Why Outbrain Is A Bad Bet, And Yahoo Shouldn't Acquire Taboola

by: Cameron Graham

"Content recommendation" services have experienced massive growth in recent years from publishers looking to boost website traffic.

The largest such service, Outbrain, has filed papers for a U.S. IPO, and Taboola has been mentioned as a possible acquisition target of larger tech companies.

Investors should proceed cautiously, as these services are currently propped up by publishers seeking low-cost traffic in order to charge higher ad rates.

The rise of ad blocking also poses an existential threat to these services, and there is no clear solution.

Traditional display ads are becoming less effective everyday, which has left publishers searching for new ad-based revenue streams. One of the most promising in recent years has been the so-called "content recommendation" modules. These are the boxes underneath articles that offer up "recommended" or "similar" pieces of content, typically from "around the web." Here's a particularly good example of this trend from a Business Insider article (I've highlighted the relevant ads in red):

The leading players in this space are Taboola and Outbrain, two Israeli startups. The latter filed paperwork for a U.S. IPO last year, and is now in the process of updating its filings (it has also brought on a new CTO). Yahoo (YHOO) has jumped into the space as well, with its Yahoo Recommends product, and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) has dipped a toe in the water via its new Matched Content tool.

By some estimates, content recommendation (or "content amplification") is set to be a $3.4B market by 2018. Taboola reportedly brought in around $200 million in revenue a year, and some have suggested that it'd be a good acquisition target for a larger tech company.

However, there are a few reasons why investors should be wary of Outbrain's potential offering, and why companies like Yahoo and Google should steer clear of what may seem like a tempting acquisition. Let's go through them.

1. Advertisers won't be fooled forever

One of the potentially largest issues with services such as Outbrain and Taboola is the fact that publishers are using them to boost their site-traffic metrics in order to charge higher ad rates. Of course, that's pretty much exactly the point of these "content application" networks, even if they're not quite as up front about it.

Large publishers such as Time and CNN provide valuable real-estate (in the form of sidebar or under-article "recommended" boxes) to Outbrain or Taboola, sometimes for a pre-negotiated fee. These services then select content from their partners (based on algorithms) and syndicate it through these placements. The articles almost always have little to do with the story they appear below, and are relentlessly hyperbolic in their titles (i.e. "clickbait").

Taboola and Outbrain typically get paid per-click when a user from, say, Business Insider clicks through to an off-site recommended article. A small percentage of that ad fee would then go to Business Insider (in exchange for providing the space), and the recommendation company keeps the rest.

Publishers have embraced these ads so far because they've proven effective at driving a lot of traffic to their sites for relatively little money. The visitors from these networks typically aren't very engaged - they spend less time on the page than other readers and have a higher bounce-rate - but a lot of sites don't seem to care about that. Additionally, if you look at most of the content being promoted by these services, you'll notice it's coming from other publishers, which means the current system revolves around publishers paying to advertise on other publishers' websites, with Outbrain and Taboola as the middlemen.

That arrangement by itself doesn't make a lot of sense, until you realize that these publishers are all still supported by traditional, outside advertisers who are paying based on the size of a site's audience. In other words, a lot of publishers are arbitraging advertisers by buying low-cost, low-quality traffic through "content amplification" services and using it to charge higher rates for on-site ads, sponsored editorial content, email promotions, etc.

This is only sustainable until advertisers start catching on, which by some accounts has already begun. Instead of using total traffic for a site, advertisers will likely insist on seeing a detailed breakdown of audience demographics and negotiating off of just a particular audience segment. Or, overall ad-rates will simply decline in order to account for the increase in low-quality visitors.

It should be noted here that Yahoo Recommends and Google's Matched Content tool are a little different than most of Outbrain and Taboola's offerings, and less vulnerable to this tactic. Yahoo Recommends promotes three articles from the same publisher (to increase visitor engagement) and one off-site ad (from its Gemini network). Google's Matched Content tool meanwhile only recommends articles that are from the publisher's own site (with the goal of increasing overall AdWords revenue).

2. Deals are getting larger, but margins are narrowing

Likely, due in part to its IPO ambitions, Outbrain has recently moved to secure a number of high-profile, exclusive content deals with large publishers. Late last year, it signed an agreement with Time Inc. (TIME) to be the sole provider of "recommended stories" on Time's websites (which include People.com, and Sport Illustrated among other sites). As part of the deal, Time Inc. is guaranteed $100 million in revenue-sharing over the course of the agreement. Outbrain recently struck a similar multi-year, global deal with ESPN, where it likely promised a similarly large (if not bigger) guaranteed payment.

At the same time, competition in the content recommendation space is increasing and margins are being squeezed. According to a recent Wall Street Journal article, Outbrain and Taboola now pay publishers around $2.50-$3.50 per thousand page views, up from 75 cents a few years ago, yet referral fees from advertisers have stayed the same. That means their margins have been cut pretty dramatically. There's little room for these companies to raise referral rates though, as a large part of their business is driven by publishers seeking low-cost traffic in order to charge higher ad rates.

On one hand, signing large sites to multi-year deals is a prudent move for Outbrain because it likely allows it to lock-in an impression rate for at least a few years (for that publisher). However, it also means it is more exposed should other sites decide to scale back their advertising with Outbrain. Finding sites that want to grab traffic from ESPN and Time (and leverage these brands more desirable names) should be doable right now, but may not be sustainable long term.

3. Ad blocking is on the rise

When "native advertising" and content recommendation companies first started gaining popularity, many industry observers thought it might offer a solution to the increasing use of ad blocking software. As it turns out though, ad blocking technology is remarkably adept at finding and eliminating even these more subtle placements. For example, here's the bottom of a normal CNN article:

And here's the same article with the AdBlock extension for Chrome:

Outbrain's recent deal with ESPN is aiming to go a step further than the typical recommend boxes, and will reportedly insert entire articles from outside sites into ESPN's newsfeed. But there's no guarantee that these "native" placements will be any better at avoiding ad blockers. On Buzzfeed, for example, a pioneer of sponsored editorial content, AdBlock has no trouble striping out commercial posts from its newsfeed or sidebar.

Ad blocking shows no signs of slowing down either. According to a recent Economist article, there are now approximately 200 million people worldwide who use ad-blocking software each month. Millennials and younger generations are particularly likely to use such programs. This movement poses an existential threat to services such as Taboola and Outbrain since it defeats the entire purpose of their platform. The most popular ad blocking software - Adblock Plus - is made by Eyeo, who maintains a whitelist of ads that are allowed through its filtering. Companies have to meet certain criteria (and pay a hefty fee) in order to be included on it. If margins continue to fall in the space, it's possible that Taboola and Outbrain simply won't be able to afford paying off Eyeo while staying profitable. The ad blocking sector itself is also becoming more crowded, which means that even if Outbrain strikes a deal with Eyeo today, there's likely to be a competitor on the horizon that doesn't allow Outbrain ads (and possibly uses that fact as a differentiator).

There's little consensus right now as to how publishers should move forward given their audience's willingness to undermine the current funding paradigm. Micro-payments, subscriptions, or simply a less invasive set of advertising principles are a few possibilities. Until a new structure emerges though ad blocking will continue to become more common and companies like Outbrain and Taboola will particularly vulnerable.

In Summary

The content recommendation and amplification space has seen massive growth over the past few years among publishers seeking to boost site visits and prop up higher advertising rates. But declining margins, the continued rise of ad blocking, and advertisers' reluctance to pay for low-quality traffic are all issues that undermine the long-term viability of such services. Investors should proceed cautiously with Outbrain's upcoming IPO, and larger companies (i.e., Yahoo) should resist the temptation to make an overvalued acquisition. The current advertising paradigm in shifting, and these services are most vulnerable players.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.