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May 07, 2007

The Great Click Rush of 2007

Ad networks are hot, and in many cases highly-profitable businesses right now.  On the heels of Google's snapping up DoubleClick for $3 billion, Yahoo! bought (the 80% it didn't already own of) 4 year old  online display ad exchange Right Media last week for $680 million.  So, a logical question to ask is, who buys whom next?

First:  who needs what?  Big portals and ad agencies without networks are logical buyers of course.  But as my colleague Jeffrey Rayport recently discussed in Ad Age, in response to the growing power of the Big 4 (Google, Yahoo!, MSN, AOL), major media firms are trying to fight back.  I think this might make some of them candidates too.  Two ways they're trying to compete with the Big 4 portals are by aggressively going "multi-channel" and getting further into the territories traditionally served by ad agencies (creative and media placement).  As they expand the range of properties and services they offer to their advertisers, at some point it becomes worthwhile for some of them to consider running their own ad networks, rather than living in thrall to third parties (i.e., the Big 4's).  Some will build, some will buy.   Who's big enough to consider buying a big ad network?

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Second:  who's interesting and available? John Chow's list is Google's top search result for "list of ad networks" and a good place to start, though it notably misses aQuantive's Atlas network (a main driver behind that firm's 40% revenue growth rate and 20% profit margins) and ValueClick, which has tripled in size to over $500 million in revenues while still dropping 12% margins to the after-tax profit line in the latest year.

Third: how to decide what to buy?  rat-brain criteria for this (usually a good place to start) might be that one should think about picking up a network whose 1) ad serving capabilities are a good match for the kinds of properties you have  or plan to build, 2) gross margins are good enough to suggest high value added from reach and targeting approaches, and 3) whose market-cap-to-gross-margin multiple suggests an attractive deal.  (I focus on gross rather than operating margins because I assume that OH and SG&A would be radically restructured in an acquisition). 

So for example, if you're planning to  do lots of video, a video ad network  like ScanScout might be an interesting  partner. 

In the second case , ValueClick's ~67% gross margin (as a proxy for value-added) looks better than 24/7 Real Media's ~35% margin.   But, it turns out that  these two  have roughly the same  9x market  cap to gross margin multiple.  At less than one fourth ValueClick's absolute market cap size, 24/7 Real Media might seem the more affordable bet.  But if I'm a really big media player I might think that the bigger purchase (VLCK's market cap is $2.7 billion as of this writing) for a network with greater value-added percentage-wise might be a better buy at the same multiple, since I'd have more confidence I could sell the better value proposition if I liked the underlying targeting capability.

Postscripts: Microsoft eyes 24/7, an interesting (if naturally biased) post fanning the flames by Tacoda's Dave Morgan which my colleague Aboud Yaqub sent me, and a cautionary look at where some of this might lead by Charlie Ballard on the One-to-One Interactive blog.

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