MZ (Machine Zone) and Its Satori Platform

Satori® – Towards a P2P Crypto-Economic Platform

 

Towards A Crypto-Economic Market Design: Discrete-Time, High Frequency, P2P

 

Machine Zone (MZ): A $10 Billion Dollar Unicorn in the Making

 

Edge Computing Use Cases for MZ’s (Machine Zone) Platform

Machine Zone and The Perversity of Unicorn Lists

 

Machine Zone (MZ): A $4 Billion Unicorn That Walks the Walk

 

Machine Zone: IPO or What?


The Bancorp (TBBK): Will a Florida Hotel Loan Default Ruin Its 1Q18 Financials?

Postscript: May 18,2018

Literally “at the 11th hour” on April 26, 2018 the night before TBBK announced 1Q2018 earnings, the bank signed an agreement to sell a troubled Florida hotel construction loan with no loss due generous bank-financing coupled with a pre-packaged bankruptcy that subordinated EB-5 lenders.  This last minute sale avoided the a 1Q 2018 loss that we predicted when this paper was first published on April 8, 2018

Then on May 16, 2018, The bank issued an 8-K announcing that the purchase agreement for the sale of the loan has been terminated.   We can can only speculate that it was the new buyer who got cold feet and backed out, given the spate of lawsuits filed by lawyers representing Chinese EB-5 investors .

Summary (originally published April 8, 2018)

The Bancorp still has continuing problems with a discontinued commercial loan portfolio first set aside on its balance sheet over 3 years ago.

The bank will likely book additional markdowns on a $37 Million loan made on a troubled Ft. Lauderdale hotel construction project with the developers finally filing for Chapter 11 bankruptcy protection in March 2018.

We estimate this additional markdown at $7.4 Million — sufficient to cause an overall loss for the bank when it reports its 1Q18 financials late in April 2018.  On the other hand, Wall Street analysts are forecasting a profit for TBBK averaging $.18 / share  or a profit of $10 Million.

 

Disclosure

We have received no remuneration for this paper. We have never received any remuneration for any of our 6+ papers about The Bancorp’s “continuing problems with its discontinued operations.”  

Our financial analysis is often directed toward deceptive accounting practices of corporations.  But, it is against our nature to talk to, or work with, opportunistic lawyers suing corporations.

We do not currently have a position in the Bancorp’s stock and do not intend ever to take a position in the stock.  Information in this paper, including forecast financial information, should not be considered as advice or a recommendation to investors or potential investors in relation to holding, purchasing or selling securities.

 

Introduction

The Bancorp (NASDAQ: (TBBK) is a publicly-held Philadelphia regional bank with a diversified loan portfolio.  It is also known for being one of largest issuers of reloadable prepaid debit and gift cards in the country.  

On March 7, 2018  two Florida LLCs filed for Chapter 11 bankruptcy to stave off foreclosure by TBBK on a $37 Million construction loan for a hotel in Ft. Lauderdale.

Note to analysts privileged to be in on TBBK’s quarterly conference calls:

  • Frank Schiraldi – Sandler O’Neill
  • William Wallace – Raymond James

Ask CEO Damian Kozlowski why a Philadelphia area bank has a history of making bad loans in Florida — this construction project in Ft. Lauderdale and the The Fashion Square Mall in Orlando, Florida discussed later)

During 2017, TBBK put together a string of four straight quarters of profits before deferred tax adjustments, largely because of no new material write downs on loans in its commercial loan portfolio set aside in late 2014 as a “discontinued operation.”  

CEO Damian Kozlowski stated in TBBK’s 4Q17 conference call :

While we may continue to have some gains or costs to resolve some of these credits, we believe that these portfolios are correctly marked, and that these adjustments will not significantly adversely impact our operating performance.

The purpose of this paper is to show that CEO Kozlowski is wrong.  TBBK once again has “continuing problems with its discontinued operations” that very likely will have a significant adverse impact on its 1Q18 financials.

 

The Timeline of the Las Olas Ocean Resort Loan

On January 25, 2018, The Bancorp (TBBK) filed foreclosure papers on two real estate LLCs in Florida Southern District Court.  

On March 7, 2018  the Florida LLCs filed for Chapter 11 bankruptcy protection to stave off foreclosure.

The Bancorp originated the loan in 2013 for $50 Million for the construction of a 12 story hotel called the Las Olas Ocean Resort at 550 Seabreeze Boulevard in Ft. Lauderdale, Florida.  This loan was part of the real estate loan portfolio set aside in late 2014 as a “discontinued operation.”  

Five years after the loan origination, the hotel was still unfinished and the loan balance was a reportedly $37 Million.

Below is a timeline of this loan.  At one time, we thought that the bank should have disclosed the January 25, 2018 foreclosure filing as a “subsequent event” on its FYE 2017 10-K filed in March 23, 2018.

In any case, we would be totally surprised if the bank failed to make special mention of this loan when it reports its 1Q18 financials sometime in late April 2018.

 

The South Florida Real Estate News  disclosed that financing for this hotel included $30 million in financing from Chinese investors via EB-5, a controversial Federal government program that fast-tracks 10,000 immigrant visas requests in return for at least $500,000 in qualified, job-creating investment

According to the publication, the project suffered numerous delays due to zoning problems and was unfinished at the time of the foreclosure…

“including have to wait nine months for a Broward County approval of architectural and engineering plans. Another six-month delay was in order to comply new Federal Emergency Management Agency flood plain requirements.”

The publication also reported that the lawsuit alleged that the developers

“… failed to finish the resort by its planned March 2017 completion date, failed to make its December 2017 loan payment…,”

The Unfinished Las Olas Ocean Resort in Ft. Lauderdale, Florida.

 

 

 

 

 

 

 

 

 

The Bancorp’s Continuing Problems with Its Discontinued Loan Portfolio

On October 31, 2014, The Bancorp announced that it was discontinuing its $1.2 Billion commercial lending operation.  It set aside this portfolio on its balance sheet, claimed it was marked-to-market, and that the bank was actively seeking buyers.  Since that announcement, the bank has had considerable trouble selling off the most troubled segments to third-parties.

We have written a number of papers since early 2015 detailing “continuing problems with its discontinued commercial loan operations.” There have been two basic points we have tried to make:

  • The portfolio was not fairly marked initially because “fairly marked assets sell fairly quickly.”
  • Once the bank began to take additional markdowns, the hits to equity brought it close to going below the Dodd-Frank standard of a “well-capitalized bank.”

A full recap of The Bancorp’s problems can be found in our  “The Bancorp: ‘An Extend and Pretend’ Loan Operation That Will Never End”

Throughout 2016, The Bancorp’s (TBBK) stock suffered a series of double digit declines on the day of quarterly earnings announcements dominated by new revelations about defaulted loans followed by foreclosure filing by the bank followed by bankruptcy by the borrower.   

In 2Q16,  it was the disclosure of a bad $30 Million loan to the owners of The Schuylkill Mall in Frackville, PA).  In 4Q16, it was the disclosure of a bad $42.2 Million loan to owners of  The Fashion Square Mall in Orlando, FL

Since a low of $5.01 per share on the day of the announcement of its 4Q16 and full year FY16 results in early February 2016, the bank’s stock has risen 119% to close at $10.99 a share on March 15, 2018.

In our opinion, this rise is largely due to an absence of new revelations about its discontinued loan portfolio rather than any fundamental improvement in its continuing operations.  

 

An Estimate of the Impact of $37 Million Loan Default on 1Q18 Financials

First, a single loan default, and subsequent foreclosure on a borrower who, in turn files for Chapter 11 bankruptcy protection, normally does not have a material impact on publicly-held bank’s quarterly earnings.

But, we think that in this particular loan default will have a material impact on 1Q18 earnings due to a combination of

  • A history of the TBBK under-reserving for its discontinued loan operations, and
  • A history of quarterly earnings from continuing operations coming in around $7 Million — tepid for a bank with $4+ Billion in assets.

First, we need to mention that there are two pieces to the bank’s discontinued loan portfolio.  The Bancorp peeled off one piece at the end of 2014 to an unconsolidated entity call Walnut Street LLC.  We have questioned TBBK’s election not to consolidate this LLC in our September 2016 paper The Bancorp: A Test for Post-Enron GAAP.

The other piece TBBK set aside on its balance sheet as a discontinued operation.

It took TBBK two full years to provide real color on the relative toxicity of the two pieces.  Even this was buried at the end of a press release announcing its 4Q16 results in February 2017.  The Bancorp finally disclosed how toxic unconsolidated Walnut Street LLC portfolio was relative to what was kept on the books.

Furthermore,  GAAP allows The Bancorp to value the two portfolios differently. For the portfolio still on its books, TBBK uses mark-to-market accounting with quarterly updates. The accounting is entirely different with the off-balance sheet Walnut Street LLC.

The LLC itself uses mark-to-market accounting internally per GAAP.  But because the LLC is unconsolidated and overwhelming financed by notes taken back by The Bancorp,  TBBK uses note valuation based on cash flow to account for the LLC’s portion of the loan portfolio. This gives them more of a cushion in accounting for changes in loan performance.

Below is our spreadsheet comparing the markdown of the two portfolios.  A more extensive comparison of the two portfolios can be found of in our 2016 paper  “The Bancorp: ‘An Extend and Pretend’ Loan Operation That Will Never End”.

The Bancorp has a history of  late accounting for losses on its discontinued loan portfolios. In 2016, TBBK P&L took a series of material hits to its P&L totalling $77.2 Million. 

While the bank does not name the specific loans associated with  markdowns / note write-offs, we believe that a majority of the $77.2 Million came from two loans where the borrowers eventually declared bankruptcy:

We believe that the majority of a 2Q16 markdown / note write-off of $31 Million came from Schuylkill Mall loan.  It was first significant loss the bank recognized since the bank first announced the discontinuation of commercial lending operations on October 30, 2014.

During the 2Q16 Conference Call, one analyst quipped, “.. maybe you guys ripped the Band-Aid off this quarter..” and went on to say he was unsure whether these losses were a one-time event or the beginning of a more forthright examination of the valuations of these troubled loan portfolios.

The bank’s history of catch-up loan reserve accounting support our belief that the bank will have to make additional mark-down in 1Q18.  Even with our estimated 41% markdown already booked on the Las Olas property, we think there will have to be more taken.

To be fair, the Las Olas hotel with its unfinished interior is still  salvageable and located on prime waterfront real estate whereas the Schuylkill Mall was not salvageable and torn done in 2018. The Orlando Fashion Mall was located in a prime area, but requires extensive redevelopment as a hotel and office complex.  

The figure for the estimated markdown at the time of the default — 41% — comes from the bank’s 4Q16 disclosure on average markdown of loans in its discontinued loan portfolio.

The figure for the additional markdown due to the default and subsequent Chapter 11 bankruptcy — 20% — is consistent with what we think TBBK took after 2016 Schuylkill Mall and the Fashion Square Mall loan defaults, foreclosures and subsequent bankruptcies.

 

 

 

 

 

 

 

 

 

 

Below is the history of TBBK’s net earnings for the past two years broken down into three components

  • Continuing operations less returns from unconsolidated Walnut Street LLC
  • Discontinued operations including markdowns
  • Returns on notes receivable from the unconsolidated Walnut Street LLC

Based on normal net income from continuing operations in 2016, we estimate 1Q18 net income from continuing operations at $7 Million.  Couple that with our estimated $7.4 Million additional markdown of the Las Olas property, we arrive at a $400,000 loss for TBBK in 1Q18.

Wall Street analysts currently are forecasting a profit for TBBK in the neighborhood of $10 Million.

This loss will be the first for TBBK in 4 quarters.

Given the toxicity of the loans remaining, we stand by our 2016 paper title:


The Facebook – Google Duopoly — Where They Differ?

Summary:

Facebook and Google differ fundamentally in the degree of adtech vertical integration.  Facebook only has a significant internal supply side platform (SSP).  Google has a significant SSP, ad exchange, and a demand side platform (DSP).

Facebook recognizes that its supply of ad impressions has reached a ceiling due to user annoyance of ads in their feeds.  With supply now inelastic within Facebook, there are three options open to increasing revenue — quantity times unit price.

  1. Get into selling impressions outside its “walled garden” which it has done through a retargeting business.
  2. Assert its pricing power as a duopolist and just “shift up the supply curve” (i.e. limit ad impressions).
  3. Work to “shift up the demand curve” of advertisers by sharing user data with independent DSPs to improve ad buy ROI resulting in a willingness to pay higher prices.

Option 2 exposes Facebook to antitrust lawsuits.  Option 1 and 3 are promising, but it relies on a sharing of user data with independent demand side platforms (DSPs) which has become problematic due to the Cambridge Analytica debacle.

We make the case for Option 3.

 

The Facebook – Google Duopoly

The intermediate market for digital ad impressions is now dominated by the Google – Facebook duopoly.  In 2017, the duopoly’s total share of ad impression sales was estimated at 60.4% (see below).

In the fast growing digital native ad subset market, the duopoly’s share rose to 91.9%.

The data above largely reflects ads embedded in mobile and PC content.  The market for real time ad impressions embedded in ad-supported streaming TV — as opposed to subscription-supported Netflix and Amazon Prime — is just beginning.

 

The Intermediate Market for Digital Ad Impressions

On the extreme demand-side of the digital ad impression market are advertisers wishing to buy ad impressions and on the extreme sell-side are content publishers selling ad impressions.

Between advertisers and publishers is an adtech intermediate market. It consists of supply-side platforms (SSPs) also dominated by Google and Facebook with Amazon being a fast riser in the SSP space.

Next comes ad exchanges where transactions and pricing takes place increasingly via real-time auctions.  Google dominates with DoubleClick AdExchange. Facebook launched its own FBX in 2011 but let it slowly die over the next three years.

Next comes demand side platforms (DSPs), which is the most competitive segment.  Google has its own internal DSP called DoubleClick Bid Manager which dominates ad buying both on Google’s “walled garden” of search and on its own subsidiary YouTube.

Facebook has an internal DSP called Facebook Ad Manager useful to small and medium business wishing to buy ads within its eponymous “walled garden.” But, Facebook seems to be holding back from customizing its internal DSP to cater to large advertisers with unique needs.

Because of the publicity surrounding Cambridge Analytica, Facebook is under enormous pressure to pull back all the ways its allows third parties to access its user data.  We think it would be “throwing out the baby with the bathwater” if Facebook were to pullback of all adtech — SSP, AdEx, and DSP — within its “walled garden”.

Rather, it needs all the help it can in filtering out “lemons” ala George Akerlof’s iconic economics paper “A Market for Lemons”.  It is in Facebook’s own interest to foster independent DSP’s with “clean room” access to data (see below).

 

The Focus of Antitrust Concerns

The sheer scale of the Google – Facebook duopoly is the current focus of antitrust concerns. But, the extent of the duopoly’s vertical integration —  owning the full vertical stack of businesses from content publishing to a SSP to an ad exchange to a DSP — needs to be analyzed in much greater detail by adtech experts for potential antitrust violations.

Antitrust concerns so far has focused on the supply side with the most recent flare-up being Facebook’s decision to limit third-party news feeds inserted into the social graphs of Facebook users.

This supply-side focus on content is understandable as such developments hurt the job prospects of the very paid  tech and business writers [ not us 😉 ] who write about Google and Facebook.

In contrast, we think a recent development on the demand-side  deserves more attention. This is because it signals that Facebook is seeking to deflect antitrust concerns by actively assisting in the development of strong, independent DSPs.

 

Facebook’s Effort to Foster Strong Independent DSPs

In December 2017, TechCrunch published an article describing how an internal Facebook team of 100 engineers has been working with big advertisers to develop their own customized DSPs.

Right off the bat, this revelation is a clear sign that Facebook today does not intend on repeating the anticompetitive tactics used by Microsoft in the mid 1990s.  Back then, Microsoft used its control over the dominant Windows PC operating system to throttle the ability of users to replace Microsoft’s own default browser with a popular third-party browser developed by Netscape.

Notwithstanding the antitrust motivation for supporting independent DSPs, Facebook’s initiative is good from a pure business perspective.  Facebook realizes that improving ROI on purchased ad impressions via reduced information asymmetry translates into a willingness by advertisers to make higher bids for “peaches” instead of “lemons” ala George Akerlof’s iconic economics paper “The Market for Lemons”.

Indeed, we see the current digital ad impression market as the “mother of all markets for lemons”  including the following list of extreme conditions for markets with information asymmetry between sellers and buyers:

  • zero marginal cost on both sides creating lemons and traps
  • dueling artificial intelligence (AI) on both sides morphing sell-side lemons and buy-side traps
  • real-time auctions
  • low latency rendering and fill of ad after purchase of impression
  • double interrelated information asymmetry (see below)

 

Facebook’s Options For Increasing Revenue

Facebook recognizes that its supply of ad impressions has reached a ceiling due to user annoyance of ads in their feeds.  With supply now inelastic within Facebook, there are three options open to increasing revenue — quantity times unit price.

  • Get into selling impressions outside its “walled garden” which it has done through a retargeting business.
  • Assert its pricing power as a duopolist and just “shift up the supply curve” (i.e. limit ad impressions) which it in effect has done by limiting outside news feeds.

Facebook Option 2: Shift up the Supply Curve

  • Work to “shift up the demand curve” of advertisers by working with independent DSPs to improve ad buy ROI resulting in a willingness to pay higher prices.

Facebook Option 3: Shift up the Demand Curve

Facebook is signaling that it is giving option 3 a try.

Here is a great quote from an April 2017 adExchanger article on digital ad prices as a reflection of quality and the opportunity for Facebook to receive higher prices — shift up the demand curve  — from advertisers and agencies using more discriminating DSPs.:

We buy it cheaper” used to be the lead differentiator in a pitch. Today, agencies that lead with “We can buy digital cheaper” have a sign taped to their back that says, “We buy lots of fraud.” Low prices in digital media are not only no longer a badge of honor, they’re a warning sign.

Here is a quote from the TechCrunch article on the ROI improvement coming from DSPs built with the assistance of the Facebook engineering team:

Facebook says that on average, clients working with the solutions engineering team see their return on ad spend improve by 100 percent.

The article mentioned that after working with the Facebook team to improve the performance of its own internal DSP,  the mobile game company MZ (formerly Machine Zone), has spun off its internal DSP as an independent business called Cognant ®.

It should be noted that even before the spin-off, MZ was already the largest “direct response” advertiser in the world and likely on Facebook itself.

As Facebook’s largest direct response advertiser, MZ was the likely first recipient of access to Facebook user data located in “clean rooms” on Facebook servers.  Here is a February 28, 2017 description by AdExchanger of the linkage:

Google and Facebook are each responding to advertiser demands for more data. Facebook does data-sharing deals on the DL with large marketers that push for it.

In so-called “clean rooms,” for example, advertisers can compare their first-party data with impression-level Facebook campaign delivery data using laptops that have never touched the internet. Facebook also allows certain large advertisers to create a private instance on its server to run advanced analytics.

We would expect Google to lag behind Facebook as Google’s supply of ad impressions is more elastic.  Google can increase revenue via increasing the supply of impressions especially on its YouTube subsidiary.

Facebook has no room in its “wall-garden” for more ad impressions. It will be interesting to see how much Facebook derives revenue from its retargeting business outside its “walled garden.”  Otherwise, the only way Facebook can increase revenue is by working to improve ROI on the demand side and “shift up the demand curve.”

 Facebook antitrust lawsuits will inevitably dwell on ad price trends as measured by cost-per-click (CPC).  Consider the following graph showing that Facebook’s CPC  rose 136% in the first six months of 2017.

How much of the above trend was due to Facebook asserting it’s pricing power and how much of that trend was due to other factors?

For example, the upward trend could be due in part to a secular improvement in ad ROI delivered by independent DSPs with help of Facebook supplied application programming interfaces (APIs), thus reducing information asymmetry on the part of buyers.

Of course, it takes more than API hooks for a DSP to deliver significant improvements in ad ROI.  It takes a DSP that can build a sophisticated real-time programmatic bid engine and a real-time predictive analytics platform that feeds off Facebook-supplied user data and spits out bids with improved click-through rates.

In sum, Facebook has deflected the antitrust case against it by assisting independent demand side platforms (DSPs) like MZ’s (Machine Zone’s) Cognant ® to build strong countervailing platforms.  

 At the same time, working with independent DSPs to improve ad buy ROI and a willingness to pay higher price is a way out of its conundrum of growing revenue while limiting ad impressions in its “walled garden”.

 


“Lemons” and Antitrust: Why Facebook and MZ Are AdTech Frenemies — DSP Cognant

(Postscript: July 11, 2018)

Adexchanger reported that MZ has shut down its independent DSP business Cognant and laid off all 125 employees as well as half of its in-house media buyers.

(Published: March 1, 2018)

Summary: 

Facebook has deflected the antitrust case against it by assisting independent demand side platforms (DSPs) like MZ’s (Machine Zone’s) Cognant ® to build strong countervailing platforms.

Facebook is signaling that it does not intend on being “the Microsoft of the 1990s” by throttling competition on the demand side of the ad impression market.

Furthermore,  this cooperation makes sense from a pure business perspective as Facebook is “shifting up the demand curve” of advertisers by working with independent DSPs to improve ROI on ad buys resulting in a willingness to pay higher prices.

Facebook wants to reduce information asymmetry in the ad impression market. It is in its own interest to help make it a market of “peaches” not “lemons” ala George Akerlof’s iconic economics paper “A Market for Lemons”

Indeed, we see the current digital ad impression market as the “mother of all markets for lemons”  accompanied by  a whole new lexicon — clickbait, click farms, fake news,  brand safety, and walled gardens.

The Intermediate Market for Digital Ad Impressions

The intermediate market for digital ad impressions is now dominated by the Google – Facebook duopoly.  In 2017, the duopoly’s total share of ad impression sales was estimated at 60.4% (see below) .

In the fast growing digital native ad subset market, the duopoly’s share rose to 91.9%.

On the extreme demand-side of the digital ad impression market are advertisers wishing to buy ad impressions and on the extreme sell-side are content publishers selling ad impressions.  In between  is a complex web of software intermediaries that would dumbfound (and still does) Madison Avenue.

The data above largely reflects ads embedded in mobile and PC content.  The market for real time ad impressions embedded in ad-supported streaming TV — as opposed to subscription-supported Netflix and Amazon Prime — is just beginning.

The value of the impressions to advertisers is a function of viewer eyeballs, associated data, and engagement as measured by time spent on the site.  Sheer eyeballs without data is of little value to advertisers as exemplified by Twitter.  Facebook and Google Search/YouTube dominate because of all three — eyeballs, data, and engagement.

If you ask people in the tech world what is the business of Facebook and Google, they would not say social networking or internet search or video delivery.  They would say the two dominate the performance marketing business — selling ads with quantifiable (as opposed to estimable ala Nielsen) results as in costs per click or impression.

Between advertisers and publishers is an adtech intermediate market. It consists of supply-side platforms (SSPs) also dominated by Google and Facebook with Amazon being a fast riser in the SSP space.

Next comes ad exchanges where transactions and pricing takes place increasingly via real-time auctions.  Google dominates with DoubleClick AdExchange.  Facebook launched its own FBX in 2011 but let it slowly die over the next three years.

Next comes demand side platforms (DSPs), which is the most competitive segment.  Google has its own internal DSP called DoubleClick Bid Manager which dominates ad buying both on Google’s “walled garden” of search and on its own subsidiary YouTube.

Facebook has an internal DSP called Facebook Ad Manager useful to small and medium business wishing to buy ads within its eponymous “walled garden.” But, Facebook seems to be holding back from customizing its internal DSP to cater to large advertisers with unique needs.

Because of the publicity surrounding Cambridge Analytica, Facebook is under enormous pressure to pull back all the ways its allows third parties to access its user data.  We think it would be “throwing out the baby with the bathwater” if Facebook were to  pullback of all adtech — SSP, AdEx, and DSP — within its “walled garden”.

Rather, it needs all the help it can in filtering out “lemons”.  It is in Facebook’s own interest to foster independent DSP’s with “clean room” access (see below) to data.

The Focus of Antitrust Concerns

The sheer scale of the Google – Facebook duopoly is the current focus of antitrust concerns. But, the extent of the duopoly’s vertical integration —  owning the full vertical stack of businesses from content publishing to a SSP to an ad exchange to a DSP — needs to be analyzed in much greater detail by adtech experts for potential antitrust violations.

Antitrust concerns so far has focused on the supply side with the most recent flare-up being Facebook’s decision to limit third-party news feeds inserted into the social graphs of Facebook users.

This supply-side focus on content is understandable as such developments hurt the job prospects of the very paid  tech and business writers [ not us 😉 ] who write about Google and Facebook.

In contrast, this paper focuses on the demand-side and DSPs.  We think a recent development on the demand-side  deserves more attention. This is because it signals that Facebook is seeking to deflect antitrust concerns by actively assisting in the development of strong, independent DSPs.

Facebook’s Effort to Foster Strong Independent DSPs

In December 2017, Tech Crunch published an article describing how an internal Facebook team of 100 engineers has been working with big advertisers to develop their own customized DSPs.

Right off the bat, this revelation is a clear sign that Facebook today does not intend on repeating the anticompetitive tactics used by Microsoft in the mid 1990s.  Back then, Microsoft used its control over the dominant Windows PC operating system to throttle the ability of users to replace Microsoft’s own default browser with a popular third-party browser developed by Netscape.

Notwithstanding the antitrust motivation for supporting independent DSPs, Facebook’s initiative is good from a pure business perspective.  Facebook realizes that improving ROI on purchased ad impressions via reduced information asymmetry translates into a willingness by advertisers to make higher bids for “peaches” instead of “lemons” ala George Akerlof’s iconic economics paper “The Market for Lemons”.

Indeed, we see the current digital ad impression market as the “mother of all markets for lemons”  including the following list of extreme conditions for markets with information asymmetry between sellers and buyers:

  • zero marginal cost on both sides creating lemons and traps
  • dueling artificial intelligence (AI) on both sides morphing sell-side lemons and buy-side traps
  • real-time auctions
  • low latency rendering and fill of ad after purchase of impression
  • double interrelated information asymmetry (see below)

Facebook recognizes that its supply of ad impressions has reached a ceiling due to user annoyance of ads in their feeds.  With supply now inelastic within Facebook, there are three options open to increasing revenue — quantity times unit price.

  • Get into selling impressions outside its “walled garden” which it has done through a retargeting business.
  • Assert its pricing power as a duopolist and just “shift up the supply curve” (i.e. limit ad impressions) which it in effect has done by limiting outside news feeds.

Facebook Option 2: Shift up the Supply Curve

  • Work to “shift up the demand curve” of advertisers by working with independent DSPs to improve ad buy ROI resulting in a willingness to pay higher prices.

Facebook Option 3: Shift up the Demand Curve

Facebook is signaling that it is giving option 3 a try.

Here is a great quote from an April 2017 adExchanger article on digital ad prices as a reflection of quality and the opportunity for Facebook to receive higher prices — shift up the demand curve  — from advertisers and agencies using more discriminating DSPs.

“We buy it cheaper” used to be the lead differentiator in a pitch. Today, agencies that lead with “We can buy digital cheaper” have a sign taped to their back that says, “We buy lots of fraud.” Low prices in digital media are not only no longer a badge of honor, they’re a warning sign.

Here is a quote from the Tech Crunch article on the ROI improvement coming from DSPs built with the assistance of the Facebook engineering team:

Facebook says that on average, clients working with the solutions engineering team see their return on ad spend improve by 100 percent.

The article mentioned that after working with the Facebook team to improve the performance of its own internal DSP,  the mobile game company MZ (formerly Machine Zone),  has spun off its internal DSP as an independent business called Cognant ®.

It should be noted that even before the spin-off, MZ was already the largest “direct response” advertiser in the world and likely on Facebook itself.

As Facebook’s largest direct response advertiser, MZ was the likely first recipient of access to Facebook user data located in “clean rooms” on Facebook servers.  Here is a February 28, 2017 description by AdExchanger of the linkage:

Google and Facebook are each responding to advertiser demands for more data. Facebook does data-sharing deals on the DL with large marketers that push for it.

In so-called “clean rooms,” for example, advertisers can compare their first-party data with impression-level Facebook campaign delivery data using laptops that have never touched the internet. Facebook also allows certain large advertisers to create a private instance on its server to run advanced analytics.

MZ’ DSP is also likely an early adopter of the Unicorn startup Sprinklr for CRM and Martech:

Sprinklr is the most complete social media management system for the enterprise. We help the world’s largest brands do marketing, advertising, care, sales, research, and commerce on Facebook, Twitter, LinkedIn, and 21 other channels globally – all on one integrated platform.

A tight integration of Sprinklr + MZ’s Cognant, especially around real-time brand management (e.g., seeing the impact of localized Facebook ads for McDonald’s garlic fries on purchases at local outlets in real-time)  would certainly be a threat to an earlier generation of cloud-based CRM,  like salesforce.com and Oracle, that draws on dated information.

MZ’s DSP very likely has benefited from face-to-face meetings with the Facebook team located in Menlo Park not more than a 20 minute drive from the MZ’s headquarters in Palo Alto.  Indeed, MZ’s current HQ in Palo Alto on Page Mill Road across from Stanford was the former HQ of Facebook.

It should be noted that MZ is also located close to Google’s HQ  in Mountain View. It will be interesting to see if Google might offer similar assistance.

We would expect Google to lag behind Facebook as Google’s supply of ad impressions is more elastic.  Google can increase revenue via increasing the supply of impressions especially on its YouTube subsidiary.

Facebook has no room in its “wall-garden” for more ad impressions. It will be interesting to see how much Facebook derives revenue from its retargeting business outside its “walled garden.”  Otherwise, the only way Facebook can increase revenue is by working to improve ROI on the demand side and “shift up the demand curve.”

The question is can MZ’s DSP Cognant and maybe a few other DSPs scale sufficiently and demonstrate enough independence to be called true countervailing powers to the Facebook – Google duopoly?

Or will Cognant become a “front” of  independence “playing nice” with Facebook?  Will Cognant become some fake sign of competition to be trotted out by Facebook lawyers in some antitrust lawsuit down the road?

Such an antitrust lawsuit will inevitably dwell on ad price trends as measured by cost-per-click (CPC).  Consider the following graph showing that Facebook’s CPC  rose 136% in the first six months of 2017.

How much of the above trend was due to Facebook asserting it’s pricing power and how much of that trend was due to other factors?

For example, the upward trend could be due in part to a secular improvement in ad ROI delivered by independent DSPs with help of Facebook supplied application programming interfaces (APIs), thus reducing information asymmetry on the part of buyers.

Of course, it takes more than API hooks for a DSP to deliver significant improvements in ad ROI.  It takes a DSP that can build a sophisticated real-time programmatic bid engine and a real-time predictive analytics platform that feeds off Facebook-supplied user data and spits out bids with improved click-through rates.

Right now, we believe that the only independent DSP that has this capability is MZ ‘s Cognant.

In sum, Facebook has deflected the antitrust case against it by assisting independent demand side platforms (DSPs) like MZ’s (Machine Zone’s) Cognant ® to build strong countervailing platforms.


An Idea For A Millennials Investment Vehicle: A Big Tech HQ2 REIT

There have been a number of recent surveys asking millennials with substantial cash savings — predominantly young professions in tech and creative positions — what kinds of investments are they interested in.  

As if they were disciples of the late great fund manager Peter Lynch, whom they probably never heard of,  they say the are interested in investing in what they use and understand.

Plus, the added benefit of such investments is being able to talk about them to friends who are familiar with the names.  Really, how fun it talking about how great your S&P 500 index fund is doing?

The Peter Lynch approach to investing is wise in some ways, but foolish in other ways as it tends toward undiversified, trendy, high risk investments as opposed to diversified, value-based investments.

At the top of the list of investments of interest to millenials is own home ownership.  Next comes stocks in the big tech companies they use and understand: Apple, Facebook, Apple, Amazon, and Google.  Next comes smaller, consumer-facing tech companies like Tesla, Netflix, and Snapchat.

And within the last two months, cryptocurrencies have captured their interest.

But, with the bust of crypto and the dim prospect of ever saving enough for a down payment on a “starter” home of $1+ Million in tech heavy areas like the San Francisco Bay Area,  there is an opportunity to come up with new investment vehicles  composed of a diversified portfolio of assets that millennials use and understand.

One recent innovation is something called an eREIT  (electronic Real Estate Investment Trust) like Fundrise — a trendy looking online website for investing as little as $1,000 in a professionally managed portfolio of property REITs.  

But there are multiple problems with eREITs.  This includes a double layer of fees charged by the managers of the eREIT on top of the fees charged by  individual REITs.

It also includes evidence that long term rates of returns (ROI) on actively managed real estate REITs are less than ROIs on low fee, passively managed S&P 500 index funds.

As an alternative to eREITs, we would like to propose a new straight-up REIT that both should appeals to millenials and should outperform existing REITs.  Obviously, the increased expected ROI comes with the increase risk as of a concentrated portfolio of properties concentrated in about 8 metropolitan areas.

We call this new millenial investment vehicle an HQ2 REIT.

We identify below 8 metropolitan areas  as most likely to be named a future location of  secondary headquarters — know as HQ2 — of big tech companies.

The includes the already announced intent of Amazon to name one city out of 20 finalists for its HQ2 in 2018 plus Apple’s recent announcement that it has plans for its own smaller HQ2.   

While unannounced,  it is highly likely that Google and Microsoft will also need to plan for an HQ2 in the next 5 years.    Assuming that it is unlikely that the four companies — Amazon, Apple, Google, and Microsoft — will pick the same metropolitan area, this means that 50% of our 8 most likely choices for an HQ2 will actually get an HQ2.

In terms of arriving at this list, we start with Amazon’s recently narrowed down list of 20 metropolitan areas in the running for its HQ2 that is projected to employ ultimately around 50,000 people.    

We next apply a Business Insider assessment of the likelihood (a simple linear ranking 1-20)  of each city being chosen.  We also make an additional division into two group based on median housing prices and proximity to a University with a top 20 Graduate School Computer Science Department in Artificial Intelligence   

Sources:

Business Insider Ranking of Finalists for Amazon’s HQ2

Median Home Prices in Top Metro Areas — 2015

US News Ranking of Graduate AI Departments

Here is the more extended version of list