Startup Review

Advertising.com Case Study

written by Nisan Gabbay, posted on August 7th, 2006

Why profiled on Startup-Review.com

Advertising.com was acquired by Time Warner AOL in June 2004 for $435 million, making it one of the most successful exits in the online advertising market. Prior to being acquired by AOL, Ad.com had filed to go public with 2003 revenue of $123M and $12M of operating income. Ad.com posted $46M of revenue in Q1 2004, making its yearly revenue run rate ~$250M. Founded in 1998, Ad.com’s revenue growth rate was impressive: 2001 $38M, 2002 $74M, 2003 $123M, 2004 >=$250M. Perhaps even more impressive was the competitive environment in which Ad.com achieved these results. There were the larger, established incumbents like DoubleClick, as well as a plethora of smaller ad networks which never came close to the scale that Ad.com achieved.

Key Contributor: Mike Woosley, ex-CFO Ad.com 1999-2004

Key success factors

Emphasis on ad targeting technology from the start

Ad.com built the most advanced ad targeting platform in the industry, perfecting its targeting algorithms well before the rest of the industry recognized the value of some of the techniques it employed (combination of behavioral and contextual). Ad.com placed significant effort in its optimization technology, enlisting the help of well-known academics.

Enabled effective, performance-based ad campaigns for advertisers

Ad.com was one of the first to offer highly targeted price per action campaigns, whether in the form of cost per lead, cost per click, or cost per action. The back-end ad targeting technology enabled Ad.com to buy inventory from website publishers on a CPM basis and monetize them on a more lucrative CPA basis.

Offering effective performance-based campaigns was essential to attracting direct marketers, the only advertisers whose spending continued to grow through the downturn. Ad.com made it easy for direct marketers to track the effectiveness of their campaigns. The background of the Ad.com team was an important factor here, as they had previously made heavy use of performance based marketing analytics at companies like P&G and Capital One.

Stayed true to ad network business model

During the downturn, many companies (most notably Double Click) shied away from the ad network business model, choosing instead to license their ad serving technology directly to web publishers. The pure ad serving industry has trended towards a commodity business with prices falling from $0.25 per thousand impressions served down to below $0.04. Ad.com did not license its technology to others, enabling it to build the largest third party ad network on the internet, reaching 110M UVs per month, or 70% of the total US online audience (note: these numbers are already out of date, but the scale is what is important to note). Having this reach was one of the significant factors in attracting both advertisers and potential acquirers.

Management discipline on operational metrics

Ad networks, perhaps more than other online businesses, are very much execution-oriented businesses. The management team ran disciplined, analytics driven daily meetings to ensure that top campaigns were performing up to expectations and that Ad.com was capturing as much of an advertiser’s campaign budget as possible.

Well-run back office critical to deal closing

In getting the company sold, having an entity with public company standards for back office systems, system integration, financial controls, audit, and legal made an enormous difference. Ad.com was too large to attract a slew of bidders - there were a handful of logical buyers. For Time Warner / AOL, this was the first large acquisition made since the abrupt write-down of the AOL-Time Warner marriage, and it was being made by the AOL division which - in the shadow of Enron and MCI scandals - was just emerging from its own set of SEC investigations and accounting problems. Ad.com was descended upon by a team of at least 50 lawyers, accountants and consultants looking for a reason not to do the deal. The lesson learned: if you want to maximize the probability for a smooth exit in an acquisition, act like a (well-managed) public company at all times in terms of control and formality, whatever your size or state of growth. Be easy to buy.

Launch strategy

Ad networks have a chicken-and-egg problem when they get started, as without web publisher inventory they cannot sell to advertisers, and without advertisers it is difficult to attract publishers. Ad.com did a good job of initially focusing on some of the smaller publishers, and securing inventory on their sites, rather than going after the Yahoo/AOL/MSN type of publishers. When Ad.com was able to prove successful campaigns using somewhat second tier ad inventory, it became easier to attract the larger publishers who were surprised that Ad.com was able to effectively monetize previously thought of junk inventory. With the larger publishers as part of the Ad.com network, it then became easier for Ad.com to attract the marquee advertisers.

Exit analysis

Ad.com produced a successful return for both its founders and investors. According to the SEC filings, the Ferber brothers owned close to 40% of the company at the time of sale. The price paid for Ad.com was a healthy premium to the EBIT multiples of most online ad network businesses at the time. Taking the Q1 2004 financials of $5.6M in net income ($22M annualized) would be a 19X trailing EBIT multiple. I have not gotten a perspective on how Ad.com has performed within AOL since the acquisition, but given the heightened interest in the online ad market through 2006, it is likely that Ad.com’s value would have continued to grow above the $435M acquisition price from 2004 (Note: closer to $500M was distributed to shareholders due to cash on the balance sheet).

Food for thought

My biggest takeaway from writing this case study was that premium exits in the ad network business are hard to come by without a substantial technology asset. Advertising.com was a successful example mainly because of their technology asset. There doesn’t seem to be much loyalty for web publishers to an ad network, so it all comes down to who can make the publisher more money.

This is not to say that an ad network is a bad business for entrepreneurs. There are plenty of ad networks out there in the sub $50M run rate range that are quite profitable and generating good cash flow. However, the trick to achieving a premium exit multiple will be solid technology that addresses a sizeable market. That will be the difference between a 5X EBITDA multiple and a 15-20X EBITDA multiple exit valuation.

Entrepreneurs should think about what drives valuation multiples within the industry that they are targeting and what asset the most likely acquirers will value in an M&A scenario. While the focus should always be on creating a fundamentally sound business, understanding exit scenarios will help in guiding equity and private financing decisions and thus should not be ignored.

Reference Articles

I did not find many high quality articles written about this transaction, instead relying on the perspectives provided to me through interviews. One obvious resource is the SEC filings. A great resource for understanding the ad network business is provided by iMediaConnection here.

This seems to be the standard story written about the transaction. The following article has a good discussion on some of the questions surrounding Ad.com’s behavioral targeting technology.

If anyone has some other links with more insight to the Ad.com / AOL transaction, please leave a comment below. I would also love to hear thoughts from people in the ad network business.

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