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Obviously we are having a little fun with the query used for the title, but it also presents two key questions - is Apple (NASDAQ:AAPL) going into the online search business and what is the quickest/most efficient way that they could enter the online search space?

Is Apple Going to Enter the Online Search Business?

If you didn't hear it here first, you saw it guaranteed here first - Apple will be a major player in search and we think it will occur sooner rather than later. While we have no access to anything that is not available to the public at large and we did not stumble upon Apple search engine prototype diagrams left in a Palo Alto bar, we simply cannot see the company’s response to recent events playing out any other way.

We believe that Apple now has what is possibly the greatest brand equity in the world. Opinions can differ on that question, but it is indisputable that Apple has one of the greatest brands in history and their iPod, iPhone, iPad successes have pushed that popularity to new heights. We believe this is causing consumers, even corporate types (like us) who were born and bred amidst the Wintel monopoly, to think the previously unthinkable - this iPhone is so much more intuitive, useful, fun and generally superior to our Blackberries (RIMM) that we should give their computers (Macs) a try too.

We believe that this could be one of the reasons why Apple set a record for Macbook sales in the quarter recently announced and half of the Macbook sales through their retail stores were to consumers who had never owned one before. We do not believe it is too big of a stretch to say that Apple’s iPhone is rapidly expanding the already high regard for the Apple brand and that they have the perfect opportunity to leverage that brand in a strategic move that will have huge implications across their entire product portfolio. Given this and Apple’s long history of success at redefining mature markets that would likely have been considered untouchable, we think Apple will be entering the online search business very soon.

But search is another matter right? Google (NASDAQ:GOOG) owns search. Even Microsoft (NASDAQ:MSFT) and Yahoo (NASDAQ:YHOO) have been unable to stop the Google search juggernaut that has single handedly given Google a $175 billion market cap. Search is the cash cow that allows Google to take on MSFT's near monopoly in Office, IE and Windows. launch a broadside attack against Apple by entering the smartphone / wireless OS market and try to take over your TV - none of these things are even within the realm of possibility without the gargantuan revenue stream derived from Google's Adwords/Adsense.

And besides - all this talk about lost love between Steve (Jobs - Apple CEO), Eric (Schmidt - Google CEO and former Apple board member) and their respective companies is just that, right? Consider this recent Steve Jobs quote:

We didn't enter the search business, they entered the phone business. Google wants to kill the iPhone - we won't let them. (NY Times Article - "Apples spat with Google is Getting Personal.")

Jobs' essentially acknowledged that we have a fight, but Google started it and at the same time acknowledged that attacking his main growth vehicle would be like Apple going head to head with Google's search business.

The iPhone is now 40% (see Business Insider Pie Chart) of Apple's revenue and its biggest growth engine. We do not believe that Steve Jobs will sit idly by while one of his former board members launches a frontal attack on his company's primary growth machine - particularly after his Ruthian public comments acknowledging what we believe to be Brutus' achilles heel. The back and forth that began earlier this year has only intensified in recent weeks as Schmidt's derogatory comments on Apple's new iPad made the rounds, Apple hired away a high level search executive from Google and then Google acquired a small startup led by former Apple employees.

Irrespective of the increasingly personal back and forth between the two, from a strategic standpoint we believe that Apple will enter the search space because:

  • Apple does not want to cede to Google (or MSFT) all the key data that can be culled from providing search results,
  • It’s a multi billion dollar business that has the potential to grow rapidly as new distribution channels emerge and it has enormous implications and profit potential for every aspect of Apple's core business (Mac) and even larger for its growth lines (iPhone, iPad, Apple TV, etc.)
  • The best defense against a Google attack on all fronts (mobile phones, ipad, music/video downloads, etc.) is a good offense. You can not slow down the Google juggernaut without attacking its bread and butter - online search.
  • Apple has a more highly valued acquisition currency than they have ever had - $40 billion in cash and a stock that is at its highest valuation in history - up over 200% over the last 18 months.
  • The timing is perfect - the longstanding "Big 3" of search will become the "Big 2" over the next six months due to the merging of Yahoo and Microsoft's online ad systems. Many large advertisers and agencies have managed three ad platforms for years, so there is an opportunity for another platform to slip in and take the #3 slot.
  • Entering the search space now could be a material blow to Google's growth machine. Some part of Google's ability to grow has been its ability to acquire key technologies using its highly valued stock as a currency and many of the best and brightest employees have been attracted to Google because of the potential to be stock option millionaires. When Apple enters the search arena, all eyes will be on those monthly market share reports and the first indication that Google is slipping will likely cause much of that growth premium in its valuation to go away. Many growth investors have already been concerned about Google's valuation in light of the Law of Large Numbers and they have grown increasingly leery as the valuation continues to climb with no apparent business line currently able to kick in at a rate that would allow prior growth rates to be sustained.

For all of these reasons and more, we believe that Steve Jobs is about to throw Apple's hat into the search ring.

One of the most respected commentators on the search engine space recently wrote an article (Business Insider article on Apple) on this topic. We have the highest regard for the article's author (Danny Sullivan) and agree with his article on nearly all points except the conclusion seems to leave the impression that Apple would not be a player in search any time soon.

The article does a great job of laying the foundation for the issue - as a competitor, Apple simply cannot continue to allow Google to be its search engine. There's too much value derived from the flow of data/information that comes with that role and Apple the deal between Microsoft and Yahoo essentially leaves Apple with the choice of using Google, MSFT's Bing or developing its own search engine. But from there it makes the point that building a search engine that could make a dent in Google's market share is just "too hard" and points to MSFT's search saga as an example of why Apple should not venture down this path. We respectfully disagree and two words come to mine - Zune and iPod.

Mr. Sullivan's article further discusses four specific issues that we address individually below -

1) Developing a relevant search engine is hard, you need many skilled engineers and Google/MSFT are already fighting over the existing ones. We believe Apple already has some pretty sharp engineers on board and also believe that they might be able to attract up and coming talent in that field and even lure a few away from MSFT and Google. Forget the cash available to pay top dollar, because they all have that - but which company would you choose to work for right now - Google, MSFT or Apple? What about stock options? If we are right and Apple does launch a broadside attack against Google's search monopoly using a low risk / low cost approach that is successful in taking market share from Google - whose stock options are going to be more attractive over the next few years?

2) The article notes that "You need to pull back billions of pages. You need lots of data centers for blazing speed." The statement is accurate and when written, correctly indicates that Apple did not have such data centers. However, we now know that Apple is building the world's largest data center near a key intersection in the backbone of the internet in North Carolina and they reportedly have recently hired Stream Realty Partners in a quest to acquire used data centers. This month Apple started running advertisements seeking their first hires for the new data center in North Carolina. Its coming.

3) "If you do get past the technological hurdles, you still have to fight an ingrained habit consumers have to use Google." We think this is a good point, but believe it is not only doable, but that Apple is the one company that could possibly pull it off. Apples brand equity and rep could quickly make it's search engine the new cool thing - more than any other company it would be able to get an enormous percentage of Google users to give it a try. On the day it is announced with the usual Apple marketing genius, the fanfare leading up to its launch and on the day of its actual launch - Apple more than any other company could make a splash and possibly even pull a surprising market share right out of the gate. That is something MSFT has never been able to accomplish over the years and billions spent, but we believe Apple has a unique ability to pull it off given the legions of Apple fans who are almost cultish in their zeal for Apple products, Apple’s potential to offer it as a default setting for the millions of Safari users, laptops, desktops, iPads and iPhones that currently default to Google. We believe that Apple's iPhone and now iPad success have established an unprecedented level of mainstream Apple fandom that would give them a platform to launch a new product (Search engine) that is instantly perceived as the "new cool thing". Thus, while the question for just about any other entrant to this space would be "how do we get people to try it", Apples will likely have the advantage of needing only to create a user experience would cause the millions who will surely give it a try to adopt it as their primary search tool. Given Apple's history of disruptive technology that that makes the simple simpler and more useful, we think its possible that they could pull it off.

4) "An easier way forward would be to buy someone else's technology and improve it." We agree wholeheartedly with this statement and also feel that it is the most likely path considering Apple's history. The article points out the issues with such an approach where the larger search players are involved both for the reasons stated and the fact Apple rarely makes large strategic acquisitions. When you look to their entry into the music business or the phone business - they could have easily made large acquisitions that would have given them a larger immediate market share position, but chose not to. An even better example might be their acquisition of Palo Alto Semi - where they chose to buy the smaller company located nearby that had a good technology base and employees/culture that could easily be integrated into the Apple culture. Yahoo is now aligned with MSFT and the other players in the space with a meaningful market share are America Online (NYSE:AOL) and Interactive's Ask.com (NASDAQ:IACI). AOL's search business is best described as an ongoing train wreck and AOL is quite likely the picture of a company that Apple would not buy, given the likely difficulty of merging 6000+ East Coast employees into the Apple culture. Interactive's Ask.com has been known to be for sale for awhile now and we think the product is intriguing enough to be attractive for Apple's purposes, but we are not sure that spending a couple billion to acquire the larger organization on the other coast would be very Apple-like either. Certainly, such a purchase would instantly give Apple a small slice of the market (about 2%), but Ask.com does not have its own advertising network, as they rely on a combination of Google’s AdSense and LookSmart’s (NASDAQ:LOOK) publisher solutions ad network, so Apple would still need to build or buy one of the other ad network players.

What is the Quickest Most Efficent Way for Apple to Enter the Online Search Business?

Given all of the issues mentioned with the larger search market share players and Apple's tendency to avoid larger strategic acqusitions, we chose to look for a smaller company with good technology that might be easier to integrate into Apple's culture. We believe that LookSmart fits this profile to a T. Looksmart is a company that has been in the search / advertising business since Sergey Brin and Larry Page were looking for a garage big enough for their .com start up. They were among the earliest of the search engines birthed at the beginning of the dot com gold rush and while there have been several major shifts in their business model, they havs remained independent while many of the other significant search players in that era (Excite, Lycos, AltaVista ) were gobbled up by larger companies. For all their starts and stops in the search business over the years, they have been quite good at monetizing their assets and they have in recent years focused their efforts and resources on adding bells and whistles to their ad network technology platform. The five most important things you need to know about Looksmart are (see discussion for each below list):

1) They have a highly regarded Ad Network technology platform
2) They own promising search engine technology
3) They own a good domain for standalone search (Looksmart.com)
4) They have a small organization - 68 employees
5) Their existing ad platform generates $50 million in revenue and is close to EBITDA profitable

1) Looksmart's ad network / platform is highly regarded among industry insiders,earning title of "Best Search Engine Platform" by a panel of search industry experts and thought leaders. Generally considered the #2 ad platform from a technology (contextual and geographic targeting, scalability, etc.)standpoint per an industry consultant. Further he stated Looksmart's ad platform is "not that close to Google, but better than MSFT, YHOO and the rest".

2) Looksmart still owns the technology and all IP from the search engine "Wisenut", a search engine company it acquired in 2002 that was then described as a potential "Google Killer" because of its unique technology that purportedly had the ability to index 100 million URLs per day and scale to over a trillion URLs at a time when Google boasted the biggest index at just over a billion URLs. The Wisenut technology was highly regarded because it could return search results that rivaled Google's prowess as the relevancy leader, but also because it offered some cutting edge (at the time) features like search results that offered categories for further refining of the search results, links to similar queries and a "sneak a peak" feature that allowed searchers to preview the page in the search results without leaving the search result page. Of course, the first two "features" are standard to Google and most all search engines now and Ask.com has incorporated a similar sneak a peak feature since that time. LookSmart shuttered the service years ago to move in a direction away from standalone search and last year it sold the Wisenut name. However, they retained the technology and all IP associated with it, so a buyer of Looksmart would have a jumpstart versus building one from scratch.

3) The Looksmart.com domain is could be used as a search engine start page again, like it was during the early dot com era.

4) The company currently has only 68 employees all located in Silicon Valley. LOOK HQ is only 42 miles from Apple's Cupertino HeadQuarters.

5) LookSmart's existing ad platform with thousands of advertisers, hundreds of publishers and a $50 million revenue run rate. In the most recent quarter reported the company generated $1.2 million in cash flow from operations and they are close to being GAAP profitable in spite of one of the search industry’s highest TACs (Traffic Acquisition Cost) and one of the lowest RPC (Revenue Per Click). LookSmart's high TAC is due to fact that company has no consumer facing properties to generate traffic, so all clicks are coming from third parties who must be paid a share of the revenue derived from those clicks. Google, Yahoo and MSFT have much lower TAC because a very significant number of their clicks come from wholly owned traffic sources, which allows them to pocket the entire amount paid for those clicks, thereby lowering their overall TAC. LookSmart's Low RPC is likely due to the much smaller number of advertisers than the bigger players have, meaning that LookSmart does not benefit from the margin expanding competition where a larger number of bidders compete and drive up the bid prices for most search terms. The more bidders competing, the more likely we are to see the upward cycle of ever increasing bids. Thus, any scenario where LookSmart’s became part of a company with significant owned traffic sources or any scenario where the number of bidders increased substantially should see a dramatic expansion of the profitability of LookSmart’s ad network.

In summary, LookSmart has many features that would allow an acquiror to hit the ground running as an entrant in the online search / advertising space and we think these features might make it an attractive target for Apple.

Would Apple really buy LookSmart?

Here are the reasons that it makes sense and why it would be a good fit for Apple:

  • Very low risk entry price, Apple could probably take them down for $50-$60 million in Apple stock, giving LOOK shareholders $3 - $3.50 per share.
  • Apple gets the $27 million in cash on LookSmart's balance sheet and $35 million in usable NOL carryforwards
  • Brings Apple 65 employees who are already in the search business doing what they do and located a few miles away from Apple HQ. This would be much easier to integrate into the Apple culture than several thousand employees on the other Coast.
  • Existing LOOK business is already close to profitable on current revenue run rate when you factor in the lower opex structure going forward. New office lease in Q1 that cuts $2 million per year from opex and Q2 begins data center lease that cuts another $500k per year from overhead. If you removed the expense of C level officers, Sarbox and other public company expenses, LOOK’s business is profitable now.
  • What if it were the default search engine on all Macs, iPhones, iPads and all Safari browser installations? Do you think some new advertisers might be willing to start bidding for search terms if the Looksmart distribution network included Apple and its partners websites? Think some publishers who are leery of Google/MSFT might sign up to further increase that distribution? Do you think existing advertisers on LOOK’s ad network might bid a little higher if their distribution were going to increase several hundred fold? The explosive cycle of higher bidding and advertiser spending that occurred in Google’s early years is the best measure for understanding how Looksmart’s current $50 million business could scale to a billion dollar revenue run rate in months rather than years with the right distribution channels. The impact on revenues and profit margins is enormous and one only needs to look at Google's early public company earnings reports to get a feel for how quickly that scaling process can occur. The huge influx of both advertisers and publishers that would surely follow an Apple acquisition would catapult the LOOk network to a top 3 player in search and it is quite possible that the Apple induced boost to the business would produce profits over the first year or so that would fully pay the difference between the purchase price and the cash acquired + tax savings.

What If No Apple/ LookSmart Deal Transpires?

We expect Apple to enter the online search business soon regardless of how and/or with whom. We also believe tha they would be better served to acquire an existing technology versus building one from scratch. We do not believe that they would look to AOL for the many reasons given above. but they could possibly look to Ask.com, Infospace (INSP) or even the startup Cuill as a potential partner. However, none of the other options offer all the advantages of LookSmart from an economic, strategic, logistical and/or cultural integration standpoint.

For LookSmart, it seems likely that they will be acquired by someone, if not Apple. The current disparity between the value of their assets ($27 million in cash, $35 million in useable NOLs, strong technology platform and business momentum) and their current market valuation ($19 million market cap) along with the potential for any company with significant monetizable content or owned search traffic to buy the company and pay for it completely in a very short time from its own cash flows make it almost certain to be acquired sooner rather than later.

However, if LookSmart's current management chooses to keep the suitors at bay for a few quarters, the asking price could move higher. The company has already (even on the higher expense base for Q4 2009) turned the company’s fortunes to the point where they are adding to that $27 million cash balance each quarter (added $1.2 million in Q4) and the stock price will surely start to reflect that if the company moves fully into the black in Q2/Q3 or when they start to put that cash to work buying back stock. Obviously, they could buy the entire public float at a 50% premium right now with their current cash position if they choose to go that route, so LOOK shareholders should be well rewarded regardless. In any case, we believe Apple shareholders would be rewarded by their company's entry into the online search space and we feel that buying LookSmart before someone else does makes a great deal of sense.

Disclosure: Author long GOOG, IACI, AAPL and LOOK

Source: Would Apple Look Smart to Enter Online Search Fray?