Raise your hand if you’re confused about the number of “market leaders” in the industry now.  Everywhere you look, someone is claiming to be better than the rest, but the truth is: “There can’t be six or seven category leaders,” argues Will Margiloff, chief executive officer of Ignition One, the digital marketing technology unit of Japanese ad agency Dentsu, adding: “it’s just not a big enough market for all the money invested.”

The Only Valuation That Matters

A wise man told me this past week that the only price that matters is what someone will pay for your company when you actually sell.  Right now, the online advertising and video market is full of way too many similar companies with a) complicated capitalization tables, b) excessive funding histories and c) no real differentiation from one another.  Even the content sub-category — which I think is the only one that has been “under-invested,” relatively speaking, in this landscape — has way too many companies that fit that description.

The main problem, continues Margiloff, is that some of these companies frequently have more money invested in them than their revenue potential.  I’ll add that most of the heavily funded companies have models that scale quickly but lack any true differentiation, defensibility or uniqueness. I see a lot of companies set up to grow rapidly with little longevity baked in them.

This means that even though their valuations can grow quickly in a revenue-based valuation model using a price-to-sales ratio, they tend to fall just as quickly.  I’ve covered valuationspreviously, but the main thing that drives value in the end is how many people want to buy a company at a given time, and what I am seeing is most companies are not differentiated enough to matter.  Thankfully for them, most have revenues or the means to change their disposition in the meantime. And yes, to some extent, most of the companies with the biggest war chests are looking at content in one way or another, but that’s not a given, let alone a slam dunk for all.

The Current Backdrop

Today, most private mid-to-large companies in online media and advertising are valued at 3 times revenue, but as recently as 2007 Yahoo bought Right Media for 10 times revenue while Google scooped up Doubleclick for 15 times sales.  Yes, that was before the 2008-09 meltdown, but the fact was, at the time, those companies had a greater level of differentiation than their peer group does today.

Today’s darlings remain the ad exchanges: Razorfish has sharply reduced the number of publishers it works with directly, from 1,832 in 2007 to 598 in 2010.  Meanwhile, it has doubled spending on the exchanges, which have emerged as the talk of the town as advertisers are more spending to them.

Media is Cyclical — Yes, Even Online Media

But we’ve seen this history before, both in the industry and outside of it.  Within the advertising market, we have seen ad networks, behavioral targeting firms etc. all come and gone.  Today they face multiple risks:

–        Display ad networks are losing budgets to video: 43% of video budgets will come at the expense of display , and less than 40% will come from TV buys.

–        Behavioral targeting firms face increasing risks over privacy concerns.

The Meek Shall Inherit the Earth, After the Quants Shall Have Destroyed It

Outside of it, the quants were running Wall Street not long ago, and investors thought the sky was the limit.  But before long, hubris and greed mixed a lethal cocktail that brought havoc to the entire economy.

And for all of the talk that “TV is dead,” it’s not, and it won’t be.  Yes, online will grow at the expense of TV, but the obituary of television can be shelved.

Consolidation Might be The Answer, But We’ve Been Saying this For Years Now

The bottom line is that you need to string together a barrage of online video, advertising and/or content companies to start to woo mainstream marketers who are content with spending their budgets on TV. To do that, you need companies that don’t have outsized valuations or too much funding in them.  That has held up this long-awaited consolidation.

Everywhere you look, I would advise caution and pragmatism over irrational exuberance.  Another wise man once said: “You never know who is swimming naked until the tide goes out.” It’s easy to want to go long and reach for scale, but scale for scale’s sake is futile and a recipe for failure.