The demise of Adult Entertainment Capital may not have come as a surprise, but the timing sure did. Launched on the first day of September, the firm shut its doors on November 12, 2008. The grand experiment of operating a publicly traded porn private equity fund lasted a mere two and a half months. Despite several acquisitions-suggesting ample deal flow-the company was not able to gain momentum. As we sift through the wreckage, the adult entertainment industry's first concern is simple: to find out if this disaster was the result of one manager's incompetence or environmental factors that preclude success.
A Good Idea
Founder and CEO of AEC, Milton "Todd" Ault III sought to bring sophisticated financing techniques to an industry that has long been neglected by banks, hedge funds and other institutional investors. For a change, he believed, the owners and managers of porn companies could secure the capital needed to jumpstart operations or accelerate growth without having to contend with financial institution bias. Ault would raise the capital through public markets, he thought, and direct it to adult companies that showed particular potential.
Over several conversations with Ault, I was walked through the alternatives he could offer the industry, from short-term credit investments to substantial equity deals in which he would take a reasonable ownership stake in exchange for a cash infusion. He comes from a mainstream finance background and brought the appropriate toolbox with him.
Despite his expertise with capital markets, Ault had some trouble navigating the adult industry. Originally, he believed that business plans would be submitted to him, and that he could work with companies already structured to accept cash from the various investment vehicles he offered. It didn't take long for the fund manager to realize that he was in a vastly different environment; the Porn Valley is nothing like Wall Street. Yet, he persevered.
AEC created the appearance of momentum, even if his sub-penny stock price didn't reflect it. The over-the-counter (OTC) markets are particularly finicky, and a fortuitously timed press release can create wealth in seconds, and a stiff breeze can render that recent largesse vacuous with equal speed. But, this didn't matter. In an effort to build a strong brand and ultimately a highly valued company, Ault focused on acquiring businesses with potential, building his portfolio and laying a foundation for future profitability and cash flow. This strategic focus, he felt, would be rewarded in the future.
Along the way, though, Ault lost sight of his original strategy. When I first spoke with AEC's skipper, he intended to direct his dollars to infrastructure investments. Payment processing and content delivery systems were on his radar, and he made it clear that his portfolio had little room for content companies.
Election Fever
The presidential election was front of mind for the American voter and the adult entertainment industry. For the latter, the typical angst associated with policy direction was accompanied by a painfully obvious business opportunity. Vice Presidential candidate Sarah Palin inspired a handful of adult film efforts, and AEC eagerly joined the fray. Whether Ault was seduced by the industry or felt that he had a leg up on the competition, he strayed from his business plan and entered the content production business. The results included a new website, AdultSpoof.com, and politically-themed porn featuring the veep hopeful. Quite simply, he disregarded the basic tenet of his market entry strategy.
The missteps with election-themed content alone would not have been enough to sink Ault's firm, but they represented a greater strategic failure. Throughout the company's brief existence, AEC consistently struck the wrong deals. Investments in ComedyNet, Stiletto magazine and Monster Tubers were made based on traditional business analysis and expectation of income in the future, but they were not the defining transactions necessary to put the firm on the map. They were good for a few press releases, nothing more.
AEC's errors culminated in Palin Erection 2008 and the broader AdultSpoof.com initiative. The move was intended to generate revenue (duh) and kick-start some buzz in the mainstream, accomplishing neither. Sales never gained momentum. The "curiosity revenue" that one could expect from both topical and satirical adult content in a politically charged environment did not materialize. It took about a week for Ault to pull the plug on his brief experiment.
As Ault tried to find a foothold in the adult entertainment industry, he encountered resistance from the people who were supposed to be on his side. AEC's shareholders, mostly holdovers from the company's previous incarnation as a trading platform, Zealous Trading, were not comfortable with the thought of AEC's having an adult-only portfolio. If Ault's company had come out of the gate strong-either with a major acquisition or substantial fundraising success-they may not have objected so strongly. With only a few small deals and no immediate signs of a return, however, Ault's decision to enter porn was easy to criticize.
And, it was criticized.
Investor discussion boards, such as InvestorsHub.com, were packed with shareholder concerns as to the company's prospects. Some communicated directly with Ault on his decision, yet Ault was confident that money could be made. He figured that the shareholders would come around after AEC posted a few wins. While the CEO was probably correct in this supposition, the firm never delivered results. Thus, porn likely became a scapegoat for the company's poor performance. Absent any victories, the venture into porn was an easy target for AEC's frustrated owners.
In part, Ault's withdrawal from the porn market was driven from pressure from investors to return to the mainstream. Investor discontent can't be avoided forever, and the absence of returns from porn gave them more ammunition.
Blame Game
For the few years that I've covered the business of adult entertainment, I have struggled with the issue of whether porn could thrive in mainstream capital markets. You've heard it all before. Investors are hesitant (if not reluctant), deal sizes are too small, management teams lack the sophistication ... and so on, and so on and so on. While this was true only a year and a half ago, the market has changed. It has matured faster than any of us expected. AdultVest has proved that it can access mainstream investors. AEBN has proved that an online player can reach a size rivaling the traditional industry stalwarts. Penthouse closed a $500 million acquisition with impressive speed.
This is not the porn market I met in 2005.
Adult entertainment companies are still underrepresented on the world's stock exchanges, and we continue to wait for a $1 billion entity. Nonetheless, the trajectory toward consolidation is evident. Management teams are demonstrating their abilities to navigate a tricky global financial market, and firms are transforming with the needs of the market. Porn is changing-for the better.
The loss of AEC, therefore, has less to do with a marketplace that lacks the maturity of its mainstream counterparts than it does with an individual failure of management. Ault seemed to think that market entry with a vehicle for public trading and access to capital would be enough to make adult entertainment his personal financial playground. It was not.
Without a doubt, porn is different from the mainstream-and not just in terms of the subject matter. We do still lag in terms of corporate management discipline, financial structure and strategic planning. There are many high-profile exceptions, but one can't lose sight of the fact that the industry is still fragmented, with the mass of companies struggling to bring in low annual revenues. Expenses, thus, have to be kept low, making boards of directors and external audits seem like luxuries. Long-range planning is typically supplanted by short-term survival ... of necessity. These are the current rhythms of the adult market that AEC missed and which ultimately led to its demise.
As every story has a moral, there is much we can learn from the implosion of AEC. Our industry does need access to some of the financing methods that the firm endeavored to bring. Short-term financing remains among the chief needs of our industry, along with an ongoing source of long-term equity investment for the new ventures that need a hand getting started. What was missing? Flexibility. A firm seeking to fill the gap left by AEC will need to demonstrate the ability to bridge the gap between adult market opportunity and the challenges associated with making an investment in this space. Finally, expertise must come with money. Wall Streeters can succeed, but they need adult industry sherpas to help them learn the landscape.
AEC may be gone, but others will follow. As we've seen over the past few months, investors need alternatives, and mainstream finance is unlikely to offer the new opportunities that will inspire investors to take a risk. AEC may have failed, but the lessons will be applied (hopefully) by the next market entrant. We're not finished with mainstream finance.
This article originally appeared in the January issue of AVN Online. To subscribe, visit AVNMediaNetwork.com/subscribe.
