Media Futures, Part 5/5: ARBITRAGE: IV. New Markets

Securitization is a financial technique that pools assets together and, in effect, turns them into a tradeable security. Financial institutions and businesses of all kinds use securitization to immediately realize the value of a cash-producing asset. Securitization has evolved from its beginnings in the 1970s to a total aggregate outstanding (as of the second quarter of 2003) estimated to be $6.6 trillion. This technique comes under the umbrella of structured finance. (from Wikipedia)

In the 1970s, from his perch at the Salomon Brothers trading desk, Lew Ranieri famously applied securitization to the mortgage market, creating what is now referred to as MBOs (mortgage backed securities).  This application has enabled (1) millions of consumers to more easily become homeowners by (2) transferring credit risk away from banks and thrifts to independent financial investors in the bond markets.  To put the size of this market- $2.5 trillion- into perspective, you could take the combined market cap of the entire Internet sector (including paid search, ecommerce, advertising, travel, etc):

• TWX = $90B
• MSFT= $250B
• GOOG= $65B
• YHOO= $50B
• IACI= $15B
• AMZN= $15B
• EBAY= $50B
• Combined Internet market cap= $600B

The innovation and size of the MBO market qualifies Ranieri as a special blend of creativity and capitalism, and this led to his becoming one of the great financial alchemists of all time.

Business Week, November 29, 2004   
Lewis S. Ranieri: Your Mortgage Was His Bond
The bond trader turned home loans into tradable securities 

The past quarter-century has seen a revolution in finance. It's felt every time a homeowner refinances a mortgage or signs up for a credit card. No one person can claim to have lit the fuse for this revolution-- but Lewis S. Ranieri was holding the match. Joining Salomon Brothers' new mortgage-trading desk in the late 1970s, the college dropout became the father of "securitization," a word he coined for converting home loans into bonds that could be sold anywhere in the world. What Ranieri calls "the alchemy" lifted financial constraints on the American dream, created a template for cutting costs on everything from credit cards to Third World debt -- and launched a multibillion-dollar industry.

Last month, online mortgage lead generation company LowerMyBills (LMB) was bought for more than $300m by Experian.  According to the press release, here is how the two companies are described:

LowerMyBills.com is a one-stop destination that offers savings through relationships with more than 400 service providers across 17 service categories including home loans, credit cards, long-distance and wireless services, and auto and health insurance. Since its inception in 1999, LowerMyBills.com has helped more than 500,000 consumers save nearly $200 million.

Experian is a global leader in providing information solutions to organizations and consumers. It helps organizations find, develop and manage profitable customer relationships by providing information, decision-making solutions and processing services. It empowers consumers to understand, manage and protect their personal information and assets. Experian works with more than 50,000 clients across diverse industries, including financial services, telecommunications, health care, insurance, retail and catalog, automotive, manufacturing, leisure, utilities, e-commerce, property and government. Experian is a subsidiary of GUS plc and has headquarters in Nottingham, UK, and Costa Mesa, Calif. Its 12,000 people in 27 countries support clients in more than 60 countries. Annual sales exceed $2.5 billion.

This is interesting on a number of levels, not the least of which is the premise that (1) the mortgage leads and data process of LMB are valuable to an information broker such as Experian and not simply to traditional mortgage companies and (2) the consumer benefits from easy access to creditors who bid in a competitive environment for the consumer’s business.

The essence of securitizing mortgages was to shift the credit risk away from the lenders’ balance sheets and into a open market.  Whereas before, the complexity and regulatory requirements of banks meant that getting approved for a loan might take months, now the determination of credit worthiness was established by a far more efficient marketplace where investors in the business of taking such risks were able to establish a price for this risk quickly and provide consumers with a rate in a matter of weeks (which has become days, hours and increasingly seconds).  Consumers benefit greatly because they are much more in control of their financial futures and not at the mercy of institutions with conflicting priorities. 

I only have a passing understanding of the nuances of the modern bond market but I am looking forward to seeing the Internet evolve into the multi-trillion dollar market that structured finance has become.  Many markets have emerged online in the past 10 years where buyers meet sellers, consumers meet advertisers, and advertisers meet publishers in low-friction, value-added environments.   

Using Chris Anderson’s framework, as one moves down the tail by searching for ever more obscure (ie "un-covered") keywords, one inevitably finds companies like Nextag, Amazon and eBay/Shopping.com as the minimum bidders.  They believe that they have enough liquidity of product opportunities so as to be able to convert any cheap click (ie $.05) into a more qualified activity within their network.  In so far as Amazon sells actual products, its role is as much marketer as anything else.  eBay sells other people's products and so is one step removed from Amazon (which of course also sells other people's products through its marketplace).  Nextag and Shopping.com don't sell anything, but are simply better engines for comparing products and finding the best prices.  Shopping.com is doing more than $100m in annual sales off of these and other techniques leading to their recent acquisition by eBay, while Nextag remains private but purports to be doing just as much revenue.

As we move further beneath the radar, there is another group of companies, mostly emerging from the online direct response agency world, that are generating significant profits by purchasing media, attracting prospects and selling leads to advertisers.  Four companies in particular stand out as the leaders in this space:  Adteractive, Azoogleads, Quin Street and NetBlue.  Together they will generate more than $500 million in 2005 sales with 30%+ profitability.  Yes, $500m.  Adteractive recently sold a minority share for more than $100m to a prestigious private equity firm.  In the next few months one of these will likely be bought or merged with another on the way to one of these going public in early 2006.

While the majority of Internet advertising is paid for on a CPM or CPC basis, the real driver of spending is advertisers’ willingness to pay on a pure Cost Per Lead (CPL), performance basis.  Remember the hand-wringing in 1999, for example, as to the efficacy of online advertising?  Strange isn’t it how we don’t hear much about that anymore. The emergence of pay-for-performance advertising online has effectively transferred the risk away from the medium.  With PPC, Internet media no longer has to convince advertisers to trust its ability to perform as effectively as other media (Cable, TV, Radio, Print…).  The quality of the commercial transaction is self-evident to the online advertiser, who now inherits all the risk from the publishers. 

Just to be clear, the fact that the risk now resides with the advertiser and not the publisher does not a pure market make.  Advertisers are companies in the business of selling things to consumers and other companies.  Their business is not buying advertising. 

Tiny (Internet) Markets

Within these new markets, there are millions of micro markets where a query or a unique user path comes into contact with one of more targeted advertisements.  A constructive tension emerges between the user who intends to find something or do something, and the sponsor of the link who is trying to lure her into their particular commercial environment.  Each one of these tiny interactions feature a buyer (advertiser), seller (publisher) and asset (consumer's att/intention).

The latest Release 1.0 article on Spyware features a fable that imagines advertisers as merchants at a Bazaar and their various adware proxies as pushy street urchins, “Miss!  Miss! Look here!  Special deal!."   Efficient markets are based on trust.  This relates to markets of any scale, from the NYSE and eBay to my decision whether or not to accept an invitation into somebody else’s LinkedIn network.   

While the modern US interpretation of the Bazaar has been typically pejorative (with a few notable exceptions), there is nonetheless a very useful economic system for transferring value that has emerged in around the Bazaar, namely Hawala.   Hawala is a peer-to-peer payment system that enables any participant to make a decision as to any other participant's credit worthiness:

The unique feature of the system is that no promissory instruments are exchanged between the hawala brokers; the transaction takes place entirely on the honor system. (From Wikipedia)

It is unfortunate that Hawala got associated with the terrorist activities of 9/11, since as a structural mechanism it has much to offer us as a model for enabling the liquidity of attention markets that Media Futures require.  It takes courage to create new markets, but in so far as new markets establish new currencies of trust and individual control, then they are well worth the risk.

*

Note:  This is an abridged post. Transparency finds its limits in posts about arbitrage.  While there is likely long term benefit in an open exchange of intellectual property, specifically around the collective invention of an attention marketplace,  the fact remains that capital is usually created by the introduction of friction and opacity onto otherwise smooth, transparent surfaces.  So long as I continue to debate the benefits of openness vs the importance of discretion, I will continue to hold certain things back.  In this series on Media Futures,  I have used all sorts of "A" words to articulate how media operates on the Internet in 2005.  I am looking forward to synthesizing the Media Futures series into a book, which will include much that is now only in note form or else is too sensitive to share at this juncture..

Finally, all comments here reflect my personal opinions and not those of any firm or organization I am associated with.  Specifically, I am proud of what our team has accomplished at Majestic Research in terms of reinventing investment research in a rigorous, unbiased and real-time fashion.  Majestic's insights are driven entirely by data, carefully interpreted by smart quantitive analysts.  When I comment on this blog about any public or private company, such comments are entirely distinct from the investment research that Majestic provides to its clients.