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Archive for the ‘M&A’ Category

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.

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Thoughts on M&A

I’ve been working on some POV’s (points-of-view) applying my experience with Open Innovation to my current position at a management consulting firm.  I’ve left out anything that might be even tenuously connected to firm IP and wanted to share just the more general perspective on M&A as it relates to Open Innovation.  There are actually two pieces here, presented back-to-back (and I’m working on a related third on the need to account for the “whole product” in an Open Innovation strategy):

Executive justifications for mergers and acquisitions (M&A) only seem bound by human creativity.  Consider for a moment the pervasive and amorphous notion of synergies.  When it comes to Product Innovation, a much more precise list can be compiled.  M&A is in its essence an outside-in Open Innovation strategy.  The reason for pursuing such a strategy can be described with the four T’s.

  • Technology The most obvious reason for an M&A is to acquire the specific product or service pertaining to the other company.  Technology here is used loosely to mean the intellectual property constituting said product or service.  A firm can choose to invest in developing its own offering, with all the risks that entails, or it can just buy the proven technology of another firm – along with all the critical systems, processes, experience and relationships described in more detail below.
  • Technique Systems and processes are the key enablers of any business model, and a product or service is nothing without the right business model to commercialize it.  A firm may have a great idea and lack the means to bring it to market.  M&A can be like one-stop-shopping for the tools necessary to unlock the value of a new product or service.
  • Talent If systems and processes are the codified knowledge supporting a business model, then talent, or the people comprising a company, is the tacit knowledge.  Knowhow can create a competitive advantage and barrier to entry, and a company can leap forward along the experience curve with a well executed M&A strategy.
  • Team Technology, technique and talent are about what is inside the company.  True to the principals of Open Innovation, what is outside of the company is equally important as well.  A company’s partners act as a value network, contributing to its business model and supporting its product or service.  M&A provides quick access to that network.

(A fourth might be added, access to new customers or markets, but I would only consider that to fall within the amorphous boundaries of open innovation if a company were interested in cross-selling opportunities associated with those new customers.  So for now, to simplify the discussion, I will set aside that issue.)

When compared to internal R&D, the value of M&A is in the ability to ramp up quickly with the new technology, technique, talent and team. The cost is typically justified with sales projections for the combined company that exceed the sum of the two separately.  So why does the equity value of the acquiring company typically decrease relative to that of the acquired company?

Assuming correct acquisition target selection and valuation, the answer is in the execution.  Take the example of a large, established firm acquiring a smaller, growth company with the aim of crossing the chasm to mass adoption with a hot new product or service.  Few firms are optimized to smoothly and seamlessly integrate acquired companies like this, leaving value from the acquisition unrealized.

Integration teams must start by overcoming the not-invented-here (NIH) mindset.  The work actually begins before the transaction even closes, selling the firm leadership on the value to be had by acquiring the technology, technique, talent and/or team.

The integration team must then convince internal stakeholders of the value of changing the way they do things to support the new business (and everyone knows how hard change can be).  This is true at both the acquired company and the acquiring company, combining “my way” and “your way” to come up with “our way.”

Unfortunately, integration teams tend to be too risk averse in planning, disproportionately focusing on preserving the success of the past rather than positioning the combined company to shape the future.  Maintaining the status quo is not usually seen as a failure, while trying something new that does not work out is.

Integration teams end up making compromises over time that diminish or undermine the value of the acquisition.  Realizing the full value from an outside-in Open Innovation strategy requires a rigorous approach to identifying, designing for and monitoring value from the initial bid to integration completion.

And scene . . . from here on the POV turns into marketing copy for our firm’s services.

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