The Cloud Hanging Over Skype

Early this week, eBay announced that after four years of owning Skype, the popular, and free, online phone service, it had sold the company to an investor group for around $2 billion. The investors included the Silicon Valley private equity firm Silver Lake Partners; Marc Andreessen’s new venture capital firm, Andreessen Horowitz; a London firm called Index Ventures; and the Canada Pension Plan Investment Board. Under the terms of the deal, eBay will retain a 35 percent stake in Skype, giving it a valuation of $2.75 billion.

Many people on Wall Street — and a number of telecommunications experts I spoke to this week — were stunned by the price Skype sold for, and not just because we’re in the middle of a recession. In 2005, when eBay bought Skype from its founders, Janus Friis and Niklas Zennstrom, it paid $3.1 billion. But the company had performed so poorly that by the fall of 2007, eBay had been forced to take a $1.1 billion write-down.

Around that same time, Mr. Zennstrom, whose relationship with eBay management had turned acrimonious, stepped down as Skype’s chief executive. (Mr. Friis had already left the company.) Although Skype’s performance has improved since the installation of a new chief executive last year, it was no secret that eBay was trying to unload it. Many potential buyers had walked away, believing that eBay simply wanted too much.

There is another reason that the Skype deal has raised eyebrows, however. Not long after Mr. Friis and Mr. Zennstrom left the company, they became embroiled in a dispute with eBay that has turned into a very nasty lawsuit.

It turns out that in selling Skype to eBay, Mr. Friis and Mr. Zennstrom retained control of a key part of the Skype technology, which they licensed to eBay. Although the details are under seal in a London court, the Skype founders’ essential complaint is that eBay tampered with their software, and in doing so, violated the terms of the licensing agreement. They were demanding that Skype be forced to stop using the technology, which, for all intents and purposes, would mean shutting down Skype itself. The case is set for trial in 2010.

Companies are sued all the time, of course. But this lawsuit feels different; to put it bluntly, it feels more dangerous than the typical lawsuit aimed at a corporation. In a court hearing in London last June, eBay’s lawyer told the court that if Mr. Friis and Mr. Zennstrom won the case, the result would be “devastating.”

In its financial documents, eBay says that it is “confident” of its legal position. But it also acknowledges that an “adverse result” could mean that the “continued operation of Skype’s business as currently conducted would likely not be possible.” That is hardly your typical corporate boilerplate. Indeed, after that court hearing in June, a telecom analyst named Jayanth Angl told Bloomberg that “if eBay can’t reach an agreement over that piece of technology, that could certainly turn the Skype acquisition into a debacle.”

And so, the mystery of the Skype deal: why were the winning bidders willing to pay so a high price for a company whose very existence could be threatened by this lawsuit? One possibility is that they have nerves of steel. The other is that they know something nobody else does.

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Skype was not Mr. Friis’s and Mr. Zennstrom’s first company. No, that was the infamous Kazaa, a peer-to-peer company that the two men founded in 1999, not long after Napster showed the world exactly how easy it was to steal copyrighted music using peer-to-peer computing. By 2001, the recording industry, having routed Napster, turned its sights on Kazaa.

Going after Kazaa was tougher because it was located somewhere in Northern Europe, outside the purview of United States law enforcement. (No one knew exactly where.) The Kazaa founders moved periodically to keep the recording industry from being able to subpoena them, and for years, they stayed away from the United States for the same reason. But the recording industry kept up the pressure, and as their legal costs mounted, Mr. Friis and Mr. Zennstrom finally decided to get rid of the company and move on.

Former Skype executives will tell you that the Kazaa experience did a lot to shape Mr. Friis’s and Mr. Zennstrom’s approach to business. It made them extremely secretive. They almost never talk to the press. (They didn’t speak to me for this column.) And it also made them extremely protective of the technology they created. Which is why, long before they sold Kazaa, they moved their peer-to-peer software into a new company, called JoltID.

In 2003, when they started Skype, that same technology that had powered Kazaa became an important part of the Skype code; it was the means by which computer users connected to each other and created a larger network. (VoIP — voice over Internet protocol — was the means by which they spoke to each other online.) But Skype never owned the technology; JoltID did.

Why eBay was willing to go along with such an arrangement when it bought Skype two years later will forever be a puzzle. But so long as the two men remained part of the eBay “family,” it didn’t matter much. Any changes to the peer-to-peer code were ones they approved.

When the deal went sour, however, and the founders left eBay, that all changed. And when eBay continued to tinker with the code — something eBay contends it has a right to do under the license — they entered into negotiations that went nowhere. Finally, by March of 2009, the two sides had sued each other.

At the same time, the founders, together with some big private equity firms, including Elevation Partners in Silicon Valley (yes, the Bono firm), and General Atlantic in New York, were trying to buy back Skype. It was, after all, their one big success. (Their third start-up, Joost.com, has gone nowhere.)

It is hard to know precisely what happened next. EBay claims that all the bidders were treated the same, and that the losers simply didn’t put up as much money as the winner. But according to supporters of the Skype founders, their investing consortium made three serious efforts, over the course of a year, to bid for the company. Every time, they say, they were stiff-armed by eBay’s investment bankers. About a month ago, they wrote a letter to eBay protesting their inability to get a hearing for their proposals.

And maybe the Skype founders did try to buy back the company on the cheap. The sense I got, however, is that the founders would have been willing to come up with a price that suited eBay — if they had been able to enter into negotiations. What is clear is that the bad blood that had developed between eBay and the founders was infecting the potential negotiations over a buyback of the company. (EBay denies this.)

And then, a few months ago, out of the blue, came the $2 billion bid from the Silver Lake consortium. One way it has dealt with the litigation risk is by persuading eBay to assume 50 percent of any losses resulting from the lawsuit. But that still doesn’t mitigate against the possibility that the founders could win the lawsuit — and put their creation, Skype, out of business.

So why were they willing to bid so high? One theory is that the Silver Lake people think they can win in court. Indeed, if by next summer the two sides are still arguing in court, we’ll know that is the answer to the mystery. That is the “nerves of steel” theory.

But how likely is that? In this environment, big-time private equity firms don’t commit $2 billion if there is a serious possibility the company they’ve just bought might be put out of business. As it happens, not long before Index Ventures became interested in Skype, it brought on board a man named Michelangelo A. Volpi, a highly respected former Cisco executive who — hmmm — once sat on the Skype board. In fact, he was so well liked by the Skype founders that they hired him to run Joost. Wouldn’t you know it? Joost uses the same peer-to-peer technology as Skype and Kazaa.

Mr. Volpi told me that not long after he arrived at Index Ventures, he discussed the possibility of making a run at Skype — and he and another Index Ventures partner, Danny Rimer, in turn rounded up Silver Lake and Mr. Andreessen, who — hmmm — sits on the eBay board. (As soon as he got involved with the bid, Mr. Andreessen recused himself from any board discussion about the Skype sale.) In the end, Mr. Andreessen committed $50 million to the deal — a very large percentage of his $300 million venture fund.

So another theory: because of his friendship with the Skype founders, Mr. Volpi believes he’ll be able to settle the lawsuit. Rich Tehrani, the president of TMC, a telecom publishing company, told me that he had just come from a conference where rumors were rife that the Silver Lake consortium had already cut a side deal with the Skype founders. (All the parties deny this.)

The third possibility is that Mr. Andreessen and the others have figured out a technology “workaround” so they no longer have to rely on the JoltID technology, something eBay had already begun working on. But almost everyone I spoke to said such a workaround would be, at best, difficult and expensive — and could cause such severe disruption to Skype’s business that it might never recover.

It is, alas, unsatisfying to delve into a mystery like this and not be able to solve it. But over time, it will become clear. Either the case will linger, and we’ll know that Silver Lake, Andreessen et al. do indeed have nerves of steel.

Or it will quickly go away, which will provide an answer of a less seemly sort. The mission of Skype, after all, is to shrink the world and bring people together.

 

Eleven Years of Ambition and Failure at AOL

article by  SAUL HANSELL of NYTimes.com

I’ve been writing profiles of AOL executives for nearly half of the company’s 24-year life. And for all but one heady 18-month period, they were on the defensive. AOL, they said, had the technology, content and love of its customers that would prove the skeptics wrong. That’s what Tim Armstrong said in the article I wrote in Thursday’s Times.

And the message is no different from the one in the first profile I wrote of the three top leaders of the company at the beginning of 1998: Stephen M. Case, Theodore J. Leonsis and Robert W. Pittman. The headline was “America Online’s Triumvirate in Cyberspace; The Service Provider Everybody Loves to Hate Changes by the Nanosecond.”

The cast of characters changed many times. And so have the specific battles: persuading newbies to buy dial-up Internet subscriptions, selling add-on services, coping with broadband rivals and finally shifting to free, ad-supported services in an age of search. But there also have been common themes: the attempt to exploit the prominence of the AOL brand, the quest for the sort of content that will lure customers, the challenges of rapid growth and then drastic contraction.

Most of all, there has been a sense of bravado, that AOL’s destiny was to lead the Internet. Here are some choice quotes from the company’s many leaders:

1998: Getting in gear

With the addition of Mr. Pittman to the management team, AOL had recovered from the period when it didn’t have enough phone lines for customers and was starting to rake in the advertising money.

“Our strategy has been in place for more than a decade…. The goal has always been to build a mass medium that is as important in everyday life as the telephone or television. How we execute the strategy has always been in flux.” — Steve Case

“When I first got here, I scared them, because I looked at the numbers so much.” — Bob Pittman, referring to AOL middle managers

“America Online’s Triumvirate in Cyberspace; The Service Provider Everybody Loves to Hate Changes by the Nanosecond” (Feb. 16, 1998)

1999: Bravado

AOL was at the top of the world, and cocky executives were talking about extending their reach to television, mobile phones and computers.

“Windows is the past. In the future, AOL is the next Microsoft.” — Steve Case

“Hopefully, we will establish AOL as the most valuable and the most respected company….We won’t settle for just one of them.” — Steve Case

“If you really love AOL, would you pay $10 a month for AOL TV and five bucks a month to get your AOL e-mail on your Palm Pilot? I am loath to predict the future, but people pay 50 or 60 bucks a month for cable. I think people see us as comparable, so we have a lot of headroom to deliver value.” — Bob Pittman

“Now, AOL Everywhere” (July 4, 1999 )

2000: The deal

Ten days after the dawn of the millennium, Mr. Case persuaded Gerald Levin, the chief executive of Time Warner, to allow AOL to buy the venerable media conglomerate for $165 billion. Ted Turner, the vice chairman of Time Warner, was excited.

“When I cast my vote for 100 million shares, I did it with as much excitement as I felt the first time I made love some 42 years ago….I voted for it because we will have a stronger company that will create value. It’s not so easy to go out and recreate AOL. No one has been able to do it so far.” — Ted Turner

“America Online Agrees To Buy Time Warner for $165 Billion; Media Deal Is Richest Merger” (Jan. 11, 2000)

“I accept that something profound is happening in the Internet space — I believe that….New media stock-market valuations are real — not in every case, of course. But what AOL has done is get first position in this new world. Its valuation is real, and I am attesting to that.” — Gerald Levin

“Medium for Main Street” (Jan. 11, 2000)

AOL’s stock dropped sharply in the months after the merger, because Internet investors were worried that Time Warner’s old media assets would drag the company down. Steve Case tried to talk up the combination’s prospects.

“When it comes to valuing the new company, it’s clear that AOL Time Warner will be an Internet-powered enterprise….That’s similar to other Internet-powered companies like Cisco and Microsoft.…I have no doubt that a year from now, AOL Time Warner will be seen as one of the must-own companies, and stockholders who invest now will be greatly rewarded.” — Steve Case

“America Online Posts Gain In Second-Quarter Income” (Jan. 20, 2000)

The backlash was starting against AOL’s powerful online marketing unit, which would charge Internet start-ups millions of dollars for “prime real estate” on its service.

“We may be 800 pounds, but I hope we’re guerrillas with an ‘e’ — not gorillas. I don’t want an attitude in our group that we don’t have to try harder because we’re No. 1.” — Myer Berlow, the president of America Online’s interactive marketing unit.

“ Not-So-Subtle Engine Drives AOL Profit Forecasts” (Jan. 31, 2000)

2001: Doubts emerge

With the merger consummated, AOL Time Warner starts to have difficulty meeting its growth targets.

“We had higher expectations for the economy and advertising than what turned out to happen….Once you make a commitment, you want to do everything you can to stand by them.” — Steve Case

“AOL’s Problems Go Beyond Even Harry Potter’s Magic” (Dec. 7, 2001)

2002: Stalling

Amid a sharp decline in ad revenue, the skepticism of AOL returns.

“I am confident that AOL will re-emerge as the key driver of growth for the whole company….Maybe it’s perverse, but it’s more comfortable to be in the idiot zone and know the pendulum will swing your way.” — Steve Case

“The Stairmaster of Mergers” (July 21, 2002)

James de Castro, a former radio executive, is put in charged of the AOL online service. He tries to restore morale by teaching spinning classes and piping rock music into the halls.

“There is some dead skin and dry skin you have to peel away to get to the beautiful skin…. Just like HBO made a real difference on Sunday night by putting on really fabulous programming, we can increase members’ satisfaction by becoming an entertainment medium.” — Jamie de Castro

“New Software (and New Bosses) at AOL Unit” (Aug. 5, 2002)

By the end of the year Time Warner brings in Jonathan Miller, a former executive of IAC/InterActiveCorp, over Mr. de Castro’s head to run AOL.

“I do think in retrospect that we did take our eye off the ball as it relates to the members, because of focusing on monetizing the service and doing advertising and e-commerce deals. The No. 1 thing Jon’s going to do is starting right now focus squarely back on the member and have our bias be maximizing satisfaction, maximizing retention and building the member experience.” — Steve Case

“This organization wasn’t clear about broadband in the recent past. Now we are in it to win it.” — Jonathan Miller

“America Online Is Making More Changes at the Top” (Sept. 13, 2002)

2003: Making a new case

By the fall of 2002, AOL’s paying subscribers peaked at 26.7 million subscribers, and then started to decline. Richard D. Parsons, the chief executive of AOL Time Warner, said the company would focus on finding a way to raise the price of the service.

“While a number of people are getting AOL over broadband now, the product isn’t really differentiated in a way that we would like….I don’t think you are going to be able to look for clear indications of how the new broadband initiative is being taken up by consumers until midyear, because before you start throwing lots of marketing dollars after it, we want to put the product together — we want to do some test marketing.” — Richard Parsons

“As Broadband Gains, The Internet’s Snails, Like AOL, Fall Back” (Feb. 3, 2003)

Mr. Miller introduces a new ad campaign, replacing Mr. Pittman’s slogan, “So easy no wonder it’s No. 1,” with “Welcome to the World Wide Wow.”

“People have already decided they know who AOL is, so you have to sound a wake-up call….The AOL brand was perceived as not sophisticated and not necessarily in tune with the times. We need people to realize we are not just the Internet on training wheels but a much more sophisticated, yet still friendly and easy, place to be.” — Jonathan Miller

“Beyond War News, AOL’s Broadband Plan May Face a Struggle” ( March 24, 2003)

2004: Embracing broadband

In an attempt to reach out to broadband users, AOL makes freely available some content that had been exclusive to subscribers.

”We want to be a broadband company all the way through.” — Jonathan Miller

“AOL’s Chief Revamps It, With an Eye On Yahoo” (Nov. 9, 2004)

“People were not signing up for AOL or canceling it because of news and sports and search.” — Ted Leonsis

“Free or Paid? AOL Will Let Its Two Halves Duke It Out; In a Risky Reversal, An Effort to Cash In On an Online Ad Boom” (Nov. 22, 2004)

2005: Portal Days

Mr. Miller put all his energy into building the AOL.com portal, meant to be different from Yahoo because it had a more populist and emotional “voice.”

“The day I thought we nailed it was the day that Terri Schiavo died. [While other portals used a headline from news agency articles similar to] “Terri Schiavo dead at 41, the AOL headline was, ‘Terri Schiavo’s sad story comes to an end,’” — Jonathan Miller

“AOL Wooing Users to Portal, With a Little Help From Its Foes” (June 10, 2005)

2006: Dialing Down Dial-up and Changing Leaders

Mr. Miller abandons marketing AOL’s access service to concentrate on free Web sites.

“There are many businesses that need to confront legacy issues. We put a stake in the ground with our legacy issues and we’re moving on.” — Jonathan Miller

“In a Shift, AOL Plans Free Mail” (Aug. 3, 2006)

Jeffrey L. Bewkes, Time Warner’s president, abruptly fires Mr. Miller, replacing him with Randy Falco, an NBC executive.

“I just wanted the best executive I could get. If there was an Internet executive as qualified as Randy, I would have hired that person.” — Jeff Bewkes

“AOL Chief Has a View, a Long One” (Dec. 19, 2006)

2007: Abandoning the portal

After several rounds of layoffs, Mr. Falco moves away from the AOL.com portal in favor of a strategy built on several different brands.

“Publishing is no longer just about the portal. We are going to be in as many different places as possible.” — Randy Falco

“Falco Prepares Another Layoff: the AOL Brand” (Oct. 17, 2007)

2008: For sale

Amid ongoing talks to sell AOL to Microsoft or Google, Mr. Falco fires Curt Viebranz as head of ad sales, replacing him with Lynda Clarizio, who had run the Advertising.com unit.

“We sat here for a long time; Ron and I agonized over this….People will say five months after announcing the change, there will be some kind of meltdown, there is instability. People internally won’t understand it. Externally, people may raise questions. I said to Ron, ‘In my experience, it is always better to move fast.’ Another six months of this, we would be too far behind. We couldn’t wait another day.” — Randy Falco

“The Curse of AOL” (March 13, 2008)

2009: The King is Dead; Long Live the King

Fed up with Mr. Falco, Mr. Bewkes, now Time Warner’s chief executive, replaces him with Tim Armstrong. Fed up with AOL, Mr. Bewkes plans to spin the company out to shareholders.

Mr. Armstrong says one of his primary challenges is to address AOL’s “crisis of confidence.”

“You can argue about its reputation, but everybody in the world knows AOL.” — Tim Armstrong

 

 

 

 

 

 

 

 

Traders Profit With Computers Set at High Speed

It is the hot new thing on Wall Street, a way for a handful of traders to master the stock market, peek at investors’ orders and, critics say, even subtly manipulate share prices.

It is called high-frequency trading — and it is suddenly one of the most talked-about and mysterious forces in the markets.

Powerful computers, some housed right next to the machines that drive marketplaces like the New York Stock Exchange, enable high-frequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense.

These systems are so fast they can outsmart or outrun other investors, humans and computers alike. And after growing in the shadows for years, they are generating lots of talk.

Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.

And when a former Goldman Sachs programmer was accused this month of stealing secret computer codes — software that a federal prosecutor said could “manipulate markets in unfair ways” — it only added to the mystery. Goldman acknowledges that it profits from high-frequency trading, but disputes that it has an unfair advantage.

Yet high-frequency specialists clearly have an edge over typical traders, let alone ordinary investors. The Securities and Exchange Commission says it is examining certain aspects of the strategy.

“This is where all the money is getting made,” said William H. Donaldson, former chairman and chief executive of the New York Stock Exchange and today an adviser to a big hedge fund. “If an individual investor doesn’t have the means to keep up, they’re at a huge disadvantage.”

For most of Wall Street’s history, stock trading was fairly straightforward: buyers and sellers gathered on exchange floors and dickered until they struck a deal. Then, in 1998, the Securities and Exchange Commission authorized electronic exchanges to compete with marketplaces like the New York Stock Exchange. The intent was to open markets to anyone with a desktop computer and a fresh idea.

But as new marketplaces have emerged, PCs have been unable to compete with Wall Street’s computers. Powerful algorithms — “algos,” in industry parlance — execute millions of orders a second and scan dozens of public and private marketplaces simultaneously. They can spot trends before other investors can blink, changing orders and strategies within milliseconds.

High-frequency traders often confound other investors by issuing and then canceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computers can essentially bully slower investors into giving up profits — and then disappear before anyone even knows they were there.

High-frequency traders also benefit from competition among the various exchanges, which pay small fees that are often collected by the biggest and most active traders — typically a quarter of a cent per share to whoever arrives first. Those small payments, spread over millions of shares, help high-speed investors profit simply by trading enormous numbers of shares, even if they buy or sell at a modest loss.

“It’s become a technological arms race, and what separates winners and losers is how fast they can move,” said Joseph M. Mecane of NYSE Euronext, which operates the New York Stock Exchange. “Markets need liquidity, and high-frequency traders provide opportunities for other investors to buy and sell.”

The rise of high-frequency trading helps explain why activity on the nation’s stock exchanges has exploded. Average daily volume has soared by 164 percent since 2005, according to data from NYSE. Although precise figures are elusive, stock exchanges say that a handful of high-frequency traders now account for a more than half of all trades. To understand this high-speed world, consider what happened when slow-moving traders went up against high-frequency robots earlier this month, and ended up handing spoils to lightning-fast computers.

It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: the hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors’ upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.

Multiply such trades across thousands of stocks a day, and the profits are substantial. High-frequency traders generated about $21 billion in profits last year, the Tabb Group, a research firm, estimates.

“You want to encourage innovation, and you want to reward companies that have invested in technology and ideas that make the markets more efficient,” said Andrew M. Brooks, head of United States equity trading at T. Rowe Price, a mutual fund and investment company that often competes with and uses high-frequency techniques. “But we’re moving toward a two-tiered marketplace of the high-frequency arbitrage guys, and everyone else. People want to know they have a legitimate shot at getting a fair deal. Otherwise, the markets lose their integrity.”