Category: digital entertainment

Online video: boom and bust

-Contact Thomas Rasmussen

The over-hyped world of online video is going through massive turmoil at the moment. While most investors and companies agree that online video is likely the future of broadcasting, no one has been able to make any money from it so far. And it’s likely to get even harder due to tighter venture funding, the closed IPO window and next-generation Web 2.0 entrants such as Hulu and even Apple’s iTunes. These factors have left the online video players scrambling toward any exit, no matter how cheap.

Consider the case of CinemaNow, which was picked up by Sonic Solutions for a mere $3m last month. The portal never managed to turn a profit and had estimated revenue of less than $4m. Yet it secured five rounds of funding (totaling more than $40m) and brokered partnerships with major studios, VCs and strategic investors. When CinemaNow went to investors begging for another round a few months ago, it found that there was no money to be had and a quick exit became the only alternative. That’s a common occurrence these days, and may well have driven rival MovieLink to sell for a paltry $6.6m to Blockbuster last year. (Expect more of these types of deals next year. According to corporate development executives who completed our annual M&A outlook survey, lack of access to VC will be the major catalyst for deal flow in 2009.)

If this sounds eerily familiar, it’s because a similar situation played out during the music industry’s awkward and reluctant switch to digital a few years ago. Several startups, even major ones backed by large studios, tried to become the distributor of choice. Yet, many of those went away in scrap sales or had the plug pulled on them (Viacom’s Urge, Napster and Yahoo’s music service, to name just a few high-profile failures). We’re now left with just a handful of dominant distributors: iTunes, RealNetworks’ Rhapsody, Amazon and, to an increasing extent, MySpace’s heavily funded music effort. Many of these companies are likely to also dominate online video. In fact, add in Google and Microsoft, and you have a list of the companies that are likely to be buyers for the few remaining online video startups.

Recent online video M&A

Year Number of deals
2008 12
2007 10
2006 5

Source: The 451 M&A KnowledgeBase

Not ‘Finnish’ with M&A

Finnish cell phone giant Nokia launched its mobile file-sharing Ovi application last week, coming quickly on the heels of the rollout of Nokia Music and other high-profile offerings. Much like Google and its Android and Chrome products, Nokia used technology that it acquired to form the core of its recently launched products. Specifically, its file-sharing technology came when it picked up Avvenu late last year.

And more M&A may be in the cards. Nokia recently told us that it is bullish on making further acquisitions to boost its service offerings. The company is aiming to evolve from strictly a mobile handset maker to a service-oriented handset maker – and strategic acquisitions are expected to play a big role in this transformation. (Of course, Nokia isn’t the only hardware company looking to do deals to get out of its core commodity market and into a more profitable – and defensible – service offering. PC maker Dell has spent some $2bn over the past two years increasing its service portfolio, buying companies offering everything from storage to email archiving to remote services.) What services could Nokia look to add and what companies might it acquire to do so?

With its music, games and mapping services well established, Nokia’s lack of a video service is strikingly curious. We suspect the company will quickly move to fill this gap. Two potential targets come to mind. Startups kyte and Qik both specialize in mobile video, and have already gotten a lot of interest from big mobile companies. In fact, kyte has drawn money not only from large telcos such as TeliaSonera, but also from Nokia’s own investment arm, Nokia Growth. Another venture that was recently brought to our attention is a startup called ZoneTag. It’s a Yahoo Labs startup that does location-based photo tagging. The software was developed for Nokia phones with the support of Nokia research and we hear the two divisions have a very good relationship.

Nokia’s recent mobile software acquisitions

Date Target Deal value
June 24, 2008 Symbian $410.8m
June 23, 2008 Plazes $30m*
January 28, 2008 Trolltech $153.5m
December 4, 2007 Avvenu Not disclosed
October 1, 2007 Navteq $8.1bn

Source: The 451 M&A KnowledgeBase *Official 451 Group estimate

BestBuy music goes digital

Just a few days after we speculated on a Napster sale, BestBuy said it will pay $121m, or $2.65 a share, for the digital music service. This is an 80% premium from where the company was trading before the offer. After factoring in Napster’s cash and short-term investments, BestBuy paid just $54m, or 0.45 times Napster’s trailing twelve month revenue. A bargain by all means, but it remains to be seen whether BestBuy can do what Napster has failed to do for the past four years: Turn a profit.

Napster sings the blues

Napster, once hailed as the king of digital music, has fallen on hard times. Its stock is down 35% this year alone, and 55% from its 52-week high set in October 2007. Resulting shareholder ire forced the company to announce last week that it is seeking strategic alternatives to boost value, and it has hired UBS Investment Bank to lead the effort. Who might acquire the house that Shawn Fanning built?

Since relaunching as a legal music service in late 2003, Napster has been unable to turn a profit. The company pulled in $125m in revenue for the trailing 12 months ended June 30 from about 708,000 paid subscribers. Despite increasing revenue 15% year-over-year, the company had a negative EBITDA of $12.3m and subscriber count decreased from last quarter’s total of 761,000. The switch from stagnation to a drop in subscribers for the first time means that Napster will be unable to keep growing revenue. Consequently, that makes it doubtful that it will be able to achieve profitability. Nevertheless, with $36.9m in cash and $30.7m in short-term investments, Napster is an attractive target at its current valuation of $62.25m.

We previously speculated that SanDisk would attempt to acquire a proprietary music service of its own. But given its financial woes, as well as reported takeover negotiations with Samsung, we do not think it will bite. We believe Napster’s fierce competitor RealNetworks, the majority owner of the Rhapsody music service, is the most likely acquirer. Amid growing competition from Apple, which unveiled its iTunes 8 and a new line of iPods this week, and with digital music newcomers Amazon, Nokia and a few promising startups making waves, this is a much more plausible proposition. Last year Rhapsody picked up Viacom’s Urge, which had been struggling despite its high-profile association with MTV and Microsoft. RealNetworks has the cash, and has repeatedly told us it is bullish on acquisitions that spur growth. Given Napster’s current valuation and similar deals, we estimate that it will fetch around $80-100m in a sale.