Sun, Feb 03, 2008 page12

• Yahoo sale could be bad for the minnows

  While the dot-com bust continues to cast a shadow, Internet advertising is booming

  • By Brad Stone and Miguel Helft / NY TIMES NEWS SERVICE
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  For decades, Silicon Valley has been the land of eternal optimism and high anxiety, traits that pitch into overdrive any time a seismic business event washes across the corporate and entrepreneurial landscape here -- like, for example, Microsoft's blockbuster US$45 billion bid for Yahoo on Friday.

  The legions of high-tech entrepreneurs who have set up camp here with clever ideas, a willingness to scramble for financing and the energy to weather round-the-clock days have typically tethered their dreams to a singular outcome: getting fabulously rich by selling to one of the three Internet giants, Microsoft, Google or Yahoo.

  But if Microsoft's takeover bid for Yahoo succeeds, that calculus becomes more harrowing because of a simple reality: The field of large, lushly endowed suitors will narrow by one. And that is a fact sure to jangle nerves already strained by growing fears of an economic recession.

  

  Slide chief executive Max Levchin, 32, sits outside the company's office in San Francisco, on June 22, last year. Levchin says that the US is on the road to recession and that Silicon Valley start-ups could be headed for a venture capital-mandated round of belt tightening. So Levchin, who co-founded PayPal, a company that successfully weathered the dot-com crash, decided to take the money while the going was good: He recently raised US$55 million in additional financing for Slide, a company that makes video and photo-sharing tools.

  PHOTO: NY TIMES NEWS SERVICE

  "From a start-up and investor perspective, if there are more companies trying to vie for the same businesses, there are more exits," said Bismarck Lepe, a former Google employee and now chief executive of Ooyala, a year-old video host and advertising company. "It's not great for competition if there are only two acquisition targets instead of three."

  To be sure, a Microsoft-Yahoo deal could be good for Silicon Valley, funneling money into the economy and triggering a round of copycat deals as other players like Google and the News Corp. look to keep up.

  But Microsoft is buying Yahoo because it has steadily fallen behind Google in the lucrative online search market and because the future of computing may not be forever linked to the desktop market that Microsoft now dominates. Apparently unable to keep up with Google through internal efforts, the legendary software giant in Redmond, Washington, has gone outside to solve its problems by trying to buy Yahoo.

  So the rationale for Friday's proposed mega-deal is based on Microsoft's own particular corporate needs and may not be a harbinger of rampant deal-making in the Valley.

  Moreover, with an economic recession looming nationally, the unsolicited bid for Yahoo comes at a difficult time for the normally cocksure world of high tech. Visibly, much of the region maintains an almost obstinate belief that it can weather any economic storm that emerges. Consumers are still flocking online, advertising is following, and the current generation of start-ups has been built frugally -- with lessons from the dot-com bust of several years ago still very much in mind.

  Venture capitalists also raised nearly US$35 billion last year, more than at any other time since before the dot-com crash, according to the National Venture Capital Association. Those financiers are ready to make bets on countless entrepreneurs who hope to build the next Google, Facebook or YouTube.

  But as the stock market lolls and an outsider, Microsoft, bids to gobble up a company that once was one of Silicon Valley's crown jewels, the region's innovators and corporate stewards appear to be growing ever more anxious. That trait is most visible in the top executives at public companies whose eyes are trained on parallel declines in consumer confidence and public equities.

  Shares of Google had dropped nearly 20 percent since the beginning of the year -- and then they fell an additional 8.6 percent on Friday after Microsoft made the play for Yahoo. Apple has dropped 33 percent since the start of the year. That was enough to prompt Steven P. Jobs, Apple's chief executive, to send a reassuring memo to options-sick employees last week that concluded: "Hang in there."

  Many in the typically overconfident venture capital world say it is foolish to believe the technology sector is somehow sheltered from the storm.

  "All markets are linked," says Peter Rip, a general partner at Crosslink Capital, adding that the pain might trickle down from the public markets to large private companies and eventually to smaller start-ups. "We just asked every one of our companies to take a sharp pencil to their hiring plan this year. It is going to be a bumpy ride for a while."

  In a blog posting this week titled "Downturn, Now What?," Will Price, a partner at the San Francisco venture capital firm Hummer Winblad, said the recession could punish technology investors for succumbing yet again to investment fads and high valuations for companies without proven business models.

  He calls these companies "Field of Dreams" start-ups, because their entrepreneurs believed that if they built popular online services, advertisers would inevitably come. Now that might not necessarily be the case.

  "There's been a suspension of belief" at Internet companies without a proven way to earn money "that the market is going to let you off the hook," Price said. "These companies are going to have a hard time getting past experimental interest from advertisers when they want to start attracting really big spending."

  Most Valley residents, including even the most pessimistic venture capitalists, are quick to say that the Internet economy would be in an enviable position if there were a recession. Mutual funds, media companies and private equity firms are all trying to get in on the Internet action. The online advertising market is booming.

  This is where true believers are likely to ward off recessionary fear with two numbers: 21 and 7. Twenty-one percent of the average American's media-consumption time is spent online, analysts say, yet only 7 percent of all advertising is online. The hope is that advertising will inevitably shift online and close this gap, whatever the economic outlook.

  "Consumer eyeballs are flooding from traditional media to the Internet," said Seth Sternberg, chief executive of the online chat company Meebo. "Recession or not, big companies have to figure out how to do really great brand advertising on the Web to keep their brands in front of users."

  For that reason, many Internet executives say traditional media companies -- not Web properties -- are likely to be the first victims of any advertising pullback.

  "If our advertisers cut their marketing budget by 15 or 20 percent, that will hurt," said John Battelle, who ran the Industry Standard magazine during the first dot-com boom and now runs the online ad network Federated Media. (The New York Times Co has invested in Federated.)

  "But my guess is that they will cut it first in print or TV and not online," he said.

  Still, the dot-com bust -- and its destructive reverberations -- continues to cast a shadow over even the most optimistic Internet evangelist. In 2000, as the stock market cratered and fear spread, venture capitalists pulled the plug on hundreds of start-ups and wrote off millions of dollars in losses.

  Lepe of Ooyala recalls his drives to Mountain View, California, in 2001, when he would see a new empty billboard off Highway 101 each week as pessimism spread through the community.

  Economic downturns have a way of fostering panic and transforming a community's collective consciousness.

  "So much in the Valley -- whether a company gets funded or not -- happens on gut instinct," Lepe said. "If someone's house isn't being sold and they can't go out and buy their yacht, it does have an impact on their psychology."

  Also See: Congress to review Microsoft bid
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