June 24, 2005

Marchex exec: From shoe salesman to Web wunderkind

By John Cook | Seattle Post

SEATTLE POST-INTELLIGENCER REPORTER
Marchex Chief Executive Russell Horowitz got his start selling women's shoes at the old Nordstrom store in downtown Seattle.

Now, nearly two decades after that summer job ended, the 39-year- old entrepreneur sits in a corner office of the former department store directing one of Seattle's fastest-growing Internet companies.

"Every day is a reminder that you are close to your roots," said Horowitz, a Seattle native whose 240-person Internet marketing company is located just a floor above where he once sold pumps and high heels.

But shoe salesman was never meant to be the career for Horowitz -- an entrepreneurial wunderkind who has helped start four companies since graduating from Columbia University with a degree in economics in 1988. One of those companies -- the Internet conglomerate Go2Net -- was bought by Bellevue-based InfoSpace for about $1.5 billion in stock near the peak of the Internet bubble.

Although that acquisition created a financial windfall for Horowitz, it did not undermine his entrepreneurial energy. Today, the former Lakeside High School soccer player has reunited the team from Go2Net to attack one of the most lucrative and highly competitive Internet sectors: search-engine advertising.

Walking through the Marchex headquarters -- complete with pinball machines and free soda pop -- Horowitz said he can't recall ever feeling a twinge of deja vu. That's a bit strange. After all, Marchex looks a heck of a lot like the old Go2Net in terms of people, culture and business strategy. The two companies even used the same investment bank to go public -- each doing so just 14 months after its founding.

"We have done a lot of similar things," admits Horowitz, who like at Go2Net takes a modest salary of less than $55,000. "But the flavor of how they have unfolded has ended up being fairly different."

One thing that has remained the same at Marchex is the Management Team. It consists of John Keister, the former chief operating officer at Go2Net and an old soccer buddy of Horowitz's from Lakeside; Peter Christothoulou, a former investment banker who ran strategic initiatives at Go2Net; and Ethan Caldwell, the former general counsel at Go2Net. All told, there are about 35 former "Go2netters" at Marchex, representing a quarter of the headquarters staff.

In less than three years, these Internet pioneers have positioned Marchex as an up-and-comer in a $4 billion industry that is growing 20 percent each year. The industry -- known as search-engine advertising and brought to prominence by Google and Yahoo! -- is helping millions of online businesses market their products and services by displaying relevant advertisements at the top and side of search-engine results.

An unknown entity

Though Marchex is benefiting from the search advertising phenomena and directly tied to the most powerful search engines, the tightly controlled company is still relatively unknown. Only a handful of outsiders attended the annual meeting in Seattle last month and just a few analysts track the stock. Average daily trading volume on the stock rarely surpasses 500,000 shares -- so thinly traded that it doesn't pique the interest of many on Wall Street.

But those who know Horowitz -- the son of a former King County Superior Court judge and private investigator -- say it is worth watching his entrepreneurial encore.

"He has a rare combination of being a visionary and also having financial savvy ...," said Summit Capital Management Vice President Alex Washburn, a longtime friend of Horowitz's and an investor in Marchex. "Bottom line, he is someone you want to bet on, no matter what he is doing."

Despite Marchex's low profile, the company has delivered strong financial results. It has posted three consecutive quarterly profits and expects to boost profit margins above 28 percent this year. Last year, it saw revenue growth of 90 percent and claimed one of the top performing initial public offerings in the country. Although the stock has fallen 31 percent this year, it is still trading at more than double the $6.50 IPO price. Of the six analysts following Marchex, five have "buy" ratings on the stock.

"They have a first-rate Management Team that has made money for investors before at Go2Net," said ThinkEquity Partners' analyst Stewart Barry, one of the most bullish on the stock with a 12-month price target of $28 per share. "... This is one of the few companies in the space that I feel -- among the smaller cap names -- the best quarters are still in front of them."

"Significant aspirations"

Marchex has primarily grown through acquisitions -- a strategy that Horowitz and his team honed at Go2Net in the late 1990s as they bought more than a half-dozen Internet companies. With a $426 million investment from Microsoft Corp. co-founder Paul Allen and positive cash flow, Go2Net expanded into nearly every corner of the Internet: multiplayer games, financial chat boards, search engines, payment processing and Web-site hosting.

Marchex has been equally acquisitive, but with a more tightened focus on search.

In April, it bought Issaquah online yellow pages operator Pike Street Industries -- the fifth acquisition in the past two years. Other deals, including the acquisitions of GoClick.com and Name Development, have added strength in new areas.

"It has been a busy couple of years. Every once in a while, you lose track of time and try to recalibrate," said Horowitz, who turned down a senior executive position at The Walt Disney Co. in 2001 to pursue his entrepreneurial interests. "We are still a young company, and we have made a lot of progress relatively quickly. But we have significant aspirations."

The Switzerland of the Internet

At first glimpse, Marchex's business is not the easiest to understand. There are complex partnerships with potential competitors such as Yahoo! and Google and nebulous terms such as "search-engine optimization," "paid inclusion" and "direct navigation" that are used to define the business.

But essentially, Marchex is a middleman: creating a bridge between Internet search engines and the online merchants who want to advertise through them. Horowitz -- who has never met a financial term he didn't like -- prefers "highly valued intermediary." Others say Marchex is like Switzerland -- a neutral party that can get merchants better advertising rates and placement on the popular search engines.

Whatever you call it, customers are signing up by the thousands. Marchex does not disclose the total number of customers, but retailers such as Best Buy, Office Depot, REI and Nordstrom are among its clients.

Jeff Nienaber, online marketing manager at Celebrate Express, a Kirkland seller of party supplies and children's apparel, contracted with Marchex last year to gain better placement in the search results on AltaVista, Yahoo! and DogPile. So far, Nienaber said he has been pleased with the results.

"It really does work," said Nienaber, who is now attracting Internet users directly to specific product pages on the Celebrate Express Web site. "It is paying off for us."

Working with Marchex, Celebrate Express chooses advertising key words that are triggered when people conduct queries on major search engines or comparison shopping sites. For example, a search on Yahoo! for "Star Wars Birthday" displays Celebrate Express' party-supply package from the hit movie as the No. 1 link.

Every time a person clicks on that link -- located just below the paid listings -- Celebrate Express pays about 25 cents for the lead. That money is then split between Yahoo! and Marchex.

Using its proprietary technology, Marchex provides reports to Celebrate Express on what advertising key words are attracting customers or should be added because of pop culture or seasonal trends. For example, last summer, Marchex identified several key words around the phrase "back-to-school shopping" that helped Celebrate Express boost sales at its Storybook Heirlooms clothing line.

Companies could manage all of those key words on their own, but with thousands of products, it could quickly become confusing and cost-prohibitive, Horowitz said. With each search engine maintaining different ad rates and listing protocols, he added that it is easier for a third party such as Marchex to handle the process across the different distribution points.

"You literally have hundreds of thousands, if not millions, of permutations," he said. "A lot of folks realize that search is the No. 1 way that you attract customers online, and they take a strategic approach, which means specific expertise and specific technology solutions."

Being a middleman, however, does have challenges. At some point, Google, Yahoo! or MSN could alter advertising policies in such a way as to eliminate the need for the company's services.

To safeguard against that possibility, Marchex has expanded into two emerging categories in the online search market: direct navigation and local.

Direct navigation

Direct navigation -- a search technique in which an Internet user types a product or service name directly into the browser window -- allows users to bypass search engines altogether. For example, a person who wants to buy a video camera could perform a search for that product by going directly to www videocamera.com or www.videocameras.com -- both owned by Marchex.

In February, Marchex paid $164 million for certain assets of Name Development -- an obscure British Virgin Islands company that owns Debts.com, LasVegasVacations.com and more than 100,000 other Web-site names. Some of those assets include misspelled Web sites such as www cameraz.com and www holloween.com, although Horowitz said those will not form the core of the company's direct-navigation strategy.

About 20 million people stumbled onto one of Marchex's Web sites through that search technique last month -- providing an important source of proprietary Internet traffic.

Horowitz has big plans for direct navigation, turning the 200,000 Web sites it owns into worthwhile destinations where consumers can find links to the products or services they are seeking. He estimates that direct navigation accounts for about 10 percent of all Internet searches and could become a billion-dollar market in the next two years.

"Our focus is to be leaders in this valuable subset of search, where we don't have to worry about Microsoft spending billions of dollars, because with direct navigation, it is analogous to real estate," he said. "If we own Beijing.com, nobody can duplicate that asset."

The jury is still out on whether direct navigation will grow at a pace that warrants Marchex's recent investments. And not everyone is a believer.

Nienaber, who runs online marketing at Celebrate Express, said he would not want to be associated with direct navigation because it often takes advantage of misspellings and, in some cases, treads dangerously close to the trademarks or domain names of established companies.

"From a business ethics perspective, it is a very gray area," Nienaber said. "Long term, it is not the kind of business I want to work with."

In some cases, the Web sites owned by Marchex use traps to ensnare traffic. For example, those who land on www searching.net are asked if they want to reset their home page to the Web site.

Caldwell, the Marchex general counsel, said those tactics will not be tolerated and the company is currently in the process of cleaning up the network of Web sites. It is not the goal to take advantage of established brands by "cybersquatting" on certain names, a questionable practice that Caldwell said could put the company on shaky legal ground.

"That is not a viable business based on the laws and regulations," he said. "And we understand that."

Despite the shady reputation, ThinkEquity's Barry said those who arrive proactively at these Web sites might be motivated buyers. And although that could entice advertisers, he said it is too early to say if that's indeed the case.

"They are really the first Management Team to put the spotlight on direct navigation as a way people search," Barry said. "It is pretty new, and it is certainly a unique strategy versus Yahoo! or Google."

Local search

However, the second core focus of Marchex's business -- local search -- is definitely on the radar of the big search engines. Just this week, Microsoft's MSN division started a new local search service to compete against offerings from Yahoo! and Google.

Still, Horowitz thinks there is an opportunity for Marchex to lead the way in local search, which accounts for about 25 percent of search queries as people look for products or services close to where they live. The Kelsey Group projects that $5 billion will be spent on local search advertising in 2009 as more small businesses try to drive customers to newly created Web sites.

To capture a piece of that pie, Marchex is licensing its technology to phone-book publishers and newspapers that have existing relationships with local advertisers.

For example, phone-book publishers SBC Communications and BellSouth are selling Marchex's technology under their own names to hundreds of their existing advertising customers. That lets a small business -- such as an auto mechanic, plumber or tailor -- add paid online search listings to their existing advertising repertoire. For example, an Atlanta mortgage broker could pay to have its Web site listed in the sponsored links of Google if a person searched "Georgia mortgages."

The Houston Chronicle, which is owned by The Hearst Corp., parent company of the Seattle Post-Intelligencer, also is rolling out the Marchex service to help its advertisers place paid listings on search engines.

With those agreements in place, Marchex now has more than 2,500 sales professionals marketing its search service to a potential audience of 2.5 million small and medium-sized businesses.

The partnerships with BellSouth, SBC and Hearst also are pushing Marchex closer to a company goal, which Horowitz said was to have more than 50 percent of yellow page operators and two or three top newspaper chains reselling the local search service this year.

It is too early to say if the bets on local search and direct navigation will pay off. But Marchex has won some respect on Wall Street in recent weeks. Earlier this month, Marchex, Seattle-based aQuantive and Yahoo! were chosen as top stock picks at the Piper Jaffray Global Internet Summit. And two of the largest investment firms in the country, Fidelity Management and Franklin Resources, have increased their stock holdings above 10 percent.

Although some investors are betting that the Marchex team will hit the jackpot again, Horowitz is quick to point out that the company is still relatively young. With all of the potential worries of a chief executive, Horowitz said his biggest concern boils down to one word: "timing."

"We have seen a lot of markets where you have the right product, the right macrotrends and the right business model but your timing is off," he said. "... I am highly confident in where we sit in our ability to execute and drive value, but you have to have the right solution at the right market window."