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Ad Deals Lacking Logic

Kevin Kelleher

You know something's off when people keep talking about tipping points.

So it was earlier this month, when WPP bought 24/7 Real Media , an Internet ad company. WPP CEO Martin Sorrell said, "You can call it a tipping point if you want, but I think there has been a tipping point in terms of the realization of the impact of these technologies."

Two days later, Microsoft paid $6 billion for aQuantive (AQNT Quote), another Internet ad company. A Microsoft executive, Steve Berkowitz, talked about hitting a "tipping point" -- where the mix of the two companies could be leveraged into higher profit.

A day later, when the The New York Times weighed in, one observer said "We've reached a tipping point" of ad dollars flooding online."

I hate to buck a good cliché, so here goes my hat into the ring: This frenzy of online-ad firm buyouts, from Google's absurdly valued $3 billion purchase of DoubleClick to Microsoft's absurdly priced $6 billion purchase of aQuantive, mark a tipping point away from value and toward speculation.

OK, it's not really my tipping point. I stole it from investing legend Ben Graham, who wrote in his 73-year-old book, "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."

There's no shortage of analysis of all the recent blizzard of M&A deals, but I don't think you can say that many of them have much rational promise of a satisfactory return. Sure, they may pay off in the end, but you can say the same about any speculative transaction.

Strategically speaking, these deals are defensible, even sensible. DoubleClick has the potential to give Google the leverage it needs to expand its advertising dominance from search and into banner ads. And aQuantive has the potential to keep Microsoft a nimble racer in Internet advertising.

But we've reached a point where deals can make a lot of sense strategically -- and none financially. Big-ticket Internet deals have been popping up here and there for a while -- Google's $1.7 billion purchase of YouTube, eBay's $2.6 billion bid for Skype and Cisco's (CSCO Quote) $3.2 billion buy of Webex -- each drawing observations that they were outrageously priced and signs of a new tech bubble.

But those earlier acquisitions had a difference: They involved clear leaders in emerging technologies that promised to disrupt old ways. DoubleClick and aQuantive -- and for that matter 24/7 Real Media (which ad giant WPP is buying for $649 million) and ValueClick (which, despite a pending FTC inquiry, is viewed as a possible target of Yahoo! ) -- all offer some interesting technologies, but none are disruptive and all have been around for the picking for years.

So, why now? And why at inflated prices? The best explanation seems to be that it's all part of a grudge match between Internet advertising giants: Microsoft wanted DoubleClick, but Google swooped in and offered more. After licking its wounds, Microsoft paid twice as much for aQuantive. WPP wanted in on the game, and others like Yahoo! may follow.

Imagine you told your neighbor you were going to buy a Jaguar, and the next day you see one in his driveway. So, you go right out and spend twice as much on a Porsche. And now everyone on the block wants a luxury car. How would you feel? Vindicated, probably -- at least until it was time to pay the bill.

Of course, if you had more money than you knew what to do with, you wouldn't even worry about it. And that's what's going on right now. Having $35 billion in cash is reason enough to pay $6 billion for a company, or at least that's how Microsoft's executives seemed to justify it in a conference call.

But $6 billion for a company with $54 million in profit last year, and an estimated $71 million this year? That's a multiple of 111 times earnings and 85 times, respectively. No matter how hard you try to explain it, it's an investment that is speculation-driven, not value-driven.

Even more notable is the reaction of the rest of the market. Rather than being dismissed as a couple of impulsive purchases, these deals are taken as a rock-solid rationale for even more impulsive buying.

These acquisitions are being defended in terms that I haven't heard spoken with a straight face since the dot-com bubble: The high valuations are justified because they'll be a value in four or five years; the "synergies" of the combined companies are worth more than the targeted company alone, etc.

Both of these are classic speculative rationalizations. Take the "synergy" argument: aQuantive could take root and flower beautifully inside Microsoft -- as DoubleClick could in Google. But many a merger has been poisoned by the devil-in-the-details of integration. Both could just as easily suffocate in a bureaucratic or disorganized culture of its parent.

We've returned to a market where big deals are happening less because they make financial sense than because there is more than enough money to make them. That was a bad sign in the late 1990s -- it's just as clear a warning today, if anyone cares to listen.