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Has The Media World Gone Crazy Again or Do These Deals Makes Sense?

2011 February 13
by Greg

Facebook valued at $50 billion? Twitter and LinkedIn to follow with their own multibillion dollar transactions?  Huffington Post sold to AOL at $315 million?   Does all this make any sense?  Nobody can know for sure.

Lately, though, it seems that as soon as a deal is announced pundits rush to pan it.  “The ‘dot bomb’ era all over again!,“ they cry. What’s startling is just how little substance is behind such claims.  Most of them are, in fact, little more than ad hominem attacks and histrionics, with little or no analysis of financial logic.

The best thing you can say about any strategic move is that it was done for good reasons and that the numbers make sense.  As I will explain below, that seems to be true of the deals happening now.

The Right Reasons for Deals

Like anything else, when transactions are done for the right reasons they have a better chance for success.  It’s no guarantee, but does explain why some people, most notably Warren Buffet, but also companies like Cisco, Google and Naspers, are able to build up great track records.

These are good reasons to acquire or invest in a company:

Good Value: Sometimes, usually in a down cycle, prices are depressed and smart cookies can swoop in and get a great price.  Determining good intrinsic value is difficult, because value lies not in the present, but in how much a stream of future earnings would be worth today.

Of course, the future is hard to determine, so often a proxy is used, like price/earnings, price/subscriber, revenue/unique user, etc.  These ratios can be helpful, but a good case still needs to be made in light of discounted earnings.

Take AOL’s recent purchase of HuffPo.  At $315 million, the price is more than 5 times forecast revenues of $60 million.  That’s a whopping figure.  However, as HuffPo is growing at 100% annually and margins of 30% in the industry are not uncommon, it’s very possible that the numbers actually do work.

Good Strategic and Cultural Fit: Other times, it can make sense to pay a bit more.  A classic case is when a company buys a similar business in a different geographical region.  While revenues increase, overhead can be slashed and better deals can be driven with suppliers.

Of course, strategy and culture are highly subjective and “unlocking synergies” is a common rationalization for bad deals, so it’s important to remember that even a acquisition with a “good fit” can fail if the price is too high.

Acquire Talent and Capabilities: When an industry is growing fast, competition for talent is fierce.  At the same time, companies’ internal resources are stretched by just keeping up with demand.  In these circumstances, acquiring small firms with the right skills and personnel can be a very smart move.

Companies in Silicon Valley do this as a regular matter of course.  Literally dozens of small deals, most of which we hear little about, are done every year.  However, even some “old economy companies” can follow this strategy with success.  As I wrote earlier, Conde Nast made two small, smart acquisitions before turning around its digital business.

Certainly, an important part of AOL’s recent Huffington Post deal is that Ariana Huffington will stay on to run their chaotic editorial operations.

The Wrong Reasons for Deals

Nevertheless, there’s a reason why most acquisitions fail:  They are often driven by hubris and stupidity.

The problem with deal making is that it’s a whole lot more fun than managing a business.  Buying companies can sometimes seem like an enormous chess game that allows managers to dream big.  Often, the temptation can entice even smart CEO’s to make dumb moves.

Here are some things to look for:

Empire Building: Great companies are built through superior products and service, not through buying other firms.  Once a CEO, like Bernie Ebbers of WorldCom, starts to seem more like he’s playing Monopoly than running a business, trouble is sure to come.

“New Economy” Deals: Some deals, like the infamous AOL/Time Warner merger, are done under the assumption that the old rules somehow don’t apply.  This rationalization, of course, means that nobody can find any concrete basis for how the deal is going to be made to work.

The Winner’s Curse: When a company is in play, a bidding war can break out.  Egos get involved and the ultimate winner inevitably overpays.  This usually, but not always, happens at the top of the cycle.

Media, being cyclical, brand driven and often artificially scarce due to regulation, is especially susceptible to this kind of error.  The problem is so pervasive that, during the crash, the bulk of media company losses came from investment write-downs, not from operations.

Why Some Potentially Good Deals Go Bad

In truth, only time will tell if a transaction turns out for good or ill.  For all the proclamations of pundits, it is notoriously difficult to know what the future holds.

As an example, take Rupert Murdoch’s ill- fated purchase of MySpace.  Even in hindsight, there were very good objective reasons for the deal.  It made good strategic sense, helped News Corp expand into digital (a direction where they clearly need to go) and, at $580 million, it seems like a bargain now.

Clearly, it was what happened afterwards that made the difference.  News Corp’s famously cutthroat culture didn’t sit well with the freewheeling types at MySpace.  Further, Murdoch’s experience with earlier successful buyouts led him to try to prematurely monetize MySpace while Facebook was zooming past it.

The result, of course, was disaster and News Corp is currently looking to get rid of MySpace.  Does that make it a bad deal?  With Facebook now at over $50 billion, what can we say about the wisdom of buying the world’s top social network in 2005 for 1% of that price?

Why The Latest Deals Probably Make Sense

Now that we’re at the beginning of yet another up cycle, big deals are happening again and it is right and proper to question whether they make sense or if it’s just moguls going crazy again.  However, this line of inquiry should be pursued in light of facts, not conjecture.

When Goldman Sach’s invested in Facebook at a valuation of $50 billion, many were up in arms.  Yet, as I previously explained, Facebook is easily worth that much.  More recently, when AOL bought Huffington Post, pundits like Om Malik disparaged the deal without even making an attempt to analyze the financial and strategic logic.

When you look at the details another story emerges.  These deals are being done at good prices relative to intrinsic value, without any crazy “new economy” assumptions or bidding wars.  In other words, they appear to be happening for the right reasons rather than the wrong ones.

No doubt, things will get out of hand eventually and, as I said above, nobody truly knows what the future will bring.  However, you can expect most of the deals being done right now will turn out to be winners.

- Greg

4 Responses leave one →
  1. February 13, 2011

    Huffington Post brings more content staffing to AOL, which needs more journalists
    to create original content to its Home Page. I believe both HQ’s are in Washington
    which eases the pain of integration. M&A is like forced marriage, with fall-out risks.
    But AOL needed to “bounce back” and so far, this looks like a suitable make-over.

    [Reply]

    Greg Reply:

    Good points! Thanks for sharing.

    - Greg

    [Reply]

  2. Jihn permalink
    February 14, 2011

    Greg,

    I’ve been reading your work for some time now and I’ve always believed your insight & opinion were spot on, but this time I must disagree! While you make some valid points, and I know you were in the biz at some level, I was in trading during the “dot-com” disaster and I learned many things. Most of all, human nature is hard wired towards greed when opportunity presents itself & be dammed with common sense! I was visiting a client for lunch when my firm opened an IPO at an industry high and I quipped, next one you’ll see will be an IPO, a split & a secondary offering on the first day of trading. That’s how absurd things had gotten and although I was being sarcastic, I wasn’t far off from picking a top. In fact the market significantly deteriorated from that point on and I got out completely in Oct. 2007. While my timing may have been fortuitous, it wasn’t brains. More like common sense. Rational action was no longer common place, it was all about perception & potential. Be dammed what the numbers & headlines were. The best analygy I can think of, based on your comments, is that of investing on the Miss America Pgt. All the girls look pretty, others are bid up and the rest are sold or shorted but the truth of the matter is, your betting on their looks. And while they may have a Phd from Harvard, be well connected and flush with cash, without real substance ( business model & revenue stream ) all your investing in is the chance to lay down with the Queen. Mark my words, unless these companies figure out a real business model, they’ll be like every other broad in a bar, a 2 @ 10 & a 10 @ 2! May not look so hot at first, but near closing time they’re the best looking opportunity you’ve had in years. The problem is, tomorrow you sober up and realize what you’ve done but it’s too late. She’s taken your wallet & and it burns everytime you discharge. Without a sustainable revenue stream, one built on something more than hype and potential down the road, People are going to invest on the biggest pump n dump of all time ( or at least in my time ). There’s a sucker born every minute and Wall Street used to know how to fleece em! Now WS knows that games over with the masses so GS investing & creating a SPV to sell shares to “Inst. Clients” ( read sophisticated ) based on a valuation that’s gone from 15 billion on MSFT’s 243 million investment to 50 billion based on theirs in 4 years is a farce! They’ve raised and burned through over 900 million ( and I’m lite ). John Deere has massive potential with the BRICS but if they’d posted 200 million in losses since 2006 they’d be on the pinks, not the in the Dow! I could be wrong, then again, most analyst and economist have always said RE has always gone up and Portfolio Mgr’s have always assumed 7% returns on an annual bases is conservative! Buy the IPO & I 5 yrs you’ll write a retraction. Buy the IPO & trade it you’ll make money, but the stock market used to be about investing and trading was for guys with a book and one they could shoot against! Keep pumping this trash but please put a disclaimer out there. You are not a professional, you have no position nor care to take one, this is just your opinion so take it what it’s worth! Then suggest they save up their money and buy small companies in their community and leave “investing” the the Europeans who are about to buy the NYSE hoping to fleece the rest of Americans who still have money to p..s away! Just 1 mans humble opinion. By the way, I do like most of your work but when you start talking about investing, I get fired up. Sorry, and sorry for the typo’s I’m on my iPhone!

    [Reply]

    Greg Reply:

    Jihn,

    Thanks for your comment. I agree with much of what you have to say in general. However, I think the are two salient points that make these deals a bit different.

    1. These companies are actually profitable and there’s no reason to believe that the profits are anything but real (at least I haven’t heard anyone make that case).

    2. We’re at the bottom of the cycle, not the top.

    Anyway, like I said, only time will tell. It’ll be interesting to watch!

    - Greg

    [Reply]

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