At the point where I wrapped up part one of our conversation from late last year, Levine had been talking about opportunities he saw around data storage in the enterprise. As he sees it, another big space ripe for disruption — and thus investment — is in security. That’s where the conversation picks up below:

AllThingsD: So Andreessen Horowitz has done a bunch of security deals. What kinds of opportunities are you seeing there?

Levine: Data security. Okta puts active directory out in the cloud. All SAAS apps, everything goes out there. That’s access control, which very much is security. Security is also being exacerbated by the number of mobile devices in an environment. If you have BYO devices and you’re using someone else’s SAAS, as a CIO you don’t own either piece of that. So an interesting security problem to solve is how you make corporate data usable in that scenario.

Is anyone coming close?

Sure. There’s one company in our portfolio. Silver Tail (now part of EMC) does behavioral prevention. It can look at the behavior of an endpoint and determine if it’s a human being. If you can detect patterns of illicit behavior, you can shut them down before they do any damage. So that’s interesting. Bromium, which just announced, which builds impenetrable walls around processes that live on mobile devices. The premise of Bromium is that you no longer have to do virus scanning. It assumes that viruses are coming into a system anyway, and they’re going to come by way of something like a browser, and affect a running process. But if that process is wrapped by an impenetrable wrapper, it can’t get onto the system. To kill that virus, all you do is shut down that process. So that’s an interesting investment we’ve made.

How do you go about finding the companies that you invest in?

We are not thematic investors, first of all. And I love that. To me, if you’re a thematic investor you end up being the 40th one to pick a company in a given stack, because you have to be in on a certain kind of company. We really do see nearly 100 percent of all the deals that are occuring at any given point of time. We evaluate every single company on its merits. As soon as we say we need to be in on something like, say, database technology, then all of a sudden I have made a preordained and preconceived decision that this is important. I don’t want to have a bias coming into things, that I throw out something that’s actually interesting, or include something that may be way overinvested. We look at each company as a fresh canvas, but we will look at companies that have great technical co-founders who believe that they are going to go dominate a given market segment. It may not be obvious at all. Most obvious things are obvious to many people. It’s a matter of finding the non-obvious things. There are a lot of things we see, and there are a lot of areas where we haven’t invested.

Is that how do you explain GitHub? That was a huge deal, and no one really understood it at first.

I wasn’t really looking to invest in a collaborative source code control system. Before last year, I didn’t even know it existed, and didn’t internalize the value of what they do. After we met them and realized the power of what they do, and have done, and the potential future for that company, we invested. It’s interesting when you don’t have biases and just let everyone come in and pitch, knowing you really can see things in the eyes of the entreprenuer, which I believe is really critical. As soon as I have opinions, I start to shape the company in my mind’s eye, and that’s really backward, because as a board member you want them forming the vision and to help along the way.

I’m hearing deal flow has been really high. Is that likely to continue for awhile?

It’s good that we’re seeing tons of stuff, and there’s a tremendous amount of innovation occuring. It used to be there was a lot of consumer stuff going on, and maybe only a few things happening in the enterprise. Now the enterprise deal flow is much higher than consumer. But I’ll tell you, it’s so cool to see all that. And we’ll pass on most things. But it’s cool being here, at this firm, but also at this time. The last time there was really a lot of flourishing innovation around the enterprise was in the mid-1990s.

Will you be doing many more deals in 2013?

I’m sure we will. We have a lot of seed investments right now. It’s a lot like dating before you get married, so I’m a big believer right now in what we have going on with our seed portfolio. They’ve come up for A rounds, and we have the opportunity to really work with the company. But I like seeds, because you get to watch a company and watch the execution and the dynamics of the team. One recent deal we did was Convergent-IO, which was a seed that turned into an A round.

What do you like and dislike in a team?

We’re very much pro-technical co-founder or founder. I would say that that is like a fundamental criteria. It is easier to coach a technical co-founder on how to run a business than it is to coach a professional manager on the DNA of what the vision of the company is. We look for someone who has a burning passion to go take on the world. We want entrepreneurs that want to go for the long ball. They want to run the company for the long term, and they want it to be a standalone enterprise, as opposed to building something to get acquired. We also like to make sure the entrepreneur understands how they’re going to use the money they’re raising. We like for them to have an appreciation of the clear understanding of how to get from point A to B.

If there’s one thing there’s a lot of demand for right now, it’s in the area of mobile management. In English, it means basically making sure that all those iPhones, iPads, Android devices and BlackBerrys either issued to employees or brought to the office by employees are secured, are running the right applications, have access to the right resources, and when an employee leaves or when a device is lost, get cut off quickly.

It’s a pretty big market. Research firm Gartner estimated last year that about two-thirds of large companies and organizations will buy a mobile device management product within the next four or five years. And within four years, Gartner says, most companies will be supporting at least two mobile platforms.

I had a quick chat this morning with AirWatch CEO John Marshall, who called from Barcelona. The first thing I wondered about was the size of the deal. AirWatch is already pretty well established with 6,000 customers and 1,200 employees. It boasts customers as varied as home improvement retail chain Lowe’s, airlines like United and Delta, the U.S. Army Corps of Engineers, automaker Toyota, pharmaceutical giant Merck and Swiss Dutch bank ING.

In the nine years it has been operating, the company has been internally funded. Marshall and AirWatch chairman Alan Dabbiere have worked together before. In the 1990s they founded Manhattan Associates, a supply chain software company.

The product is a mixed software-as-a-service or on-premise solution. About 70 percent of AirWatch’s customers choose the cloud-based product, the remainder use it on-premise, he said.

“We feel like this is a great opportunity to push harder and continue to differentiate our company from the rest of the marketplace,” Marshall told me.

One competitor AirWatch sees is software giant SAP; computing giant IBM is also starting to make noise in this arena. And there will almost certainly be more companies talking about this. “The interesting thing here is that every single company has mobile devices, every single student will have a tablet, every single government agency has or will have mobile devices. The opportunity is so massive that it will boil down to the companies that have the scale and size to be able to manage across the entire spectrum of devices.”

He says AirWatch is about two to three times the size of other players in the business in terms of the number of people devoted just to mobile device management. “We’re pretty much the biggest one.”

So what’s he going to do with all that money? In a word: Grow. “The interesting story here is that we’ve been building the business in a consistent and accelerated way for the last two years. We’ve have 40 percent quarter-over-quarter growth for the last eight quarters.” Marshall wants to expand operations through Asia and the Pacific region. There’s also a possibility of some strategic acquisitions.

And down the road, maybe: An initial public offering. “We don’t feel the pressure to do that right now,” Marshall told me. “But we certainly view that as a viable option in the future.”

Update: I just had a quick chat with Richard Wells, managing director at Insight. He said AirWatch is the kind of company that Insight tends to like. “They got to where they are without having raised a dime of institutional capital. That’s the kind of DNA we love.”

You also can’t argue with the market opportunity, Wells said. “It doesn’t get any bigger in terms of potential and here-and-now demand than managing mobility in the enterprise. It’s really hard to overstate it.”

“Our prediction that the Zynga IPO might have been the high water mark for Social Games 1.0 investment has been validated, with the VC market moving sharply away from that sector,” said Digi-Capital Managing Director Tim Merel.

A report conducted by Digi-Capital, an investment bank focused on gaming and companies in America, Europe and Asia, concluded that dollars are now being funneled toward tablet games, mobile games that are social, and cross-platform games, which work across all screens — mobile, social networks and the Web.

In December, Zynga raised $1 billion in a public offering, capping off a vibrant year of social investing that also included Nexon’s $1.2 billion public offering on the Tokyo Stock Exchange.

In 2011, social gaming represented 57 percent of the dollars invested and 45 percent of all acquisitions. But ever since the two IPOs, the smaller screen dominates, Digi-Capital reports. During the first nine months of the year, mobile and tablet games were the largest transaction group, receiving 42 percent of all fundings and 32 percent of all acquisitions. However, it should be noted that valuations are much lower today for mobile than social gaming last year, given that it is a much earlier stage market.

While Digi-Capital reports that social gaming is on the way out, the good news is that the broader games sector continues to see an accelerated level of interest. So far, in 2012, 71 transactions have been completed, totaling $3.6 billion, beating last year’s record level of activity. In 2011, 113 transactions generated $3.4 billion in transaction value.

Other trends to keep an eye out for:

• In addition to mobile, massively multiplayer online games (MMO) and middleware software continue to see investments and exits.
• Chinese, Japanese and South Korean companies are still looking to buy Western game companies, but are facing cultural hurdles.
• In the first nine months of the year, free-to-play MMO exits were a surprise, representing 42 percent of all M&A, by transaction value.
• Middleware software also performed well in the first three quarters of the year, receiving 39 percent of all private investments, driven, in part, by Visa’s $190 million acquisition of PlaySpan.

Dyn’s speciality is delivering what is known as “managed DNS services,” essentially the phone directory for the Internet. DNS — the initials stand for Domain Name System — keeps track of which domain names (like, say, AllThingsD.com) belong to the numerical Internet Protocol addresses that aren’t as human-friendly, like 205.178.190.40. While it seems trivial, it’s actually a pretty fundamental function of the Internet. If your DNS server goes down, your site is down, which means you’re not making any money.

Dyn provides its clients with a rock-solid DNS lookup service that keeps sites running, even when they’re hit with high demand. It also provides several services around the delivery of email. Its customers include companies like Zappos, Jive, Twitter, and OMGPop.

The company has been running along just fine since 2001, when it was born at the Worcester Polytechnic Institute. Bootstrapped from the start, it has been growing a lot faster in the last three years –a compound annual rate of about 70 percent per year. If it sounds like an opportunity to you, you’re not alone. Today, Dyn will announce that it has taken a $38 million Series A minority investment from North Bridge.

It has also enlarged its board of directors: At first its board was just two guys: Co-founders Jeremy Hitchcock and Tom Daly. Today, it’s adding three more people, the best-known of which is Jason Calacanis (pictured), the CEO of Mahalo; former CEO of Weblogs Inc., which he sold to AOL; and now co-founder of ThisWeekIn.

“We’ve kind of kept up a friendly rapport with him and have been following the things that he does,” Hitchcock, Dyn’s CEO said. “The time had come to think about governance and professionalizing the company, so we reached out with him, and had dinner with him in June.” Within a few days, Calacanis was ready to take his seat on the board. He is not making an investment.

The other two new directors are Ric Fulop, general partner at North Bridge and co-founder of A123 Systems, and Russ Pyle, general partner at North Bridge.

North Bridge’s interest sort of makes sense when you realize that among its investments are a bunch of Dyn clients, including Disqus, Quora, Demandware, Acquia, and Spil Games. “We have seen Dyn grow into the worldwide leader in Infrastructure as a Service with many of our portfolio companies as customers and are proud to be part of their story,” Fulop and Pyle said in a statement.

And while DNS services are one of those things that, like oxygen, are seemingly uninteresting to talk about until you lose it, the the number of customers that Dyn has gives you a pretty solid idea as to its importance: 2,000 enterprise clients, 450,000 e-commerce clients, and four million active users around the world. It has offices in Manchester and San Francisco, and two in the U.K., in Brighton and Wrexham. Headcount is 170 employees.

That changed a little bit last year when he disclosed in a television interview and in SEC filings that he had taken stakes in two technology bellwethers: IBM and Intel. Today, SEC filings show that he’s increased his already sizable stake in IBM but has sold off his Intel shares.

Explaining that Big Blue “treats its stock with reverence,” Buffett last November spent $10.7 billion to buy 64 million IBM shares — amounting to about 5.5 percent of the shares outstanding — making him the company’s biggest shareholder, slightly ahead of State Street Investments. His holdings are now north of 66.6 million shares and worth more than $13 billion.

His holdings in Intel were much more modest: The same day he announced the IBM investment, Buffett disclosed a stake in Intel amounting to 9.3 million shares, which at the time was worth about $200 million. By the end of March, that investment had declined to about 7.8 million shares. Now the latest SEC filings show Berkshire Hathaway liquidated its Intel shares as of the end of June.

Disappointing debuts of Web companies such as Facebook Inc. and Zynga Inc. have put some pre-IPO investors under water, leaving them with shares worth less than what they paid. Other investments remain profitable, but with much smaller gains than projected as recently as a few months ago.

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Pundits and others are using the B word — bubble — more than ever. Is it time to stop, or will this gain even more traction in 2012?

The company earned $177 million, or 38 cents a share, on revenue of $17.43 billion.

Even though revenue was up 35 percent compared to the year-ago period, it fell short of Wall Street estimates. Fueling the bad news, Amazon also said net income fell 58 percent.

Amazon’s stock tumbled in after-hours trading, falling nearly 10 percent, or $19 a share, to $175.50. The stock recovered a tiny bit later in the session, trading down 8.8 percent.

Analysts had expected Amazon to report sales of $18.3 billion, up more than 40 percent from the fourth quarter in 2010, according to FactSet Research.

For the full year 2011, the company’s sales increased 41 percent to 48.1 billion, while net income fell 45 percent to $631 million, or $1.37 a share.

The Seattle-based e-commerce company, which is notorious for offering little insight into its results, did not stray from standard operating procedure. It’s still unclear how many Kindles and how many Fire tablets it is selling.

“We are grateful to the millions of customers who purchased the Kindle Fire and Kindle e-reader devices this holiday season, making Kindle our bestselling product across both the U.S. and Europe,” said Jeff Bezos, CEO of Amazon.com, in a statement.

But it did not get any more detailed than “millions.” The company added that during the nine-week holiday period ended Dec. 31, Kindle sales — including the Fire — increased 177 percent over the same period last year. Furthermore, the Fire was Amazon’s most-gifted and most-wished-for product.

The big wild card for the quarter was not supposed to be revenue, but margins. The low margins of the Fire, and the company’s gigantic investments in infrastructure spending, such as warehouses, were expected to weigh down earnings.

Analysts were estimating that Amazon’s operating margin would fall to 1.3 percent from 3.6 percent last year.

Sure enough, the company’s margins were down, but it wasn’t quite as bad as people thought it would be. Actual operating margin for worldwide sales during the quarter fell to 1.5 percent.

Many investors were hopeful that some of those investments would wane in the first quarter, as Amazon started to reap the profits. However, the company’s first-quarter guidance is also less than expected.

Net sales are expected to be between $12 billion and $13.4 billion, representing year-over-year growth of 22 percent to 36 percent. Amazon is also expecting an operating loss of $200 million to a profit of $100 million, suggesting that heavy investments could continue.

NOTES FROM THE EARNINGS CALL

• After a riveting rundown of the company’s balance sheet and income statement, Amazon is opening up the call for questions.
• First question everyone wants the answer to: Can you talk about Kindle hardware units? A non-answer: “The only thing I can help you with is the holiday season — unit sales nearly tripled with Kindle and Kindle Fire, so we are very pleased with the growth we have,” says CFO Tom Szkutak.
• In North America, Amazon saw strong growth in digital media, for books, video and music. “All of those grew really well,” Szkutak says, but he said that most notably the videogame category, including consoles and games, was up in terms of unit volume, but down in terms of revenue.
• Another media area that grew was physical books, which were up double digits in the fourth quarter year over year. “We are very pleased, considering the shift to digital content and the rapid growth of the Kindle.”
• Seventeen fulfillment centers were built in 2011, and more are coming in 2012, but no precise numbers yet.
• In Q4, the company had 56,200 employees, up 67 percent year over year. “The majority of those increases is in operations and the customer service area. It supports a lot of the growth, and you are seeing that in our operating costs. Certainly you’ll see that over time go in cycles, but we are feeding the growth we are seeing.”
• A question about whether Amazon will slow down its level of investment. “No. No. We learn every week, month and quarter about customer adoption, and we are looking at a lot of positive things across the business, including Kindle growth from the device standpoint, and the content that’s following that,” Szkutak says. “We are seeing strong growth in categories like soft lines, like clothing, and in consumables, and very good growth outside of the supply-constrained areas in consumer electronics. … There’s a lot of interesting opportunities to invest in, and we are pleased with the performance in Q4 and what it means going forward for us.”
• Will investments continue in Amazon Prime? “We are investing a lot there, and we are making sure we understand it very well. We’ll continue to monitor it very closely, and over time, we’ll be sharing more about how we are doing there.”

Whether explicitly or not, everyone has their own answer to this question, and based on the success rates of start-ups, those answers by and large stink. I don’t have a Magic 8 Ball on the topic, but two things make this the issue I wrestle with most:

1. The often-unpredicted success or failure of “nobodies” or “sure things” respectively
2. The outsized rewards for locating great people, juxtaposed with the probability of abject failure when settling for good ones

There is no central casting for these players — many of the A+ entrepreneurs with whom I have partnered have come in unusual packages: a biology post-doc who thought about opening a microbrewery B&B; a large-animal veterinarian who went to business school in his late 30s; and an ex-EMT who was also a nephew of the President. The best VCs seem to show the same diversity of background.

I now focus on these attributes:

• Great talents find a way to win, and are relentlessly driven to do so. They follow through and complete the task at hand — after all, starting is easy, it’s finishing that takes real will. It is not that they think outside of the box, there simply is no box for them. They view ambiguity as opportunity, not risk. When things get uncertain is when they really perk up and start to pay attention, because that is when real change is possible. Most of all, they exceed expectations. They bend the space-time continuum in some fashion, and their accomplishments are extraordinary.
• Experience is overrated. By and large, the world is changed by the young and the hungry. Experience can be enabling or constraining, but it is not even close to the dealbreaker that many believe it to be. If you are seeking a VP marketing or head of sales at a 100+ person company, absolutely, look at a resume. But to find someone with the passion and uniqueness to actually create an early-stage venture, you have to take time: Watch them and see what they do, talk to them and see what they think, ask around and see how well respected they are.
• Balance exploring/driving with learning/listening. Great people have a very clear grasp of their vision, while understanding that the world has a lot to teach them. They are humble students of the game, but are very confident in their abilities, and never “do what they are told.” They don’t avoid conflict and will always bet on themselves rather than shy away from risk. They ask questions and argue on facts, balancing innumerable data streams with a gut feeling to get to what they believe is the right answer.
• Great people are magnetic. They are not only smart and driven, they attract resources when all the data suggests they should not — whether capital, people or partners — and thereby become larger than just their singular efforts.

While it’s a potentially controversial idea today, I have come to believe that great entrepreneurs and great VCs are two sides of the same coin. Both embody these attributes. They are maniacally focused on changing the way we live with innovations that others thought were not possible. They are passionate about building a great company, and put the company before themselves. Their roles are complementary, like looking down opposite ends of a telescope, but those different perspectives on a problem can be extraordinarily synergistic. Great future entrepreneurs can look like great young VCs, and vice versa — in fact, three of my recent investments are stellar companies started by folks who have crossed from one role to the other.

All venture firms are simultaneously never, and always, looking for team additions. I believe this is a direct result of how difficult it is to identify those who will be not only smart, passionate, personable and high integrity, but also successful in this ever-changing, ambiguous entrepreneurial world, in which a strategy that worked the last time is not a recipe for a future win, but more likely charts a path to mediocrity. In fact, my own difficulty in finding great new additions for our firm is what spurred putting these thoughts on paper.

Bryan Roberts is a partner at Venrock and has been the highest-ranking healthcare investor on Forbes Midas List since 2008. You can follow him on Twitter at @brobertsvc and learn more about him at Venrock.com.

Investors are not taking it as a good sign that Netflix needs a $200 million infusion of cash, and issuing fresh stock in the process. Netflix’s share price, which fell Monday during an ugly trading session, slipped about 8 percent in after-hours trading but clawed back some of those losses.

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Marc Andreessen: We love security, we’re all excited about security: It’s government, it’s businesses, it’s organized crime. It’s a phenomenal commercial opportunity.

Kara Swisher : What would you invest in?

Andreessen: That’s why I was smiling inappropriately. The threats keep morphing.

Walt Mossberg: Which companies would that be?

Andreessen: We have some interesting undisclosed investments, and I’m on the hunt.

Well, now we know why he was smiling. Today Andreessen Horowitz announced that it is leading a $20 million Series B funding round in SilverTail Systems, a Web security company. Additionally, Scott Weiss, the co-founder of IronPort, now part of Cisco Systems, who joined AH as a general partner in March, is joining SilverTail’s board of directors.

So what does SilverTail do? Banks and insurance companies and Web commerce companies use it to track traffic to their sites in real time and to distinguish good traffic generated by normal customers from bad traffic generated by criminals probably trying to do naughty things that more often than not tend to break the law.

How does it do that? CEO Timothy Eades told me that the company has developed a way of performing predictive analytics on live Web traffic at a massive scale. “When the market opens, we can look at hundreds of thousands of clicks a second and tell the criminals from the good guys,” he said. Among the ways to tell good guys from the bad are the speed with which they move from one page within a site to another, and the kinds of data they look for. “Depending on how they move around we can determine their intent,” he says. When it sees traffic that’s outside the norm, it flags it. Given the known patterns, there are almost never any false positives, he says.

There aren’t many companies who have publicly disclosed that they’re using it, but one is ING Group, the big Dutch bank. Today the firm monitors more than 750 million users and more than 1.8 billion web sessions per year through online banks in Europe, the Middle East and the U.S., online payment providers, e-commerce players, and government sites.

And among its investors is In-Q-Tel, the venture capital firm of the U.S. Central Intelligence Agency. What’s having an investment from In-Q-Tel like? Pretty much like an investment from any other firm, Eades says, except that this one has an in with government agencies that do a lot of secret stuff. Other prior investors are Leapfrog Ventures, Atlanta’s Seraph Group, and Startup Capital Ventures.

I also talked with AH partner Scott Weiss. He said an investment in Silvertail is a little “counterintuitive” for the firm. “Most security companies end up being tuck-in acquisitions for Cisco Systems, or Symantec or McAfee,” he says. “Silvertail is right in our sweet spot,” he says, playing in a market where the winner could take all.

There isn’t a day that goes by that you don’t hear about some organization or another coping with an attack of some kind by hackers. (You’re telling me!). Right now the standard way of dealing with all the incoming attacks is to run intrusion detection software, which Weiss says amounts to little more than a car alarm that tells you something bad is going on. Once you know that, you capture all the packets from the attack traffic and try to figure out what if anything was stolen. It’s slow and unsatisfying.

Silvertail’s team is made up of veterans from eBay and PayPal. “I can’t think of a pair of sites that are attacked more often,” Weiss said. Watching those attacks taught them a thing or two about what to look for in detecting an attack that’s underway.

Weiss said that during the due diligence process he noticed something you almost never see in the security business. “The people we talked to were willing to talk about this,” he says. “You almost never see that with security companies. CIOs don’t like to talk about what they’re using unless it really makes their eyes pop out. They wanted to talk about this.”

Yesterday, in a major policy speech in Washington, D.C., Secretary of State Hillary Clinton jumped on the Internet bandwagon again, unveiling a $25 million government investment for entrepreneurs to allow dissidents to thwart “thugs, hackers and censors.”

Since that’s about the amount a third-string social photo-sharing site gets while walking down University Avenue in Palo Alto, Calif., from venture capitalists with bags of money to spend, let me just say the money is, well, underwhelming.

Luckily, Clinton’s speech–the latest chapter of the Obama administration’s “Internet Freedom Agenda”–was much better.

In fact, it was a sobering look at the situation, replete with all its conflicts and compromises, including some related to the State Department of late (hello, WikiLeaks!).

While more of a gimmick, Clinton outlined what she called a “venture capital-style approach” to stopping governments from closing down digital communications platforms.

In Egypt, that has included the whole dang Internet after times got tough and protesters tweeted too much.

Even still, said Clinton, such efforts–however effective now–were ultimately useless.

“Those who clamp down on Internet freedom may be able to hold back the full expression of their people’s yearnings for a while, but not forever,” she said.

Still, even though Facebook and Twitter have been lauded as critical tools in the reform protests in the Mideast, those Luddite strongmen did manage to put up a very good fight in shutting them down.

But Clinton advocated pressing on. Along with the seed funding for firewall-piercing and evading technologies, she also announced the creation of a new coordinator for cyber issues and the fact that the State Department had just begun to tweet in Arabic and Farsi and would soon be doing so in Chinese, Hindi and Russian.

All very nice steps, but the overall arrival of the long-promised global “strategy for cyberspace,” which has gotten bogged down in politics, is still to come.

In fact, a GOP-fueled criticism of the State Department was also released yesterday, designed to muck up Clinton’s speech, about how another $30 million in digital investments was being spent or, more precisely, being spent badly.

Clinton answered critics:

“Some have criticized us for not pouring funding into a single technology–but there is no silver bullet in the struggle against Internet repression. There’s no ‘app’ for that.”

Well, actually, since there is an app that turns your Apple iPhone into a hand massager, there certainly should be.

Speaking of that, Clinton was deft at dealing with the obvious delta between pressing for Internet freedom, even as U.S. government lawyers were whacking away at WikiLeaks–and, by association, Twitter itself.

Clinton noted the release of a mass of classified State Department documents “began with an act of theft,” arguing that this was the real issue.

She went on to further argue:

“I said that the WikiLeaks incident began with a theft, just as if it had been executed by smuggling papers in a briefcase. The fact that WikiLeaks used the Internet is not the reason we criticized its actions. WikiLeaks does not challenge our commitment to Internet freedom.”

Actually, the issue is that the Internet, once it really gets going, doesn’t really want to be controlled by anyone.

Kind of like humanity.

Or as Clinton so correctly noted about the various protests taking place abroad:

“In each case, people protested because of deep frustrations with the political and economic conditions of their lives. They stood and marched and chanted and the authorities tracked and blocked and arrested them. The Internet did not do any of those things; people did.”

In any case, judge for yourself: Here’s the video of the speech at George Washington University from the State Department’s Web site, as well as the full text below:

Thank you all very much and good afternoon. It is a pleasure, once again, to be back on the campus of the George Washington University, a place that I have spent quite a bit of time in all different settings over the last now nearly 20 years. I’d like especially to thank President Knapp and Provost Lerman, because this is a great opportunity for me to address such a significant issue, and one which deserves the attention of citizens, governments, and I know is drawing that attention. And perhaps today in my remarks, we can begin a much more vigorous debate that will respond to the needs that we have been watching in real time on our television sets.

A few minutes after midnight on January 28th, the Internet went dark across Egypt. During the previous four days, hundreds of thousands of Egyptians had marched to demand a new government. And the world, on TVs, laptops, cell phones, and smart phones, had followed every single step. Pictures and videos from Egypt flooded the web. On Facebook and Twitter, journalists posted on-the-spot reports. Protestors coordinated their next moves. And citizens of all stripes shared their hopes and fears about this pivotal moment in the history of their country.

Millions worldwide answered in real time, “You are not alone and we are with you.” Then the government pulled the plug. Cell phone service was cut off, TV satellite signals were jammed, and Internet access was blocked for nearly the entire population. The government did not want the people to communicate with each other and it did not want the press to communicate with the public. It certainly did not want the world to watch.

The events in Egypt recalled another protest movement 18 months earlier in Iran, when thousands marched after disputed elections. Their protestors also used websites to organize. A video taken by cell phone showed a young woman named Neda killed by a member of the paramilitary forces, and within hours, that video was being watched by people everywhere.

The Iranian authorities used technology as well. The Revolutionary Guard stalked members of the Green Movement by tracking their online profiles. And like Egypt, for a time, the government shut down the internet and mobile networks altogether. After the authorities raided homes, attacked university dorms, made mass arrests, tortured and fired shots into crowds, the protests ended.

In Egypt, however, the story ended differently. The protests continued despite the internet shutdown. People organized marches through flyers and word of mouth and used dial-up modems and fax machines to communicate with the world. After five days, the government relented and Egypt came back online. The authorities then sought to use the Internet to control the protests by ordering mobile companies to send out pro-government text messages, and by arresting bloggers and those who organized the protests online. But 18 days after the protests began, the government failed and the president resigned.

What happened in Egypt and what happened in Iran, which this week is once again using violence against protestors seeking basic freedoms, was about a great deal more than the internet. In each case, people protested because of deep frustrations with the political and economic conditions of their lives. They stood and marched and chanted and the authorities tracked and blocked and arrested them. The Internet did not do any of those things; people did. In both of these countries, the ways that citizens and the authorities used the Internet reflected the power of connection technologies on the one hand as an accelerant of political, social, and economic change, and on the other hand as a means to stifle or extinguish that change.

There is a debate currently underway in some circles about whether the Internet is a force for liberation or repression. But I think that debate is largely beside the point. Egypt isn’t inspiring people because they communicated using Twitter. It is inspiring because people came together and persisted in demanding a better future. Iran isn’t awful because the authorities used Facebook to shadow and capture members of the opposition. Iran is awful because it is a government that routinely violates the rights of its people.

So it is our values that cause these actions to inspire or outrage us, our sense of human dignity, the rights that flow from it, and the principles that ground it. And it is these values that ought to drive us to think about the road ahead. Two billion people are now online, nearly a third of humankind. We hail from every corner of the world, live under every form of government, and subscribe to every system of beliefs. And increasingly, we are turning to the Internet to conduct important aspects of our lives.

The Internet has become the public space of the 21st century–the world’s town square, classroom, marketplace, coffeehouse, and nightclub. We all shape and are shaped by what happens there, all 2 billion of us and counting. And that presents a challenge. To maintain an Internet that delivers the greatest possible benefits to the world, we need to have a serious conversation about the principles that will guide us, what rules exist and should not exist and why, what behaviors should be encouraged or discouraged and how.

The goal is not to tell people how to use the Internet any more than we ought to tell people how to use any public square, whether it’s Tahrir Square or Times Square. The value of these spaces derives from the variety of activities people can pursue in them, from holding a rally to selling their vegetables, to having a private conversation. These spaces provide an open platform, and so does the Internet. It does not serve any particular agenda, and it never should. But if people around the world are going come together every day online and have a safe and productive experience, we need a shared vision to guide us.

One year ago, I offered a starting point for that vision by calling for a global commitment to Internet freedom, to protect human rights online as we do offline. The rights of individuals to express their views freely, petition their leaders, worship according to their beliefs–these rights are universal, whether they are exercised in a public square or on an individual blog. The freedoms to assemble and associate also apply in cyberspace. In our time, people are as likely to come together to pursue common interests online as in a church or a labor hall.

Together, the freedoms of expression, assembly, and association online comprise what I’ve called the freedom to connect. The United States supports this freedom for people everywhere, and we have called on other nations to do the same. Because we want people to have the chance to exercise this freedom. We also support expanding the number of people who have access to the Internet. And because the Internet must work evenly and reliably for it to have value, we support the multi-stakeholder system that governs the internet today, which has consistently kept it up and running through all manner of interruptions across networks, borders, and regions.

In the year since my speech, people worldwide have continued to use the Internet to solve shared problems and expose public corruption, from the people in Russia who tracked wildfires online and organized a volunteer firefighting squad, to the children in Syria who used Facebook to reveal abuse by their teachers, to the Internet campaign in China that helps parents find their missing children.

At the same time, the Internet continues to be restrained in a myriad of ways. In China, the government censors content and redirects search requests to error pages. In Burma, independent news sites have been taken down with distributed denial of service attacks. In Cuba, the government is trying to create a national intranet, while not allowing their citizens to access the global internet. In Vietnam, bloggers who criticize the government are arrested and abused. In Iran, the authorities block opposition and media websites, target social media, and steal identifying information about their own people in order to hunt them down.

These actions reflect a landscape that is complex and combustible, and sure to become more so in the coming years as billions of more people connect to the Internet. The choices we make today will determine what the Internet looks like in the future. Businesses have to choose whether and how to enter markets where internet freedom is limited. People have to choose how to act online, what information to share and with whom, which ideas to voice and how to voice them. Governments have to choose to live up to their commitments to protect free expression, assembly, and association.

For the United States, the choice is clear. On the spectrum of Internet freedom, we place ourselves on the side of openness. Now, we recognize that an open Internet comes with challenges. It calls for ground rules to protect against wrongdoing and harm. And Internet freedom raises tensions, like all freedoms do. But we believe the benefits far exceed the costs.

And today, I’d like to discuss several of the challenges we must confront as we seek to protect and defend a free and open Internet. Now, I’m the first to say that neither I nor the United States Government has all the answers. We’re not sure we have all the questions. But we are committed to asking the questions, to helping lead a conversation, and to defending not just universal principles but the interests of our people and our partners.

The first challenge is achieving both liberty and security. Liberty and security are often presented as equal and opposite; the more you have of one, the less you have of the other. In fact, I believe they make it each other possible. Without security, liberty is fragile. Without liberty, security is oppressive. The challenge is finding the proper measure: enough security to enable our freedoms, but not so much or so little as to endanger them.

Finding this proper measure for the Internet is critical because the qualities that make the internet a force for unprecedented progress–its openness, its leveling effect, its reach and speed–also enable wrongdoing on an unprecedented scale. Terrorists and extremist groups use the Internet to recruit members, and plot and carry out attacks. Human traffickers use the Internet to find and lure new victims into modern-day slavery. Child pornographers use the Internet to exploit children. Hackers break into financial institutions, cell phone networks, and personal email accounts.

So we need successful strategies for combating these threats and more without constricting the openness that is the Internet’s greatest attribute. The United States is aggressively tracking and deterring criminals and terrorists online. We are investing in our nation’s cyber-security, both to prevent cyber-incidents and to lessen their impact. We are cooperating with other countries to fight transnational crime in cyberspace. The United States Government invests in helping other nations build their own law enforcement capacity. We have also ratified the Budapest Cybercrime Convention, which sets out the steps countries must take to ensure that the internet is not misused by criminals and terrorists while still protecting the liberties of our own citizens.

In our vigorous effort to prevent attacks or apprehend criminals, we retain a commitment to human rights and fundamental freedoms. The United States is determined to stop terrorism and criminal activity online and offline, and in both spheres we are committed to pursuing these goals in accordance with our laws and values.

Now, others have taken a different approach. Security is often invoked as a justification for harsh crackdowns on freedom. Now, this tactic is not new to the digital age, but it has new resonance as the internet has given governments new capacities for tracking and punishing human rights advocates and political dissidents. Governments that arrest bloggers, pry into the peaceful activities of their citizens, and limit their access to the Internet may claim to be seeking security. In fact, they may even mean it as they define it. But they are taking the wrong path. Those who clamp down on Internet freedom may be able to hold back the full expression of their people’s yearnings for a while, but not forever.

The second challenge is protecting both transparency and confidentiality. The Internet’s strong culture of transparency derives from its power to make information of all kinds available instantly. But in addition to being a public space, the Internet is also a channel for private communications. And for that to continue, there must be protection for confidential communication online. Think of all the ways in which people and organizations rely on confidential communications to do their jobs. Businesses hold confidential conversations when they’re developing new products to stay ahead of their competitors. Journalists keep the details of some sources confidential to protect them from exposure or retribution. And governments also rely on confidential communication online as well as offline. The existence of connection technologies may make it harder to maintain confidentiality, but it does not alter the need for it.

Now, I know that government confidentiality has been a topic of debate during the past few months because of WikiLeaks, but it’s been a false debate in many ways. Fundamentally, the WikiLeaks incident began with an act of theft. Government documents were stolen, just the same as if they had been smuggled out in a briefcase. Some have suggested that this theft was justified because governments have a responsibility to conduct all of our work out in the open in the full view of our citizens. I respectfully disagree. The United States could neither provide for our citizens’ security nor promote the cause of human rights and democracy around the world if we had to make public every step of our efforts. Confidential communication gives our government the opportunity to do work that could not be done otherwise.

Consider our work with former Soviet states to secure loose nuclear material. By keeping the details confidential, we make it less likely that terrorists or criminals will find the nuclear material and steal it for their own purposes. Or consider the content of the documents that WikiLeaks made public. Without commenting on the authenticity of any particular documents, we can observe that many of the cables released by WikiLeaks relate to human rights work carried on around the world. Our diplomats closely collaborate with activists, journalists, and citizens to challenge the misdeeds of oppressive governments. It is dangerous work. By publishing diplomatic cables, WikiLeaks exposed people to even greater risk.

For operations like these, confidentiality is essential, especially in the Internet age when dangerous information can be sent around the world with the click of a keystroke. But of course, governments also have a duty to be transparent. We govern with the consent of the people, and that consent must be informed to be meaningful. So we must be judicious about when we close off our work to the public, and we must review our standards frequently to make sure they are rigorous. In the United States, we have laws designed to ensure that the government makes its work open to the people, and the Obama Administration has also launched an unprecedented initiative to put government data online, to encourage citizen participation, and to generally increase the openness of government.

The U.S. Government’s ability to protect America, to secure the liberties of our people, and to support the rights and freedoms of others around the world depends on maintaining a balance between what’s public and what should and must remain out of the public domain. The scale should and will always be tipped in favor of openness, but tipping the scale over completely serves no one’s interests. Let me be clear. I said that the WikiLeaks incident began with a theft, just as if it had been executed by smuggling papers in a briefcase. The fact that WikiLeaks used the Internet is not the reason we criticized its actions. WikiLeaks does not challenge our commitment to Internet freedom.

And one final word on this matter: There were reports in the days following these leaks that the United States Government intervened to coerce private companies to deny service to WikiLeaks. That is not the case. Now, some politicians and pundits publicly called for companies to disassociate from WikiLeaks, while others criticized them for doing so. Public officials are part of our country’s public debates, but there is a line between expressing views and coercing conduct. Business decisions that private companies may have taken to enforce their own values or policies regarding WikiLeaks were not at the direction of the Obama Administration.

A third challenge is protecting free expression while fostering tolerance and civility. I don’t need to tell this audience that the Internet is home to every kind of speech–false, offensive, incendiary, innovative, truthful, and beautiful.

The multitude of opinions and ideas that crowd the Internet is both a result of its openness and a reflection of our human diversity. Online, everyone has a voice. And the Universal Declaration of Human Rights protects the freedom of expression for all. But what we say has consequences. Hateful or defamatory words can inflame hostilities, deepen divisions, and provoke violence. On the Internet, this power is heightened. Intolerant speech is often amplified and impossible to retract. Of course, the Internet also provides a unique space for people to bridge their differences and build trust and understanding.

Some take the view that, to encourage tolerance, some hateful ideas must be silenced by governments. We believe that efforts to curb the content of speech rarely succeed and often become an excuse to violate freedom of expression. Instead, as it has historically been proven time and time again, the better answer to offensive speech is more speech. People can and should speak out against intolerance and hatred. By exposing ideas to debate, those with merit tend to be strengthened, while weak and false ideas tend to fade away; perhaps not instantly, but eventually.

Now, this approach does not immediately discredit every hateful idea or convince every bigot to reverse his thinking. But we have determined as a society that it is far more effective than any other alternative approach. Deleting writing, blocking content, arresting speakers–these actions suppress words, but they do not touch the underlying ideas. They simply drive people with those ideas to the fringes, where their convictions can deepen, unchallenged.

Last summer, Hannah Rosenthal, the U.S. Special Envoy to Monitor and Combat Anti-Semitism, made a trip to Dachau and Auschwitz with a delegation of American imams and Muslim leaders. Many of them had previously denied the Holocaust, and none of them had ever denounced Holocaust denial. But by visiting the concentration camps, they displayed a willingness to consider a different view. And the trip had a real impact. They prayed together, and they signed messages of peace, and many of those messages in the visitors books were written in Arabic. At the end of the trip, they read a statement that they wrote and signed together condemning without reservation Holocaust denial and all other forms of anti-Semitism.

The marketplace of ideas worked. Now, these leaders had not been arrested for their previous stance or ordered to remain silent. Their mosques were not shut down. The state did not compel them with force. Others appealed to them with facts. And their speech was dealt with through the speech of others.

The United States does restrict certain kinds of speech in accordance with the rule of law and our international obligations. We have rules about libel and slander, defamation, and speech that incites imminent violence. But we enforce these rules transparently, and citizens have the right to appeal how they are applied. And we don’t restrict speech even if the majority of people find it offensive. History, after all, is full of examples of ideas that were banned for reasons that we now see as wrong. People were punished for denying the divine right of kings, or suggesting that people should be treated equally regardless of race, gender, or religion. These restrictions might have reflected the dominant view at the time, and variations on these restrictions are still in force in places around the world.

But when it comes to online speech, the United States has chosen not to depart from our time-tested principles. We urge our people to speak with civility, to recognize the power and reach that their words can have online. We’ve seen in our own country tragic examples of how online bullying can have terrible consequences. Those of us in government should lead by example, in the tone we set and the ideas we champion. But leadership also means empowering people to make their own choices, rather than intervening and taking those choices away. We protect free speech with the force of law, and we appeal to the force of reason to win out over hate.

Now, these three large principles are not always easy to advance at once. They raise tensions, and they pose challenges. But we do not have to choose among them. Liberty and security, transparency and confidentiality, freedom of expression and tolerance–these all make up the foundation of a free, open, and secure society as well as a free, open, and secure internet where universal human rights are respected, and which provides a space for greater progress and prosperity over the long run.

Now, some countries are trying a different approach, abridging rights online and working to erect permanent walls between different activities–economic exchanges, political discussions, religious expressions, and social interactions. They want to keep what they like and suppress what they don’t. But this is no easy task. Search engines connect businesses to new customers, and they also attract users because they deliver and organize news and information. Social networking sites aren’t only places where friends share photos; they also share political views and build support for social causes or reach out to professional contacts to collaborate on new business opportunities.

Walls that divide the Internet, that block political content, or ban broad categories of expression, or allow certain forms of peaceful assembly but prohibit others, or intimidate people from expressing their ideas are far easier to erect than to maintain. Not just because people using human ingenuity find ways around them and through them but because there isn’t an economic Internet and a social Internet and a political Internet; there’s just the Internet. And maintaining barriers that attempt to change this reality entails a variety of costs–moral, political, and economic. Countries may be able to absorb these costs for a time, but we believe they are unsustainable in the long run. There are opportunity costs for trying to be open for business but closed for free expression–costs to a nation’s education system, its political stability, its social mobility, and its economic potential.

When countries curtail Internet freedom, they place limits on their economic future. Their young people don’t have full access to the conversations and debates happening in the world or exposure to the kind of free inquiry that spurs people to question old ways of doing and invent new ones. And barring criticism of officials makes governments more susceptible to corruption, which create economic distortions with long-term effects. Freedom of thought and the level playing field made possible by the rule of law are part of what fuels innovation economies.

So it;s not surprising that the European-American Business Council, a group of more than 70 companies, made a strong public support statement last week for Internet freedom. If you invest in countries with aggressive censorship and surveillance policies, your website could be shut down without warning, your servers hacked by the government, your designs stolen, or your staff threatened with arrest or expulsion for failing to comply with a politically motivated order. The risks to your bottom line and to your integrity will at some point outweigh the potential rewards, especially if there are market opportunities elsewhere.

Now, some have pointed to a few countries, particularly China, that appears to stand out as an exception, a place where Internet censorship is high and economic growth is strong. Clearly, many businesses are willing to endure restrictive internet policies to gain access to those markets, and in the short term, even perhaps in the medium term, those governments may succeed in maintaining a segmented internet. But those restrictions will have long-term costs that threaten one day to become a noose that restrains growth and development.

There are political costs as well. Consider Tunisia, where online economic activity was an important part of the country’s ties with Europe while online censorship was on par with China and Iran, the effort to divide the economic internet from the “everything else” Internet in Tunisia could not be sustained. People, especially young people, found ways to use connection technologies to organize and share grievances, which, as we know, helped fuel a movement that led to revolutionary change. In Syria, too, the government is trying to negotiate a non-negotiable contradiction. Just last week, it lifted a ban on Facebook and YouTube for the first time in three years, and yesterday they convicted a teenage girl of espionage and sentenced her to five years in prison for the political opinions she expressed on her blog.

This, too, is unsustainable. The demand for access to platforms of expression cannot be satisfied when using them lands you in prison. We believe that governments who have erected barriers to Internet freedom, whether they’re technical filters or censorship regimes or attacks on those who exercise their rights to expression and assembly online, will eventually find themselves boxed in. They will face a dictator’s dilemma and will have to choose between letting the walls fall or paying the price to keep them standing, which means both doubling down on a losing hand by resorting to greater oppression and enduring the escalating opportunity cost of missing out on the ideas that have been blocked and people who have been disappeared.

I urge countries everywhere instead to join us in the bet we have made, a bet that an open internet will lead to stronger, more prosperous countries. At its core, it’s an extension of the bet that the United States has been making for more than 200 years, that open societies give rise to the most lasting progress, that the rule of law is the firmest foundation for justice and peace, and that innovation thrives where ideas of all kinds are aired and explored. This is not a bet on computers or mobile phones. It’s a bet on people. We’re confident that together with those partners in government and people around the world who are making the same bet by hewing to universal rights that underpin open societies, we’ll preserve the internet as an open space for all. And that will pay long-term gains for our shared progress and prosperity. The United States will continue to promote an Internet where people’s rights are protected and that it is open to innovation, interoperable all over the world, secure enough to hold people’s trust, and reliable enough to support their work.

In the past year, we have welcomed the emergence of a global coalition of countries, businesses, civil society groups, and digital activists seeking to advance these goals. We have found strong partners in several governments worldwide, and we’ve been encouraged by the work of the Global Network Initiative, which brings together companies, academics, and NGOs to work together to solve the challenges we are facing, like how to handle government requests for censorship or how to decide whether to sell technologies that could be used to violate rights or how to handle privacy issues in the context of cloud computing. We need strong corporate partners that have made principled, meaningful commitments to internet freedom as we work together to advance this common cause.

We realize that in order to be meaningful, online freedoms must carry over into real-world activism. That’s why we are working through our Civil Society 2.0 initiative to connect NGOs and advocates with technology and training that will magnify their impact. We are also committed to continuing our conversation with people everywhere around the world. Last week, you may have heard, we launched Twitter feeds in Arabic and Farsi, adding to the ones we already have in French and Spanish. We’ll start similar ones in Chinese, Russian, and Hindi. This is enabling us to have real-time, two-way conversations with people wherever there is a connection that governments do not block.

Our commitment to internet freedom is a commitment to the rights of people, and we are matching that with our actions. Monitoring and responding to threats to internet freedom has become part of the daily work of our diplomats and development experts. They are working to advance internet freedom on the ground at our embassies and missions around the world. The United States continues to help people in oppressive internet environments get around filters, stay one step ahead of the censors, the hackers, and the thugs who beat them up or imprison them for what they say online.

While the rights we seek to protect and support are clear, the various ways that these rights are violated are increasingly complex. I know some have criticized us for not pouring funding into a single technology, but we believe there is no silver bullet in the struggle against internet repression. There’s no app for that. Start working, those of you out there. And accordingly, we are taking a comprehensive and innovative approach, one that matches our diplomacy with technology, secure distribution networks for tools, and direct support for those on the front lines.

In the last three years, we have awarded more than $20 million in competitive grants through an open process, including interagency evaluation by technical and policy experts to support a burgeoning group of technologists and activists working at the cutting edge of the fight against internet repression. This year, we will award more than $25 million in additional funding. We are taking a venture capital-style approach, supporting a portfolio of technologies, tools, and training, and adapting as more users shift to mobile devices. We have our ear to the ground, talking to digital activists about where they need help, and our diversified approach means we’re able to adapt the range of threats that they face. We support multiple tools, so if repressive governments figure out how to target one, others are available. And we invest in the cutting edge because we know that repressive governments are constantly innovating their methods of oppression and we intend to stay ahead of them.

Likewise, we are leading the push to strengthen cyber security and online innovation, building capacity in developing countries, championing open and interoperable standards and enhancing international cooperation to respond to cyber threats. Deputy Secretary of Defense Lynn gave a speech on this issue just yesterday. All these efforts build on a decade of work to sustain an Internet that is open, secure, and reliable. And in the coming year, the Administration will complete an international strategy for cyberspace, charting the course to continue this work into the future.

This is a foreign policy priority for us, one that will only increase in importance in the coming years. That’s why I’ve created the Office of the Coordinator for Cyber Issues, to enhance our work on cyber security and other issues and facilitate cooperation across the State Department and with other government agencies. I’ve named Christopher Painter, formerly senior director for cyber security at the National Security Council and a leader in the field for 20 years, to head this new office.

The dramatic increase in internet users during the past 10 years has been remarkable to witness. But that was just the opening act. In the next 20 years, nearly 5 billion people will join the network. It is those users who will decide the future.

So we are playing for the long game. Unlike much of what happens online, progress on this front will be measured in years, not seconds. The course we chart today will determine whether those who follow us will get the chance to experience the freedom, security, and prosperity of an open Internet.

As we look ahead, let us remember that Internet freedom isn’t about any one particular activity online. It’s about ensuring that the Internet remains a space where activities of all kinds can take place, from grand, ground-breaking, historic campaigns to the small, ordinary acts that people engage in every day.

We want to keep the Iternet open for the protestor using social media to organize a march in Egypt; the college student emailing her family photos of her semester abroad; the lawyer in Vietnam blogging to expose corruption; the teenager in the United States who is bullied and finds words of support online; for the small business owner in Kenya using mobile banking to manage her profits; the philosopher in China reading academic journals for her dissertation; the scientist in Brazil sharing data in real time with colleagues overseas; and the billions and billions of interactions with the Internet every single day as people communicate with loved ones, follow the news, do their jobs, and participate in the debates shaping their world.

Internet freedom is about defending the space in which all these things occur so that it remains not just for the students here today, but your successors and all who come after you. This is one of the grand challenges of our time. We are engaged in a vigorous effort against those who we have always stood against, who wish to stifle and repress, to come forward with their version of reality and to accept none other. We enlist your help on behalf of this struggle. It’s a struggle for human rights, it’s a struggle for human freedom, and it’s a struggle for human dignity.

Thank you all very much.

So many people have asked Napier about the possibility that Rackspace might be taken out, it’s not hard to detect that his answer is well rehearsed. Rackspace is not for sale, he says, and he won’t comment on any approaches by larger companies it may be fielding. But he clearly doesn’t mind the speculation.

The market certainly is working on the assumption that an acquisition is coming. I talked with Napier on Friday, the day after Rackspace reported quarterly earnings that grew 50 percent over the same period in 2009, which was enough to send Rackspace shares up by more than $3, or more than 8 percent, closing at $40.07–more than twice what it traded for a year ago.

Rackspace will be a giant all its own, Napier insists, before it gets taken out by one of the lumbering tech giants that might like to drop a few billion dollars to absorb it. Ask him Rackspace’s chances of being acquired in the next several months, and he insists the company is not for sale. It sure sounds like he means it, as the growth opportunity that lies before him is just so good. But it’s also clear that he enjoys being in the position of being asked.

It’s a nice sentiment, but organic growth is only going to get you so far. Rackspace will cross the billion-dollar mark in revenue for the first time this year, and it has only $105 million in cash, so the only acquisitions Rackspace can make without going into a debt are small ones like the one last week of Anso Labs that NewEnterprise reported exclusively. The smart money says we’ll get a chance to see how serious Napier is about remaining independent before the end of the year.

NewEnterprise: Let’s talk about your business against the backdrop of the industry you’re in. In the last few weeks we’ve seen both NaviSite and Terremark acquired by larger companies. Clearly there’s some consolidation going on in the Web hosting and cloud services hosting business.

Napier: There is a shift in technology market around cloud. The market is shifting from one where companies do things themselves to buying technology as a service. We think of it as a world that’s going from buying inputs to buying outputs. We think this is a nascent trend and we’re in the first game of a seven-game series. On a macro basis we see this as the biggest growth opportunity in technology. Our strategy is to win the most valuable segment, which we believe is going to be the service segment. So if you look at how the market is developing, you have players like Amazon that’s offering a do-it-yourself cloud. For people who want the lowest price, and can do the work themselves, Amazon is an incredible pick. What we’re focused on is trying to be a service leader. We want to serve companies that want to run a critical app and who want us to run it for them and take accountability for it so they can sleep well at night. Over the past six quarters or so we’ve found ourselves in a crazy good spot. The growth opportunity ahead of us is expanding.

Let’s talk about growth. You don’t have all much cash on the balance sheet, about $105 million or so. You can grow organically, or you can acquire. You’ve made some small acquisitions recently. Is that going to continue?

We are an organic growth company. We have been since inception. The acquisitions we’ve done have been about technology and talent to improve our portfolio and the way we serve customers. We will remain an organic growth company. There are, I think, really two kinds of companies. Those that can grow organically and those that can’t, and so they grow by acquisition. Some companies are good at growing through acquisition. We’re just not. We’re organic growth folks here, so we’re going to stick to that. But we’ll still buy technology, capabilities and talent that we think is critical. As to the consolidation that’s taking place in the industry, it’s a great validation of the growth opportunity. There are some legacy tech and telecom companies that are behind and are trying to buy their way into the game. There was a similar wave of consolidation eight years ago and a lot of our competitors got taken out.

So let me ask the question you’re getting a lot lately. I’ve had three conversations with different people who have each picked three different large technology companies they think should acquire Rackspace. Have you been approached by anyone?

We have a policy not to comment on anything like that all. What I will tell you is that we’re not for sale. We feel like we have a tiger by the tail. I’ve been lucky to be at the company for 11 years and I think the next 11 years look better than the last. We’re not building the company to flip it. We think the market opportunity is such that new giants are going to emerge, and we want to be one of those giants.

Absent a scenario that someone shows up with eight or 10 billion in cash to buy your company, what are your strategic priorities for the year?

There’s a couple. We are making big investments in our product and service portfolio. That’s one. And then number two, we think we have a chance to improve the fundamental economics of our business model. As we make these investments, we’ll add more services and capabilities on top of our basic compute service. This drives up the average revenue for our basic compute which creates better outcomes for our customers and increases our economics. It’s a virtuous cycle. Our average revenue per server has increased for six consecutive quarters.

What are your biggest costs, and what kind of gross margin do you tend to run?

I think of them as investments, but I know that’s just semantics. Our no. 1 investment is technology and the Rackers [employees] that serve our customers. So if you look at the cost of revenue line, a year ago it was 31.5 percent. As of the end of 2010 it was 31.1 percent. We made some improvement. But we’re more focused right now on developing customer loyalty than we are in driving efficiency. It’s early in the game, and anytime a market is going through a period of rapid growth like this, it’s all about winning as many loyal and profitable customers as we can. When the growth slows down someday we’ll focus more on improving efficiencies throughout the business. Even so, in 2010 we grew faster, increased our margin and and improved our return on capital. Those are all difficult things, and we pulled it off.

Hewlett-Packard’s not the only company with an enterprise-ready Windows 7 tablet. Dell’s got one as well and plans to launch it later this year. “The upcoming tablet is designed for end-users who need greater mobility, as well as IT organizations that demand control, security, manageability and integration with existing infrastructure investments,” the company said. “Dell’s tablet will empower a more mobile workforce in a way that offers customers the business applications and corporate data they need, while meeting regulatory mandates and IT requirements.” Dell showed off the Windows tablet at a media event in San Francisco this morning, where it uncrated 24 new pieces of business-geared hardware.

It’s yet another big-dollar buyout for the game industry, which has been in an M&A frenzy for about a year, and one of the biggest investments by a Chinese company in an American digital property.

The transaction was first reported by Bloomberg, and Riot confirmed the deal to VentureBeat, though neither outlet has the financial details. Here’s how they break down, according to people familiar with the transaction:

• Tencent, which had already invested in the game maker, will pay “just south” of $400 million to buy out other investors, primarily Benchmark Capital and FirstMark Capital, which along with angels had put approximately $18 million into the company.
• The company’s management team will receive some portion of that buyout themselves, but will also retain an equity stake; some will receive “stay packages.”
• The total investment values the company at $472 million.

The chief appeal of Tencent is Riot’s League of Legends game, which is free to play but encourages players to pay for extra goodies via micro-transactions. (Thanks to readers who educated me about what you can and can’t buy with real-world money in the game.)

In that sense it’s like Zynga’s FarmVille and other popular social games. But it’s a much more sophisticated game, with arcade-style action: Think of World of Warcraft, on steroids and amphetamines.

The deal follows a string of Web-based game deals in the last year. Among the more notable ones: Walt Disney purchased Playdom, Electronic Arts purchased Playfish and DeNA purchased Ngmoco.

Now, five months into the job, Williams is finding a voice of his own, separate from Digg founder Kevin Rose’s, and trying it out on the Digg community; the longtime veteran of Amazon recently participated in a well-received Digg Dialogg video interview, posted on Tuesday, to answer user questions. (It’s viewable here).

“There was a launch that was in violent disagreement with what our community expected out of the Web site,” Williams told Leo Laporte, who facilitated the interview based on Digg users’ questions. “It’s truly a tragedy of the ages, to some extent.”

But Digg is still a “very vibrant Web site,” with close to 20 million monthly unique visitors, Williams said, and the opportunity to hone a focus on social news that other companies may not have.

(Plus, despite layoffs, a perceived lack of relevancy relative to other social start-ups and multiple leadership changes, Digg still has plenty of money in the bank.)

“It is our top priority to rejuvenate the community,” Williams said.

Digg’s latest launch, called V4, was seen by many as a move to devalue the site’s homegrown community. V4 was the most significant in a string of product changes that took power away from the small body of users that set the agenda for the news site and gave a stronger voice to publishers and Digg’s own curators. And V4 was also an overdue, complete technology overhaul that left out many much-loved features.

In the Laporte interview, Williams quickly tackled precise details about previous features the Digg community wants reinstalled, noting, for instance, that the site has already brought back the “bury” button, allowing users to counteract other users’ votes on submitted stories. He said Digg is also planning future features such as a honing of its news-ranking algorithms for slower weekend traffic, when less-worthy stories may make it to the top.

Beyond those tweaks, Digg will make large-scale efforts to become more personalized, said Williams, and to create communities around specific topics. That’s not necessarily something that the old-time crowd will love, but it may make the site more useful for a broader audience.

Williams encouraged users not just to visit the site, but to comment on and vote up stories with Diggs; those participatory behaviors have decreased as a portion of overall traffic since the launch of V4, he said.

Being the voice of Digg is no small task, and it’s not just because of the company’s hypercritical user base. Digg has long been associated with the founding presence of TV and online video host Kevin Rose. And until Williams joined, Rose had been interim CEO after longtime leader Jay Adelson was pushed out of the company in April. Now Rose is occupied with his many angel investments, a new video show and a newsletter called “Foundation.”

Digg users were uncharacteristically positive in the comments section of the Williams interview entry. (The friendly tone makes me wonder if the old crowd has indeed high-tailed it somewhere else!) “Digg is in good hands,” said one. “I must say that Digg is doing a fantastic job listening to the community and implementing new features,” said another. One user even acknowledged, “I realize changes take time to implement.”

After reminding the nation that “South Korean homes now have greater Internet access than we do,” he went on to call for a national wireless broadband network.

Within the next five years, we’ll make it possible for businesses to deploy the next generation of high-speed wireless coverage to 98 percent of all Americans. This isn’t just about–(applause)–this isn’t about faster Internet or fewer dropped calls. It’s about connecting every part of America to the digital age. It’s about a rural community in Iowa or Alabama where farmers and small business owners will be able to sell their products all over the world. It’s about a firefighter who can download the design of a burning building onto a handheld device; a student who can take classes with a digital textbook; or a patient who can have face-to-face video chats with her doctor.

It’s the latest attempt by Obama to try to solve the difficult problem of broadband penetration in America. In many places, most of them rural areas with low population density, cable and telco companies can’t make back the investments required to build out network infrastructure, and so they don’t build at all. As I’ve said here before, for Americans in those places, the options for participating in the digital culture the rest of us take for granted are few, and it often means the difference between participating and not in so much of the daily discourse that occurs online.

Part of the answer lies in taking back some radio spectrum that’s used for other things. In June, Obama signed a memorandum calling for the freeing up of certain radio frequency spectrum in the 500 MHz range. This is a block of spectrum largely owned by TV broadcasters for free over-the-air TV transmission. Broadcasters have been under pressure–and so far they are resisting–to voluntarily give those licenses up so that the spectrum can be re-auctioned off.

Julius Genachowski, chairman of the Federal Communications Commission, essentially telegraphed that this is going to be the commission’s major policy priority in comments at the Consumer Electronics Show in Las Vegas earlier this month. He has said he’d like to offer broadcasters incentives to give up their spectrum, but this would require a new law passed by Congress, and those in Congress have their own ideas about how this should be done. You can expect a lot of debate about this in Washington this year, but probably not a lot of progress.

I caught up with Li last week to talk about the way he sees the cloud shaping up in the enterprise, and where he’s seeing opportunity as it develops. If cloud computing turns out to be the fundamentally new computing platform that many think it is, then there’s a lot of different pieces–Li refers to these as layers–that have to be assembled to make it work. And it’s in those layers where he looks for opportunities.

NewEnterprise: So what do you mean when you talk about the “cloudframe”?

Li: “I keep telling everyone that every time there’s a new computing platform, you basically have to re-create all the pieces of the mainframe. The basic building blocks of computing don’t change. You still need provisioning, management, security, and you need networking. The pieces may change, and different layers get merged into others. I’ve been calling it the cloudframe, for lack of a better word, which allows you to redefine all the layers, from the data layer to the storage layer to the provisioning management layer. Some of the layers that may have been separate before are being merged into one. So I’m spending my time figuring which are the layers that you can build a company around and which are the ones that become features rather than products.

So what are you finding?

There are two layers I’ve spent a lot of time time on, and where we’ve made investments. One is the data layer, and one of the companies I’ve spent a lot of time on is Cloudera, which is built around the Hadoop ecosystem. With the new types of data and applications that are out there, it’s really challenging the idea about whether the relational database is the right data management solution of the future. If you look at the big Internet data centers, say at Google or Facebook, the answer is no. There are no Oracle databases running those applications. Instead they’re using things like Hadoop and MapReduce and distributed file systems on commodity hardware. So I think the whole data structure is moving because the types and volumes of data are changing so much. The data is a lot more complex, and there’s a lot more of it.

There’s been a lot of suspicion and resistance in the enterprise toward letting critical data and applications out the door to run on someone else’s hardware. Is that changing?

I’m less rigid with my definition of the cloud. It doesn’t have to all run on Amazon or something like that. This cloudframe idea is really about extracting applications and services from underlying hardware and resources. It’s about having things available to you anywhere, and having them scale up quickly. They can exist on both sides of the firewall. When we launched Cloudera we thought everyone was going to want to run things on Amazon’s cloud. But most enterprise customers are running large installations of Hadoop on their own servers.

So the data layer is clearly one place where you think businesses can be built. What are some of the others?

Once you have the data layer set, there will be a lot of innovation on the storage side. We’re doing a lot of things around flash memory storage. We’ve invested in Fusion-io, which uses flash memory to build high-performance storage systems. Before, you had to have a storage area network to get the performance and availability you needed to run a big database application. Adding flash memory to your storage lets you expand a lot and do it efficiently. If you look at a lot of the cloud data centers, there’s not a lot of EMC and NetApps gear running in them. There’s a lot of commodity white boxes with Fusion-io starting to get deployed in them.

Last year you joined the board of Nimbula after Accel made an investment in it. That must be part of another layer you like, right?

That’s the application layer. Nimbula is from the guys who first built Amazon EC2. Now they’re actually building a private version of EC2, for the enterprises who for one reason or another can’t go to the public cloud. If an IT manager wants to deploy an app these days they have to put in a request and then he may get servers in six months. With EC2, if you want to deploy something for testing or whatever, all you need is a credit card and you can get it going right away. The Nimbula guys are building a technology that provisions and manages cloud services out of your own IT resources. A lot of enterprise IT guys I talk to say their bosses point to Amazon EC2 and ask, “Why can’t you build me one of those?” Now they can.

All the layers are all getting reinvented. Some will be a service, some will be on-premise. For a new platform to emerge, a lot of things need to come together, and I think a lot of things have been in the making for a while. The environment feels as ripe as it ever has.

His role will be a little different from that of most other VC partners. As AH’s partner for “market development,” rather than evaluate new deals he’ll spend his time on developing the sales and go-to-market strategies of companies that the firm has already invested in.

AH co-founder Ben Horowitz said it’s all part of the firm’s preference for founders becoming CEOs. “The thing that’s most difficult, especially for a technical founder, the most difficult thing to learn is sales. It’s the most difficult thing to learn operationally,” Horowitz told me. “If you don’t have experience with sales, it can cause you to fail as a founding CEO.”

It turns out that Cranney knows a thing or two about sales, and his history with Horowitz and AH’s other co-founder Marc Andreessen runs deep. Cranney spent four years as vice president of worldwide field operations at Opsware, which Andreessen and Horowitz sold to HP in 2007 for $1.65 billion. During that time Cranney’s team grew from 10 to 350 and sales grew from $18 million to $150 million. Horowitz wrote last year about how he came to hire Cranney at Opsware and how he possesses what Horowitz calls “the right kind of ambition.”

Cranney said that sometimes new companies get so focused on selling their new product or service that they forget to consider the larger backdrop of what’s going on inside a potential customer’s operations. “You want to help them avoid looking like a hammer in search of a nail,” Cranney told me. “There’s a systematic way of helping companies identify what’s going on in particular industries and companies and how they can tie what they do to projects already underway.” He’s also building out a network of contacts at large companies–including the Walt Disney Company, FedEx and JPMorgan Chase–that could become potential customers of the companies in the AH portfolio.

He’ll be focused on helping companies in the AH portfolio build their sales talent, and help them grapple with tricky issues like moving from “freemium” to premium business models, working with partners, identifying customers and responding to competitors.

One company he’s already worked with is Apptio, which helps companies manage their IT costs. It’s also notable for being the first investment that AH made. “They’ve had explosive growth in the last year and have been staffing up their sales teams,” Cranney said. “They had been a little concerned that these teams weren’t ramping up fast enough,” he said. Cranney helped Apptio develop a sales training program.

Besides Opsware, Cranney’s prior jobs include time at Aster Data, where he was executive VP of worldwide field operations, and a position as vice president for the Americas at Hewlett-Packard’s software and solutions business. He was also a vice president at Parametric Technology.

It’s another sign of growth at Andreessen Horowitz, which debuted in 2009 with a $300 million fund, then raised a bigger one of $650 million in November. It has recently taken positions at Groupon and Facebook on the consumer side. Its enterprise investments besides Apptio have included stakes in Okta and Fusion-io.

As I noted yesterday, there are lots of reasons for Qualcomm to want Atheros, not the least of which is its extensive customer list.

Qualcomm’s specialty has always been in CDMA technology, the flavor of mobile phone technology favored by Verizon Wireless and Sprint, and it collects considerable royalties around its patent portfolio there. It has struggled to penetrate other markets, and last year shuttered its FloTV operation amid minimal demand. The good news was that it sold its FloTV spectrum to AT&T for $1.93 billion, which is no doubt offsetting the cost of this deal. Add that to the $10.3 billion in cash and short-term investments on its balance sheet as of Sept. 26 and this is an easy deal to do.

It’s also the biggest deal in Qualcomm’s history and the first significant one under CEO Paul Jacobs, who is the son of founder Irwin Jacobs.

Atheros shareholders have plenty of reasons to smile today as well. The company’s stock price surged by 19 percent yesterday. At $45 a share, Qualcomm is paying more than Atheros has ever been worth in its entire history as a publicly held company. As Shira Ovide over at Deal Journal notes, its highest price before yesterday was $43.90. Happy New Year, indeed.

I caught up with Qualcomm Executive Vice President Steve Mollenkopf and Atheros CEO Craig Barratt to talk about the deal.

NewEnterprise: Steve, let’s start with you. What got Qualcomm interested in Atheros?

Mollenkopf: Historically Qualcomm has been focused on the cellular phone, though recently we’ve done much more than that. We had some integration relationships with some companies that allow us to deliver a platform to our customers. They’re essentially technical relationships, and one of those companies was Atheros. So we were familiar with them. But the real reason, the why Atheros and why now question comes down to this. We think the industry is moving to a place where a lot of the technology and use cases that are being created as part of the shift to smartphones will be used outside of just phones, and will move into many adjacent spaces. The requirement of technology and different customers overlap a lot with Atheros. They’re a leader in their space, we’re a leader in ours and we want to go into markets that will require the expertise from both of us. It seemed natural, actually.

Craig, the idea for the acquisition seems to have grown out of an existing partnership. When did the talk turn from being Qualcomm’s partner to becoming part of Qualcomm?

Barratt: The partnership has gone on for about five years, where we’ve cooperated on joint reference and designs and software and feature integration. Over the years we’ve broadened out from Wi-Fi, Bluetooth, GPS, powerline and optical networking. We do have a much more horizontal business. Qualcomm has a very strong vertical business. Through our partnership we saw the teams had a good cultural fit, the engineering teams really respect each other. When we looked at our own strategic imperatives over the long term, we saw that cellular technologies are going to be applied in a much broader markets over time, beyond just smartphones and tablets. There’s an intersection between the Qualcomm technology and our technology, and that’s only going to increase. You’ve probably heard that set-top boxes and things like that are going to start to run Android. So a lot of these mobile technologies are going to start showing up in things like the connected home. Strategically it all started to make sense.

And what will your new job be at Qualcomm?

Barratt: After the acquisition closes, which should be in the first half of 2011, my role will be president of Qualcomm Networking and Connectivity, reporting to Steve.

Steve, if I’m not mistaken, this is the biggest deal that Qualcomm has ever done.

Mollenkopf: You’re correct. For us on the Qualcomm side this is a big step toward expanding our business beyond our traditional platform business and we’re doing it in a way that is in line with how the industry is changing. A lot of the things we’ve been doing with Atheros are things we’ve already been doing as part of our relationship, so this is a natural next step.