The acquisition of The Huffington Post by AOL has generated hundreds of expert views on the matter. Mergers and acquisitions (M&A) transactions, in general, show mixed results. Despite making sense on an Excel spreadsheet, many M&A transactions are plagued by problems: systems integration issues, differences in cultural communications, lack of post-merger direction, and a failure by management to articulate the benefits to the market cause the downfall of many transactions.
According to Thomson Reuters, the value of M&A transactions globally surpassed $2.4 trillion last year, an increase of 23 percent over 2009. Clearly business owners, managers and their financial advisors aren’t swayed by the risks.
So does this deal make sense? Answering that question is important for small business owners because:
1. M&A activity among small businesses is common. Analyzing prominent deals can provide valuable insight into determining whether or not a deal is sound.
2. Small businesses are often the target of acquisition by larger companies. Understanding the mindset of potential suitors can help you position your company for an eventual acquisition.
Framework for analysis
A good framework for analyzing an M&A transaction asks four questions:
1. Does it make sense strategically?
2. Does it make sense financially?
3. Does it make sense operationally?
4. Does it pass the smell test?
Let’s answer these questions for the AOL–Huffington Post deal, keeping in mind that these principles can apply towards your company as well.
Does it make sense strategically?
Yes. According to AOL’s CEO Tim Armstrong, the company’s current turnaround strategy relies in large part on their 80:80:80 focus. Discussed in the memo he sent out announcing the merger, the trio of 80s come from the fact that “80 percent of domestic spending is driven by women, 80 percent of commerce happens locally, and 80 percent of considered purchases are driven by influencers.” Operating from this basis, The Huffington Post provides a high profile method to expand AOL’s reach in at least two of these areas, women and influencers.
For The Huffington Post, AOL provides resources to continue execution of its expansion strategy into local and global content. It also offers the chance to expand its core audience and reach as many as several hundred million additional users. It will be important, though, for the company to balance the needs of its new corporate parent with those of its loyal user base which is a core part of its success.
Does it make sense financially?
For AOL, this is a high-stakes wager which may not make financial sense. The company lost over $790 million last year and saw revenues plunge 26.4 percent during the fourth quarter of 2010. The company has around $802 million in cash and it will use approximately 40 percent of that cash to pay for The Huffington Post.
The market has not placed a very high value on AOL as a company. Enterprise Value is a good measure of what a company is worth. It estimates what it cost to take over a company. AOL’s EV (which by definition does not include cash on hand) is only $1.5 billion. This leaves very little room for error.
For Huffington Post’s owners, there is little doubt that it is time to pop the champagne. Based on published reports, the company generates around $50 million in revenues and $10 million in Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA). A $315 million purchase price represents a purchase price multiple of 6.3 times revenues and 31.5 times EBITDA. According to Clayton Moran a Senior Analyst at The Benchmark Company, acquirers in this sector typically pay 8-12 times EBITDA.
The lesson here for small business owners is clear: When a suitor feels they need you, they’ll pay.
Does it make sense operationally?
Yes. From an operations perspective, AOL was very interested in having Arianna Huffington play a key role in shaping the company’s content strategy. That has been achieved, as she will now oversee all AOL content websites and give the company a high profile boost. The Huffington Post also brings an impressive network of 6,000+ bloggers (who work for free) and seasoned writers and journalists who are paid to produce high quality content. The company also has a very effective sales and search engine optimization infrastructure which can add value to AOL. The companies operate on different content management systems, but CMS integration is an area where AOL has much expertise.
Does it pass the smell test?
The answer to this question depends on whose nose you are using. Taking on the persona of a seasoned technology-sector analyst, the question is “it remains to be seen.” The deal assumes that AOL’s 80:80:80 focus is correct; it assumes that The Huffington Post is the ideal vehicle for acting on this focus; it assumes that AOL will be able to generate sufficient cash to continue its expansion strategy; and it assumes that Arianna Huffington will be able to transition successfully from “HuffPo founder” to Media empire executive. This is not a simple transaction.
If your business is considering a merger, acquisition or a sale, this framework provides an initial analysis of the potential transaction. Proceed carefully.