TKG Data & Analysis: Investments Indicate Online Growth

Summary

An article yesterday on the SeekingAlpha blog examines a recent wave of investment consolidation in the online media space. This signals, among other things, an impending acceleration of advertising shifts from offline to off, and a revenue diversification play on the part of search giants. As this happens, TKG data suggests vertical search sites will see a great deal of these spending shifts, while IYPs will grow faster than the overall local search market. These trends are supportive of data presented in TKG’s recently released Internet Yellow Pages and Local Search Forecast as well as Wave X of Local Commerce Monitor.

Analysis

Within the past 60 days we’ve seen a few groundbreaking (and record breaking) deals announced by search giants to effectively extend their online advertising reach and capability (independent of deals to extend offline reach and capability – an different, though related, subject).

The deals that SeekingAlpha’s Seth Gilbert cites include:

• May 18: Microsoft (MSFT) announces it will pay $6b in cash for aQuantive (AQNT), parent to digital agencies Avenue A, Razorfish, Atlas and DRIVEpm. That price constitutes a huge premium relative to $442m in ’06 revenue (net income was $54m)
• May 17: British advertising giant WPP Group (WPPGY), which is known for its offline ad services, announced it would acquire 24/7 Real Media (TFSM) for $649m. (the price represented a premium of approximately 17x EBITDA)
• April 30: Yahoo (YHOO) acquired the 80% of internet ad auction exchange Right Media it didn’t own for approximately $680m.
• April 13: Google (GOOG) acquires DoubleClick for $3.1b (price represents approximately 20x EBITDA)

As Gilbert points out, too much air has been wasted on diminishing these deals with the thought that they are in response to one another or represent “part of a game of competitive one-upsmanship between Yahoo, Google, and Microsoft.”

Though there is a certain amount of this factor present, this largely takes away from the significance of the deals themselves, the strategic planning behind them, and, importantly, the larger online trends they represent. The premiums paid with each deal are also telling of the presence of factors greater than simply “one-upsmanship.”

“To suggest Yahoo bought Right Media because Google bought DoubleClick or Microsoft is buying aQuantive because they had to keep up with Google and Yahoo is misleading.,” writes Gilbert. “These deals didn’t happen overnight – they happened over weeks and months. Several of these deals were in discussion at the same time, and most were on internal target lists for more than a year.”

So what do these deals really represent? A maturing paid search market has caused each of these players to seek diversification and revenue growth in other areas. Google’s acquisition of DoubleClick is probably the clearest example of this (as are Google’s many investments and partnerships with various offline media – again a different story).

This is supportive of data presented in TKG’s recently released Internet Yellow Pages and Local Search Forecast, which pointed to rising paid search rates and resulting margin compression. This will lead to increased investment in forms of online ad spending beyond paid search. Enhanced display advertising capability from G, Y, & M (and a general treading on one-another’s territories) represent diversification and revenue growth plays to get ahead of this trend.

The investment levels and premiums paid in these acquisitions also represent an accelerated shift in local ad spending from offline to online. TKG’s forecast specifically expects the global interactive directory market (local search and IYP) to grow at 22.3 percent (CAGR) from US$4.1 billion to US$11.1 billion. The U.S figure will meanwhile grow 26.1 percent (CAGR) to US$4.9 billion.

The high growth rate will also result from increased investment levels in SEO (driven by the same increasing SEM prices and margin compression). Citysearch’s acquisition of InsiderPages to (among other things) deepen its content and better optimize its listings are evidence of this. Other examples can be seen all over the search world, such as the SEO strategy of local retail search startup Krillion, and that of Google to deepen content with SMB contribution of structured business data in its Local Business Center.

Increased advertiser demand in online verticals will also contribute to this growth. According to Wave X of the Kelsey Group’s Local Commerce Monitor, SMB advertisers doubled their spending on vertical or specialized sites and publications to reach more targeted audiences. Spending jumped from 4 percent to 8 percent between Waves XI and X.

It’s also interesting to note that among the two categories that made up total U.S. digital revenues – local search and IYP – IYP will have a greater compound annual growth rate (29.9 percent), compared to local search (23.2 percent). One reason is that Yellow Pages companies are becoming more adept at executing multi-platform sales strategies among an established local advertiser base. These sales forces give IYPs an edge in reaching SMBs, given the aforementioned SEM price pressure and the lack of time and ability among many small businesses to self provision SEM campaigns.

The bottom line is that TKG expects IYPs to grow faster than the overall search and local search market. This will come from flat growth in print (global print revenues are expected to grow at a 0.9 percent CAGR from US$26.5 billion to US$27.8 billion according to the forecast) and an ability for publishers to transition dollars from offline faster than the overall search market will grow. TKG data suggests this will happen at an accelerated pace.