Google Company Was Doing Revnues $100M+ With Arbitrage
Fri, 07 Mar 2008 13:46:22 -0600

Awesome story in the Financial Post Today

Cover story: Blown away

A record $160-million VC investment. A rich Web strategy. A quirky founder. For a few weeks last spring, Guelph, Ont.’s Geosign had it all. Then mighty Google stirred. And it was over

Kevin Hewitt
(http://www.financialpost.com/magazine/story.html?id=324817)

It started simply as another "town hall." No surprise in that - Geosign Corp. employees were used to town-hall meetings because they happened almost monthly. Staff would leave the office, pile into cars and make the short drive to the Holiday Inn on the south edge of sleepy Guelph, Ont., where Geosign was located. Once assembled, they'd typically get an earful from management about the business, new initiatives and big plans for the future.

The only difference this late May day was that the meeting had been hastily arranged, with employees directed to the hotel that morning. But why worry? Just 12 weeks earlier, Geosign had joined the elite list of hottest Web companies in the world. After operating for seven years in near-anonymity, an hour's drive from the prying eyes of Bay Street, Geosign landed the largest-ever venture-capital investment for a Canadian tech company:

$160 million, for which U.S. investor American Capital Strategies Ltd. got a "significant" minority stake. At that time, Geosign said it had more than $100 million in sales. And it was hiring new employees like crazy. At the previous town hall in mid-April, CEO Ted Hastings, who took over from Geosign's founder and chairman Tim Nye that January, discussed a new facility they were planning for all the staff, then numbering more than 250. There, they would keep building their online media "powerhouse." Geosign boasted a network of 180 websites, with consumer news and information content ranging from hockey to girlfriends to lawn furniture. It said it had created a technology that drove traffic to its sites through placements in search engines, with up to 35 million unique visitors landing each month. Given the red-hot interest in Internet advertising, American Capital managing director Virginia Turezyn said Geosign's true value lay in its "automated systems," not its content.

For everyone arriving at the Holiday Inn, the future seemed golden. But as soon as they were assembled, things turned strange. Each employee was handed an envelope. In the envelope was a piece of paper with a geometric shape on it - triangle or square. That's when the bomb dropped. Hastings told the assembly that there had been a massive change to the company's business model, brought about by search engine and Web advertising giant Google Inc. It would require massive adjustments, but Geosign would persevere, he said. Stunned employees tried to decipher what was happening. Many had just joined the company to create "webzine" content packages for its sites. What did Google have to do with their online magazines anyway?

Those with triangles in their envelopes were directed to speak with human resources staff on the premises. Regardless of their circumstance or how long they'd been with the firm, the triangle indicated their time at Geosign was over. Between 50 and 100 people were cut that day, with many more to follow. "It was awful," says one former employee. "None of us knew what was happening. It didn't make sense. The woman standing next to me had just quit her job and moved to the city to start. She burst into tears when she realized she'd just been fired."

Companies fail all the time. Sometimes with little warning. But companies that are highly profitable and only weeks removed from a record-setting venture capital investment? Not so much. Yet in Geosign's case, the cuts that began last May continued through the summer. Late last year, fewer than 100 employees remained. Today, Geosign itself no longer exists, its still-functioning website an empty reminder of its former promise. And while the national business media has, until now, overlooked the story - surprising, given the size of the investment and the fact that Google played a direct role in the outcome - within Canada's technology and venture-capital communities, the $160-million investment is known as the deal "that didn't go well." When the collapse happened, even jaded industry watchers accustomed to financial debacles in the tech sector were stunned. "I've seen a lot of meltdowns," says Duncan Stewart, a technology and investment analyst in Toronto. "But something happening like this, over just a few weeks, that's unprecedented in my experience."

The same question occurs to everyone: How did a business making $100 million a year, a company so full of promise, disintegrate so quickly? With Geosign, it turns out, there's more to the tale than anyone directly involved has so far been willing to say. And much of it revolves not around its plans for a content powerhouse, but the story of how the Guelph startup found a loophole in Google's vaunted advertising model, enabling it to make boatloads of cash - until Google decided enough was enough.

It's hard to know exactly what Tim Nye had in mind when he established Geosign in 2000, the same year Google launched its first keyword-targeted ad program, the money-spinner at the core of its enterprise. "Geosign wasn't much more than a shell at that time," says Jim Estill, CEO of Synnex Canada, a Toronto-based computer distributor, who invested in two of Nye's earlier ventures. "But it had Tim, and he's one of those consummate entrepreneurs who fails sometimes but keeps coming up with new ideas." Nye's first company, Carbotek Computing, had been a computer parts distributor. His second, a software company called CadSoft, was a "marginal success" according to Estill. Nye sold that in 1998.

Estill says Nye bucked conventions, wore his hair long, preferred jeans to suits and had bold ideas. "He's technically creative, the type who knows what computers can do," he says. "There's a tendency in the press to make everyone either a dog or a god. The truth is most people are somewhere in between. Tim is no different. He has shortcomings, but he's also a highly creative guy."

Retracing Geosign's origins through old news stories, Nye sounds like he spent considerable time searching for a business model. In early interviews, he described Geosign's business in vague terms, suggesting it was somehow linking online consumers with local businesses. "The market is connecting buyer to seller, and up to now, the consumer has been left out," Nye told the Guelph Mercury in 2001. He called his new technology "geosearching," and added that his company had inked an arrangement with an Internet search engine, but wouldn't disclose the name. Still, he told confidantes and investors that he had grand ambitions for Geosign extending far beyond Guelph, concepts that would create a business with huge upside. Not that anyone outside of a small circle knew of Nye's plans. For the next five years he stayed out of the limelight. Even in a small city like Guelph, he and Geosign garnered no media attention.

Meanwhile, as Nye tinkered away in silence, Google was doing just the opposite, laying claim to the title of most popular search engine. More significant, perhaps, was the success of its keyword-targeted ad program. To recap, Google began selling advertisements associated with keywords that would be searched by Internet users. Pricing of keywords was based on a combination of bidding and click-through use. As Google's popularity soared, so did the price it could charge for linking an ad to a keyword. For example, if your company wanted the phrase "car accident lawyer," it could cost upwards of US$38 per click to have the most prominent ad link on the Google page when that term was searched. Less common phrases cost less, as little as 5¢.

In 2003, Google made another huge leap forward on the advertising side, with the launch of its AdSense program. Essentially, this application allowed people to put keyword-targeted ad links, served by Google, on their own websites, with them and Google splitting revenue tied to the volume of user click-throughs. As its popularity grew, a cottage industry began to develop called "search arbitrage." Essentially, search arbitrage involves an individual or company buying Internet traffic through the acquisition of keywords from Google, then sending viewers who click on the ad links to a site ("landing page" in Google terminology) that appears to have content, but is actually just full of online advertising linked to the original search term. Anyone clicking an ad link there makes money for the keyword holder. For example, a company might bid for the Google rights to the phrase "small town car sales" and send traffic to a website it controls, filled with more car advertisements, called "Alltheautomotive.com." The keyword cost only 20¢, while a click on the advertising on the website might yield $1.50 return. According to Niki Scevak, an analyst at Jupiter Research in New York, the majority of those initially involved in search arbitrage were small players. "These were guys running search arbitrage out of their basements, making maybe $20,000 a month," he says.

As the possibilities of the arbitrage business became apparent, however, other more ambitious players got interested. One of them, it seems, was Geosign. While both Nye and Hastings declined to comment when contacted for this story, former Geosign insiders who spoke on the condition of anonymity confirm that the possibility of a big payoff in search arbitrage caught Nye's attention after he created Geosign. What's more, he envisioned a network of thousands of websites all automated by software linking keywords to pages filled with ads, returning millions in cash in the process.

By 2005 that was exactly what was happening. Nye crafted a maze of Internet sites that included tens of thousands of Web pages and bought up even more keywords from Google. By connecting the keywords and the websites, Geosign was indeed generating more than $100 million in annual revenue and was extremely profitable. To put a value on the company at this time, analyst Scevak points to Marchex Inc., a publicly traded company in Seattle, Wash., with a comparable business model. At its peak in 2006, Marchex had a market capitalization of US$500 million.

Meanwhile, Nye began to run Geosign like his version of a California dot-com at the peak of the investing craze in the late 1990s. He brought three Segway Personal Transporters into the office. "They didn't make any sense at all given the size of our offices," says one former employee. "But we used them anyway." Wolfgang Puck gourmet coffee makers were soon introduced, free Perrier abounded and rumours circulated that staff lunches would soon be catered. A lavish Christmas party thrown at the end of 2006 saw employees head home with iPods and gift certificates worth of up to $1,000. The grand prize was a lease on a Toyota Prius. Fittingly, Nye dressed as Santa for the event. "It was amazing while it lasted," says another former employee.

Even as the perks flowed, many Geosign employees, especially those the company hired in 2006 to start developing a new online publishing division of the business, weren't necessarily aware of where the money was coming from, especially as the websites they designed struggled to find an audience. "It didn't make any sense to me," says another former employee - one of many contacted through a Facebook group set up after the first big round of layoffs last May. "There was all this money around, but the website I was working on had like 1,500 visitors a day."

There were other oddities, as well. One Geosign staffer recalls being asked to work through weekends in late 2006, in order to add text to Web pages that appeared to be nothing but ads. "They told us it could be our B-grade writing," the ex-employee says. "We were writing for strange sites like roundtables.info and sticks.info. And we were just writing a paragraph or two. It didn't seem to matter what we wrote."

The change in atmosphere had everything to do with measures that Google was taking to rein in those doing search arbitrage. This action was a response to two main concerns. First, that the practice was becoming so widespread, it was hurting legitimate advertisers by artificially inflating keyword prices. And second, that if too many keyword-targeted ad links only took users to pages filled with other ads, that users would lose interest and faith in the online ad system. Obviously, with advertising revenue being the key to Google's finances, it had to respond. It did so by expanding the terms of service for its AdSense program (published on its website) to place greater restrictions on the way links could be used and by spelling out detailed landing page and site quality guidelines. A top priority there: relevant and original content. By these standards, a landing page full of ads is inadequate - as this text in its current guideline explains: "Provide substantial information. If your ad does link to a page consisting mostly of ads or general search results (such as a directory or catalog page), provide additional, unique content." Since most companies doing search arbitrage bought both their keywords and landing page ads through Google, it was easy for the company to isolate and monitor them. Non-compliant parties risked being banned from the AdSense program. A simpler tactic, however, saw Google target those abusing the process, raising their fees and making it too costly to continue.

For the moment, Nye and Geosign were still a step ahead. Instead of buying ads and keywords from Google, Geosign had always purchased keywords from the search engine company and directed the traffic to sites filled with ads from rival Yahoo! That meant Google was receiving millions of dollars from Geosign for access to its keywords, but didn't know where the traffic was directed. Given the amount of money flowing to Google, most in Geosign thought the search engine would turn a blind eye.

But not Nye. Geosign insiders say Nye voiced concerns that Google could eventually move against arbitrageurs utilizing the Yahoo! model. That left him with a decision ­- to continue running Geosign and hope Google would continue to accept the company's money even if it didn't like the business model, or to search for something that might one day replace the arbitrage revenue. With the online advertising market for content-oriented sites growing rapidly, Nye decided to move into Web publishing. He purchased still more domain names and began hiring staff to create "webzines" focused on everything from sports to travel. Nye's plan, insiders say, was to develop a legitimate content business before Google cracked down on its arbitrage angle. This explains why Geosign quickly began hiring so many reporters and editors, and why it begin to talk about itself as a big-time online media play.

Nye knew he had to move fast. He also knew he needed to make acquisitions on both the content and advertising sides of the business. That would require more cash than Geosign had on its own. Soon, Nye began seeking venture capital and private-equity investments. In early 2007, American Capital, which calls itself an "alternative asset" management firm, won out over several suitors.

The deal was announced in the first week of March. But even that had an odd twist. Nye was not available for any interviews, with the exception of some comments he gave to a couple of tech industry bloggers. In one case, he said the money was critical to his "BFE - big empire strategy. I forget what the ‘f' stands for." For his part, Hastings only spoke publicly for a very short time before he, too, clammed up.

A source inside the company says their behaviour stemmed from fears that the more they talked, the more they would attract Google's attention. For this same reason, some insiders had apparently advised against partnering up with American Capital prior to the deal, because it was a public company and therefore had to disclose the investment.

While no one at American Capital would comment for this story, sources say it was well aware of how Geosign made its money and what it was planning going forward. It was, in other words, placing a bet that Google would not take steps that would alter Geosign's lucrative business. "Since we didn't know Google like we do now, the question always was, ‘Is someone really going to shut off the kinds of dollars we were paying them?'" a former Geosign employee says. "It turns out the answer was yes."

The end came suddenly, well before Nye and American Capital could reposition the business - in fact they were still hiring new employees in the days leading up to the layoffs. Google had started to look more closely at companies like Geosign, which were buying keywords from Google and ad links from Yahoo! or another provider. And soon Geosign got word that Google would now begin penalizing its Web pages that had "a low landing page quality score" - that is, lots of ads and little or no original content. While Google won't comment specifically about Geosign, sources say it raised the prices it charged Geosign for keywords overnight. "When Google ‘shuts you down,' that isn't exactly what they do," explains Jupiter's Scevak. "Instead, what they do is start charging you $50 for what they were charging 10¢ for previously. They make the model financially unfeasible."

Sources say the American Capital deal included provisions whereby it would recover its money if things fell apart. "As any private-equity firm does, they find a way to make sure they come out OK," says one former Geosign executive. "If they are going to put $160 million into a company, they are going to make sure that if something bad happens, they are holding the keys to the castle."

Negotiations dragged on through 2007. Ultimately, American Capital reached a settlement with Nye that saw two new companies created. American Capital got control of Geosign's marketing and advertising assets and spun it off in a new company called Moxy Media Inc., with ex-Geosign CEO Hastings as chief executive. In early January, a spokesperson for Moxy Media confirmed that it has about 50 employees and had recently acquired Florida-based SWI Digital Inc. "Life goes on," says one insider. "You might not be thrilled with where it is, considering what it had been, but search marketing is still a viable business." American Capital's latest securities filings peg Moxy Media's value at US$128 million - which means the sum of Geosign's former assets are worth less than American Capital's original minority investment.

Besides remaining tight-lipped about its Geosign experience, American Capital has apparently tried to keep a tight leash on Geosign's former employees, many of whom were asked to sign a non-disclosure agreement before receiving their severance. An employee who spoke with the Guelph Mercury was sent a letter warning about the repercussions of talking with the media.

As for Nye? He came away from the breakup with what one former executive describes as "assets with little value" - a few domain names, such as hockey.com and golfcourses.com, a few staff and little else. He created a new company called eMedia Interactive Inc., where he is listed as chairman.

A final attempt to contact him to see if he'd be willing to put his version of events on the record for this story yielded a short response. "As part of the transition, I signed a confidentiality agreement, which would prohibit any comment from me," he wrote in an e-mail. "I have some exciting things in the works. But I am not comfortable adding anything else at this time."

In time, he might talk about his new venture, he says, but there is "no benefit for any press at this time." Those close to Nye say he did very well financially with Geosign even before the American Capital deal, has a home in Barbados, and often uses a local service to charter private jets. Even though his dream of creating a publishing empire in Guelph seems to have ended - a handful of staff were recently let go from eMedia - those around him wouldn't be surprised if he resurfaces with another company. "There won't be any penny sales for him," says Estill, who thinks Nye could produce a lasting hit if the right concept catches his fancy. "He knew he was living on borrowed time at Geosign. He had a golden goose - it just didn't lay eggs forever."

To view The Kid's complete poker party blog, please visit:
http://burnandturnpoker.blogspot.com

Joseph Hachem

Birthplace: Lebanon
Current Residence: Melbourne, Australia
Nickname: Hash, Back Cracker

Joseph Hachem is a 41 year old poker player who just won the 2005 World Series of Poker Main Event. It was a remarkable run for the man from Australia as he wins the main event in his first ever appearance at the World... [more]

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