Buy, Buy For Now
Penthouse Media Group is on an acquisition streak.
After a $500 million deal, Penthouse Media Group International is still hungry. In December 2007, the diversified adult media company announced that it had added Various Inc. to its portfolio. In the process, PMGI picked up the hot property AdultFriendFinder, the dating website that generates most of Various' revenue. Despite having made what appears to be the largest purchase in the history of adult entertainment, PMGI is eager to make more acquisitions in 2007 - of all sizes and sectors of the adult industry.
Deals approaching the size of this acquisition rarely materialize in the adult entertainment industry. A number of deals happened in 2007, and the sizes varied. The low end of the spectrum consisted mostly of individual content-company purchases. But it wasn't all small. In the substantial merger of the year until that of PMGI and Various, Ninn Worx and Spearmint Rhino came together to form Ninn Worx_SR, a combined entity with more than $300 million in annual revenue. Even though the Ninn Worx-Spearmint Rhino deal was large by the standards of the industry, it does not compare to PMGI's acquisition of Various.
And PMGI shows no signs of stopping. The company seems to have the appetite and capital for more large acquisitions in 2008.
What did PMGI buy?
In the acquisition of Various, PMGI picked up an Internet property with more than 260 million consumers across 25 communities. The Various network has at least 1.2 million paying customers. AdultFriendFinder is one of the 50 most-trafficked websites in the U.S. and boasts more than 18 million members.
By adult and mainstream standards, Various is a prominent brand. PMGI has established a foothold in the online sector by acquiring a company with a non-media business model. Not only does PMGI have an online revenue stream, but the Various revenue probably is not correlated with content revenue. Total company growth and diversification are the direct results of this deal.
Critics say PMGI overpaid substantially by laying out $500 million for Various. PMGI bought Various for 1.5 times its annual revenue, which is a bit steep. But the premium could be justified by the fact that Various is inherently diversified across mainstream and adult properties, its global reach and its growth potential. Also, if Various has high profitability measures or solid cash flow, the premium would be more reasonable.
Without a doubt, the purchase price dominates the discussion. At half a billion dollars, AdultFriendFinder was pricey. Some say the cost was a bit high, especially relative to the target's $340 million in revenue for the most recent year reported. But the advantages are salient. With this acquisition, PMGI has taken control of the most powerful online business in the adult entertainment industry. Various was among the three largest adult entertainment companies in the world - of those for which revenue is publicly available. Now, it belongs to a business famous for its flagship print publication.
By adding AdultFriendFinder to its portfolio, PMGI became the largest company in porn and ensured that nobody else can gain a sizable foothold in the online space. While there are plenty of content companies that are ripe for acquisition, none come close to Various in top-line revenue, membership, traffic or brand strength. Additionally, the monetization of content is still maturing, and piracy remains a threat. The Various properties are relatively impervious to these challenges, making normal business competition the only real consideration.
Where PMGI has distinguished itself is in the process of absorbing its properties. By the time of the announcement, Various already had been integrated into the PMGI operation, according to CEO Marc Bell. In the mainstream business community, a post-merger integration of this size would take months, but PMGI appears to be transforming itself into an organization with a bias for growth through acquisition. With the ability to integrate new companies quickly and the capital to add more to the stable, PMGI could become the stabilizing force that the industry needs in a bear market.
What happened?
PMGI did not announce its intention to purchase. It announced that a deal had closed. By the time the news release hit the wires, Various was part of the PMGI family. Not only was this the largest deal in the recent history of the adult business - and possibly the largest ever - but it also appears to have closed with relative ease. In true industry fashion, Bell is taking a tight-lipped approach to the deal, offering only what has been announced in the news release.
PMGI now claims to be the largest company in the adult entertainment world as a result of the acquisition, which is unsurprising, given that Various already was in the top three. The acquirer also offers an array of traffic statistics related to Various and parent Various, but no details pertaining to the nature of the acquisition are available. Bell said he did not intend to disclose the companies' financials until "if and when we decide to go public." Essentially, he won't tell until he has to tell.
PMGI was eager to acquire in 2007, after testing the waters in 2006 with smaller deals. PMGI picked up the assets of Jill Kelly Productions Inc. in April 2006 for almost $2 million and acquired Danni Ashe Inc. and Video Bliss Inc. for a total price of $3 million. In 2007, the company brought the third quarter to a close with a $10 million joint venture involving New Frontier Media. But these deals were minor league compared to the acquisition of Various.
Bell did not disclose who initiated the discussion of an acquisition, but he said the deal closed quickly. Most merger-and-acquisition activity involves a cumbersome post-merger integration process in which the two companies iron out fiscal year-ends, benefit packages and payroll systems, but Bell said Various already had been integrated by the time of the announcement. "We do things quickly," he explained.
The integration did not involve any layoffs, and Bell does not expect to see any in the near future, since Various complements PMGI's business model. There appear to have been few redundancies. If there are any economies of scale to be found, according to Bell, they will be exploited. The company is eager to continue to improve its efficiency, but all the hints point to the retention of Various as a portfolio company, rather than a business unit.
Bell disputed this characterization, emphasizing the word "integration," and he may have a point. Various, which had been seeking to satisfy an M&A appetite of its own, will not make any purchases under its own name. PMGI will continue to aggressively acquire, based on the portfolio needs of the parent company. As a result, Various and its business lines will focus strictly on operations. Insiders said Various approached two media companies in the past two years, but discussions never gained any real momentum.
PMGI isn't ready to stop
The year of the big acquisition is behind us, with PMGI's purchase of Various topping the list and the Ninn Worx merger with Spearmint Rhino a distant but substantial second. Rick's Cabaret has been on a shopping spree. AdultVest made headlines, and the threat and promise of outside money loom. The general climate supports continued industry consolidation, and while most M&A has been cross-channel, it is worth noting that the largest deal, by far, involved the purchase of a substantial Web asset.
Various may be PMGI's largest deal, but it will not be its last. Salvaged from bankruptcy four years ago, the recovered adult media giant wants to continue the M&A momentum. "We're looking for companies of all sizes," Bell said. "Big and small, it doesn't matter." The range of PMGI's M&A history - from Jill Kelly at almost $2 million to Various at $500 million - illustrates Bell's point. The benefits of the deal, rather than size, seem to drive the company's M&A strategy.
The CEO's confidence is fueled by cash. Even after a substantial acquisition, Bell said, PMGI remains the best-capitalized company in the business. It has capital on hand and the desire for rapid growth. To PMGI's advantage, it also has little competition in the acquisition space. Few companies could match PMGI's spending power, and the likely acquirers could wind up sellers if offered the right deal by Bell's company. It seems safe to assume that just about every company is in PMGI's sights right now.
While Bell hasn't disclosed any specific targets, he said he is prepared to make another large acquisition in 2008 and just about every company in the industry is in his company's price range. Another Various-size acquisition is unlikely, in large part because there are few companies of that size. Only Beate Uhse, Playboy and Ninn Worx_SR remain, and only Ninn Worx_SR is privately held.
Current market conditions favor PMGI's growth aims. Executives across the industry are almost unanimously bearish on porn for 2008, after a year that many expect to result in a net decline in revenue. (As of this writing, 2007 estimates on industry size were not available.) For Bell, this means discount shopping, as many potential targets will suffer from depressed valuations.
An anchor for the fragmented adult market
Until 2007, the adult entertainment market suffered from severe fragmentation, with the top 10 companies (measured in annual revenue) owning only 10 percent of the total market. Assuming flat growth for 2007 (i.e., unchanged from 2006), PMGI could represent up to 5 percent of the market.
While PMGI does not disclose its revenue, the fact that the merger has created the largest company in the adult entertainment industry signals what the consolidated entity's revenue could be. Prior to the acquisition, the largest companies in the adult entertainment business were Playboy and Beate Uhse, each with revenue between $300 million and $400 million. Thus, PMGI's annual revenue probably was less than $300 million. With a number of acquisitions under its belt from 2006 and diversified operations, it seems safe to assume PMGI's revenue was north of $100 million.
Assuming an annual revenue range of $100 million to $300 million, the combined entity would boast combined annual sales of $440 million to $640 million. The result would a market share ranging from 3.41-4.96 percent, substantially changing the landscape of the adult entertainment industry. But the curious aspect of the deal is that, assuming PGMI's revenue was between $100 million and $300 million, PMGI would account for only 23-47 percent of the consolidated entity's revenues. Given that it probably is less than half the size of the combined entity, how could PMGI acquire Various?
How was the deal structured?
Despite the paucity of details, it is possible to reconstruct the deal, based on standard merger-and-acquisition transaction practices, some available information and a bit of a lesson in history. According to a number of sources in the investment banking industry, the acquisition probably was a cash deal. Once the mechanism is identified, the moving parts become limited.
Assuming PMGI has attained maximum annual revenue of $300 million, the company would have had to secure debt financing in nearly twice that amount. This is possible, but investment bankers have indicated that it is extremely unlikely. Thus, the deal probably came in the form of cash. This brings up a new question: How does a company with, at most, $300 million in annual revenue find $500 million to spend? Sources familiar with the deal suggest that PMGI received a cash infusion for the specific purpose of acquiring Various.
A cash infusion of $500 million to finance the acquisition makes sense. It allows investors to purchase the Various asset without having to disclose the identities of the buyers. PMGI buys Various, and, since PMGI is private, the source of its capital remains discreet. Using history as a guidepost, the likely buyers appear to be PET Capital Partners, the fund Bell started to acquire PMGI's predecessor, General Media, in 2004. Participating in the acquisition were a number of institutional investors, including private equity and hedge funds.
Once investor capital has been put into the entity - PMGI, in this case - it can be deployed as the company sees fit. The decision to invest in the entity has little to do with the long-term prospects of PMGI itself, under this model. Instead, the decision to put capital into the company results from the companies being targeted for acquisition by PMGI. Additionally, PMGI can go back to the well as often as it sees fit. If there is an acquisition PMGI would like to make - which would require more capital - investors simply can put more money into the company. For the near future, it does not seem as if PMGI will need to access additional capital from investors, given that Bell claims that the company is capitalized to continue to make large acquisitions through 2008 and beyond.
PMGI and the future of porn
If PMGI is able to deliver on its growth aspirations, the company may become the focal point of market consolidation, particularly through 2008 and 2009. While there are few targets of Various' size, PMGI could acquire smaller - though still large - adult entertainment companies that would lead to a consolidated acquisition cost roughly equal to the cost of Various. The combination of aggressive acquisition and the likelihood of a bear market that could take a while to recover could result in increased market leadership for a company that was rescued from bankruptcy only four years ago.
The market appears to be unanimous in predicting constrained growth, at best, for the foreseeable future. Flat growth could be the norm for a number of years. PMGI, as a result of capital from investors outside the industry, is in a position to increase market share from one year to the next. Market-share growth would be magnified as other large competitors struggle against revenue declines.
So what does PMGI's acquisition agenda mean for the future of the adult entertainment business? PMGI has the potential to become disproportionately influential by growing rapidly in a business that could see continued decline. Even the largest of PMGI's competitors could become acquisition prey. Outside capital is changing the porn business. In the past, with the market fragmented, it was more difficult to see its impact.
The acquisition of Various and PMGI's substantial acquisition agenda, though, provide sufficient size and market concentration to send waves through the adult entertainment industry. In five years, this market will bear little resemblance to the porn market of today.
This article originally appeared in the April 2008 edition of AVN Online magazine. To subscribe to AVN Online, visit AVNMediaNetwork.com/subscriptions/ .
