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Adtech and martech deals

Why the recent M&A explosion is not a bubble (and why it might not matter even if it were)

According to the recently published figures of corporate finance boutique Ciesco, Adtech and martech M&A activity continues to rise at a staggering pace. The first quarter of 2015 saw the completion of 280 deals across the globe, worth $8.4 billion in total. If 2014 was the year of consolidation (and it was, with acquisitions in the sector up nearly 25% compared to 2013) then 2015 looks to continue the trend. At the time of writing, Twitter appears poised to acquire digital ad platform TellApart for around $530 million, putting it in the same bracket as some of the largest ad platform deals in recent years, such as the $405 million paid for Adap.tv by AOL, the c. $500 million spent by Facebook for LiveRail and the $640 million it took for Yahoo! to acquire BrightRoll.  

Whilst not quite in the same territory as some recent valuations of tech companies such as Snapchat ($15 billion) or Pinterest ($11 billion), and despite being able to back up the valuations with actual (growing) revenues, some commentators have been quick to call the adtech and martech M&A market a bubble: one which is on the verge of popping, or – depending on what publication you read - one which has already burst.

But is that really the case? And how can we tell the difference between a bubble and a growing sector?

What makes a bubble? 

To find an answer, let’s start with tulips.

"Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

             Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds (1841)

By the early 17th Century, Holland was entering a Golden Age. Spanish power over the Dutch provinces was waning, and the amount of resources she had needed over the preceding sixty years to wage all-out war with Spain had dropped dramatically, allowing for explosive economic expansion. Since the late 1580s, trade capital had poured into Amsterdam, often invested into high-risk ventures attempting to claim a slice of the lucrative spice trade of the East Indies. The profits of these voyages – some yielding around 400% return – were ploughed back into financing new trade and an era of “merchant capitalism” began.

In 1593, Charles de l’Écluse (Carolus Clusius) was appointed a professor of the University of Leiden and began creating what would become one of the oldest botanical gardens in the world, the Hortus Botanicus. After a lifetime as a scholar of flora from European countries, Clusius was fascinated by the new breeds of plant arriving daily on merchant ships and made sure that tulips, fresh from the Ottoman Empire, were added to the University’s extensive collection. Clusius had studied tulips in some depth, being one of the first people to record his observations on the “breaking” of tulip blooms – the process by which the petals “break” colour, resulting in dramatic streaks or flames of different colours across their surfaces.  

We now know that what Clusius was describing were the symptoms of a plant virus which weakens the bulb, affecting the ability of the plant to flower through generations and ultimately ending the genetic line.  Tulip bulbs can take between seven and twelve years to bloom, and while bulbs can produce two or three “offsets” annually, the mother bulb lasts only a few years.  With a “broken” infected tulip, the entire variety (with its particular unique patterning) could be wiped out after a single flowering. 

Tulips were already highly-prized amongst wealthy Hollaenders as a status symbol, their intense colours more concentrated than most of the other flowers known to 17th Century horticulturists. “Broken” tulips – the rarest of these rare beauties - became even more in demand, but although the supply of buyers was high, the supply of bulbs was not. Unsurprisingly, prices for these varieties soared (with the Hortus Botanicus losing hundreds of its bulbs in a series of break-ins by enterprising florists). At that point, the traders who had cut their teeth at the newly-founded Amsterdam Stock Exchange and the Wisselbank, began to take note.      

As tulips bloom for about one week a year, between April and May, with bulbs appearing between June and September, the window for sales was fairly short. In order to trade in bulbs all year round, a rudimentary derivatives market, similar to modern-day futures contracts, arose in which speculators would agree to purchase bulbs once they appeared for a price set at the time of the contract. 

Tulip bulb prices rose steadily and dramatically throughout the 1630s as more and more people looked to acquire contracts, and then “flip” them for a profit. Farmers, weavers, chimney-sweeps and clothes-women traded all of their belongings for bulbs so they could cultivate the flowers and sell them for more profit than they could ever otherwise have made in a lifetime. Ordinary bulbs began trading for extraordinary amounts, and the rarest of tulips sold for astronomical sums, as prices increased twentyfold in a single month. Charles Mackay’s account of this “tulipomania” records the sale of a single root of Semper Augustus (a “broken” variety) for 12 acres of land, and a second for 4,600 florins (around £30,000 today), a new carriage, two grey horses and a complete suit of harness.    

What makes a bubble burst?

Inevitably, the mania ran its course. In February 1637, a Haarlem buyer defaulted on his contract and speculators, worried that others may default in turn, flooded the market looking to sell. Within a few days, bulbs were worth only a hundredth of their former prices and, with all confidence lost, the market plunged.

The true severity of the damage to the Dutch economy is difficult to assess. Mackay is in no doubt that it was disastrous (“the commerce of the country suffered a severe shock, from which it was many years ‘ere it recovered”) but his research was second-hand and based on the writings of those generally opposed to speculation. Some modern historians believe the effects were isolated and that the parties to tulip deals could afford to agree extraordinary high prices, safe in the knowledge that in practice the debt would never be called.  Agreements to trade tulips were futures contracts, so little or no money changed hands at the time deals were struck and, with the plague sweeping Haarlem at the time, there was a good chance the counterparty to the deal would be dead before the payment terms were enforced. 

There is even a (good) line of argument to suggest that because of a change in the market rules first proposed in late 1636, this wasn’t a bubble after all, but merely savvy investors responding in an efficient-market fashion. Under the new deal, if investors paid a fee of 3% of the contract value, they wouldn’t have to pay their agreed contract price in Spring unless the market value of the bulbs was higher than the agreed price – effectively turning the tulip futures contracts into tulip options.       

What we can be sure of, though, was the effect of “tulipomania” on the appetite of the populous for investment risk. Anti-speculative pamphlets, vituperative in nature, flooded the market-places of Amsterdam in the months that followed the crash, castigating the investors as fuelling what Simon Schama in The Embarrassment of Riches, called a "contagion of pandemia: the gullible masses driven to folly and ruin by their thirst for unearned gain."    

What REALLY makes a bubble?

“Those who cannot remember the past are condemned to repeat it.”

                     George Santayana, Reason in Common Sense (1905)

Bubbles tend to be created where there is an error in forecast modelling. These errors may be due to the fraudulent operator of the venture hiding its true nature from investors (the typical Ponzi scheme), over-reliance on an algorithm which fails to model extreme outcomes or foresee changing rates in mortgage defaults (for example), or simply due to the human tendency to misunderstand randomness. Whatever the cause, what follows is the same: the forecasts are exaggerated to the point of over-confidence which results in a surge of enthusiasm for a particular type of asset amongst a majority of participants in the market. Once the observed data becomes so overwhelming as to call into question the excessively optimistic forecasts, the bubble bursts and the forecasts are reset at an overly-cautious level.    

The same pattern emerges in every crash, bubble or market craze since the height of “tulipomania” – from the UK’s South Sea Bubble, to France’s Mississippi Bubble, via the stock market crashes of 1929 and 1987, the Dot-com Bubble of the late 1990s and the Sub-Prime Mortgage Housing Bubble (which burst spectacularly in 2007), all the way to the recent dips in commodities valuations. The outcome never changes, just the scale: investors lose money, stock valuations plummet, or world-wide recession hits.

So, bubbles can produce disastrous results; but does that mean all market bubbles are bad?

Re-appraising the adtech and martech figures: in praise of “irrational exuberance”

The M&A market in the adtech and martech sectors tends to generate smaller versions of market bubbles all the time: global giants such as WPP, Dentsu, Omnicom, Facebook, Google and Twitter look to acquire businesses with disruptive technology, because it is usually quicker to bring new ideas to market by acquisition than it is by building it through internal R&D processes. This prompts a rush for competitors to acquire similar functionality, creating a mini-bubble of activity in which valuations of target businesses can grow dramatically. 

With the proliferation of smartphones and tablets, global mobile ad spend (to pick an example) is growing dramatically and, accordingly to MagnaGlobal, the strategic global media unit of IPG, is set to reach $73 billion by 2018. Unsurprisingly, M&A within this sub-sector has been rife through the last year, with WPP acquiring Double Encore, Yahoo! buying Flurry and Publicis plumping for Hawkeye. Sometimes these adtech and martech acquisitions are very successful, but sometimes the acquirer faces having to write off much, if not all, of the acquisition cost and effectively admit the valuation was much too high. Whilst, at the time of writing, Microsoft is currently dismissing rumours of an imminent takeover of Salesforce.com (valuation: $49 billion), it wasn’t too long ago that it was announcing a $6.2 billion write-down to account for its disappointing acquisition of aQuantive in 2007.             

Clearly, such bubbles can be bad for acquirers who have made a poor deal, but – perhaps paradoxically – they actually encourage innovation. A buoyant M&A market will encourage adtech and martech entrepreneurs to make their businesses attractive to buyers. Cash-rich, experienced acquirers taking calculated risks on the ability of target companies to produce synergistic growth throughout the acquirer group is a sign of a very healthy sector. The main difference between this type of speculation and that leading the craze of “tulipomania” is that the participants in these risky adtech and martech deals can afford to lose. Microsoft’s share price barely moved following the aQuantive announcement. Market bubbles seem to only cause mayhem when the market is flooded with inexperienced traders; they differ, then, from healthy markets only by degree.    

Sure, in adtech and martech, just like anywhere else, there will be winners and losers; but the addressable market is huge. According to a recent report by eMarketer, spending on digital ads is estimated to reach $171 billion by the end of 2016. This means that even though eMarketer estimates that Google and Facebook will swallow up over 40% of the spend between them, this still leaves a healthy $100 billion for everyone else.  There is also diversity in the market.  It’s not just the usual suspects who are buying up the newcomers – Keda Group, a conglomerate based in China which historically has concentrated on financial services and real estate, has acquired five companies in the martech space since January 2015, putting it ahead of Omnicom and Havas in the list of most-active acquirers in the sector this year.

Even if this were a bubble, that might not spell disaster: the most spectacular market crashes can – when viewed at a historical distance – be seen to add to the health of the sector. Take the Dot-com Bubble, for instance, in which internet-related stocks listed on the Nasdaq Composite Index hit an intra-day peak of 5,132.52 on 10 March 2000 but by 4 April 2000 had fallen to 3,649. Pets.com raised $82.5 million in an IPO in February 2000 but had collapsed before the year was out. The resulting crash wiped $5 trillion from the market value of companies from March 2000 to October 2002.

Yet those who invested early but sold out early made great returns. Research shows that most fund managers who avoided Internet stocks in the 1990s under performed.     

Indeed, the greatest legacy of the Dot-com Bubble was the infrastructure it left behind when the bubble burst. You can sneer at the speculative excesses that it created (although reports of Razorfish’s “legendary” $10,000 May Day 1997 party are almost all apocryphal), but you can’t sneer at all the innovation that it ultimately helped to produce: email, cheap data storage, search, near-universal broadband, global distribution networks.

Fred Wilson, a venture capitalist who backed many online businesses (both successful ones and failures) during the bubble, said: “A friend of mine has a great line. He says: ‘nothing important has ever been built without irrational exuberance’. Meaning that you need some of this mania to cause investors to open up their pocketbooks and finance the building of the railroads or the automobile or aerospace industry or whatever. And in this case, much of the capital invested was lost, but also much of it was invested in a very high throughput backbone for the Internet, and lots of software that works, and databases and server structure. All that stuff has allowed what we have today, which has changed all our lives…that's what all this speculative mania built.”

The Internet crash left us with Web 2.0: Facebook, Amazon and Twitter. Each of these businesses was established or gained critical mass after the Dot-com Bubble burst. Each was effectively able to dramatically up-scale its operations almost overnight thanks to cheap excess capacity and infrastructure built during the bubble’s height. This has allowed ideas which were stillborn during the boom to thrive after the bust: boo.com (with its 3D virtual fitting room) spent $188 million in just six months and went bankrupt in May 2000; in the last few years retailers Superdry, LK Bennett, Adidas, Hugo Boss and Nicole Farhi have all launched online virtual changing rooms supplied by Fits.me.

We may even be condemned to live through cycles of adtech and martech market bubbles (just as we are with the general technology market). Research developments in neuroscience and behavioural psychology have revealed that Mackay’s “madness of crowds” may well be an inevitable product of our brain chemistry. But even some of the worst bubble excesses are not without a silver lining. The Amsterdam Stock Exchange wasn’t torn down in 1638 and neither was the internet unplugged and switched off in 2002. What is left behind after a bubble has burst may enable the remaining or subsequent participants to blossom. It may actually be that innovation needs “irrational exuberance” to fuel it; a community of settlers thriving due to the deaths of pioneers. As Daniel Gross, the author of Pop! Why Bubbles are Great for the Economy says: “without the disasters of Global Crossing and Worldcom, would we still have Google?”.

For more information, contact Andy Moseby, corporate partner.

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About Kemp Little’s corporate team 

Kemp Little is a specialist technology and digital media law firm. The Kemp Little Corporate team has an enviable pedigree advising adtech and martech companies on exits.  

Since 2012, we have advised on many high-profile deals in the sector, including:

  • AKQA - the UK aspects of the sale of AKQA (one of the largest independent digital agencies at the time) to WPP​
  • Upcast Social – the sale of Upcast Social to MediaMath
  • Fortune Cookie - sale of a majority interest in Fortune Cookie to Possible Worldwide, a WPP owned agency
  • Portland PR - representing the PR agency Portland PR and its majority shareholders on the sale of approximately 80% of Portland PR to Omnicom
  • pH Associates – the sale of pH Associates to Chime Communications
  • I Spy Marketing - sale of I Spy Marketing to Aegis, to become part of iProspect (the global performance marketing agency)
  • Imano plc - the sale of Imano to Ness Technologies Inc, a global IT services provider 
  • Blue Barracuda – sale of Blue Barracuda to Interpublic Group of Companies

and have been named as:

  • Best in Tech & Digital Media Law 2015 (UK) - the Acquisition International M&A Award
  • The Corporate INTL Digital Media Law Firm of the Year
  • The Acquisition International UK Digital Media Law Firm of the Year
  • The Finance Monthly Information Technology Law Firm of the Year
  • ICFM Leading Lawyers 500
  • Managing Intellectual Property Magazine IP Stars (Ranked Firm)
  • The FT Innovative Lawyers – Highly Commended in the Legal Pioneer Award 
  • Top ranked firm in both Chambers & Partners and Legal 500.

Andy Moseby, corporate partner, continues to represent the firm on the executive committee of the British Interactive Media Association (BIMA). BIMA is committed to supporting and promoting the British digital industry, as well as providing a forum to share knowledge and best practice within the sector.