Second Life, Virtual World Platforms

Why Linden Lab is Not for Sale (Yet)

There’s a pretty simple rule for investing: buy low and sell high. Now, there’s another set of rules, and they’re a lot more complicated: how much something is worth will depend on who you ask.

In Silicon Valley, for example, something can be worth a lot even though you can’t seem to find any money changing hands. In the rest of the world, there are formulas for valuation, they’re often well known (a services company in Industry X might be worth 1.5 times earnings, for example), and they’re often adjusted based on intangibles like “synergy” and “goodwill” but you’ll usually still float around a predictable price point.

With recent changes and announcements at Linden Lab, speculation is running high that a sell-off is imminent. Tateru has read the tea leaves (and spoken to ‘a lot of people’ with ‘wide variety of business backgrounds’) and has come to the conclusion that its bikini season:

Swimsuit weather is fast approaching, and the old girl wants very much to lose about an inch off her hips so she can get into that bikini and have someone pick her up.

I do not find myself in any doubt now that Linden Lab has been positioning itself for a sale. Either that, or the Lab has some serious problems that it has not divulged. A suitor is not looking for something with too much weight on its hips, or much in the way of special needs. Prospective suitors are either looking for a trophy wife… or for a source of valuable organs.

A Lab, Irrelevant
Now, maybe I like to buck convention. Maybe I have inner angst and turmoil over a change at the Lab: I mean, who would I write about, be astounded by, and shake my head at? I mean, I do business in Second Life, but it’s just another tool in our tool kit.

I don’t deny that people can be deeply impacted by the changes at the Lab. I don’t deny that they make monumental mistakes, they don’t always finish what they say they will, they break things that weren’t broken and all the rest of it. But for me, at least, I’ve come to realize that when I look back the actual impact of their decisions (on my life at least) has been, well, negligible.

I can even think back to the days I was making and selling houses. It was exhilarating, fun, I made some money – but it was also maddening and frustrating. The Lab would change something and I’d need to check my parcel listings, or re-script the doors or whatever. But taking a slightly broader view, it wasn’t really that much different than needing to tweak a Web site to take advantage of HTML-5, or keeping an eye on Google to make sure that the keywords were still returning a high enough search result.

Technology changes, you roll with it (or you don’t), and you’re often at the whim of things outside your control – Apple either supports Flash or it doesn’t, Google either changes its search algorithm or it doesn’t, and you need to know what the latest social media gadget is so that you’re still talking in the places that your audience will listen.

So I say all this to make the point that for the most part the Lab might be idiotic, they might be tone deaf when it comes to messaging or how they implement change, but generally a few months passes and you can’t entirely remember what the drama was all about. Remembering all of this, I don’t have a particular stake in what the Lab does, and my preference would be that they sit in the background as much as possible, they do a better job providing the basics (like customer support and fixing bugs) but that they otherwise just sort of leave us alone.

A Lab for Sale?
That’s my way of saying that I don’t really think I’m doing some kind of magical thinking about where the Lab is at.

I mean, maybe I am and am so delusional I don’t realize it, but my belief is that the Lab is NOT for sale (at least not yet) and that this is a logical conclusion.

All they’re doing with all this trimming and changing, adjusting and plodding, is what they said they’d do: focus on a broad consumer market (believing that by doing so “sub-segments” would also benefit); make things fast, easy and fun; and take a new approach to how things are developed and executed.

But against the backdrop of value, I’ll return to the simple rules noted above:

Buy Low, Sell High
Linden Lab and Second Life aren’t worth as much now as they were a year ago, or 5 years ago. You don’t sell when you’re down unless you have a liquidity crisis, or you see one on the horizon.

And as much as there’s a lot of speculation that the cut-backs in staff, offices and other overhead must mean that there’s a liquidity or profitability crisis, I’m failing to follow the logic.

If your stated strategy is fast, easy and fun, if you’re going after a broad (mostly consumer) market and no longer worrying about individual constituencies (like Europe, say, or educators) then how does trimming offices and staff that don’t assist with that mandate indicate anything other than being “on strategy”?

Now, neither you nor I can see the Lab’s balance sheet. Maybe I’m wrong – maybe they leveraged all of their hard assets (how many millions of dollars in servers and other capital equipment do you think they have?), maybe sim sales and revenues have plunged drastically (can anyone point me to a statistic showing a significant decrease in revenue from server rentals?), or maybe the money they make from other sources has evaporated (can anyone show me a significant decline in a relevant statistic related to the money the Lab makes?)

So while I don’t discount it as a possibility that the Lab is losing money or is headed for a crash, I actually haven’t seen anything which indicates this is true, other than speculation that cut-backs are a de facto indication that the company is failing.

I mean – maybe they’re simply doing what they said they’d do?

I strongly lean towards discounting the theory that the Lab is losing money. But I also strongly lean towards the theory that they are worth less than they were a year ago, 4 years ago, whenever. Concurrency is flat, sales growth is negligible, and the new revenue streams from the Marketplace (the Lab, for example, will be taking a cut of purchases made using dollars rather than Lindens) and mesh imports haven’t kicked in yet.

So for the Lab to be selling now, it would be selling low. And as noted above, that’s not what investors typically try to do.

The other factor in selling a company is valuation. For a lot of companies, valuation is primarily based on trailing revenues, hard assets, and intangibles like ‘goodwill’ or ‘brand value’. In many industries, and the tech world in particular, projections play a role that’s just as important as history. And in Silicon Valley, projections are often divorced from actual money: you’re more interested in how many users (or click-throughs or user hours or whatever) a platform has than you are in how much actual cash it makes.

Based on this, Linden Lab has a suboptimal sell price because, well, it isn’t growing.

This limits its options for a sale to those companies that have existing audiences, or as part of a technology sell-off where it’s not the audience at all which is important, it’s the code.

Frankly, I don’t think the code itself has much going for it. Maybe it did 7 years ago or whenever, but I don’t think the technology assets on their own are worth a whole lot.

Linden Lab, in other words, needs growth of some kind in order to raise its market value (assuming that they are still aiming to ‘sell high’ because they aren’t faced with a liquidity crisis – an assumption I’m going with).

Due Dilligence
Now, Tateru brings up an interesting point: there have been a lot of moves at the Lab which look a lot like ‘clean-up’ ahead of a sale. Making sure that licenses are up-to-date, the Terms of Service still make sense and the rest of it. As Tateru says:

That means lean to the point of anorexia. To the point where the business becomes almost unable to function. Staff reductions, team elimination, making sure all your obscure licenses are not in breach, not even slightly. It means reducing paperwork, overhead and special deals, rechecking your intellectual property inventory, update the terms of service and so on.

It means becoming as simple as possible. Every single complication or special case that requires documentation beyond GAAP, or a meeting is going to knock a million dollars or more off the company sale price. That would also include all manner of contractors, messy overseas assets and payrolls, and special people like newly-hired CEOs. The current interim CEO doesn’t really represent that level of complication.

And I find this a very plausible interpretation although I actually tend to think that these changes are related to two things: being “on strategy” (as I note above); and the invisible hand of Bob Komin, who is rarely mentioned but is the Chief Operating Officer (working side-by-side with Philip) at Linden Lab.

Bob’s position, as noted on the Lab’s Web site, covers:

Bob Komin is the Chief Financial Officer and Chief Operating Officer at Linden Lab. In this role, Komin will be responsible for all financial matters and controls, human resources, legal and administrative functions globally. Komin will also oversee the Second Life economy, the largest user-generated virtual goods economy in the world. Prior to joining Linden Lab, Komin was the CFO for early stage solar energy start-up firm Solexel for the past two years. Before that, he was the CFO for privately-held Tellme Networks, a voice technology that is used by more than 40 million people each month. In his seven years at Tellme, Komin helped to build the business from pre-revenue stage to over $100 million in revenue and grow its employees from 160 to 300. He was also a leader of the acquisition and integration of Tellme by Microsoft in a transaction valued at approximately $800 million. After 5 years in senior financial roles at Cincinnati Bell, Komin was the VP, Finance & Treasurer of the founding executive team of Convergys, a NYSE traded company that was formed by a spin-off and executed its $225 million IPO in 1998. Komin was responsible for raising over $2 billion in equity and debt offerings while VP, Finance & Treasurer at both of these public companies.

Komin received an MBA from Harvard Business School and a B.S. in Accounting and General Science with a minor in Chemistry from the University of Oregon.

So, we have someone who has been in the position for a few months in the top position (next to Philip), and whose responsibilities include financial matters and controls, and legal functions, who has an MBA and a B.S. in Accounting, (and who has contacts at Microsoft) and we wonder why the Lab is doing what could easily appear to be nothing more than operational housekeeping?

It feels to me like Komin may be the “invisible hand” behind a lot of the recent changes at the Lab, while Philip continues to drive his strategy of ‘fast, easy and fun’.

But What About Microsoft?
Against the speculations about a sell-off was recent news that Microsoft had at least ‘sniffed around’ at the Lab.

And I’m going to leave a full analysis of that to later, but I will propose one other thing: that while tech companies are often approached by other companies, the Lab may not be looking for a buyer, they may be looking for a “Stage 2″ (or is it 3?) investor.

Bring in Microsoft, or Blizzard, or Amazon or whoever – tell them your plans, and offer to sell them a stake so that they’re in on the ground floor of the next wave – and that if things go really, really well, they can gobble up the whole thing later, once the platform is back on a growth curve.

The Investor Pitch
So where does that leave us?

My personal guess is that:

- The Lab is not facing a profitability or liquidity crisis
- Structural changes have been part of the stated strategy of focusing on a broad market and making things fast, easy and fun
- Non-structural changes (licenses, TOS, etc) are being driven by the ‘invisible hand’ of Bob Komin
- And the Lab intends to drive a high valuation by doing what it said it would do: making Second Life faster and easier to access and more fun to use.

And here’s my guess at the pitch. The imaginary dinner Philip had with the investors. And it goes something like this:

Second Life is flat. Concurrency is flat. And we can’t rely on schools or enterprise to drive the sort of massive growth that will lead to the kind of valuation we all dreamed of, where the virtual world isn’t being used by 10 million users but 100 million….or a billion.

Give me 12 months because we can turn this around. And the strategy is really simple and it goes like this:

- There are two things that will drive the valuation of Second Life. First, it’s a social media platform. It connects people. Key to this is that when it connects people, it does so at a level of engagement that can’t be matched.
- Second, it has the largest virtual goods market in the world. Virtual goods are the future and we see it with Zynga and we see it in the fact that the market has grown to exceed a billion dollars.
- As a social media platform with a large virtual goods market, we’re sitting on gold. The problem is, we need more users. And in order to get more users, we need to get more people in and we need to make that fast and easy to do.

Our strategy for growing this social media/virtual goods platform includes three interlinking parts:

- Raising the bar on content by providing new tools, like mesh import, expressive avatars and new controllers (think the Wii or Move) and then using the availability of these tools to create significant strategic partnerships around content development
- Drive the virtual goods marketplace by using the newly designed Marketplace as the launch point for new in-world shopping experiences (Marketplace in the Viewer) and the ability to port the Marketplace to other platforms like Facebook
- Make access to Second Life easier by launching a new “no-download” product that utilizes server-side rendering. With no download and access to Second Life as easy as launching a Web site, we’ll be removing one of the major barriers to new users.

Tactically, this will mean significant changes. Among these changes:

- Second Life doesn’t need significant technical development. We need to fix the Viewer, because it’s the ‘portal’ through which both users who download the client and those who access SL through a browser will “see” the world, and it’s the platform from which we can launch social media integration and a full “side-tab” Marketplace experience. So, we’ll be able to trim technical development costs to focus primarily on bug fixes, stability, the Viewer 2.0 and new products. But we’ll be able to trim this to the bone because our main focus will be driving new users
- Our customer support, community support, and vertical outreach needs to be scalable. If we’re targeting 100 million users, we can’t afford the types of hands-on support we’ve been giving to education, geographic markets or sub-communities. We’ll close off all efforts that are high-touch and with Bob Komin at my side, we’ll focus on scalability (which means scalable out-sourcing of customer service, automated systems, consistent pricing across segments, etc).
- With the money saved from the above, we’ll be able to invest significantly in new marketing and advertising. I’m pleased that we’ve been joined by Kim Salzer as new VP of Marketing – if anyone knows how to do marketing to ‘scale’ it’s Kim, whose background at Blizzard on titles like Call of Duty are nothing if not mass products.

Sure, we’ll hear moaning and complaining. It will seem, at first, that we’re cutting our nose to spite our face. But those sorts of problems will take care of themselves as we move from a world of 10 million to a world of 100 million – and return to the days when Second Life was the Next Big Thing.


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