Zack Miller
www.IsraelNewsletter.com

I wanted to let the dust clear a bit before positing my opinion on Answers.com’s (ANSW) acquisition of top 30 (in terms of traffic) website, Dictionary.com. Readers of IsraelNewsletter.com know that I’ve written somewhat critically on Answers.com before and I wanted to provide an update on my thesis.

See what I’ve written previously here; the crux of my point could have been summarized as the following: while Answers.com’s content model is very much Web 2.0, its revenue model isn’t.

Now, purists can take issue with whether or not Answers really is Web 2.0. given the fact that there is no user participation, data-sharing, social networking, etc. Fine. My point was merely that Answers is competing on the Web 2.0 playing field. Essentially, Answers is aggregating Web 2.0 content and that in an of itself, means it competes against the same companies it aggregates.

But as I said previously, I believe that the company’s revenue model is very much Web 1.0. Why the distinction, you ask? Because while Web 2.0 companies can very quickly scale their content models via user-generated content and social networking (see in point, Facebook’s recent meteoric rise in value), not many Web 2.0 companies have levered revenue models. Traditionally, to make money with straight-ahead advertising (whether that’s TV, radio, Internet, video, whatever), you need to execute on the ad sales side. Nothing 2.0 about that: selling ads is all about hiring people and squeezing dollars out of partners. Ultimately, both activities hit a huge wall with CPMs eventually plateauing.

Michael Eisenberg has written a great article on Answers but I have to disagree with his point regarding scalability: getting a top 100 web site does not mean ad sales becomes scalable. It just means that the publisher may get a larger piece of advertisers’ wallets. True, large advertisers frequently don’t even want to talk to smaller publisher fish. Getting big gets you in front of their marketing/advertising team but the same problem of scalability remains and this is a question of human execution, not economies of scale.

So, what do I think was actually behind Answers’ purchase of Dictionary.com? Paul Kedrosky had a keen comment that this was a story about a record-setting domain name purchase. I think Paul’s partly right. But it’s also about the the traffic that came along with the domain name. From all accounts (including Answers’ own CEO), Dictionary came at a hefty price tag and a poor history of monetization and I’m not even talking about the cost of capital that Answers is going to incur (sorry, that investors in Answers are going to have to incur) when they buy a company at 1X their market cap and almost 10X their cash position.

But how many of us actually saw that within the announcement of the impending purchase, Answers pre-announced to the downside. If this is a game about optimizing ad sales, Answers is having a hard go at it.

By the way, in Answers defense, Google has the most successful ad sales team on the planet for its network and although sell-through for a network is a different game of optimization, Google is spending heavily on this non-scaleable activity. Their secret sauce is working and good as they are at sales, this will return less and less over time. To bring in big Fortune 500 advertisers, Google is wooing them with a direct sales force and packaging together vertical groups of publishers for larger buys.

So, if advertising revenues = page views X cost per impression, Answers has decided that growth is not going to come from boosting its own cost per impression, but rather by boosting its impressions. Answers has a lot of dependence on Google for impressions and like most non-Facebook websites, occurs significant TAC (traffic acquisition costs). Doing the math, management must have decided that making a huge acquisition is a better investment than making the tough ad sales slog.

This puts Answers.com right back where it started. This is an admission that ad sales is very much a question about execution and that Answers was completely dependent on this non-scaleable, Web 1.0 activity.

In some sense, this was the only way to grow, albeit at investors’ expense.

Disclosure: Author’s fund does not have a position in any of the stocks mentioned here as of 7/18/07.

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Zack Miller is the lead equity analyst for America Israel Investment Associates, LLC. and a former equity analyst for a leading multinational hedge fund. For more information, go to www.israelnewsletter.com or call 1-888-327-6179, or email zack@profile-financial.com

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