Googles Largest Acquisition: A Strategic Imperative

Google has reached an agreement to buy DoubleClick, a display ad network, for US$3.1 billion in cash. The acquisition moves Google deeper into the critical display and rich media markets, a segment the company has vowed to become a larger player in for some time.

According to a Google statement, all 1,200 DoubleClick employees will be staying, and the company will remain independent until the post-merger planning is complete.

Estimates of DoubleClick’s revenues differ. The New York Times is reporting that the company generated US$300 million in revenues while The WSJ is reporting roughly US$150 million, including US$100 million from ad serving.

Either way the purchase price represents a substantial premium over both revenues and earnings. Microsoft was also rumored to be in the bidding, and reports surfaced in the past several weeks that a potential US$2 billion price tag was high. Unlike the US$1.6 billion purchase of YouTube, this deal was an all-cash transaction.

Contrasting a few of the competitors’ metrics and historical highlights of DoubleClick gives us some indication of the range that DoubleClick likely falls into:

DoubleClick Timeline and Highlights

• 2003 – DoubleClick reports revenues of US$271 million and net income of US$16.9 million.
• 2004 – Revenues reach US$301.6 million and net income is US$37.5 million
• 2005 – DoubleClick is taken private by private equity firms Hellman & Friedman and JMI Equity for US$1.1 billion.
• 2005 – The company sells two data and e-mail advertising businesses for a reported US$525 million.
• 2006 – DoubleClick purchases Klipmart, a company that specializes in online video.
• 2007 – Google purchases DoubleClick for US$3.1 billion in cash.

Competitors Grid

Sources: Hoover’s, Capital IQ (2007)

Assuming DoubleClick’s divestitures in 2005 were roughly equivalent to the percentage of revenue (~ $150 million) and since then DoubleClick managed to maintain growth relative to the industry, we would estimate revenues to be roughly at the US$270 million mark. Further, given private equity companies’ propensity to manage cash effectively, we would estimate that operating margins are at least on par with, but more likely above, those of aQuantive and ValueClick.

Whether or not you agree with the purchase price, DoubleClick fills an important strategic hole for Google, moving the company into a position to capitalize on two large ad segments. According to eMarketer, the display ad market generated US$3.4 billion and the rich media/video market generated another US$1.5 billion in 2006. Both of the markets represent tremendous growth and upside for Google.

2006 Online Ad Market by Format

As everyone is acutely aware, Google dominates paid search share, but there are a few important factors in the search market to keep in mind. First, growth in the U.S. search market is clearly slowing. As George Reyes, CFO of Google, eloquently stated sometime ago, the “the law of large numbers” is taking effect. Second, we have continued to state the position that Yahoo!’s much maligned Panama initiative will be extremely effective, and we will begin to see the financial implications of the change by the end of Q4 2007 or the end of Q1, 2008 at the latest.

A resurgent Yahoo! in the search market with its impressive array of strong content verticals that include Finance, Autos, Personals, Real Estate, Shopping and Sports to name a few would be a worrisome competitor.

Positive ad metrics and momentum in the paid search market combined with Yahoo!’s audience means the company is capable of making deeper inroads into the wallets of larger advertisers. Many of these advertisers are the ones that push new formats like video advertising. The latter is critical for the other large Google acquisition, YouTube.

A solution that allows advertisers to easily place ad spend across multiple formats is becoming a strategic imperative. Yahoo!’s newspaper consortium project aims to do just that. The project will share advertising and editorial content across a network of 250 newspapers and this is just the beginning. More newspapers will come to the table.

Many of the top advertisers below would like to easily buy a geotargeted display ad solution across all local markets and content verticals. Google’s Finance initiative could not make a dent in Yahoo!’s vertical position, and buying into the display market was clearly the fastest and most prudent countervailing strategy.

Top Advertisers (millions)

Source: eMarketer (2006)

Conclusion

This deal making leads us back to Microsoft and AOL. While DoubleClick would have been a nice asset for Microsoft, AOL looks more important than ever. Google owns 5 percent of AOL and DoubleClick is one of AOL’s largest partners.

We have recently learned from credible sources that AOL is pushing hard against its quarterly advertising goals in an effort to make the company more attractive to potential buyers. Time will tell if this is more fact than supposition.

With all the deals lately, our opinion is that Microsoft is going to take a hard look at exactly what strings are attached to the AOL-Google investment and the AOL-DoubleClick deal. We believe Microsoft will look at getting Google/DoubleClick out of the AOL camp and into a friendlier orbit.