Apple iTune Gets Hacked

Apple Computer Inc. today had no comment on reports that a well-known hacker had cracked the code containing the restrictions that prevent iTunes music products from being replayed on any other player than the iPod.

A 22-year-old Norwegian, John Lech Johansen, aka "DVD Jon," claims to have unlocked the playback restrictions placed on downloaded music not only by Apple but by some of its competitors too.

Johansen became famous when he was only 15 by posting software that unlocked the scrambling system used by the film industry to prevent illegal copying of DVDs. But this time, Jon's latest effort may not carry the word "illegal."

Apple uses copy-protection software to make sure music downloaded from its iTunes Music Store cannot be played back on devices other than the iPod. Similar restrictions are imposed by many other online music stores to prevent their songs from being played on the iPod because Apple doesn't support those systems.

Johansen has told many in the Internet industry that he got around Apple's restrictions by "reverse engineering," creating a code that mimics the company's restrictions. That is important legally.

U.S. law, according to lawyers at the Electronic Freedom Foundation, may support what Johansen has done.

"It is called interoperability," says Corynne McSherry, a lawyer at EFF. "Johansen has done his best not to raise a legal issue."

The law protects interoperability so that a new digital product developed by one company works with other software it doesn't control.

Think Microsoft and Web browsers.

The theory behind the law, McSherry says, is that software produced by different companies should be able to work together so competition isn't stifled.

"You have to be sure that my software operates with their technology so as a company, I can offer something new, in short, so that my software works with their software," she says. "We like competition in the United States, so that one company doesn't own all future development."

Apple likely has a different view. Just last quarter it sold almost 9 million iPods. And since the openning of its online music store, it has sold 1.5 billion songs at 99 cents each.

And Johansen's plan, unlike the fruits of his previous hacking, is to use this reverse engineering for profit. Through a company he has set up, called DoubleTwist, he plans to sell the technology.

A spokeswoman says DoubleTwist already has a client, presumably to sell music that would now be compatible with the iPod.

What will this mean for Apple?

It's too early to say. The company will clearly mount a legal challenge, but some analysts believe Apple could end up selling fewer iPods but more music.

"It could be in Apple's interest that when people download music from iTunes, that consumers will be able to import it to other places: your home, your computer, your car," McSherry says.

And other lawyers say there's a big difference between "reverse engineering" and hacking into a company's internal, confidential information or a bank's records, for example. That is clearly against the law.

But, a spokesman for Johansen says, "There's a certain amount of trouble that Apple can give us."

Copyright © 2006 ABC News Internet Ventures

Why Yahoo! Gets 4 Cents Per Search, While Google Gets 11 Cents

IN mid-October, Yahoo, the world's biggest Internet portal, reported a sharp profit skid and warned of a further growth slowdown in two major lines of business — a performance that its unusually contrite chief executive said had failed to fully exploit the company's strengths.

That was enough for Scott W. Devitt, an analyst based in Manassas, Va., who covers Yahoo for Stifel, Nicolaus & Company, the investment banking firm. Three days later, Mr. Devitt downgraded Yahoo shares — which at the turn of the century traded above $100 and were then about $23 — to a hold from a buy. Fidelity Investments has also soured on the stock, but declined to say why it sold 55.6 million Yahoo shares between midyear and Oct. 31.

But Justin Post, a Merrill Lynch analyst in San Francisco, had the opposite reaction to the grim news from Yahoo. Just before Halloween, Mr. Post, noting the stock's sharp drop this year, saw "an attractive entry point" and raised his appraisal to buy from neutral.

So is Yahoo stock, which now trades at $26.91, down 31.3 percent this year, a bargain suitable for value investors? Or is the once highflying company — which in its heyday was regarded not unlike today's Google — destined to bring further disappointment?

Despite contrasting opinions, analysts and stockholders of Yahoo generally agree on what ails it. And there is a consensus that if it remained an underachiever, it would be a candidate for takeover.

The main problem is that Yahoo has not been nearly as good as Google at reaping profits from the huge volume of search traffic it attracts. Yahoo's search revenue in the third quarter was $191 million, versus $911 million for Google, Mr. Post's report estimated.

"Yahoo touches one out of every two people on the Internet every month, which is unparalleled reach," said Randy Befumo, co-director of research at Legg Mason, which holds some 40 million Yahoo shares in various accounts, including funds run by Bill Miller, Legg Mason's marquee mutual fund manager. Despite the fact that Yahoo actually has more traffic than Google," Mr. Befumo said, Google has more revenue. "So there definitely is a problem with Yahoo's monetization."

According to Mr. Post, who also points to this issue, each domestic search generates about 4 cents for Yahoo, compared with 11 cents a search at Google.

Some analysts see other sources of concern — questions that the market may not have recognized as fully as the lag in converting search traffic to cash. Prominent among these is the strength of challenges to Yahoo's commanding position in the branded business of display advertising on the Web. Mr. Devitt calls this issue "the new surprise."

He points to more aggressive investment by Microsoft in MSN.com, its Internet portal; AOL unbundling its business and making it available free; and the rapid emergence of fresh competition from social networking sites like MySpace, Facebook and YouTube.

"That, as well as the traditional media moving on the Internet, has significantly increased the inventory for display advertising alternatives," Mr. Devitt said. "It's impacted the pricing pressure and the dominance that Yahoo had in that business."

Mr. Post of Merrill Lynch acknowledges the drag on Yahoo's business. The industry's growth rate is catching up with Yahoo's in this area, he said. "When someone's growth rate is declining, it's hard to know where the bottom is," Mr. Post said. Still, he said, Wall Street's worries about this seem overdone, creating a buying opportunity at the beginning of a traditionally strong holiday period for the Internet.

Then there is the problem of eroding revenue from Web sites that are increasingly choosing to link to Google, which can provide better monetization of traffic. "This is something that puts at risk Yahoo's network business longer-term," Mr. Devitt said.

Yahoo management, led by its chief executive, Terry S. Semel, is counting heavily on a technological upgrade of its search engine to enhance profits. The delayed upgrade, called Project Panama, is now scheduled for introduction in 2007, and analysts expect it to narrow Yahoo's search gap with Google. Merrill Lynch figures that the project will raise revenue per search to around 5 cents in 2008, or as much as 7 cents if Panama proves a rousing success.

"Monetization is a hard thing; not too many people do it very well," said Mr. Befumo at Legg Mason. But, he contended, Yahoo has some appealing alternatives.

"If you have a traffic problem, then you have a fundamental business problem because you have nothing to convert into revenue dollars," he said. "But if you have a monetization problem, which is what Yahoo effectively has, you always have options."

If Project Panama falls short, Mr. Befumo said, Yahoo could have Google or Microsoft do Web-searching for it in return for perhaps 5 or 10 percent of the revenue. "You could solve the monetization problem overnight" with such a contract, he said.

Yahoo shares, which have climbed about 11 percent in the past month, have been supported by company buybacks — over $1 billion worth in the third quarter, more than triple the purchases in the second quarter — and by what appears to be increased speculation that the company is a possible target for acquisition, perhaps in a private-equity deal or a leveraged buyout. Yahoo could also buy another company, and Facebook has been mentioned as a possibility.

A spokeswoman for Yahoo said it did not comment on such speculation.

In his report upgrading the shares, Mr. Post wrote that "we think Yahoo's assets would be compelling for Microsoft or a large media conglomerate looking to build a meaningful online presence." He set a 12-month price goal of $32 but said that there was a risk they could fall to $22.

MR. POST came up with his $32 figure this way: he assigned a multiple of 25 to projected 2007 free cash flow of $1 — meaning that the stock would be worth $25 on the basis of that flow alone — then added $3 for the value of Yahoo Japan, $1 for the company's Alibaba operation in China and $3 in cash.

Mr. Devitt, who is more skeptical about the stock, said that it "probably does have upside" potential if Yahoo can stabilize its branded graphic display advertising and derive some benefit from Project Panama next year. In the meantime, he said, the stock is likely to languish. At Legg Mason in Baltimore, Mr. Miller, portfolio manager of Legg Mason Value Trust, told investors in August that the intrinsic current value of Yahoo was perhaps double its market price then of about $27.

The firm's optimism seems undiminished. Though it has pared its peak Yahoo position, Legg Mason Value Trust still held 19.2 million shares on Sept. 30. Yahoo's stock decline this year is one reason that the fund may fail to beat the Standard & Poor's 500-stock index after outperforming it for 15 years in a row. So far, the fund is lagging behind the index by more than nine percentage points.

Mr. Befumo of Legg Mason said that Yahoo's stock began to be "sort of crazy cheap" last month, and that other "classic value guys are actually starting to sniff around the name because, on a cash-flow basis, it's particularly cheap."

Mr. Miller was not available for comment, a spokeswoman said. Mr. Befumo contends that Yahoo's intrinsic value is in the mid-$40s, pointing to the stepped-up buybacks as evidence that the company agrees. Although he said the stock could drop into the teens if it were ever evaluated like traditional media businesses, he also said that it could leap into the $60s in the perhaps equally unlikely event that it traded at parity with Google.

At the moment, though, the gap between the stock market's valuations of Google and Yahoo is enormous. Yahoo's market capitalization is about $36.6 billion, and its price-to-earnings ratio is 34.1, based on trailing earnings. By contrast, Google has a market cap of $152.7 billion and a trailing P/E of 63.3, according to numbers available on the Yahoo Finance site.

Students of Yahoo say that while the company may be acquired, no deal is likely before Project Panama begins to show results, one way or another. Merrill Lynch figures that the project will raise Yahoo's revenue $250 million to $500 million in 2008 — and warned that investors could be "too late" if they waited to buy until Panama's rollout risks had passed.

Ultimately, Mr. Befumo said, the search engine business will shake down to a natural worldwide duopoly. "We think that Google and someone else — we think the odds are Yahoo — will do this for a majority of the Internet," he said. "Very few other people will be able to get the scale of traffic required to make it work."

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Pay-Per-Click Search Engine Marketing Handbook: Low Cost Strategies to Attracting NEW Customers Using Google, Yahoo & Other Search Engines