Research 2.0 Monthly March, 2007

THE TECHNOLOGY MONTHLY Volume 2, Number 2 March 30, 2007

BOSTON|NEW YORK|PARIS www.research2zero.com

In this issue: Simon’s Law (Moore’s Law for Energy) Old names in new clothes: AT&T and 3COM The Web 20 status and a check on other Web 2.0 adoption metrics Random bits

Simon’s Law Today there may be more value in viewing energy as a technology rather than a natural resource industry. There is a strong theory, proven by historical events, that energy (and other raw materials) decline inexorably in cost over time. Despite our intuition, natural resources (energy included) are not in any way finite or scarce. Our notions about declining supply and scarcity are deeply rooted in our individual experience of shrinking production from an oil well and sparser lodes of ore from existing mines. However these individual notions are the opposite or our collective experience throughout history. The implications are not only lower energy costs going forward, but also great advances in innovative solutions and new technology. Julian Simon, noted professor at Maryland University and senior fellow at the Cato Institute, spent several decades researching and documenting these findings, which include the impacts of human population growth on raw materials cost, pollution and biodiversity. His work, while controversial, has never been disproved. Despite the truth these theories do not garner as much attention from analysts, economists and investors as near-term price fluctuations and oldfashioned notions that black pools of oil left by the dinosaurs will run out and leave us with secular increases in energy costs. These ideas strike people as objectionable or unsatisfactory because we don’t want to be complacent about our planet. Particularly in areas that inspire emotions like global warming and shrinking bio-diversity, people wrongly take these theories to mean that we should do nothing and the problems will simply go away. Simon’s Law says quite the opposite and acknowledges the collective power of society to focus on and solve problems by applying its best efforts to what is most important. There’s no reason to believe the

outcome this time will be any different than it has been during the last few thousand years. We will spare our readers a pile of statistics on inflation and energy prices, but two things should be noted. The first is that the U.S. Department of Energy statistics on global supply and demand show that oil is a very orderly market; supply equals demand with very little difference year after year. The second is that the recent increase in crude prices reflects more of a reversion to the mean from very low prices a few years ago. In 2003 crude was selling about the same price it did in 1983 ($26/bbl) despite the fact that inflation figures would allow crude to trade at more than double that figure and still be well within the envelope of a long-term decline in real energy prices. After four years of major increases (+22%, +41%, +19% and +25%) the 2006 average price of $58/bbl is still not abnormal. However we can’t resist pointing out that since 1949 we have never had four straight years of double-digit price increases, and past declines warrant preparation for $30/bbl prices in the next few years. Today we can already see the forces that Simon outlines beginning to drive the changes that will lead to a larger, more efficient energy industry. First and foremost is the huge wave of financial and intellectual effort now mobilizing into energy. Of course traditional energy companies themselves are stepping up their investments in exploration and production. Increases in extraction rates are coming from the application of newer 3D imaging techniques, steam injection, smarter drills, better pipes and a myriad of other tricks that are worth the effort at current oil prices. Venture capital investments into innovations around energy more than doubled in 2006 to $1.8B invested in 183 companies. The increase was even greater in the alternative energy sub-segment, which jumped 272% to $727M in 39 companies. It’s easy to foresee another big increase in 2007 based on current levels of activity and

enthusiasm for the sector. Thankfully for venture capitalists the virtuous cycle has just received a major boost from the $2B acquisition of Horizon Wind Energy by a Portuguese utility company. Large companies such as GE, ADM, the automobile manufacturers and the semiconductor material and equipment providers are also shifting more of their spending on alternative energy sources. The ultimate success of new innovation in energy depends on the development of a large and viable marketplace. Public attitudes and the political environment for creating incentives and subsidies for new forms of energy supply and conservation has probably never been better. This is necessary now because if one simply runs the numbers on making use of solar panels on a residential property they don’t suggest a very attractive return. Tom Evslin at Fractals of Change has done a complete analysis for his own situation taking account of installation costs as well as the ability to take advantage of higher time-of-day rates which gives solar an edge over wind. After all is said and done, the current ROI appears to be about 2% in his circumstances. Of course over time we can expect the initial investment per watt of solar faceplate to decline. More help is on the way from none other than our favorite financial innovators, the investment banks. In particular, Goldman Sachs has created a structure whereby a large commercial customer can switch to solar without having to make any capital investment or worry about ongoing system maintenance (handled by a third party). Commercial customers do have to sign a long-term supply agreement but at rates already lower than what they are paying now. Structures like this are so attractive that they can drive the commercial industry forward into solar with some force. Local providers are starting to figure out that they can build franchises around this business in the residential sector. There are already emerging providers, such as Ready Solar, springing up that provide a simple kit that can be easily installed by general contractors. Some utilities may enter this market as well as they have done in the past with energy efficient appliances. Small financial services companies are creating a package that includes analysis and financing for homeowners that takes into account the numerous incentives and tax breaks available in many states along with low-cost home equity financing. (What a great way to create jobs for all the unemployed sub-prime mortgage agents!)

There is also an attenuation of demand that comes from a huge number of small improvements from use of LED and fluorescent illumination to replace incandescent lighting, more energy efficient vehicles and hybrids, greater use of geothermal to cut heating and cooling costs and so forth. Having been convinced that the future opportunities in energy innovation are here to stay and that they have everything to do with technology and investments we hereby plant our flag in the space. As we did with the software space, we will be introducing a “Power 20” group of companies that best represent the investment vehicles for this space. The Power 20 will include sector and company reports, beginning with solar energy where we have already done a considerable amount of work. We’ll then likely move on to advanced materials and energy-related technologies. We’re excited about adding this space.

ÇÇÇ Old name in new clothes No. 1: AT&T The launch of the Apple iPhone precipitated an avalanche of commentary, almost all glowing but for the fact that Apple had chosen Cingular as an exclusive service provider partner. We were thinking along the same lines at the time. But then a little voice started reminding us that maybe we can make more money by thinking the other way. Visualizing a revitalized AT&T piqued our interest. At the time, AT&T was trading at less than 5x operating cash flow. Although we are not expert investors in communication service providers, in the past buying similar companies at such a multiple (like Telecom Italia back in the ’90s) has paid off well. Since then T has done well and was the top performer in the Dow for Q1. Developing fundamentals hint that there may be a larger story here. First of all, the iPhone may indeed be a catalyst for AT&T in terms of visibility and investor sentiment. It’s becoming clear that the pull of having the coveted iPhone is more powerful than the objections to AT&T as a service provider. While the business may not move the needle in terms of the overall revenue, it should be a strong win for AT&T in terms of acquiring new customers. What about the rest of AT&T? In combination with BellSouth and Cingular it’s over a $100B business that Page ‐ 2

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will need way more than the iPhone to drive it. AT&T has been doing pretty badly the last couple of years making for easier comparisons and perceived improvements. At least a few things have been going right for AT&T, including their IPTV offering, which is accelerating rapidly after a false start in 2006. The enterprise sector is at least healthy enough for it to execute an orderly consolidation plan. Lastly the company has plenty of opportunity to improve cash flow and dividends as efficiencies are driven by the combined organization. When one imagines the cost structures of AT&T/SBC/Cingular it conjures up pictures of some low-hanging fruit ripe for the picking. In short, we see the company improving operational results across the bulk of its businesses and growing the desirable segments of wireless, broadband and data much faster than the rest of the company. As a major Dow component AT&T won’t wildly outperform the market, but at these levels it still looks too cheap on both an absolute and relative basis. Compared to GE, Cisco and Verizon the shares should be 20% higher, and if the stock gets afforded a better multiple (say a 15x PE on 2008), the shares could certainly trade in the $45-47 range.

ÇÇÇ Old name in new clothes No. 2: 3Com The 3Com stock chart has been almost a flat line since the end of 2001 when it changed hands for $6/share. There was a brief rally in 2003 that brought the stock to $8.50, only to be followed by three years of dreary decline to an embarrassing $4/share — obviously left for dead, clearly off the radar. Our first positive hint about 3Com came during a client move into state-of-the-space around MIT. We were briefed on how the phone system worked and were all duly impressed. Afterwards I was surprised to discover that the system wasn’t from Cisco or Asterisk but 3Com. At the time (which was two months ago) I chalked it up to a bad decision from the distant past. But still, a mental note was made.

an opening for 3Com in this market it may come from open source. Early in 2007, 3Com made it clear it was not allergic to open source and would offer an opposing approach from the (understandably) single-vendor solutions the large companies are pushing. Could 3Com end up somehow riding the Asterisk wave? For those who don’t know, Asterisk is a very impressive open source IP PBX software solution that has been doing very well over the years, but no major vendor has embraced it yet. There is some evidence that 3Com is at least actively considering this. 3Com has completed some restructuring and purchased 100% of its joint venture with Huawei Technologies for $882M. There is little question that the success of the company will hinge on how well the newly owned unit does in meeting targets and adding to the impression that 3Com is able to deliver strong results. 3Com also has a rapidly growing security franchise (TippingPoint), which it acquired. While only 10% of revenues today, it adds to the appeal of the story and will grow in materiality from here. The momentum appears to be strong enough to carry through over the medium-term. Even though analysts are bearish (19 out of 23 have neutral or negative ratings as of March 30, 2007, according to Jaywalk), they are forecasting sustained profitability from here and revenues of $1.2B for this year. A new CEO, Edgar Masri, who is a technologist with a financial background, is driving the company. On the surface this would at least suggest a levelheaded decision making capability and management style. If 3Com can put a few decent quarters together the stock could begin to discount an improved outlook, which would translate to 2x EV/R and a stock price of about $5.70. 3Com may not be a phoenix rising from the ashes like Akamai, but it could be story similar to a Sun Microsystems, which has climbed over many doubters to reach $6/share from $4.

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More evidence of a sustainable business for 3Com in the SMB market around converged networking and VoIP came from a partnership solution with IBM. It’s no game changer, but it’s another validation point. Without it, it would be hard to consider 3Com in the land of giants such as Cisco, Avaya, Siemens and Nortel all vying for a piece of the VoIP pie. If there is Page ‐ 3 © March 30, 2007 

 

Web 20 Update and Other Barometers

business adoption is aiding continued growth in the U.S. market.

Finally! Our first Web 20 stock is getting acquired. Cisco is absorbing WebEx in a move likely to set Cisco ever more directly in competition with Microsoft. Just prior to the Cisco move, Microsoft moved closer into Cisco territory with the acquisition of Tellme. We will have to find a good replacement for WebEx in our Web 20 before August. For the month the group held up well without much aggregate change in valuation.

Figure 2 – Concurrent Skype Usage

The odd bump in the peak usage for February from 9 p.m. to 3 a.m. reflects that with Skype you don’t need money to send love on Valentine’s Day.

Figure 1 – Web 20 TTM Performance

Our Web 20 Widget for Google has been a success, and in response to client requests we will be releasing a new version this month with the ability to customize the widget to compare the Web 20 stock index with other stocks. We will send an email out with the new link in the next few weeks.

Skype Figure 3 – Peak Skype Usage

Following our overview last month showing Skype’s strong adoption trends we probed a little deeper into the data to try to discern some usage trends within this growth. By examining the average concurrent users by time of day (all times are EST) in the chart in Figure 2, we can roughly determine that growth has been particularly concentrated and continues to accelerate during the business hours of the Americas and the early evening hours in western Europe. Daily concurrent peaks consistently occur from 9 a.m. to 3 p.m. EST. Together these trends reaffirm last month’s report that

Two new features were introduced with the latest product release on March 7 that aim to facilitate the sharing of information between Skype customers: SkypeFind and Skype Prime (still in beta). Skype has received some criticism due to its lack of an actionable monetization plan. However, as the profit margins approach zero on even the most efficiently developed VoIP infrastructures (attributed to downward pressure on prices due to increased competition), only those providers that can sell value added services to their install base stand a chance of subsidizing their operations, let alone becoming a profit center. Skype is positioning itself for exactly that eventuality. Page ‐ 4

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SkypeFind is Skype’s wiki-style entry into the restaurant/product/business review market. This business has historically been hard to break into, and even those who have found their way in have had difficulty in generating significant revenue. Skype will be facing similar obstacles here. Much more interestingly, and worthy of a deeper look, is the addition of Skype Prime, the greatly anticipated service that enables Skype users to connect with one another and exchange paid services. This could be particularly interesting to contractors and freelancers and may eventually bring about the realization of the eBay “triple-play” combining eBay, Skype and PayPal. A potentially deal-breaking question is whether the two major ancillary eBay properties, PayPal and Skype, can be securely coupled together. In fact, the linking of a PayPal account to a user’s Skype account may well be the best possible solution to the identity issues that have been plaguing Skype. The strong security associated with PayPal’s “confirmed” status conferred upon its users could be transferred to the Skype user once that user has associated the two accounts together in a one-to-one fashion similarly to when eBay acquired PayPal and integrated it into its auction platform. While strictly forbidden in the terms of service, there is the distinct possibility that Skype Prime could simply act as a safe harbor for adult entertainment. If Skype communications are secure and encrypted, as they claim to be, who would know if illegitimate businesses began operating under false pretense? So, what legitimate professional would be interested in this service? Taking a look at the terms of service helps us determine the potential revenue streams and associated expenses with the Skype Prime service. As it stands now, service charges are either billed by the minute or as a one-time fee and are limited to $0.50-2.50 (€0.40-2.00)/minute and $0.50-12.00 (€0.40-10.00)/call. Skype takes a (perhaps unreasonable) 30% cut of the final payment amount. Assuming the maximum allowed charge (a call length of approximately five minutes) is reached (in USD): Gross Revenue = $12.00 * .7 = $8.40 Less: PayPal Fees = ($12.00 * 0.029) + $0.30 = $0.65

Given the lack, as of yet, of an official “directory” of services, expect to see service offerings listed on eBay’s auction site, adding another cost to the equation: eBay fees = ($12.00 * 0.0525 ) + $0.60 = $0.93 Therefore, the total revenue that the service provider would see per five minute call would be approximately $6.82. Assuming that a provider can make 10 such calls per hour, the provider would effectively get paid approximately $68.20/hour. There are many professionals that would gladly hawk their services at that rate. Of course, the end-user demand must exist as well. In order to place a Skype Prime call, users must have sufficient Skype Credit, requiring many users to upgrade to premium accounts. The service is in its infancy, and we expect that there will certainly be some tweaking during the beta period to make the service more attractive to both the service providers and consumers.

Job Listings Total job listings increased 5% from February 1 through March 31 based on the aggregated data supplied by Simply Hired. Our time series is expanding and should provide an increasing array of insights in coming months, but a few things jumped out of the numbers this month: 1. AJAX is clearly catching on in a major way with a 40% increase to 7,923 job postings. 2. Solaris seems to still be losing share (+1.2%) vs. Linux (+16.1%), Windows (+13.8%) and Mac (+33.8%). 3. Other technologies with meaningful numbers showing the best growth are Ruby, Vista, MySQL, Google and Virtualization. 4. BEA growth was a little less than we would have expected at +4.4% to 5,339 listings. It’s sobering to reflect on the sheer dominance of Microsoft in the market with 351,836 listings (vs. 91,905 for Oracle and 52,471 for IBM.)

Second Life Linden Labs’ Second Life (SL), the increasingly popular Massive Multiplayer Online Role-Playing Game (MMORPG), has drawn its share of criticism as well as praise as businesses rush to evaluate the economic viPage ‐ 5

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ability of the virtual world and determine what, if any, action should be taken to bolster their online presence in this much-hyped new marketplace.

OpenID has been anointed as the open identity solution of choice but still has a road to travel before it can reach the ease of use required for the mainstream.

A number of issues have arisen that bring into question both the scalability and the stability of the economy and underlying technology platform. Many, such as Clay Shirky, believe that the numbers released by Second Life are grossly inflated and simply too good to be true. Others believe that Linden sits atop the newest evolution of the Ponzi scheme. Linden controls LindeX, the virtual currency exchange and, at times, buys and sells Linden Dollars (L$) to help stabilize the exchange rate relative to the USD. Compared to other MMORPG economies, the L$ has remained surprisingly stable hovering between L$250-300 per $1 USD.

There’s a new kid on the Web server block. Netcraft confirms that lighttpd, which is open source, has burst on the scene at some leading Web site. It is designed for new style interactions like AJAX, and while it has a long way to go to measure up to Apache or Microsoft, it will soon pass Sun.

The normalized population of Second Life is estimated at just under 2M “residents.” The figure given by Linden, which claims a population of more than 4.8 million, is grossly overstated due to users having multiple identities or signing up and having never actually signed on. Peak concurrent users hit an all-time high of 33,000 in mid-February, up from 5,000 at the end of 2005. Linden expects peak concurrency to reach 150,000 by year end, an annual growth rate of over 350% for CY2007. Using the industry average of 30 days since last activity to determine returning users, churn rate as of March 21, 2007, was about 77%, meaning that only about 23% of users will return within 30 days of signing up.

Integrated 3D could be a key feature of Leopard and another positive software thrust from Apple to be pushed across iPod and iPhone devices as well.

Second Life is controversial but still worth watching in our view, so our coverage of its metrics will be expanded.

Agassi leaving SAP is bad enough to sell the stock. Salesforce.com (CRM) is being extra aggressive right now, making it tougher for new competition. Pricing of $9 per user per month is being advertised through April 30.

We have friends who actually tried the tablet PC form factor one last time. They just don’t seem to solve any user issues. Nobody wants them. Words to filter out of your incoming email subject lines (other than approved senders) include today, don’t miss, congratulations, complimentary, ETF, tip, and top. EBay growing in power but still has lots of significant fraud problems. Contributes to the view that doing business there is risky.

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Advertising on some leading sites such as Forbes.com, ZDNet, eWeek and many others is getting out of hand. Full screen flash advertisements and animated annoyances are getting bad enough to possibly render them less than useless.

Our most savvy investment clients have always said that what they really want is more of the material we see and think about before it turns into anything that looks like a research report. We do use our blog for that, but still, many prefer the printed word over RSS.

We’re going to see traditional media figure out how to start leveraging new sources such as blogs through editorial controls and traffic.

Random bits

So for the month this is a partial list of the thoughts we had, trends we watched and things we noted, loosely grouped by subject area.

The number of ETFs has passed the ridiculous stage and is now worth excluding from all incoming communication. (The new trend = managed accounts!)

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Nomura published a credible survey in February showing increased domestic sentiment vis-à-vis the Japanese equity market. Technology companies in Israel still don’t get much respect from institutional investors. Will they ever? Will LSE or AIM-listed technology stocks fare better?

THE TECHNOLOGY MONTHLY Kris Tuttle, Editor Pete Bishop, Analyst Charlotte Borde, Copy Editor The Technology Monthly is published by Research 2.0 12 times a year by Blue Caterpillar LLC, 1313 Washington Street, Boston MA 02118. USA Telephone: 617.381.4762. Individual subscriptions by the month or year are $32 and $256 respectively. Some free content is available via email and our blog. Please visit us online at www.research2zero.com. It is a violation of federal copyright law to reproduce or distribute any part of this publication to anyone by any means without permission (often readily provided.) Sponsorships come with internal redistribution rights and in some cases the right to distribute externally to customers and prospects is available. Copyright 2007, Blue Caterpillar LLC.

Coming in future issues… April: Gödel would be short May: Enterprise IT Update June: Future in Review Report

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