once upon a time in seattle

Seattle's InfoSpace took investors for a ride

By David Heath and Sharon Pian Chan
The Seattle Times
Friday, March 25, 2005

Five years ago, at the height of the dot-com stock frenzy, a young Seattle-area company called InfoSpace was worth more than Boeing.

Wall Street analysts hailed the startup, which promised to bring the Internet to everyone's cellphone, as "a new Microsoft," and its charismatic leader, Naveen Jain, as a visionary.

Microsoft co-founder Paul Allen had hundreds of millions invested. Small investors such as Bev Hess, a real estate agent in Phillips, Neb., poured their retirement savings into what appeared to be a sure bet.

At its peak, InfoSpace was worth more than $31 billion US and Jain himself $8 billion.

What Allen, Hess and hundreds of other shareholders didn't know was this: InfoSpace's success was an illusion.

Jain and other InfoSpace executives deceived the public by making the company appear far more successful through the use of accounting tricks and dubious deals, a Seattle Times investigation found.

The investigation was built on internal company e-mails, confidential documents filed in court and scores of interviews.

One e-mail from a venture capitalist to Jain captures the nature of the deals. The man refused to participate in an investment that Jain had proposed, bluntly telling Jain that if he did so, "I believe that I could go to jail."

The investigation found:

- InfoSpace officials misled Wall Street and the public about how their company was doing, concealing that revenues were falling far short of expectations;

- Much of InfoSpace's reported revenue came from "Lazy Susan" deals, whereby company officials invested in other firms that turned around and gave back the same money;

- While investors clamoured to buy InfoSpace's highly touted stock, company insiders were unloading it. Two executives later angled to get around trading restrictions by asking for demotions to sell stock before its value evaporated. Others just quit and sold their holdings.

Then, unknown to investors, Jain and his top two executives all resigned in a single week.

"I had never heard of anything like that before," Rick Thompson, former InfoSpace executive vice-president, said in court documents. "It was the (Exxon) Valdez running along with nobody driving the damned thing."

When the game was up, investors took a beating. The company once worth more than Boeing fell to the value of two Boeing 777s.

Allen lost an estimated $400 million when InfoSpace shares collapsed. Hess, 65, saw her $40,000 investment shrink to $1,450.

"I scrimped and saved for 42 years, and I feel that I have been duped out of my hard-earned money," she said.

Rather than investigate Jain for misconduct, the federal Securities and Exchange Commission aided Jain in court after he hired a prominent former SEC lawyer to lobby the agency.

InfoSpace today barely resembles its former self. The board ousted Jain more than two years ago and hired Jim Voelker as chief executive. Voelker has restructured the company to make it profitable, and the stock has been on the rebound.

The real story behind InfoSpace's rise and fall comes to light now because The Seattle Times recently won a two-year court battle that led to the release of thousands of pages of records that had been sealed in a shareholder lawsuit.

Naveen Jain, a native of India, came to the United States as a young man through a business-exchange program and in 1989 joined Microsoft.

He watched Netscape's spectacular stock run-up in 1995, marking the beginning of the dot-com era: No longer did companies, particularly Internet startups, have to show a few years of profit before Wall Street would consider offering their stock to the public.

Jain saw an opportunity. In March 1996, he started InfoSpace.

Though InfoSpace was a tiny, unprofitable company offering a hodgepodge of online phone books, stock quotes and horoscopes, Jain was able to take it public in late 1998 during the dot-com frenzy.

On its first day on Wall Street, Jain's shares were worth $110 million.

He soon realized, however, that making money from charging for ads on its websites was a long slog with limited potential for growth.

So he came up with a new plan: What if InfoSpace offered the same content -- weather reports and stock quotes -- to cellphone users, charging them a monthly fee?

He finally had a business that people could understand: the web in your pocket. InfoSpace was no longer just another dot-com. It was the pioneer of the wireless Internet.

With contagious fervour, Jain told people there would soon be a billion cellphones in the world and InfoSpace would get $1 to $3 per subscriber per month.

"You do the math -- that's a (expletive) load of money," he said.

Analysts bought the concept and gushed over InfoSpace's prospects. An analyst from US Bancorp Piper Jaffray even proclaimed: "A new Microsoft is born."

Fuelled by hype, InfoSpace's stock went stratospheric, soaring 1,300 per cent in just five months.

But the rise was short-lived. In early March 2000, the dot-com bubble burst, and InfoSpace's stock went into a freefall.

The news only got worse. On April 20, 2000, InfoSpace's finance director sent an alarming e-mail to Jain about wireless Internet revenues. It warned of a disaster with Saraide, a company InfoSpace had just bought.

Saraide was backing away from its promise to bring in $31 million from Europe that year, InfoSpace finance director Garth MacLeod had just learned.

Instead it would come up with only $12 million -- a devastating $19-million shortfall for a company expecting $106 million in revenues for the year.

"This is not good," Jain wrote back.

Although InfoSpace was slashing its internal revenue forecast, Jain gave a rosy forecast about InfoSpace's prospects to a Merrill Lynch analyst.

In an April 24 e-mail, analyst Sofia Ghachem wrote to her colleague Henry Blodget: "Naveen saying we won't be embarrassed if we go out on a limb for results."

Privately, Blodget already had reservations about Jain and InfoSpace, asking a colleague in an e-mail just the week before: "Is this really a world-class company or just a world-class storyteller?"

But, on April 27, 2000, as Jain had urged, analyst Blodget boosted his own estimate of InfoSpace's annual revenue by 18 per cent and gave the stock his strongest buy rating.

This burst of renewed optimism about InfoSpace stopped the stock from tumbling and even pushed it up that day from $63 to a closing price of $72.

The bump in the stock price that Thursday put extra money in Jain's pockets. The following Monday, he sold 220,000 shares at $68.75 a share for a total of $15.1 million. The misguided euphoria over expected revenue growth had increased Jain's gains by at least $1.2 million.

Other InfoSpace insiders, who had been included in an e-mail warning of revenue shortfalls, also sold stock in the ensuing weeks. In all, InfoSpace insiders sold $158 million in stock from May to July 2000.

Failing to meet expectations, InfoSpace relied on accounting gimmicks and questionable deals to make up the shortfall, records show.

InfoSpace bought an $8-million interest in netgenShopper, owned by Jain's brother Atul, which in turn sent $5 million of it back as payment to InfoSpace for promotional services.

It was the kind of deal that InfoSpace insiders referred to as "buying revenue" or "a Lazy Susan" because the cash the company gave out came right back to it as revenue.

Experts say these types of deals are suspicious because of the inherent conflict: one company doing business with another company it owns.

Lazy Susan deals are illegal when they're not genuine business deals but instead merely a fraudulent way for companies to convert their own cash into revenues.

Atul Jain declined to comment about netgenShopper for this story.

By the end of 2000, more than one-quarter of InfoSpace's revenues came from a host of one-time deals, such as Lazy Susans, and other accounting tricks.

Meanwhile, key executives were looking for ways to cash in their stock, whose value was quickly evaporating.

InfoSpace general counsel Ellen Alben demanded a demotion to skirt trading restrictions created by a recent merger, according to court records.

Violating the restrictions could be disastrous for the company, forcing it to use less favourable accounting methods.

After the demotion, Alben made $1.6 million selling her stock. The new general counsel urged Alben not to sell, but later said in court records that she brushed him off, saying: "You don't know what I know."

Chief accounting officer Tammy Halstead, who clashed with new management over her accounting methods, took a demotion to staff accountant and sold $627,500 of stock. Jain said in court records that she wanted an "Ellen deal."

Behind closed doors, new president Russell Horowitz was sounding alarms about lagging revenue. In an e-mail to Jain and others, he noted $16 million in revenue was coming from one-time deals that "fall off" at the end of the year.

"In looking at Q1, we have some SERIOUS work to do," Horowitz wrote on Nov. 15, 2000. He warned that InfoSpace needed to come up with another $40 million just to meet the first quarter target of $78 million.

Two weeks later, Horowitz received more bad news from the finance director. For the second and third quarters of 2001, InfoSpace had signed contracts for only one-third of the revenue the company had told Wall Street to expect.

As for deals in the works, the "pipeline is anemic," the finance director wrote.

Yet the company was publicly forecasting rapid revenue growth for 2001, up 70 per cent to $360 million.

To counter negative news, InfoSpace issued a news release Dec. 13, saying it expected to meet its fourth-quarter revenue target.

It added: "InfoSpace continues to experience momentum across all of our areas of focus, and we remain very confident with the financial guidance we have previously provided."

Internally, Jain accused insiders who sold of trading on insider information, according to court records.

Horowitz sold $1.4 million of InfoSpace shares on Dec. 15.

It was obvious by then that InfoSpace could not meet its target of $360 million for 2001, Jain would later insist. He was in India at the time and said he wasn't involved in the release.

In court documents, Horowitz said he didn't know the $360-million forecast needed to be revised until a month after he sold his shares.

He contended the Dec. 13 press release was not about the $360-million figure.

Horowitz quit weeks later and sold all of his stock for $32 million.

Jain now hopes to take a new company -- Intelius -- public one day.

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