“Data-Driven Thinking” is written by members of the media community and contains fresh ideas on the digital revolution in media.
Today’s column is written by Todd Van Fleet, managing partner at Van Fleet Capital Strategies.
Greek philosopher Heraclitus is credited with the observation that life’s only constant is change.
Those in the digital media world know how true this adage is. M&A activity in the space, perhaps the most significant representation of change, has been reasonably strong, leading many to wonder what is to come over the next year to two.
Expect more of the same. Slow economic growth and significant capital availability increase acquisition appetites. Industry participants can assess their status as potential targets by asking a fundamental question: Do we own our customers?
Macro Environment Favors M&A
The latest outlook for global economic growth is slightly more than 3% annually, according to the IMF. This type of growth might be considered reasonable by US standards, but the figure is an aggregate estimate representing expected growth among both developing and developed nations. US GDP growth in Q2 was just 1.2%, and European growth is even more muted. Western economies will continue to bring down the global average growth rate.
In this environment, central banks are likely to keep interest rates where they’ve been for nearly eight years now: near zero. The Bank of Japan currently has a negative interest-rate policy and some would suggest the real rate of growth, including effect of price inflation, in Western economies is negative as well.
A persistently low-interest-rate environment has its benefits. Companies can refinance their balance sheets, reduce borrowing costs and add to cash balances. Businesses with positive cash flow and profit margins enjoy expanded access to debt financing, which can come in handy when executing an M&A strategy.
The biggest drawback to a sustained low-interest-rate environment is that it can cause equity investors to take on more risk than they would otherwise to generate return, creating price bubbles within asset classes and imbalances with respect to risk and reward trade-offs, such as higher risk for the same reward or lower reward for the same risk.
Simply put, the world is awash in capital but developed economies are relatively stagnant. Acquisitions are the primary tool companies use to expand when organic growth slows or becomes nonexistent.
The Most Attractive Targets Own Their Customers
At the risk of oversimplifying, I’ll suggest the rationale behind most successful M&A strategies is a central tenet underlying the business models of successful enterprises: owning the customer. It is having the customer dependent on your solution, whereby displacement becomes more difficult or impractical.
A critical aspect of any investment due diligence process, whether of a public or private company, is to reasonably assess the degree to which a business owns the customer relationship.
Customer ownership reduces uncertainty and generally leads a business to have better pricing power, improved revenue visibility, the ability to manage margins and a higher customer lifetime value.
The financial risks of a bad acquisition are higher in a slow growth environment as the impact is felt more acutely – take Yahoo’s purchase of Tumblr, for example. Expect acquirers to intently focus on the risk and reward profiles of their targets. Strong customer ownership makes any profile look better.
As a side note, automation technology and data intelligence obviously play substantial roles in the digital media space. They’re critical for generating ad revenue dollars and informing buyers and sellers about audiences and their behaviors, which highlights another important M&A driver for the industry: customer monetization.
A number of high-profile monetization deals have transpired over the past two years or so, including Facebook’s purchase of LiveRail, Twitter’s acquisition of TellApart and the AOL/Millennial Media, Yahoo/BrightRoll, Oracle/Datalogix and LinkedIn/Bizo deals, as well as many not-so-high-profile ones.
While important in terms of what they mean to the evolution of the acquirer, monetization deals will tend to be less highly coveted than those for which enhanced customer ownership is the driver. Customer ownership enables monetization. It generally does not work the other way.
It’s Not About Mar Tech Vs. Ad Tech
It’s tempting to suggest mar tech companies will continue to get the most attention vis-a-vis ad tech because the former tend to sell directly to brands, with no agency intermediary, and have revenue models looking more like traditional SaaS, with monthly recurring revenue. These are important distinctions, but go-to-market traits alone don’t secure customer ownership.
Business leaders will be more holistic in their thinking. Keeping an eye on the competition, they’ll consider the parts of the sales funnel or the mindshare of the consumer they want or need to own. Their strategies will be based on expectations of consumer behavior and their most important B2B and B2C customers, for it’s these relationships they want to own themselves. Monetization will be a secondary consideration.
They’ll look at the scope of technology platforms in the market and ask themselves which ones will make them more indispensable and sustainably so. They’ll then size up the risk and reward profiles of each of those targets, including assessing the degree to which the targets own their customers.
Valuations will be scrutinized. Acquirers domiciled in the US and western Europe will be terribly conscious of overpaying, with China-based acquirers less so.
With homage to Heraclitus, all will be trying to hit a moving target.
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