AOL is buying Internet News site Huffington Post for $315 million. Here’s what you need to know about the deal and what it says about the tech world, investing and the economy.
Mergers are tough
Most mergers fail because the ‘synergies’ which deal hounds expect never come to fruition or because the distraction of post-merger integration causes strategic missteps. So, a deal of this size is certainly fraught with peril. However, it makes sense because AOL gets back into the game. Display advertising is moving online and AOL needs the content in order to monetize its user base. AOL could even be one of the winners online if it manages the integration right. AOL makes the lion’s share of its revenues from an ever dwindling subscriber base, one that doesn’t necessarily need to pay for AOL’s services. As these subscribers leave AOL, they may not necessarily ‘leave’ as users if they have content which they find compelling. AOL’s huge reach via former and current users could be a big boon for both sides of the transaction.
Technology valuations are going up
The Web 2.0 melt up is for real. And the Huffington Post acquisition is a part of that. The company is selling for 10x 2010 revenues. That’s an eye-popping valuation for a media company. But this is not about media companies, is it? Old media is still out of favour with investors. New media is doing rather well because investors see the second wave of big Internet companies as a good bet. The crop of companies destined to come to market like Skype, LinkedIn, Groupon and Facebook are real companies with real business models and a lot more profit than their Web 1.0 pre-IPO brethren. That’s in part because online advertising has finally taken off. comScore estimates there were 1.3 trillion display ads online in the U.S. alone in the third quarter of 2010. That’s up 22% year-on-year. AOL is betting the Huffington Post is going to grab an ever-bigger slice of this expanding pie. For investors, could it be that this kind of deal is like the Pavlov’s bell? Are we about to witness an onslaught of mergers and internet stock buying? The stock market seems to like the deal so far [not for AOL shareholders but for the market as a whole].
This deal is not indicative of a double dip, is it? A lot of mergers are coming
It seems pretty obvious, but I thought I should flag this anyway, since a lot of people are still not bought into the recovery. The recovery is for real. You can question the fundamentals of this recovery; I certainly do. But the fact is the economy has improved. And deals like the AOL – HuffPo deal simply don’t happen when the economy is bad. In fact, I fully anticipate more high profile mergers and acquisition activity, especially in the technology space. Many of the leading technology companies like Google, Apple, Cisco, Intel and Microsoft are flush with cash. In the case of Microsoft, a major player online, it is a mature business selling at a multiple of 12x earnings, not revenues like the Huffington Post. The pressure to return cash to shareholders is increasing on these firms. They can either start or increase dividends to investors and admit they have no alternative use for cash or make splashy acquisitions to shore up their weak spots. Given Google’s failed acquisition of Groupon, you can bet these companies will be looking for targets.
Expect online consolidation
This acquisition is the first salvo in a major consolidation online. Companies like Yahoo will have to give up the ghost and recognize they can’t win it alone. Their business strategy has failed. And with major new competitors starting to get flush with cash, they won’t be able to buy their way into success either. It is notable that the Huffington Post’s first major potential buyer was Yahoo! Yahoo was rebuffed. Yahoo is not the only company that looks increasingly vulnerable in the social media centric new Internet world. Ebay is another Web 1.0 company that I believe needs to make a move now or risk being left behind permanently. Amazon, on the other hand, is leading the charge in e-Commerce, a $43 billion business last quarter in the U.S.
Old Media may be sunk
The paradigm shift to online seems to be nearing completion. If you look at Newspapers and their revenue streams, classifieds and display advertising were always more important than subscriber revenue. The same is true for magazines. In the first wave of Internet companies, the classified revenue stream was decimated. Companies like Monster.com and E-bay ate into their offline revenue. And as Old Media moved online, they quickly understood that the new business model could not support their old infrastructure and offline distribution channels. During recessions, media companies haemorrhage losses as advertising revenue sinks and fixed costs reveal a lot of operating leverage. We saw some major casualties in the newspaper business during this past recession. Right now, media companies should benefit from the cyclical upturn. However, the same pressures will still apply: revenue is moving online and they must decide whether to cannibalize their revenue stream before the next downturn hits. Inertia will be a huge factor here. So I don’t think they can all do it. When the next recession hits, there will be a lot more bloodletting in old media. Recognition of this possibility may drive even more media M&A acquisitions. I am sure Investment banks are dialling for dollars right now, as a result.
The Fed is behind the curve
Clearly, if you have a macro brain like me, you see this acquisition in a larger context which is ‘frothy’. As I said near the outset, this is not the kind of deal you see in a sagging economy. It is indicative of the mid-to-late stages of an economic cycle. The IPO wave coming on stream reminds me of Amazon, Yahoo! or the like 15 years ago. Meanwhile, the Federal Reserve is on easy street with short-term interest rates at zero percent. During the housing bubble, Alan Greenspan voiced disquiet over the ‘conundrum’ of the Fed raising short rates, but long rates coming down. Some have looked at the so-called Asian savings glut as the source of this dichotomy. I look to animal spirits as the explanation, on the other hand. The reality is that when animal spirits get going and continue going, people build up a lot of vested interests in the status quo. You can’t just tap on the brakes and expect people to unwind their positions as if they were all so many frictionless stock market transactions. It takes a great deal more tightening than policy makers realize. Will this time be different?
Those are my initial thoughts about this deal.
P.S.- AOL is going all-in on the blogging-type media model, with its having already bought Tech Crunch. I don’t know what this says about the future of the web. But, clearly, blogs have value.