Online video is booming and the are tons of small video companies across production, advertising, distribution, and technology. Yet we have yet to see a serious attempt to roll up the industry. The reasons, I submit, boil down to egos and greed.
What is a Rollup?
Historically, large private equity firms have “rolled up” various small companies in a given market through mergers or acquisitions in order to reach economies of scale. A rollup is different than a simple merger in that it involves multiple parties, oftentimes taking place in a mature industry where growth can’t occur organically, but rather, through financial engineering or cost cutting.
This is partially why we haven’t seen that many rollups of Internet companies, because usually a merger is all it takes to reach considerable market dominance. Sometimes rollups make sense because building a product or business would take too long to build internally and grow organically. Ask Jeeves bought Interactive Search Holdings for $343M in March 2004 to double market share and then sold to IAC a year later for $1.8 billion.
Other times a company will roll other assets up to make itself more attractive for an exit. In 2005, I saw first-hand how IGN merged with competitor Gamespy, and then proceeded to acquire Rotten Tomatoes and my old company AskMen before flipping to News Corp. for $650 million.
How multiples work
In finance, companies are valued either through a discounted cash flow exercise, or by comparing one’s financials to similar companies in an industry. Oftentimes, a company’s value is measured through price-to-sales and price-to-earnings multiples. In traditional media for example, companies trade for about 15 times earnings and two times sales. Online, then numbers vary considerably depending on the economy and cycle.
But seeing how the only valuation that matters is the one at which you sell a company for, then it’s worth noting that multiples tend to be abnormally high at both the low and high end, then they tend to normalize in between. In other words, early on, a company’s valuation in a sale boils down to the price at which an entrepreneur is willing to let a business go, even if it makes little financial sense.
As companies grow to reach mid-sized status, their multiples fall within industry standards. As such, a company can only reach outsized returns if they really consolidate the market as multiples grow when the business acquires greater scale.
Rollup concept is nothing new
While the rollup concept is popular in private equity, venture capitalists have rarely adopted the strategy. Part of the resistance to the idea is focus: it’s better for a founder, team and company to tackle just one idea. Another reason is that the notion of attaching a number of far-flung businesses rarely works.
Of course, in video, the premise is intriguing, partly due to the many inefficiencies and shortcomings inherent in the landscape.
Vertical or Horizontal Rollup
There are four pillars in video: tech, advertising, content and distribution. A case can be made for both a vertical and horizontal rollup.
In a vertical rollup strategy, for example:
- In content, a number of producers can combine forces to grow reach, augment their audience, cross-sell programming, and inevitably cut costs.
- In advertising, Tremor Media merged with Scanscout to boost its tech offerings and bolster its management ranks – Tremor’s CEO Jason Glickman became Executive Chairman, and Scanscout’s Bill Day took over as CEO – and then acquired Transpera (a mobile ad network). They recently raised $27 million more.
- In tech, with CDNs increasingly commoditized, it’s natural to see consolidation amongst competitors to weed out unhealthy players and eroding margins.
- In distribution, we saw VideoSurf sell to Microsoft. But an alternative strategy would have been for VideoSurf to first merge with other distribution partners to add more reach – and thus become more valuable – before selling.
In the horizontal rollup strategy, or what I call the “Script casting” method, you are basically casting a number of actors in a movie for a given script. In other words you might need Brad Pitt or Tom Cruise as the lead, but you won’t need both. You do, however, need a Zach Galifianakis in the supporting role, as well as a Meg Ryan to round out the story.
Similarly, in the horizontal approach, a content company’s catalog might be better monetized against a large distribution company’s audience which can then generate more sales if they leverage the advertising company’s sales force which can better target ads and content on the right tech platform.
In video, the right strategy is actually a combination of horizontal and vertical, and the reason why it hasn’t happened yet boils down to two simple reasons.
Obstacle #1 – CEO Egos
This may come as newsflash to many, but CEOs tend to have big egos, and those egos tend to get in the way of doing the right thing. Depending at what stage of a company’s life cycle a startup finds itself in, it’s also possible that the CEOs don’t even see a reason to do this until it’s too late, even though their companies are too small to really make marketers want to open up their wallets and spend ad dollars with them.
Mind you, most CEOs in our industry have, for lack of a better word, enough fatigue and battle scars that this is becoming less of an issue.
Obstacle #2 – VC Greed Outweighs Fear
The second, bigger issue, frankly, is that while most VCs have been invested in video companies for the better part of the past decade, few are willing to throw in the towel, or specifically, trade in their Preferred Equity standing on their company’s capitalization table for a subordinated standing.
In other words, in their existing structure, they stand to get their money out first… and seeing how a rollup inevitably requires fresh money, then this creates the thorny issue of “women and children” first, then who? New investors want to get ahead of the pack, and occasionally, that kills most discussions with existing investors.
When it’s said and done, online video keeps growing and with the rising tide everyone feels good enough to expect a better day tomorrow, but most VCs are not – despite the bravado – very patient or even risk-takers.
Eventually, though, someone somewhere will try the rollup strategy in online video.
Photo credit: Matt Septon