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The Lion's Den Vol. 6 - Tech's "Step Children", Unite!
Why thoughtful consolidation in AdTech and gaming, two troubled sectors, is the key for value creation
Tech companies are not all created equal. Some businesses, particularly enterprise software companies, have been overhyped by investors, leading even mediocre companies to raise a lot of money at high valuations. Other businesses, like gaming and AdTech, have been a bit of an ugly duckling in the markets, often trading well below their software peers. On the surface, this valuation gap shouldn’t exist - gaming and AdTech companies are software-based, can grow fast and some even showcase better profitability and unit economics than SaaS companies. However, fundamental business model challenges and epic failures have caused investors to look away.
In this post I’ll walk through why AdTech and gaming companies scare off so many investors, why strategic consolidation in both spaces is needed and which potential combos could be game-changing. Let’s go!
Why Do Investors HATE AdTech and Gaming?
The conflation of these industries is not accidental. These companies face similar fundamental challenges that, when combined, create a lethal combo:
To make this a “double whammy”, consider the fact that companies in these sectors are also interdependent. ~47% of mobile gaming revenues (largest gaming platform by far) stem from…that’s right, digital advertising.
As a result, in the past ~10 years, investing around both sectors has been binary - investors cherry-picked very few scaled winners (e.g. EA, ATVI in gaming; TTD in AdTech) and rewarded them with high multiples while overlooking the rest of the field. Something clearly has to change in order to attract investors more broadly.
Unite the Clans! Making a Case For 1+1=3
Consolidation could be the winning formula, potentially even between AdTech and gaming companies directly. But it has to make strategic sense vs. financial amalgamation of unrelated assets (e.g. Verizon’s ad tech “strategy”). Good combos will create:
Revenue diversification: healthy mix of in-app and ad revenue from owned apps, ad take-rate from 3rd party apps, and subscription revenue from software tools (e.g. attribution, verification).
One-stop-shop for advertisers and app publishers: a suite of AdTech capabilities (creative, mediation, user acquisition, analytics, etc.) could be powerful for the ecosystem and render many point solutions obsolete.
Meaningful cost and revenue synergies: cost synergies around product development, integrations, sales force and physical space. Revenue synergies around cross-selling solutions and improved CPM/CPI as a result of more data.
This trend has been in motion for the past few years and will only intensify. In gaming, companies like EA (Glu), Activision (King), Take-Two (Zynga) and others have acquired to bolster their growth and strengthen their portfolio. In AdTech, M&A activity was always abound, but there were few large-scale consolidation attempts. ~5 years ago, the enterprise software giants seemed to be going in that direction when Salesforce, Oracle and Adobe acquired data management, campaign planning and execution tools, but those efforts were scaled back or shut down, partially due to regulatory concerns and partially due to prioritization of other initiatives.
The recent big merger in the space between ironSource and Unity is another indication that consolidation is upon us. Both companies are growing, successful and healthy, but they’re each heavily discounted in the market and together they can be so much more powerful and profitable. I predict we’ll see at least several more blockbuster deals in the next ~24 months combining digital advertising and content (gaming, media, etc.) companies.
What Could Big Consolidation Plays Look Like?
As a former banker, I couldn’t help but think through potential transactions that could (or should?) take place. To keep it brief, I won’t address the obvious feasibility, integration and cultural risks that exist in every M&A transaction (let’s stay positive :)). Also, while I personally know key people in some of these companies, these are strictly theoretical scenarios:
Buying a generation: Netflix + Roblox
Rationale: this deal would supplement Netflix’s slowing growth, help both companies engage with new demographic groups and add new monetization engines:
Growth: Netflix has been experiencing serious headwinds and lost ~1M subs in the last quarter. It is now a single-digit grower with minimal profitability (don’t be fooled by the operating profit, the biggest cash outlay is for content, which is only reflected in the cashflow statement). Netflix is now experimenting with initiatives it intentionally avoided in the past (e.g. ad-supported subscriptions, policing of subscription sharing), which implies growth prospects are not promising. Roblox, on the other hand, is a high-growth company that will generate ~$2.5B this year and is cashflow positive.
Audience: Netflix’s largest demographic group is 30-45 years old, whereas Roblox’s is users under 25, mostly 9-12 years old who spend A LOT of time in front of a screen and are a few years away from becoming highly valuable consumers. Capturing the attention of that generation is massively accretive. When Microsoft acquired Minecraft for $2.5B (I was on the team that advised Minecraft), it wasn’t about revenue or EBITDA. It was about accessing a generation of users and ushering them into the Microsoft ecosystem. In retrospect, it was one of Microsoft’s most successful acquisitions and this combination has similar potential.
Monetization: Netflix is already exploring gaming opportunities, but building that at scale will take time and is hard. A combination with Roblox would allow testing of new concepts on either company’s platform and broad distribution as a show, a game or even both simultaneously. Imagine, for example, Roblox incentivizing its developer community to build engaging games for Netflix hits, lengthening their relevance and monetization potential. Alternatively, Netflix could produce long- or short-form content based on Roblox’s hit titles, knowing there will be a large audience eager to consume that content.
Embracing a cookie-less future w/ 1st party data: Yahoo + Opera
Rationale: despite a slew of bad decisions, Yahoo is still one of the premier internet assets and under the new ownership of Apollo, Yahoo has the resources to go on offense. Combining with Opera would promote Yahoo’s sites and apps on a popular browser, allow the collection of 1st party data at scale and nurture high potential gaming opportunity:
Integrate Yahoo’s assets with Opera’s browser: Getting users’ attention is extremely difficult, which makes owning the browsing experience so valuable. It allows placing content (personalized feed, recommended sport/finance/weather reads and, of course, ads) in front of users before and during their sessions and guiding their “next click”. Yahoo has tried to align its search engine with Firefox in the past, but got displaced by Google (and ended up paying for it too…). Combining with Opera’s browser would place Yahoo’s sites and apps in front of >300M Opera’s MAUs and displace Opera’s default search engine, Google, which would be another nice little win. In addition, Yahoo will now own another attractive “personalized space” to market to advertisers through its DSP.
1st party data at scale: One of Yahoo’s biggest challenges going forward is the deprecation of cookies, which I wrote about in my previous post. While they’ll need to come up with alternative solutions across other browsers, owning the 6th most popular browser will provide deep insights and 1st party data about a large user base.
Nurture a growing gaming opportunity: Opera has a burgeoning gaming business with interesting potential. It is centered around OperaGX, a gaming-oriented browser that allows developers to set CPU/RAM limitations, optimize performance and integrate with Discord/Twitch. The browser is complemented by GameMaker, a software suite for developers to build games and GX.games, a marketplace for games on OperaGX. While still small, this business has 14M users and over 500k developers. This could be Yahoo’s foray into gaming and could be promoted across Yahoo’s assets to relevant users.
Uniting the content recommendation space: Taboola + Outbrain
Rationale: Honorable mention for the obvious merger that should’ve happened many years ago. And then happened. And then fell through for the last time (maybe not?). Taboola and Outbrain are two similar companies that monetize publishers’ properties through ads, promoted content and organic content. They each have treasure troves of data, long-lasting relationships with the world’s leading publishers and are both marginally profitable. However, they face all the AdTech challenges I mentioned before AND they compete fiercely, eroding each other’s margins. The cost synergies here are immense - duplicate sales forces, engineering teams, offices, systems, etc. More importantly, a combined entity could offer more “real estate” to draw advertisers, increase CPM rates and improve the rev. share agreement with publishers, all of which would translate to better growth and higher EBITDA margins. The market is clearly bearish on each company separately (both stocks are down ~70% in the past year) and with a challenging macro environment, I expect that to continue barring a meaningful event like a merger or sale.
Final thought: It’s hard to predict how the ecosystem will look like in ~10 years. I am convinced, however, that the large tech platforms will continue to corner the digital advertising and gaming markets and that without consolidation it will be difficult for a $50B+ platform to emerge and thrive. Consolidation is key and that notion should instruct investors when thinking about the type of founders, companies and cultural DNA that they should back in these sectors.
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