Things seem to be getting frothy in tech these days. Facebook paying nearly 1/10th it’s market cap for the WhatsApp user base sounds a lot like paying for “eyeballs” in the Dot-com era of the 1990’s. That acquisition was then quickly followed by the $2 billion Oculus announcement, which seems to be an even more awkward fit for the social network. Facebook is definitely playing the long game here.
The other news maker recently has been Disney’s acquisition of Maker Studios for nearly $1 billion. The fit between those two makes more obvious sense but the valuation still seems rich and has many around Silicon Beach scratching their heads. (UPDATE 4/14/2014: The plot only thickened when Relativity Media made a counter bid for Maker for an estimated $1.1 billion under a slightly different structure. This twist suggests a land grab for “new media” properties driven in part by fear of being shut out from all the good deals.)
The “follow the photos” theory for the WhatsApp purchase offered on PandoDaily (above link) sounds not only consistent with prior acquisitions (e.g. Instagram, a failed bid for Snapchat) but strategically sound as well. (UPDATE 4/28/14: Others have since echoed this theory as well.) An elegant explanation: co-opt the competition. Facebook can circumvent a disruptive threat by buying control now but letting the company continue to evolve separately. A simple solution to the classic innovator’s dilemma. A similarly consistent strategy and market view point probably lies behind Disney’s decision too.
Just last year, AwesomenessTV had around 14.5 million subscribers when it was acquired by DreamWorks Animation for $33 million (plus potentially $84 million more based on financial targets). Compare that to the 380 million subscribers and 5.5 billion monthly views Maker has today, and the Maker deal starts to look more reasonable. On a per subscriber basis, Disney paid (very) roughly $2.50 per Maker subscriber while DreamWorks Animation paid $8.00 per AwesomenessTV subscriber.
Of course there are a great many other metrics to consider -measures of engagement like average view duration, likes, shares, and comments as well as demographics and devices, all of which can drive differences in the value derived from one subscriber or viewer to the next. One cannot simply impute a linear relationship between enterprise value and total subscribers. It would be analogous to looking at just the spot price today to estimate an options value, but there is no Black-Scholes model for new media start-ups.
I’ve written before about M&A as an open innovation strategy, and I submit for your consideration that these MCN acquisitions are part of one such strategy – investments in future innovation. Just as Box could rightly allocate to marketing some of the costs associated with supporting its non-paying customers (the customer acquisition costs of a freemium model), some of the premium being paid for Maker or AwesomenessTV could be considered investments in R&D.
Of course, some of the acquisition price still includes projected revenues. Trends such as market consolidation (a.k.a. all the recent acquisition activity), the growing popularity of brand integrations, a shift in ad dollars away from traditional television, and pressure building on YouTube to share more of ad revenues all add up to rosier financial projections, but for a start-up, those are just vanity metrics. (UPDATE 4/11/2014: As it turns out, Internet ad revenues have now overtaken broadcast.) They don’t account for the derivative value of what a company might learn from all the experimentation and audience engagement taking place on the YouTube platform.
Both Maker and AwesomenessTV have access to coveted customers segments – users that acquiring companies like Disney actually need to understand better to ensure their futures. They are paying for help figuring out where the market is going next so they can, “skate to the puck.” Next generation, digital-native media companies such as MCNs, unburdened by legacy operations, are uniquely positioned to provide that help.
Return on R&D is notoriously hard to estimate, and in an environment like this one, beware the winner’s curse. All that said, I get it. You can pay to play or risk being shut out – without the subscribers, the revenues or the future product/service pipeline.
After today’s Big Frame announcement, which seems like a sensible roll-up at just $15 million, I wonder who will be acquired next. (UPDATE 4/15/2014: Already DreamWorks Animation is rumored to be in talks with Vevo, in which YouTube also has a stake. Now that Relativity has lost out on Maker, surely that company will be looking for other deals. With Big Frame already out of play, one possibility would be going after a vertical like DanceOn or even looking outside of LA at something like Rooster Teeth in Austin or Diagonal View in the UK. I could see both of those latter two getting a reciprocal benefit from the connection back to the Media & Entertainment capital in California. The only thing that seems certain is Relativity will have to move fast because no one else seems to be slowing down.)
UPDATE 5/2/2014: Rumor has it that Relativity Media has decided to go after the most obvious next choice, one I considered but omitted above because I presumed to be too expensive. I ruled out Machinima almost immediately because Warner put money in that company just the prior month, but I should have at least mentioned Fullscreen. No deal has been reach, and if there’s truth in all the dramatic speculation in reports of a Relativity bid for Fullscreen, a deal may still be very unlikely. Nonetheless I wanted to update this post yet again because this latest development clearly demonstrates something at play in addition to financial considerations and even open innovation. My take is that Relativity sees the cost of acquiring Fullscreen for a loss (e.g. for an anticipated negative ROI) is less than the expected cost to its business of being shut out of any good MCN deals and slowly watching new media erode its business. The situation seems analogous to an airline that continues to operate unprofitably because of its fixed costs; old media companies like Relativity are better off staying in the game and making a bid than forfeiting altogether.