As I was writing out my previous post Memo to Yahoo! RE: Video and trying it with “Will Web Video Represent $150B in market value creation by 2011 for web startups?” something occured to me:
The economically optimal thing for old media companies is NOT to acquire web video startups but actually simply invest in them.
The reason is simple: startup companies get a much higher multiple than old media companies do, so as these startups grow, fight for the $4.3B-$10B that online video advertising will represent by 2011 and rise in value, they provide with a capital gain opportunity for investors.
But, old media companies are not exactly investors, they are integrators of companies into operations, hoping to yield a strategic value of sorts. The problem, or disparity here is simple: a $4.3B-$10B online video ad market is paltry next to the $75B TV advertising market, so the opportunity for income is slim, with limited upside.
It should be noted that CBS Interactive has been very aggressive in investing in companies, and NBC set up a $250M investment fund managed by Beth Comstock, with a first investment in Adify. So, they’ve done the math, too, I suspect. Then again, other firms, like News Corp., “don’t lease, they buy”.
Regardless, the math suggests, old media is far better off investing and leaving independent these media companies… because at the kind of multiples that Web companies command, a $10B ad market for web video could represent a $150B market valuation. Those are, after all, the figures for Google’s 2006 revenues and market cap respectively.
A basic math reinforces this:
Say you are really lucky as a TV company and buy a company X that gets 10% of the online video ad market, some basic, straight line math suggests that they get anywhere from $430M to $1B in revenue. We chose Disney as the media stock of 2006 as a benchmark. As I write this, according to Yahoo! Finance, its P/E is 16.3 and its P/S is just under 2, at 1.93. Forget earnings, let’s just look at Sales. If the company X does $430M to $1B in revenue (10% of the $4.3B to $10B estimates), that adds a lot of potential income (depending on Disney’s Degree of Operating and Financial Leverage) but it only adds,
- at the low range, 1.93 x 430M = $829M
- at the high range, 1.93 x 1B = $1.93B
for an average of $1.37B in added market cap.
Disney, it should be noted, is currently worth $68B in market cap, so that means about 1.5-3% of its value. Pretty paltry. Admittedly, an annuity of $430M to $1B adds a lot of a company’s market cap… but it’s not exactly a perpetuity as revenues for such companies go up and down quite a bit.
But by investing, if the same company does 10% market share, and using straight math once again, then at the high end of $10B in revenue and $150B in market value, company X can command a $15B market cap.
There are other variables, ideally an old media firm would buy 80.1% of a startup to consolidate financials, but leave them independent so they can remain lean, mean and a capital gain building money machine. But at anything over 10% equity, as the math shows, old media is probably better off investing and not buying.
It’s really challenging to be a TV executive these days. If you look back, you see what happened to print companies, if you look forward, you realize you’re caught between a rock and a hard place.
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August 3rd, 2007 at 12:08 pm
I like the thinking but wouldn’t a decent analyst value the acquired company separately? MySpace breaks this example because it isn’t valued using News Corp. multiples. They (should) look at it as a component of the News Corp. portfolio carrying its own set of multiples and then roll all of the components up to get the weighted corporate picture. An old media acquirer’s multiples would be updated to reflect the value of that asset.
August 3rd, 2007 at 2:02 pm
Dan, I think you are right on part 1, but I disagree on part 2, because the portion of the new media company is pretty small, and thus would not move the needle for the big media company.
News Corp./Myspace is the outlier, clearly, but even there, with News Corp. being a $75B company with $25B in sales and assets, really, how much does a company making $500M in revenues and no profits to show for account for? Sure, Murdoch might argue MySpace is worth $10B when he sought to exchange it for 25% of Yahoo!, but just last year he said “Myspace was $6B” when a UBS analyst pegged all of FIM at $2B.
My point is: few analysts or execs really want to stick their neck out and estimate the value of a new media company, but if they let the marketplace do it, they’d be better off with the strategy I outlined above.
August 3rd, 2007 at 8:36 pm
This is an interesting idea, but it won’t fly for two major reasons.
One is that corporations are set up to operate things, not invest in them. It is generally not in their DNA to focus on ‘investing’ as a core activity, though many do invest as a way to learn, to hedge, to stimulate consumption of their products, and/or to position for later acquisition.
Second, stock prices rarely fully reflect the value of individual investment holdings such as these. Usually such investments are steeply discounted and/or buried inside too much other stuff to get full market value credit. This is why you periodically see companies hive off fast growing units which can achieve much higher market caps as standalone pure plays than as part of a basket of businesses.