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Robert H. Heath
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Robert Heath is a private investor with a focus on fundamental research and fact-based analysis. He believes that markets are mostly efficient and they equilibrate with a small, but necessary level of inefficiency which allow excess risk-adjusted returns to accrue to superior research.
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  • AOL Acquires Leading Media Company (2011 version)
    Last Sunday, AOL announced the acquisition of the Huffington Post for $315 million. The acquisition is right in line with the strategy Armstrong has articulated for AOL, and the management team deserves credit for its focus and decisiveness. Time will tell if they overpaid; it's notable that the HuffPo's shareholders took 95% of the purchase consideration in cash even as AOL's stock price is bumping around its all-time lows.

    The ensuing press coverage is way out of line with the importance of the deal, probably because $315 million seems like such a big number for a five-year old, controversial and unconventional news site.

    But most remarkable about this deal is how "conventional" it really is. AOL is simply amassing a stable of media titles under one umbrella, with the hope that it can figure out some scale economies before the cash flow from its dying ISP business runs dry. Michael Wolff has a pithy column on this topic here: www.mediaweek.com/mw/cont... ;

    AOL is unabashedly becoming a content farm, much like the recently IPO'ed Demand Media. But with HuffPo and some of its other brands, AOL seems to think it can slap a brand name on its product (think "Chiquita" or "Sunkist") and get a small premium compared to generic produce. This may be a survival strategy, but it lacks the scalability to make it a big winner online.

    After all, there are other brand name content providers on the internet, and this strategy hasn't really worked for them either. The websites of most metro newspapers in the US offer some pretty high caliber content, but revenue and a profitable business model remain elusive. The problem is not solved by replacing so-called "high priced" talent -- go ask a journalist how well she gets paid -- with low-cost freelancers generating search-engine optimized ad bait, because that's not the problem. 

    The problem is that, on the internet, there's a lot less value to the curation and aggregation of content (and ads) than there was in the pre-internet days when your local newspaper had a quasi-monopoly on the process. (roberthheath.blogspot.com...) The value created by "organizing the internet" is captured by search sites like Google and social media sites like Facebook and Twitter that direct users to relevant content. 

    Take a look at the following graph, which plots "enterprise value" (the value of all of a company's stock, plus its net debt) against revenue for various companies.

    (Click to enlarge)

    There are three highly scalable businesses: Google (NASDAQ:GOOG), Facebook (NASDAQ:FB) and Twitter. For Facebook I have assumed $1.8 billion in revenue and $50 billion of enterprise value. For Twitter, $45 million in revenue, $4 billion of enterprise value.

    Then there are some traditional newspaper companies, the New York Times (NYSE:NYT) and McClatchy (NYSE:MNI). These two publicly listed companies are mostly "pure play" newsgathering companies working through the transition to the online world. Clustered among them are Demand Media (NYSE:DMD), AOL and HuffPo, online media companies pursuing a distinctly conventional approach to aggregating content.

    Finally, I have added Yahoo! (NASDAQ:YHOO), which is a bit of a tweener and the company AOL probably aspires to be... or to be acquired by. (see Note 1)

    Note that the vertical axis is a logarithmic scale. For each dollar of revenue, the market is according an order of magnitude more value to the scalable internet businesses than to the content aggregation businesses. This is not surprising, since the scale economies in these businesses provide meaningful growth opportunities and enviable profit margins, something that investors used to say about newspapers. 

    I expect AOL will continue to acquire as its bank account and stock price permit and a merger with Demand Media would be a way to add acreage to the content farm, while eliminating the temptation for both companies to over-produce and drive down the value of their ad inventory. One can even imagine AOL merging with a traditional media company so long as the merger partner could suffer the inevitable comparisons with the ill-fated AOL-Time Warner merger a decade ago.


    (Note 1. I have reduced YHOO"s enterprise value by approximately $7.5 billion, my estimate of the after-tax value of YHOO's passive investments in Alibaba and Yahoo! Japan in order to show a "pure play" value for the company.)
    Tags: AOL, NYT, MNI, YHOO, GOOG, DMD
    Feb 09 11:58 AM | Link | Comment!
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