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Smart Money Or Silly Money 2.0?


Imagine being Philippe P. Dauman, who has been the chief executive of Viacom Inc. (VIA) for a mere six weeks. His boss, Chairman Sumner M. Redstone, booted his predecessor, Tom Freston, in large part because Freston was too slow to do a big Internet deal. The expectation is that Dauman, who ran his own investment firm, will be quicker to act. In turn, the assumption is that shareholders will applaud and the stock will soar.

But the view from Dauman's 52nd floor Times Square office is foggy at best. Only last summer, people were saying News Corp. (NWS) Chairman Rupert Murdoch had overpaid for the social-networking site MySpace.com. Now the $580 million price tag looks cheap. At least it does compared with the $1.65 billion Google Inc. (GOOG) is paying for YouTube Inc., a 20-month-old video-sharing site with zero profits. Viacom's team held talks with YouTube founders, Chad Hurley and Steve Chen, too, but the negotiations never went anywhere.

Everyone from Time Warner (TWX) and Viacom to Yahoo! (YHOO) and Microsoft (MSFT) is under enormous pressure to acquire the next MySpace or YouTube. But amid steadily rising valuations, Old and New Media executives alike are afraid of overpaying and being punished by their shareholders. "We are seeing a valuation gap that sometimes doesn't make sense," says Wade Davis, Viacom's senior vice-president for mergers and acquisitions, who has overseen a handful of Web 2.0 deals whose prices collectively are well below what Google is paying for YouTube. Time Warner Chairman and CEO Richard D. Parsons, still dealing with the aftermath of the disastrous merger with AOL in 2001, has similar concerns. "We're interested in businesses that endure," he says. "You are not going to grow a business over the long term if it's being valued at 60 times earnings."

FICKLE YOUTH

Paying up is less of a concern for a Google, of course. While Old Media continues to suffer from lagging stock prices and tepid advertising revenues, Google, Microsoft, and Yahoo have huge cash hoards, manageable debt, and, in the case of Google, a lofty stock price. Paying $1.65 billion for YouTube amounts to less than 2% of Google's $130 billion market cap -- and the big bet on the video-sharing site could be as much about gut and ego as it is about hard-nosed business sense. And even if Yahoo decides to spend $1 billion to acquire Facebook, the popular social networking site for college students, that isn't likely to break its bank, either.

Nonetheless, some analysts see a lot of froth in the market, and the risk remains that even highfliers like MySpace and YouTube could flame out if their fickle, youthful audiences decide to move on. "Every monkey with a video-sharing site is going out there and asking for double their previous valuation," says Paul Kedrosky, a venture investor with Canadian VC firm Ventures West Management Inc.

What really has the media world agog is the assertion by RBC Capital Markets analyst Jordan Rohan that MySpace could be worth $15 billion in three years -- or nearly 30 times what News Corp. paid for it. Rohan says the social-networking site's "trajectory for profitability" is every bit as steep as Google's. But his reasoning is based largely on the fact that Google has agreed to pay MySpace $900 million over three and a half years in exchange for being its search provider.

Critics have pounced on Rohan. One is Robert Holthausen, a finance professor at the Wharton School at the University of Pennsylvania. He notes that Google trades at 55 times earnings, so if you were to apply that multiple to MySpace, it would need about $270 million in annual profit to justify a $15 billion valuation. Furthermore, Holthausen questions whether Google is even an appropriate yardstick for MySpace and whether Google's 55 times earnings is a realistic fundamental value in itself.

Whether or not a Web 2.0 bubble is in the making, how valuations get assigned to these New Media properties is certainly more art than science at this point. Their prices can't realistically be based on hard and fast metrics like, say, current revenues or profits. "There is no neat, concise, formulaic approach," says Terrence G. Kawaja, a managing director and online media specialist with investment banking boutique Gridley & Co. For the most part, sites are being valued largely on existing traffic (unique page views and monthly visitors) and on the potential to leverage those audiences to sell advertising in the future.

Since most of the traffic on these sites is viral, their costs to attract users are very low, if not zero. Advertisers love that, or so goes the deal broker's pitch to potential acquirers. Combine that with "the medium of all mediums, video, and you have a winner," Kawaja says. "By putting the rich medium of video together with reportable and traceable ad metrics, and ads that can be targeted to any demo, it's nirvana for a marketer." The other factor driving these valuations is the competitive fervor from bidders that ratchets up the prices. "There's definitely defensive buying," says Rodd C. Langenhagen, managing director at Revolution Partners, a Boston M&A shop. If Google had not faced other potential bidders for YouTube, who knows if the price would have reached $1.65 billion?

Even so, many people believe Google, more than most companies, can easily justify the price. "This is a big slug of [content] inventory," says Leapfrog Ventures partner Peter Rip, who ran Knight-Ridder Inc.'s venture arm in the late '90s. In other words, with YouTube in its grasp, Google can more easily place ads on pages where videos are viewed or even in the videos themselves. As a result, Google can take a bet on continued growth at YouTube, which now serves more than 100 million video clips per day, up from 10 million in January.

Now, the question is whether YouTube's valuation will extend to up-and-coming buyout contenders. So far, it looks like only a few sites have demonstrated growth and engagement with users that might command similar prices. Exhibit A: Facebook, whose value as determined by its venture investors has jumped from $100 million in its first round in September, 2005, to $500 million in a second round last April. And that's just the start. Sources say bidders such as Yahoo are willing to pay up to $1 billion today. "We're not in a crazy mode," says Michael J. Montgomery, the Santa Monica (Calif.) investment banker who sold MySpace to News Corp., the video site Grouper Networks Inc. to Sony, and another one, iFilm.com, to Viacom. "When a quality company with quality traffic comes up, you can get a lot of companies who will bid on it."

Maybe so, but even a titan like Microsoft isn't necessarily prepared to pay a big premium for a Web 2.0 company. "I am surprised that Google would pay $1.6 billion" for YouTube, CEO Steven A. Ballmer told BusinessWeek, though he acknowledged he might have paid the same. For Old Media companies, the hurdle is even higher since they lack the ability of a Microsoft, Yahoo, or Google to mesh an acquisition with their existing networks of daily users.

So what can a Time Warner or Viacom do to avoid being left behind? For starters, they can cut distribution deals with the online upstarts. On Oct. 9, just hours before YouTube announced its deal with Google, CBS Corp. (CBS) said it would offer short-form programming to YouTube in exchange for advertising revenue. Warner Music (WMG), Sony BMG Music Entertainment, and Universal Music announced similar deals with YouTube. It may be that some traditional media executives are beginning to see no reason to own these distribution sites if they can be guaranteed protections and revenues for their copyrighted materials. Still, revenues from these outlets will be paltry, at least for now, compared with what they generate by selling programming to cable and satellite TV.

Other media giants are building their own digital businesses. One is Walt Disney Co. (DIS), which just relaunched ABC.com, where it is streaming programs like Lost, Grey's Anatomy, and Ugly Betty just days after they air on TV. What's next? A relaunch of Disney.com will include streaming of Disney movies. And although Viacom continues to get a slew of pitches, CEO Dauman recently told a packed Goldman, Sachs & Co. (GS) investor conference that as time goes on, there may be less urgency to do deals as Viacom's internal digital operations grow stronger across such brands as MTV, Comedy Central, and Nickelodeon. "We see tremendous opportunity," Dauman said, "with what we have inside." Yes, but every media executive probably dreams of grabbing the Next Big Thing out from under Google's nose.

By Tom Lowry and Robert D. Hof, with Sarah Lacy, Roben Farzad, and Ronald Grover


Hollywood Goes YouTube
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