Startup Review

Marchex Case Study: Execution rather than innovation

written by Nisan Gabbay, posted on January 8th, 2007

Why profiled on Startup Review

Marchex is an online marketing services firm, offering merchant advertisers a mix of performance-based advertising and search-oriented services. Marchex has emerged as a leader in the direct navigation market with its purchase of Name Development Ltd. in February 2005 for $164M. Marchex was founded about four years ago and went public shortly thereafter. Marchex has a market cap of $490M on trailing twelve month financials of $125M in revenue and $39M in EBITDA.

Interviews conducted: Two early employees who preferred not to be disclosed.

Key success factors

Previously successful management enabled access to inexpensive capital

Marchex was founded in January 2003 by Russ Horowitz and four other executives from Go2Net. Go2Net was founded by Russ Horowitz in 1996 and ultimately sold to Infospace in a deal valued at $1.5B in October 2000. Before Go2Net, Russ was twice previously a successful entrepreneur, founding a sports apparel company and a merchant bank. Once Russ and team had left Infospace, they had no problem raising capital based on their previous track record. Marchex raised $20M from its founders and individual investors to acquire two companies that would form the basis for Marchex. Just 15 months after founding, Marchex held an IPO that raised an additional $27M. Marchex had one of the most successful IPOs of 2004, trading up 37% on its first day. Marchex achieved this despite only having ~$20M in revenue and ~$2M in operating profit from its initial two acquisitions.

Maybe the investment bank underwriting the IPO played a key role? Probably not. Marchex used National Securities Corp, who hadn’t underwritten an IPO in 6 years. Marchex’s success in raising capital can be attributed to Horowitz’s previous track record and the competency of the management team. Even more impressive is the fact that the founders accomplished all this and still controlled more than 70% of the equity post-IPO! Marchex’s financing strategy is worthy of a case study on its own. Unfortunately, most entrepreneurs aren’t usually in the same type of position to raise capital so easily.

Strategy focused on acquiring and improving undervalued assets

Marchex was not about product innovation at its start – it was about identifying underperforming assets and acquiring them on the cheap. They looked at acquiring the number 3, 4, or 5 companies in a market as opposed to paying a premium for the top two assets. Interesting to me is that this goes counter to the well-known GE motto of “get out of a market where you are not number 1 or 2”. Perhaps this motto doesn’t apply on the Internet? If Jack Welch is reading this blog, please leave a comment below. Marchex was about financial engineering – acquire good, but not great performing assets on the cheap. Marchex has made 8 acquisitions in its brief history.

Once the assets were acquired, Marchex brought the necessary investment capital and management oversight to improve performance. The team’s experience with Go2Net and Infospace gave them plenty of knowledge and relationships in the search market. As a smaller player, they could move more quickly to exploit emerging markets like local search and direct navigation.

Launch strategy

As mentioned above, Marchex was launched and built through a series of acquisitions, using them as beachheads into emerging markets. Marchex started in search marketing, but quickly expanded into local search and direct navigation. These two markets were underserved, and perhaps undervalued, by Marchex’s larger competitors. Marchex used a simple strategy of building a portfolio of proprietary traffic sources and acquiring unique technology platforms.

Marchex was launched via the acquisition of Enhance Interactive (formerly ah-ha.com) in March 2003. Ah-ha.com was a Provo, Utah-based, profitable company employing 50 people at time of acquisition. Ah-ha specialized in managing paid search placement for clients, listing client web sites in search engines for a fee.

Exit analysis

Marchex raised $20M of private funding in February and May 2003, with $7M of that contributed by the founding executives themselves. Prior to the IPO in March 2004, the 10 founding executive officers owned 77.5% of Marchex. Thus the $13M raised from outside investors was done at a post-money valuation of $100M. Marchex completed its IPO just one year after its acquisition of ah-ha.com and only 15 months after founding. Marchex raised $27M in its first offering and became the best performing IPO of 2004. The company did this on just $12M of trailing revenue over the nine months from inception to IPO filing, all of which came from the ah-ha.com acquisition. Today, Marchex trades at a market cap of ~$500M. Thus the initial investors have made an ~5X return on their holdings in four years.

Food for thought

When most of us think about Internet start-ups and entrepreneurship, we generally think about product innovation. But the Marchex story is not one of product innovation; it was about management execution and financial engineering. Marchex manufactured a company from undervalued assets, a relatively simple strategy, and great execution.

Coming up with the next great idea has sex appeal, but Marchex proves that you don’t need to invent the next great product or service to be successful. There are plenty of opportunities out there to play a mini-LBO type of role as an entrepreneur. This strategy requires access to capital however, and not all of us have the background and connections of a Russ Horowitz. Nonetheless, there are plenty of smaller scale entrepreneurial opportunities out there to turn around an underperforming asset.

Reference articles and additional reading

Marchex Company Profile on Reference for Business website
Great chronicle history of the company

“Marchex makes money as Internet middleman,” Puget Sound Business Journal (Seattle), May 2006
Article has a nice description of Marchex’s three main sources of revenue.

“Internet start-up plans first local IPO in years,” SeattlePI.com, December 2003
Article describes the Marchex IPO process in nice detail.

“The Marchex Story: Why They Spent $164 Million on Domains and What They Have Planned For Their Eye-Popping Portfolio”, DN Journal, September 2006
In-depth article on Marchex’s direct navigation strategy.

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