunity and build valuable franchises in the next few years.

In the Spring of 2002, when the market was in the process of capitulating, I wrote a few pieces of investment research focused on the Internet sector. This was before I came up with the idea for Majestic Research and before I met Tony, Eric, Jim, Yan, Michael, Don and the rest of the team I am lucky enough to work with now. One of the analyses I did was on Overture, and specifically on the competitive dynamics with the nascent Google. As you will see, I was wrong in a number of ways: Overture not only grew in value but arguably has been the number 1 driver of Yahoo’s market cap going from $10b to more than $40b in the past 2 years. Bill Gross, regardless of how much stock he unloaded in Overture, must be credited as the inspiration for Google’s Ad Words program. Finally, as you will see, I am a much better prognosticator than stock picker. Even though Overture dropped more than 10 points within a week after I wrote the short-biased report, it ended the year significantly above the $10 price I anticipated. I have since learned not to get involved with research that has price targets or stock recommendations, and leave the equity analysis to members of my team far more capable than myself. Click here for the report I wrote in April 2002 on Overture.

For the past few months I have been using another Idealab! application called X1 which indexes all of one’s email, files and contacts locally and provides a superior search experience than Microsoft. It does a better job as a search interface to my Outlook mail than Outlook itself. I wouldn’t be surprised if Yahoo buys X1 and integrates it as a premium, client side extension of Yahoo’s core search and directory offering. At PC Forum a few months ago, Bill also discussed a new search engine he was working on. Will have to keep up with this development as well.

In closing out this post, and before turning back to my normal Wall Street rants, I thought it might be useful to describe as succinctly as possible the key drivers of the Internet sector:

Amazon is the best single merchant on the web and understands how to sell better than anybody else.

EBay offers the broadest selection of merchants and therefore guarantees the greatest amount of choice for consumers.

Google is taking on the role of Kinkos, a convenient, self-service outpost for businesses big and small to market their products and services.

Yahoo is the AOL of today.

AOL is the ATT of today.

Microsoft is Microsoft

I will forever remember Thursday April 29 2004 as a seminal moment. First, just after lunch Google filed its S1. Largest IPO in recent history, larger than Netscape which ushered in the first .com valuation bubble. At the same time, as word spread of Google’s filing, more and more people started to chatter about the company’s insistences upon gaining leverage over the ways things are traditionally done on Wall Street.

A few hours later, after watching the Nasdaq wrestle, alomost succumb, but ultimately battle back from its March lows, I hustled off to Pier 59 at Chelsea Piers where there was a 6p poker tournament hosted by one of our broker dealer partners. Replete with 27 beautiful hostesses on loan from the Ford agency, a full and active bar, and more than 20 poker tables feeding into a tournament of no-limit Texas hold-em, the party fulfilled the full set of ambitions and desires of the traditional sales trading function. We are here to service you and make you feel like a king. Please trade with us as a gesture of thanks for how much and how often we put ourselves out for you (sports tickets, reservations to new restaurants, etc) not to mention how we will be there for you to execute complex trades and participate in valuable “flow” from the desk.

As the sunset shimmered off of the Hudson onto the veranda, and beautiful women handed out pigs in a blanket and shish kebabs, I thought to myself: “God bless the sales trader!” If he is going to become a dinosaur, he is going to do so in style. Booze, Gambling and Sex remain as compelling now as ever: the perfect premiums to layer on to the front end of a broker dealer to generate commissions. Forget about research, or even access to underpriced hot issues. Investors have little problem accepting such fringe benefits, not unlike advertisers getting nice perks from their media sales counterparts.

So there you had Google coming out rightfully declaring that any incremental value generated by investors belongs to Google, at the same time as the broker dealer mechanism was busy trying to steer basic equity trading business through its desk. I believe that Google’s decision to set its offering price through a retail auction mechanism has the potential of destroying a traditional profit center of wall street. Most hedge funds and mutual funds of a certain size think nothing of paying each bulge bracket firm millions of dollars each year in commission fees. As we have reviewed previously, traditional equity research, access to management and trade execution have become commodities in the wake of Spitzer, Reg FD and Technology respectively. The last bastion of hope for wall street has remained capital commitment and access to hot issues. I will leave aside the former concern and focus on the relationship between institutional investors and hot issues.

Wall Street has cut back their coverage of equities in order to rationalize their cost structures (no more investment banking to pay for the analysts) at the same time that investors have begun to self-regulate their position vis a vis the safe harbor qualification for their trading commissions. Increasingly, commission dollars are becoming more accountable. This is similar to the recent evolution of online advertising from destination web sites and branded banners to pay for click pricing. If new technologies enable increased accountability, such markets will indeed become more accountable. This is what is happening in the brokerage industry, as the powerful meme of transparency has become a consistent menace to bundled commissions and opaque pricing.

Google’s IPO is above all a capital performance. Its offering memo describes a set of rules that at once promise zero short term accountability on behalf of management while at the same time promise unparalleled tick-by-tick efficiency in terms of equity pricing.

On Friday, Tina and I got together with some friends for dinner. One of the husbands works for CSFB and I congratulated him on the coup of being named the lead on the Google IPO. Whereas I expected a little gloating, instead he bit his tongue and complained about the greed of Google and how little money CSFB was going to make (including its not insignificant banking fees). I think the point he was trying to make was that by going the way of the auction, that Google was trying to take every single penny off the table that they can. Seeing his genuine anger, I didn’t have the heart to remind him that this was a good thin overall, namely that companies were going to start to benefit fully from the intersection of buyers and sellers of their stock, not the marketmakers per se.

Instead what I saw was the end of a certain kind of investment banking innocence. No, the outsized commissions are not your divine right. No, you can’t control the allocation of underpriced shares to your best clients. Yes, you will be paid, but it will be in fees like those paid to lawyers, consultants or accountants. Profiting from outsized bid-ask spreads will need to be replaced by a different type of value. I am not sure Wall Street has figured out what it will do if Google’s auction model proves to become the rule rather than the exception.

It is interesting to note that the lone vocal holdout of the Google offering has been Goldman Sachs, who was rumored to express concern about the company’s auction format. This from a firm that perhaps more than any other benefits from proprietary trading desks. Perhaps this is the next stage of conflict, between the democratization of hot issues and the entrenched commitment of the bulge bracket to commit more and more capital behind their trades.

I will leave the notion of capital commitment for a future post, as I collect more research. In the meantime, my partner Tony Berkman who is Director of Research at Majestic was asked to respond to some of the recent media hype about Soft Dollars potentially going away, and specifically MFS’s somewhat misguided attack on the practice. Tony is one of the smartest guys I know, and here is how he responded:

“MFS’ decision to ‘get off soft dollars’ raises some important and interesting issues. It was a very different tact from Fidelity which had advanced a proposal to simply make soft dollar research expenses more transparent. Clearly, the Fidelity proposal would have less of an impact on Majestic’s business than MFS’ decision, however we should examine the impact of both scenarios particularly given the possibility that the SEC takes the draconian measure of mandating all mutual funds abandon soft dollars as proposed by the ICI (in an embarrassingly laughable press release which did all but announce: “the large wall-street firms sell our funds therefore we will recommend something most beneficial to them”). This would require a repeal or amendment of the “safe harbor” rule, and is generally not expected but should not be dismissed. The truth is, the SEC did a surprise study of soft dollars in 1998 and “found no soft dollar abuses by mutual funds.”

What strikes me about the Globe article, and why I think that ultimately any reform will be in the form of increased transparency versus elimination of soft-dollars for independent research (and not brokerage research), is that the article completely misses some extremely important and pertinent points.

First of all, where does the author come up with $10-15 Million for “proprietary data from the brokerage firms.”? And what exactly is meant by this proprietary data? I’ll tell you what it is: “IT”S THE SAME LOUSY RESEARCH PRODUCED BY THE BROKERS!!!” So they haven’t really “gotten off of soft dollars” - just stopped paying soft to companies that don’t sell their mutual funds. The real issue is that these brokerage firms were over-charging for crap… the amount paid to third parties is already transparent and accountable. Why not just force the brokerages to break out execution from everything else. Why not expose the emperor? What confuses me is that they are shifting the one part of the equation that was already completely transparent. They will still be egregiously overpaying for the schlock. This strikes me as little more than lip-service and grandstanding to help alleviate their bad-image from the market-timing scandal (incidentally, the impact of the market-timing on shareholders has been estimated at 3-4% annually in some of the international funds, hardly pennies as the article would lead one to believe), and the media seems to be buying into it hook-line-and-sinker. The question must be asked, “would Pozen take the same brokerage-friendly, anti-independent stance if the brokerage weren’t selling shares of his funds?” I doubt it.

Still, Pozen quotes, “We’re going to pay cash out of our own pocket. We want to pay for research that is valuable and not just pay 5 cents per share for research that we don’t think is valuable.” indicating a willingness to pay for valuable independent research and if Majestic is the best, we should get our fair-share even from wrong-minded funds such as MFS. Assuming the amount they paid for independent research and market data was in the range they are now allocating, we have not lost an opportunity, but potentially can not grow the opportunity as much as we would like unless they increase their allocation. One would think that differentiated research should ultimately be worth more than 1% of their mgmt. fees, but it is very big of them to “pay cash to the tune of $10 million to $15 million per year for research and market data [and]… take a hit.” This tells me that MFS doesn’t values independent research very highly and probably would not be one of our best clients to begin with (but probably would be good for 200K or so if they respond to our research the way most firms do).

My point is that ultimately, the money managers will find a way (whether by hard or soft) to pay for the research that helps them the most. A couple of our best clients already pay us by hard dollars which is fine and which we applaud. What would be unacceptable would be a situation whereby the brokerage firms are still allowed to bundle, while the independents were banned from soft. Because of the inherent unfairness of this possibility, as well as the corruption already exposed within the brokerage’s research shops, I find this scenario increasingly unlikely.”