News 2.0

News flash: The hot new investment sector is news.

Blogs, citizen journalism, news aggregation, news personalization technology. All are part of an emerging segment of the Web 2.0 market that has been dubbed News 2.0. At least a dozen such companies have attracted about $100 million in total venture capital in the past year (see table), and many more are being launched. Just last month, Internet kingmaker Sequoia Capital jumped into the fray with a $5 million Series A for celebrity gossip blog PopSugar.

“There is absolutely a lot of VC interest in the news space,” says Christine Herron, investment director at Omidyar Network, a venture firm started by eBay founder Pierre Omidyar. “That’s because there’s real innovation taking place and the implications are far reaching.”

News 2.0 companies are changing how news is created, discovered and distributed, as well as how readers engage it. “These are huge changes that bring with them huge opportunities,” Herron says. “That’s why VCs are so excited. They’re starting to see the vision and the impact and the ability to create huge value.”

Certainly, News 2.0 sites are easier (and cheaper) to start given the rapid proliferation of enabling technologies. For instance, anyone can download basic code and start a blog. Likewise, you don’t need 500 developers to build the software behind a news aggregation site. But the easy availability of these technologies is a double-edged sword. It lowers the barrier to entry for competing startups and may potentially limit the upside for investors in the companies that do come out on top.

Handle with care

After all, a news site, no matter what form it takes, holds only small potential for the large-multiple payback that VCs need. “I would recommend taking care if you’re looking at this space,” warns Alan Patricof, founder and managing director of Greycroft Partners, which has made two investments in the News 2.0 space.

In June, Greycroft put an undisclosed amount into ContentNext Media, which owns three News 2.0 sites, including PaidContent.org, which covers the business of digital media. Two months later, Greycroft joined with Softbank Capital Partners in a $5 million Series A for The HuffingtonPost, a political news blog run by liberal gadfly Arianna Huffington.

Everyone knows who Huffington is—her name attracts lots of eyeballs to her site—and PaidContent is the first stop for followers of digital media. That sort of high profile is a necessary ingredient in a News 2.0 investment. “You have to have something unique,” Patricof says. “We did PaidContent because it’s the place to go for news on the digital media industry. HuffingtonPost is the No. 1 news and opinion blog.”

Skeptics listen patiently to such reasoning and wonder how in the world any of these investments will pay off. They believe the news industry is a pretty lousy business to begin with, which may explain why there has been almost no VC interest in the space until now. They also question why, say, a blogger would even need to raise money, especially if he or she is already popular enough to attract advertising and earn a decent living.

I would recommend taking care if you’re looking at this space.”

Josh Grotstein, Co-founder and Partner, SAS Investors

Easy access

The attraction of GigaOm is the low cost of doing business, Malik agrees. No bloated infrastructure, no expensive printing costs. “You don’t have people making $200,000 sitting around doing nothing like at some magazines,” he says.

“From a venture capital point of view the risk-return is high because the investment is relatively low,” explains Nick Hanauer, a partner at Seattle-based Second Avenue Partners, which invested in an ad-supported site called NewsVine. “It’s a small bet. It doesn’t take $50 million to crank this thing up and get it working. If we invest $1 million and get $10 million back that’s fine. I don’t need to get $100 million back.” Yes, but he presumably wants to get at least $50 million back, since Second Avenue actually put $5 million into NewsVine.

NewsVine was created by five people in a year, Hanauer says. “You don’t have to have 500 developers to create something like this.” That’s the upside. The downside is that competitors can spring up quickly and give a company like NewsVine a run for its money.

One quasi-news company is raising the barrier to entry by buying up popular domain names. Demand Media Inc., which describes itself as a “different type of new media company,” has pulled in $220 million in two rounds (including $100 million in September) from 3i, Generation Capital Partners, Oak Investment Partners and Spectrum Equity Investors. The company, run by the former CEO of MySpace’s parent company, needs all that cash to buy high-traffic Internet domains that are already making money from advertising. Demand Media’s plan is to boost the ad revenue of its sites by adding user-generated content. For example, a gaming website could allow its users to post game reviews or a cooking site could allow its users to post their favorite recipes. It isn’t exactly a News 2.0 company, but it illustrates how VCs are getting creative in their approach to user-generated content.

Rapid rise

What’s driving the rapid evolution of the News 2.0 market? “No question the technology is making this possible,” says Jed Katz, a managing director at Draper Fisher Jurvetson Gotham Ventures, which invested $5 million in finance-news aggregator Monitor110 in September along with Draper Fisher Jurvetson. “Partly it’s search technology and filtering technology.”

Another key factor driving the market is the sheer volume of information that’s now being published. “Just like the massive number of websites need search engines to get through them, the mass of opinions and other publications need tools to bring the right ones to the attention of users,” says Katz. “There are 10 million sources of information out there, and that’s increasing every day.”

It doesn’t take $50 million to crank this thing up and get it working. If we invest $1 million and get $10 million back that’s fine.”

Nick Hanauer, Partner, Second Avenue Partners

Monitor110, for its part, sifts financial information and sells it to corporations and hedge funds on a subscription basis. Customers use the service not because they don’t trust other traditional finance-news sources, but because there are deeper layers of information now available that mainstream sources can’t access easily, Katz says.

“Say a company is having its CFO leave and before they put out a press release about it they take his name down from the corporate website, maybe just a few hours earlier,” Katz says. “Monitor 110 will pick that up. The rest of the world won’t know until the press release goes out.”

Seeking info

A finance-news aggregator with a different approach is blog-aggregator Seeking Alpha, which gathers online posts from professional money managers and other finance professionals. “It provides organizational scale and distribution scale for quality content” that wouldn’t otherwise reach a receptive audience, writes Michael Eisenberg, a partner at Benchmark Capital, in his own blog.

Benchmark invested an undisclosed amount in Seeking Alpha in September. Eisenberg calls the site “a perfect bridge between the micro-expertise that bloggers bring by being intimately familiar with the topics they write on—in this case stocks—and the distribution that gives readers a broad range of topics and content so they are not searching every nook and cranny of the blogosphere for the particular company or content they are looking for.”

Eisenberg notes that there are over 5,000 stocks traded on Wall Street and hosts of exchange traded funds (ETFs) and mutual funds. Less than 1,000 of those are covered by investment banking analysts. By collecting information from a wide range of investor bloggers who write about the stocks they own, Seeking Alpha covers over 4,000 stocks, giving readers “a supermarket of opinion,” Eisenberg says.

Getting personal

Users who want to go even more granular can do so through news-personalization sites, which give readers control of the news delivered to them. Intelligent news sites learn users’ personal tastes, interests and political views, then tailor specific packages of news, analysis and opinion based on those criteria.

Just like the massive number of websites need search engines to get through them, the mass of opinions and other publications need tools to bring the right ones to the attention of users. There are 10 million sources of information out there, and that’s increasing every day.”

Jed Katz, Managing Director, Draper Fisher Jurvetson Gotham Ventures

Leaders in the intelligent news space include Claria (formerly Gator.com), which recently received a $40 million round led by Softbank America, NetVibes, which raised $15 million from Accel and Index Ventures, and Findory, which has yet to be funded. They automatically customize content, delivering news items similar to others that readers have enjoyed. Users no longer have to proactively select their preferences. Those who are not interested in customizing their pages can simply wait until a service like Findory knows enough about them to serve up appropriate suggestions based on things they’ve read in the past.

VCs like this model because it allows sites to target ads according to user preferences. “Personalization has the ability to change advertising,” says Findory founder Greg Linden, who led the technology team that built Amazon.com’s recommendation and personalization engines. “Advertising is a form of content. It’s useful when it’s relevant. When it’s not relevant it’s annoying.”

JupiterResearch found that consumers who engage in personalization are more likely to pay attention to online advertisements. Twenty-one percent of those surveyed said they have responded to contextual or behavioral ads related to their online activity. That’s almost double the response rate of users who don’t customize.

Findory’s personalization technology matches content to audiences and does the same with ads. That way it can provide targeted information about useful products and services to interested audiences. This makes the ads more relevant and effective.

Unanswered questions

Yet even with his seemingly attractive technology and impressive track record, Linden has yet to lure venture money for Findory, which suggests there is still a measure of caution in the VC community where News 2.0 is concerned. “I’ve talked with several VC firms,” Linden says. “Generally, the reception has been favorable and they’ve understood the vision—their questions are about the risk in achieving the vision. There seems to be a view that there’s too much risk in investing early in an unproven and difficult-to-evaluate technology.”

The problem is that there are not good examples of other startups succeeding by doing the same thing Findory is doing. There are also no good examples of blockbuster exits.

Another problem: Many VCs don’t share Om Malik’s and Alan Patricof’s belief that a blog or news site can be built into a media business. They’re more worried about step one: Where’s the money coming from?

There seems to be a view that there’s too much risk in investing early in an unproven and difficult-to-evaluate technology.”

Greg Linden, Founder, Findory

After all, can a successful Web business be built on ad revenue? “That’s the biggest question,” concedes Herron. “We still don’t know what the final business model will look like. Is there actually a new model for advertising here or is it just the traditional ad model? What are the relevant new models and how much are sponsors willing to pay?”

While these questions go unanswered, most News 2.0 sites remain purely ad-revenue-driven, although some, like Monitor 110, sell subscriptions. Others, like Malik, say they could potentially widen their revenue stream by experimenting with other lines of business, such as conferences.

PodTech, which distributes audio and video news podcasts, is another company trying to find a sustainable business model. “It’s hard to aggregate an audience and get it to be advertising-supported, so you have to figure out other creative models to monetize it,” says Matteucci of U.S. Venture Partners, which put $5.5 million into PodTech in March along with Venrock Associates.

PodTech has two revenue streams. One is corporate. For a fee, it creates and distributes content for corporate websites. That’s a major revenue model. The other stream is advertising. Asked the percentage split between the two revenue streams, Matteucci says: “Normally I wouldn’t tell you, but I can because only one of them is turned on at the moment and that’s the corporate one. It’s 100% to zero.”

This way out

Another shadow looming over News 2.0 companies is the one being cast by media giants such as CNN and big online players such as Yahoo, which are just now turning their attention to the space. News 2.0 outfits are dealing with that issue in various ways. Seeking Alpha has partnered with Yahoo and now provides content to Yahoo Finance. Moreover, there is no reason why a personalization company like Findory or NetVibes couldn’t license its technology to online newspapers.

Traditional media companies could prove to be key partners for News 2.0 startups as well as potential acquirers. One of the original news aggregators, Topix.net, last year sold a majority stake to a media consortium led by Gannett, Knight-Ridder and the Tribune Co. for approximately $50 million. Meanwhile, Weblogs Inc., which operates a network of news-oriented blog sites and raised no venture capital, was acquired by AOL for an estimated $20 million.

“At some point I assume they’ll either acquire other things or be acquired,” Patricof says of HuffingtonPost and PaidContent. “We’ll see how the marketplace is next year.”

Stay tuned for updates on this breaking story.

Tom Stein and Tim Devaney are Silicon Valley-based freelance writers who specialize in covering technology startups and venture capital. Stein may be reached at tom_stein25@yahoo.com. Devaney may be reached at tim.devaney@sbcglobal.net.