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

SanDisk amps up its music player offerings

With its $6.5m tuck-in acquisition of MusicGremlin last week, SanDisk is bulking up its digital music player business. MusicGremlin, with just eight employees and about $5m in revenue, will obviously not have a material effect on SanDisk’s business. Nonetheless, the importance is not so much the size or scope of the company, but more the technology it has developed during its four years in operation. Specifically, MusicGremlin gives SanDisk the ability to effectively stream music wirelessly to its products. We have learned that SanDisk was very eager to acquire the startup, with the large company initiating talks and sealing a deal within a few weeks. Given SanDisk’s recent effort to build its product offerings through strategic acquisitions, what other acquisitions might the company be considering?

From our perspective, SanDisk needs to do some shopping. It currently ranks a distant second place to Apple in the digital music player market, but also faces stiff competition from the likes of Microsoft, Sony and Panasonic. Perhaps the biggest hole in SanDisk’s offerings is the lack of an in-house music and video content provider, like Apple has with its iTunes and Microsoft has with its Zune Marketplace. To date, SanDisk has relied exclusively on partnerships, but learned the downside of that strategy the hard way in February, when Yahoo suddenly shuttered its Music Unlimited service. The disappearance of the service, which was the very foundation of SanDisk’s Sansa Connect player, left users understandably sour.

As to where SanDisk might look for a music service, two names come to mind: Rhapsody (owned by RealNetworks) and Napster. Despite taking in about $150m and $130m last year, respectively, both are consistently running at a loss. Clearly they could be had for a steal. More importantly, they are both proven and established music services with mobile offerings that would make integrating MusicGremlin’s technology an easy task. Using Napster as a comparable, we believe either company can be had for just under $100m, representing a 40% premium over Napster’s current price on Nasdaq. With $1.22bn in cash and a market cap of $5.2bn, SanDisk could certainly afford a few deals to shore up its defenses for the inevitable battle of the titans.