Yesterday, I wrote that if I would have known that Dennis Publishing (publishers of Maxim, Blender and Stuff) could have been acquired for $235M or so, I would have enlisted the services of a private equity firm and leveraged our digital media, services and technology company and my expertise in the men’s content space to buy the firm myself. Crazy, but not insane, as I explained in the post.
I started to look at private equity, which I had done so previously in VCs vs. PE firms - who’s stepping on who’s toes? and realized that the party is just getting started: May 2007 marked a record month, with $115B in transactions. Just today we learn that Palm sold 25% to Elevation, that’s right, Bono’s in the palm of your hands.
$115B, that’s a lot of dough. An article I’m working on is the question of: are conglomerates dying or about to make a resurgence?
Think about it: yes there’s a lot of merit for breaking up conglomerates, we even looked at what NBCU would be worth if it were spun out of GE, but if the Web industry is experiencing a consolidation of sorts, then it can be argued that we haven’t seen anything yet. So with that in mind, I asked myself, what would a $1B Web-based conglomerate look like?
MACRO TRENDS WORTH CAPITALIZING ON
- People spend 25% of their time online, marketers spend 5.9% of advertising online.
- Offline not dead, and won’t disappear, current single-digit multiples suggest out-of-style assets worth looking into, in fact, magazines generate a lot of revenue and have an “in” with traditional agencies who still control advertising. This is a wise place to look into, if there’s a distressed company we can scoop up for cheap.
- Search, reference are still king of the hill: 8 out of 10 websites found via search AND search traffic is the easiest to monetize. Previous look at small companies “in play” here.
- Video and mobile are growth opportunities, as is outdoor. Broadband is an immediate area to look for, outdoor is strategic but worth investigating.
- Global will outpace US growth: small example is Canada is 1/10th of US in terms of population but in 2006, US generated 16 times the Canadian interactive revenue. If interactive is bastion of efficiency, then these numbers will converge. China, India, Europe and South America all important.
- Free, ad-supported model has proven winner, so it is important to position to win in advertising.
- Advertising growth opportunities:
a) Volume-wise: Health, Car, Entertainment will generate largest revenue category-wise.
b) Fastest growing categories: Health 19.7%, Travel 18.3% and Household Goods 15.1%.
COST SAVINGS IN THE $300-500M PER YEAR
- Naturally, an advantage in this exercise is to look at cost savings. So looking at an income statement, we need to see where we can find efficiencies in operating costs: rent, labor, administrative, etc. Bear in mind that labor is always a major component of costs and in a relatively new market like the Internet finding experienced talent is not always going to be easy or cheap. So by streamlining this you can really generate cost savings. We’re not saying to lay off people that get the job done, boost sales and improve client satisfaction; but you can use your imagination and realize that there is a lot of fat at companies large and small, young and mature.
Constraints in the model:
- The one thing I realize is that when you buy a company, you have to pay a premium. Some companies that are in high-growth industries and generating profits who operate in red-hot sectors can command whopping premiums. aQuantive, for example, got MSFT to pay an 85% premium. Others are not so lucky.
- As well, we’re pretending that we’re in an Alice in Wonderland world where we’re given $1B in cash and can basically go out there and buy $1B worth of companies that are trading on the stock markets.
- For this exercise, we’re only going to look at publicly traded firms because this is really a financial engineering exercise.
- Lastly, I fully understand that high-growth companies are sometimes better served to operate independently and not as part of a giant corporation, but the flip side is that such companies tend to waste a lot of resources in non-revenue generating areas. So if we can create an efficient in these areas and create value through financial engineering, maybe it’s worth it.
- Some of these companies might stink individually, but I think - given $1B and looking at 10 or more companies - put together this can create a lot of value.
- If you work at these companies and think what I am doing is crazy, great. I am not suggesting anyone to make a run for your company and lay you off, this is just an exercise.
THE LUCKY 13 COMPANIES IN OUR $1B PORTFOLIO
- We’ve identified 13 companies, they are: PlanetOut, Roo Group, Answers.com, Looksmart, Napster, Salon Media, Traffix, Handheld Entertainment, Autobytel, Insweb, Vertical, Linktone, Miva.
- Each company is chosen for a different reason.
1. PlanetOut: The company’s capital structure is dire, but it has a lot of revenues and bought a stable of magazines. It’s also a leader in the Gay market, which is larger than the Hispanic, Black or Asian market with a purchasing power of $580-800B. A major way to benefit from travel advertising. And its magazines infrastructure could be used from other brands we’re acquiring.
2. Roo Group: A money losing machine with a great market position in the booming online video space.
3. Answers.com is a play in navigation, directories. It’s not really a search engine.
4. Looksmart is a strong player in vertical search, something is has done over the past few years. It also boasts a lot of cash on its balance sheet. Lastly, it bought Wisenut which is a search algorithm and could be used as a cornerstone of the search strategy in our network.
5. Napster is a legal way to play the music business, which is going through radical change. Napster is also well positioned to lead in free, ad-supported music. Lastly, it has a lot of room for cost savings and boasts plenty of cash on its balance sheet.
6. Salon.com is a mess because of the preferred shares and realistically will be hard to buy, but it has a fantastic brand, great content, can launch into video and is a natural to move into print. Using some of the infrastructure from Planetout’s magazines, this could be easily accomplished.
7. Traffix is a marketing services company that actually makes money. It’s a strategic buy in the sense that if we will have 13 websites with different profiles, demographics and marketing strategies, we need an in-house solution to manage this monster and make it into an efficient, optimized network. It also has outside relationships that could be leveraged within our new network.
8. Handheld Entertainment burns through money, but it has a handheld devide - yes, we know, much smaller than iPod, Sandisk’s Sansa and Microsoft’s Zune - that gives us an “on the go” button to push. It has also bought a number of comedy-oriented, user-generated content websites that could add up to bolster ad inventory or at least funnel traffic to other areas (using Traffix’ tools/expertise, we presume).
9. Autobytel is a leader in automotive. A category we want to be in. Lost of cost saving potential.
10. Insweb is a leader in financial products. A category we need to be in.
11. Vertical is a wild card. For one, it’s cheap. But the upside is there as a software as a service / on demand provider. While it currently focuses on supply chain management this will be a strategic buy as it will probably be able to provide the backbone to integrate all of the systems and then manage everything on one common platform. Not an easy thing to do, but important.
12. Linktone will provide a wireless and China strategy, it’s the cheapest of options (perhaps for a reason) but something we can risk diving in.
13. Miva provides some interesting bells and whistles: a contextual ad network that is no Google Ad Sense but comes at a cheap price. It also boasts click to call technology that is interesting to have once we have Autobytel and Insweb in the portfolio. Lastly, having acquired eSpotting it is our foothold into entering Europe.
- The market capitalization and balance sheet items for each are as follows:
So we’re $74M over budget, but when you consider that these 13 companies boast $277M in cash and carry only $28M in debt, we’re well below our budget in terms of enterprise value or what we’ll actually need to pull this off.
- The financials and income statement items for each are as follows:
As you can see, this company will boast $700M in annual revenues but stands to lose $230M per year.
The Price to Sales Multiple = $1,074,000,000 / $717,000,000 = 1.5
This is where the argument for cost savings come into play, remember how an income statement is broken up:
So maybe it’s worth looking at each company’s Cost of Goods Sold, but that is not really an area to find savings in, mainly each company’s operating costs and an additional column we calculated: operating cost per employee. This is a fantastic measure to see how efficient a company’s operations are:
As you can see, the 13 firms spend in aggregate $592M per year in operating costs, on average, each firm’s average costs are $45M.
CONCLUSION:
A few things come to mind,
- a P/S multiple of 1.5 times is extremely low.
- this portfolio / conglomerate was made up of largely money losing firms, so there was no P/E to speak of.
- We project being able to cut off 65% of the conglomerate’s new operating costs, so 65% x $592M or roughly $400M per year. We also think that we can find efficiencies in other costs as well… I know 65% sounds draconian, but with all of these offices in NYC and SF, you can streamline things quite a bit. And, like I said, you don’t need 13 VPs of this and that…
New Sales Based Valuation: $2.4B
- We also think that using all of this we can optimize revenues. I’ve always been more of a revenue guy anyway, so if we can raise revenues by 15% per year, in the first year, revenues grow from $700M to $800M, at a decent P/S of 3 that is now a $2.4 Billion enterprise, and not a $1B one…
New Profit Based Valuation: $3B
- Once we cut out all of these redundancies and cut off $400M or so in annual costs (this is just looking at operating costs, by the way), we can boast a profitable company, swinging from a $200M loss to a $200 a year profit. Using a very conservative 15 times P/E, that’s a market cap of $3B.
Bottom Line: any way you look at it, the wave of consolidation has just begun and if you though private equity had a record month in May, 2007, this was a very quick and simple look at what is potential ahead.
So, anyone’s got $1B to lend me?
Disclaimer: this was just an exercise for fun, go consult a investment professional before you do anything, this applies to both individual and institutional investors!
I own securities in a number of the companies mentioned…
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