Color by Numbers: A Valuation Framework for the Ad Tech Sector

January 21, 2014

This past summer, trade press commentary focused on the impending doom of the Ad Tech space, pointing to the industry’s fragmentation and noting the underperformance of recent IPOs: Millennial Media (MM), Tremor Video (TRMR) and YuMe (YUME).

The tides quickly shifted in the fall when Rocket Fuel (FUEL) went public and finished up nearly 100% on its first day of trading. The following month, Criteo (CRTO) also had a successful IPO and, along with Rocket Fuel, trades at higher multiples than the first batch of deals with a market cap well north of a billion dollars. In addition, two high-growth private companies were acquired (Adap.TV by AOL and MoPub by Twitter) at more favorable multiples.

These positive events led to a swift change in industry sentiment, though we believe the comparative disparity in multiples has created a lack of understanding of relative valuations.

From a fundamentals perspective, the Ad Tech sector overall has rarely seen better times. The ongoing shift of consumers’ time and marketing spend to digital channels has continued unabated at a 20%+ annual pace. The more data-driven and programmatic ad spend is experiencing much faster growth — IDC estimates a 75% CAGR from 2010 to 2017. This growth has disproportionately benefited the large platform players like Google (GOOG), Facebook (FB) and Twitter (TWTR), which has been reflected in their recent superlative stock performance. We are optimistic that new platforms and formats will add to this already torrential growth rate.

This rapid growth, coupled with a relative dearth of consolidation and, until recently, limited public market access, has resulted in a large group of scaled private companies. We estimate that the Top 20 private companies average over $300 million of media spend (or gross revenue) and have a median growth rate of 60%. That’s a lot of companies at scale and growing rapidly!

Given that at least a dozen of these companies are contemplating IPOs in 2014 and 2015, we want to share a framework for how we believe the market values this sector. This paradigm is not a prescriptive scientific formula, but rather a suggested framework to understand the way public markets look at investments in Ad Tech. We would also point out that this framework applies to scaled companies capable of accessing the public markets and does not necessarily translate to smaller players.

To assess public market valuations, it is helpful to take the investor’s perspective. Regardless of the industry, investors tend to focus on three parameters:

Growth (which encompasses the total addressable market).
Operating leverage (the ability to grow revenues at a faster pace than expenses).
Predictability (which encompass revenue certainty and defensibility).

We could add a fourth parameter — strategic value — that in some cases captures potential takeover premium. Note that predictability materially improves as ad spend moves along the performance curve and is considered more of a cost-of-goods-sold than a discretionary expense. In search advertising, for example, marketers usually buy keywords all the way to the efficient frontier due to the tight connection to performance (sales). Display is not quite there but moving in that direction.

Below we have plotted the six public display Ad Tech companies by forward revenue growth and valuation multiple based on current trading levels and consensus estimates. Note that we are using “Net Revenue,” which excludes media costs, in all cases that allow for the comparison of these different business models. We added some public software-as-a-service (SaaS) companies for comparative purposes even though most companies intermediating ad sales do not employ SaaS models.

One would obviously expect valuation multiples to be positively correlated with growth, as well as business models that apply more leveraged technology relative to media. It’s a spectrum.

So far, this is all observed fact — black-and-white, if you will.

To better understand the significant variances in valuation shown above, we group the companies into four primary categories: Network 1.0, Network 2.0, Programmatic, and SaaS. Note that while some companies have traits of one category, many have hybrid business lines that span categories.

Network 1.0 businesses have campaign-based models serving as middlemen between advertisers and publishers and earn profits from the spread between media bought vs. sold. Network 2.0 companies have similar business models, though they typically source media from exchanges (rather than direct relationships with publishers) and possess more proprietary technology that provides greater performance for the marketer. This superior performance, as well as the focus on the higher-growth customer-acquisition segment of the market, has resulted in higher revenue growth for these companies.

Programmatic businesses typically have a media pass-through model, charging a technology fee based on the amount of media dollars managed by their systems. For these Programmatic companies, the margin on media spend is around half that of the Network companies, but when looked at on a Net Revenue basis, have higher margins more typical of software models. Finally, SaaS refers to companies with contractually recurring monthly software fees with no regard to media, which is the most predictable model of the four categories. In Ad Tech, these could be companies providing data management or analytics capabilities as opposed to media intermediation.

Now we apply some color — the four categories with corresponding valuation vectors. As stated at the outset, this is not a strict formula but rather a framework to provide valuation context. You can see where the public companies trade with respect to these valuation vectors:

We believe the market values Network 2.0 businesses at a premium to Network 1.0 businesses, and the SaaS businesses trade even higher. We believe the market will value Programmatic companies higher than Network 2.0 (again, on a net revenue basis) due to their greater operating leverage and higher predictability of revenues. Note that the vectors associated with higher technology categories have greater slopes, reflecting their higher operating leverage.

Companies that are perceived by the market to be in a particular category can potentially use M&A to improve their position. For example, ValueClick’s (VCLK) acquisition of Dotomi (a comparable of Criteo) improved their positioning and Millennial Media’s recent acquisition of JumpTap also elevated their valuation.

Speaking of M&A, we litmus-tested the Color by Numbers framework on the relevant scaled M&A transactions and believe it holds up (see the link to the presentation on SlideShare below). We also plotted the B2C digital giants against the vectors. Yahoo ex-Asian investments is trading at around 3x net revenue, AOL that has multiple business models from access to content to programmatic trades closer to 6x net revenue and Google, again with multiple businesses, trades even higher at over 8x revenues. And the more nascent companies, Facebook and Twitter are off the page.

We are likely to see several Programmatic companies pursue the public market over the next 24 months. Not all candidates have pure-play models. The market will need to assess each of these business models and the companies’ respective roles in the ecosystem in order to determine their appropriate valuations. We hope this Color by Numbers framework is a helpful start.

To access a SlideShare presentation and download the Color by Numbers slides, click here.

As originally published on Re/code.

Disclosure: LUMA Securities, a wholly owned subsidiary of LUMA Partners, acted as co-managing underwriter for Rocket Fuel and may pursue underwriting or other advisory assignments with companies mentioned in this report or in the sector in general.

Rocket Fuel and the Revitalization of Ad Tech

December 9, 2013

It’s amazing what a couple of months can do. In July, the Ad Tech sector was reeling from its third underwhelming IPO of the year – Marin Software (MRIN), YuMe (YUME) and Tremor Video (TRMR) – and 2012 IPO Millennial Media’s stock (MM) was also languishing. Not a day would go by without another press article on the coming doom. The themes were consistent: Ad Tech is fragmented and competitive and public investors don’t like the industry.

Then came Rocket Fuel and everything changed.

Rocket Fuel (FUEL) went public on September 20, 2013 and was very well received by the market. The issue traded up 93% on its opening day and currently supports an approximate $1.5 billion market capitalization. The stock trades at a substantially higher multiple than the other industry comparables thanks to advanced technology and a growth rate worthy of the company name.

Currently, investor attitudes towards the sector have improved dramatically. Other positive events led to the rebound such as well-priced M&A deals for programmatic Ad Tech companies Adap.TV (bought by Aol) and MoPub (bought by Twitter) as well as the successful IPO of retargeter Criteo (CRTO). While all of these factors contributed to the change in investor perception, the Rocket Fuel IPO was clearly the inflection point. We believe this bodes well for other scaled quality companies in Ad Tech as they seek public finance options in the quarters ahead.

LUMA Securities, a wholly-owned broker-dealer of LUMA Partners, acted as co-managing underwriter to Rocket Fuel. This was LUMA’s first co-managed IPO and represents an extension of our product suite from M&A and private capital finance advisory to public finance underwriting. Our strategy is to selectively assist leading companies in the digital media sector as they pursue public market finance options. For issuers, we leverage our deep industry knowledge to help position the offering as well as prepare management for investor inquiry.

Look for more activity in 2014!

blinkx Acquires Rhythm NewMedia

December 3, 2013

Today, blinkx PLC (LON:BLNX) announced the acquisition of Rhythm NewMedia Inc., a leader in mobile video advertising. With this combination, blinkx plans to accelerate growth of its mobile video advertising business, the fastest growing segment within online advertising, and expand the scope of its solutions for brand advertisers.

LUMA Partners represented Rhythm NewMedia in the transaction.

We discussed in our State of the State at DMS 13 presentation that mobile is not an individual “channel,” but is rather another screen – a philosophy we call “mobile everything.” blinkx is a leading video monetization and syndication company. Rhythm provides blinkx with a perfectly complimentary mobile video solution, enabling “blinkx to satisfy growing brand advertiser demand for integrated video campaigns across devices.” As demand for these types of integrated solutions increases, we anticipate continued consolidation across mobile and video through 2014.

Congratulations to Rhythm NewMedia and blinkx on the transaction!

Neustar Acquires Aggregate Knowledge

October 30, 2013

Today, Neustar (NYSE:NSR) announced the acquisition of data management platform Aggregate Knowledge (AK). LUMA Partners represented AK in the transaction.

In this deal, Neustar continues to build out its complete workflow solutions for marketing professionals by leveraging the offline and online audience segmentation and targeting capabilities of its AdAdvisor business with AK’s real time media analytics, optimization and attribution in the digital channel.

As we suggested in 2010, the data intelligence layer (DMP before the acronym was formed) lies at the very heart of audience-based media buying that predominates the digital media channel.  Why else would it be in the center of the LUMAscape?  We anticipate that many more companies (from large technology providers to offline data giants and potentially data-rich consumer networks) could leverage the analytical capabilities of a well-positioned DMP.

Congratulations to Aggregate Knowledge and Neustar on the deal.

This transactions marks the 7th data deal LUMA has completed in the last few years, reflecting the important role data plays in digital media. We know data!


DMS 13

June 16, 2013

LUMA Partners hosted its 5th annual Digital Media Summit on May 22, 2013 during Internet Week NY. It was a huge success! More than 500 leaders from the digital media industry were on hand (300 CEOs, 100 strategic investors, 100 financial investors) for pithy discussion of topical issues and power networking. Re-cap below:

For speakers and sponsors, DMS started the night before at the VIP Reception. This year we hosted a party on the rooftop of The NoMad Hotel. It was a terrific evening.

At DMS, there was “steak” (the hour-long breakout sessions that leveraged peer-to-peer CEO participation) and “sizzle” (main stage keynotes, fireside chats) and lots of fun entertainment in between. The morning breakout sessions covered content, commerce, video, data, brand solutions and exits, while the afternoon sessions focused on multi-channel marketing, social, mobile, programmatic premium and investing trends.

The main-stage sizzle included the following:

  • Terence Kawaja and Brian Andersen opened with a discussion of markets and trends in digital media with their State of the State presentation (available on video and via SlideShare).

Morning Session

  • An excellent keynote from Neal Mohan of Google who previewed Google’s incredible new Lightbox product that is squarely aimed at digital solutions for brand advertisers.

  • A fireside chat with Facebook’s Blake Chandlee and Twitter’s Kevin Weil who discussed their API partnership strategies. Kevin made the second product announcement of the day with the launch of Twitter Lead Generation card product. Yes, that’s right, two of the most influential companies in digital media launched product at DMS!

Morning Keynotes

  • Scott Meyer of Evidon reviewed Evidon Labs, a cool new product that brings the LUMAscapes to life.

  • Amanda Bicofsky presented Behind the LUMAscapes, and Jonathan Greenglass announced our own product launch – the LUMA App for iPad. Available in the App Store, the LUMA App has graphical and drill-down data on the companies that comprise the LUMAscapes. Download it today!

Lunch Session

  • The Winners’ Circle, featuring recent deal successes involving Akamai, MediaMath, and Ziff Davis.

  • Rick Chavez of Microsoft Advertising, who gave a compelling talk on the future of digital tech and the interrelation with people.

Afternoon Keynotes

  • An episode of The Terry Springer Show that united Randall Rothenberg of the IAB with Harvey Andersen of Mozilla on stage to meet and hopefully start a meaningful conversation about third party cookie policies (since we firmly believe the industry is best served by having open dialogue about issues.) Kudos to Randall for being a great sport.

And of course there was lots of fun – from Jony Ive to Mad Men (yes, Terry is appearing on an episode next season) to the LUMAsuit (you have to see the video) and finally the premier of Terry’s Use Bitcoin comedy video – there was plenty to keep the capacity crowd entertained!

Afternoon Session

All in all it was a day of substantive content, insight, perspective, networking and entertainment with a goal of advancing dialogue in the ecosystem. We were even able to host representatives from Camp Interactive, a charity helping inner-city kids learn to code. We appreciate all the CEO and senior executive participants and want to again thank the DMS 13 sponsors; without their support, the event would not be possible.

We look forward to hosting DMS 14 next year!