Buying a Web-Based Business? Here’s What To Look For
Due diligence is due diligence;any acquisition target deserves proper attention. And strategic acquisitions by publishers these days are almost as likely to be Web-based companies as they are print publications. Yet a Web operation does have its own unique features that publishers should pay close attention to. Scalability, infrastructure and growth rate should figure heavily in any due diligence process.
“For us, the first thing was identifying a property that would add value to our portfolio and that we could build on,” says Bonnie Bachar, president, U.S. magazines at Reader’s Digest Association. Value was a key driver behind the company’s first Web site acquisition;Allrecipes.com, a $66 million purchase expected to contribute EBITDA of $4 million in its first year under RDA. “We looked for a property that was going to be complimentary to our existing print products. And I think that has come to be true in terms of the initial integration.”
Yet Bachar is quick to admit that having print-based business development expertise does not wholly translate to acquiring Web companies such as Allrecipes.com. “The differences are we as print people know how to evaluate circulation and ad revenue, for example, and you need to have the same expertise on the Web side, which is what kind of people, product, traffic and technology am I buying? You still have to know what you’re buying but now that ‘what’ has a different set of categories.”
One of those categories was technology. Bachar says RDA brought in an outside consultant to help them evaluate Allrecipes.com’s technical infrastructure. “If you don’t get a handle on the technology part, you don’t know whether someone could just knock you out of the market in three months,” she says.
Tolman Geffs, a managing director with a specialty in Web properties at New York M&A brokerage firm Jordan, Edmiston Group, notes that publishers with in-house Web tech teams often don’t measure up to those that run a strictly Web-based company. “Often that team doesn’t have the depth that a pure online business does. The natural tendency of the home team’s IT group is to say, ‘We can build that.’ It’s a lot harder than it looks.”
“We’re looking for three things,” says Greg Strakosch, CEO of IT media company TechTarget, which built its online business first, then print. “Growth rate, scalability;how big is the business now and how big can it be;and profitability.”
If all three are in place, Strakosch says they’ll pay a premium for the company. “On growth rate, we’re looking for revenue growth of 20 percent plus per year. For scalability, online revenue should be in the $5 million per year range and we can see a clear path to $10 million. And we expect EBITDA margins of 30 to 50 percent on those types of businesses.”
Strakosch warns against sellers who have large valuations based primarily on their traffic projections. “We see these businesses that have a lot of traffic but they have less than $1 million in revenue. For us, we’re not going to pay premium valuations for traffic or for businesses under $1 million in revenue. We definitely want to see that someone’s been able to prove that there’s revenue.”
Bachar also suggests looking at topline growth. “You don’t have paper costs on the Web so that your ability to grow on the topline does absolutely fall to the bottom and you want to know where they are in that growth curve.”
CPM, obviously a major (and complicated) contributor to the topline, needs special attention as well. “How much of their inventory has been sold versus how much is being used for remnant or house?” says Bachar. “Where are the higher CPMs coming from? How much inventory do you have in those CPM areas?”
Geffs agrees that growth is a critical metric. “It’s always a mix but you’re using growth-based valuation rather than cashflow valuation for many of these businesses,” he says. “So it’s very important to understand forward drivers of revenue growth and test those and understand how to sustain that revenue growth.”
Like any print property, a Web business deserves its fair share of due diligence. Here’s what to pay special attention to.
Will you migrate it to your own back end? Or is it powerful enough to stand alone? Make sure that the target’s technology will stand up to incoming competition.
There are many ways to slice and dice ad inventory and its CPM across a Web property. Look closely at how the seller has sold theirs and what kind of rates they’re getting.
Make sure you understand where the traffic is coming from and if the seller is counting it properly. Much of the scalability of the operation will be built off of the quality of traffic.
Maintain a healthy skepticism of the seller’s valuation. Many times they’ll base this on unrealistic comparisons to public companies that have better scale, growth and profitability.