Game Over in Download Valley?

The lucrative companies that make their profits from toolbars are hitting new obstacles that have led to mergers, splits and other survival strategies.

Freeware developers and distributors, which are among the most profitable and fastest growing companies in Israeli high-tech in recent years, have lately run into turbulence. The industry, dubbed "Download Valley" and comprised of companies like Babylon and Conduit, is still generating revenues like never before but now needs to contend with a new set of thorny strategic challenges.

Although companies like Babylon, Conduit, IronSource, iMesh, and Perion Network are already worth hundreds of million of dollars if not billions, their income-generating engines could be sputtering. The legitimacy of some, with their controversial distribution methods and questionable value to users, is on the skids. Meanwhile, regulations in this field are becoming tighter.

"All in all this isn't a nice industry," says an executive at one of the Download Valley companies. "It's easy to get swept up into more problematic areas and I also got carried there. You need to sustain a company and it's very easy to pursue the money. You buy a user for a dollar and make $1.20 on him: That's the whole idea. A search of most of the companies in the field shows that the main thing users want is to remove the toolbar and these plugins.

"Perhaps for a year or two revenues will continue growing, but it's not a genuine industry," he continues. "All the companies know that the industry won’t remain the same forever. Companies like Google and Facebook are starting to fight back. In response, Download Valley companies are looking for ways to make their existing assets liquid and create new assets. What's happening now is an attempt by the companies to maintain the revenues derived from the existing models and at the same time reinforce and increase other activity – until it is possible to forgo the original business."

Creating a nuisance

For years the companies in this field helped global giants like Google and Microsoft attain market share until the method finally became a nuisance and the two companies, thanks to their dominance in network browsing, performed a series of moves to restrict their freedom of action.

As part of these changes, Google informed its partners last October that software advertised on its search engine results will require the user's active consent before downloading. It also said that any auxiliary software downloaded with the main program without the user's knowledge must be removed.

Babylon subsequently reported being asked by Google to correct flaws connected with the commercial agreement between the two. "The entire field of user referrals has greatly expanded, and a sense of fairness is needed in order to maintain it," said Babylon CEO Alon Carmeli.

Another threat to Download Valley companies is the movement of users towards mobile platforms. Tablet and smartphone usage patterns differ greatly from those of personal computers in which the focus was on the companies' products. Apple blocks entry to models of the type used by these companies. Most applications now being downloaded to mobile devices are supplied by the apps stores of the operating system providers – Google and Apple – which can subject application developers to their own sets of rules.

All this follows a period in which Download Valley companies registered astonishing growth. Over the past three years Babylon's revenues grew nearly six-fold – from NIS 118 million in 2010 to NIS 685 million in 2012. Adjusted revenues for Perion Network, dual-listed on Nasdaq and the Tel Aviv Stock Exchange, more than doubled from $29.5 million in 2010 to $60.2 million in 2012.

Perhaps the most major change currently underway is a strategic move by Conduit to split its operations into two separate companies: One company will continue in the realm of toolbars and merge with Perion Network, while the other will maintain Conduit's other activities – including those geared towards the mobile market – under the direction of co-founder and CEO Ronen Shilo. The move will put the company's profitable activity, which generates hundreds of millions of dollars a year, on the market. Meanwhile Shilo, who for years has deplored registering the company for trading, can continue pursuing new ventures through the privately-held company.

Publicly-traded Babylon, valued at NIS 1.39 billion, is exploring a similar move. The company said it is conducting talks towards a merger with IronSource. Market sources believe two other large mergers in this field are also now on the drawing board.

Talks between Perion and Conduit are still ongoing but industry sources maintain an agreement will likely be concluded by the end of the year. Among the five industry leaders, Perion appears to be the most vulnerable to approaching threats and more exposed than the others to decisions by Microsoft and Google. Its non-core activities are limited and it has a very small presence in the mobile market.

Although Perion disclosed a new cooperative venture with Yahoo! at the beginning of the month, this is likely to affect its revenues only several quarters down the road, and its recent quarterly financials have been disappointing. Its purchase by a larger, more diversified company like Conduit before the anticipated upheavals in the industry will allow company owners to realize their holdings.

For Conduit, the merger can be seen in a different light. Shilo has been trying for everal years to change the company's character. Most of its revenue stream currently comes from referring its toolbar users to search engines. According to industry sources, Shilo wants to rid Conduit of its negative image and turn towards new areas of activity, and this is why Conduit spent $45 million in 2011 to acquire Wibiya (a local startup, founded in 2008, which creates tools that enable greater on-site engagement through audience targeting).

Conduit has also begun, in an effort led by Shilo himself, to divert resources towards strengthening its capabilities in the mobile market. This has led to friction between the older departments responsible for the continued toolbar operations – the company's bread and butter – and the newer departments with more of a startup-like culture.

The emphasis on new activity that has yet to generate income, along with little investment in the company's profitable operations and the departure of some of the company's founders who continue enjoying dividends, has led to internal tension according to the industry sources. "Conduit has turned into a company of frustrated people," said one industry executive. "Toolbar technology has become generic and wages aren't up to par with those offered by competitors."

In April 2012 Conduit brought in Josh Wine to head its toolbar operations and revenues from this activity grew dramatically. But inter-departmental tension ensued and Wine indicated his intention to leave. In response, Shilo made the decision to split Conduit into two companies and leave Wine in charge of the toolbar company after its anticipated merger with Perion.

Prior to the current merger talks Conduit explored an initial public offering on Wall Street, according to the industry source, but was rebuffed by investors. "The real problem is that it's very hard to sell companies like these," he said. "There are almost no natural buyers for a company worth over $1 billion, especially in Conduit's field which is considered unsavory. Large players like Google or Facebook don't buy such companies and others don't want to be connected with them. The alternative for a company like Conduit is a share offering, but this market is bone dry."

Conduit didn't provide a response.

David Bachar
David Bachar