Mergers and acquisitions have become the natural order of the industry. What you don't see in the headlines, though, is how to find the right target. Finding a buying opportunity probably is the most important part of the acquisition process. Deals may require cash and be difficult to close, but think about how much worse the cost and effort is if you make a poor targeting decision.
There is some science to choosing businesses to add to your portfolio. Generally, you should look for one that fills a gap. If you need content, it may be advantageous to buy a struggling studio. If you have plenty of content but need more traffic, try to identify a traffic-heavy website that has not figured out how to make money. Perhaps you want nothing more than to increase revenue. In this case, set your sights on a rapidly growing company, even if it does almost exactly what you do.
Recent mergers have made sense
Through 2006, the story of the adult entertainment industry was one of fragmentation, especially for the still-young online segment. Small companies that can start quickly with little capital have come to dominate the sector.
Penthouse Media Group International's acquisition of Various Inc. captured most of the headlines, along with the large Ninn Worx-Spearmint Rhino deal (in the video and gentlemen's club sectors). But adult entertainment's smaller deals show the most potential for the online sector.
Overshadowed by PMGI's $500 million buy of Various, for example, was Shane's World's announcement that it had acquired Hush-Hush Entertainment, a brand known for its online presence and strong rate of growth. Large and small, the common theme is targeting, even if the underlying reasons are vastly different.
A changing definition of success
What does it mean to close a deal successfully? Most investment bankers would point to the signing of contracts or the exchanging of cash for ownership. Unfortunately, this sort of thinking can keep mergers from increasing the acquirer's value. After all, the success of a merger really is defined by the management measures you are accustomed to using on a daily basis. Increases in revenue, wider margins and more robust cash flow indicate a successful acquisition. Instead of focusing on the dotted line, it makes more sense to keep your eye on the bottom line from the time you start thinking about a merger through the years that follow the deal's completion.
To this end, the most important aspect of dealing in mergers and acquisitions is finding the right company to buy. The decision to buy a company tends to be strategic; it can fundamentally change your business. There are new employees to integrate, overlapping product lines and new markets to understand. M&A deals are complex, expensive and risky, but the rewards are not trivial.
"Doing the deal" may seem like the hardest part of an acquisition. You have to hire an attorney, and possibly an investment banker and an auditor, depending on how big your company is, not to mention the company you plan to buy. Company values have to be determined, and the deal has to be structured. Few revel in the thought of tedious extensive negotiations. And the moment of truth - when you write that first check - can be absolutely frightening.
Despite the imposing specter of the deal, the right acquisition can be worth the anxiety. Sometimes, it can even be easy. Ultimately, none of the decisions you make during the deal process will be as important or long-lived as the one that comes before the deal itself. The decision of who to buy can stay with you for decades.
Finding targets for optimal growth
M&A starts with strategic planning. Ask yourself the question "What do I want my company to be?" If you do not have an immediate answer, you are not ready to go on the prowl. Spend some time developing a vision for your company, and revisit the topic of M&A in the future. Acquiring companies without a broader purpose will lead to disaster. For example, the merger of two low-growth companies just creates a larger low-growth company. Every acquisition should offer easily discernable results, and these results should correspond directly to at least one of your company's objectives.
No two companies will have the same M&A strategy, as plans for acquisitions should be driven by the unique business goals of each. The notion of trying to find high-potential companies with rapid revenue growth and strong cash flow may not always be the answer. In fact, market conditions indicate that the opposite may be true. Anecdotal evidence suggests that video-sector revenue declined around 30 percent in 2007, dropping twice as fast as it did in 2006. In the past, Internet-sector acquisitions tended to center on traffic acquisition. The fundamental shift in the market has made content the commodity.
Whether buying content, traffic, brand strength or even complementary revenue streams (such as adult novelty businesses), the first step is a "gap analysis." This bit of consulting jargon really means "find out what you need but don't have." This will limit the scope of possible targets to those that will deliver the most value to your company. This, essentially, is how you will close the gap.
Even after your gap analysis, it is important to remember that M&A may not be the answer. In some cases, you may want to use the strength of your brand to launch a new product line instead of acquiring one from another company. While it may be possible to buy content, sometimes it makes sense to license it from a third party instead. As painful as it may be, spend some time crunching the numbers. M&A may be attractive, but it isn't always necessary.
Always look under the hood
From the time you start looking for an acquisition target, think about what life would be like if you actually purchased the company. Unless you plan to let it operate as an independent subsidiary - which does make sense in some cases - you should be ready to integrate the new business into your existing operation.
When you are perusing the market, spend a few minutes developing a game plan for each possible acquisition. Think about what the company does well and what your company's strengths are. Consider which pieces of the target you will adopt and which you will eschew. This will make the process of combining the businesses much easier.
Among the most important factors to consider is culture, and this is where the mergers of the Fortune 500 often become problematic. While every company has its own style, some are more similar than others. If you prefer formal titles and clear lines of responsibility, a laid-back startup that favors "Hey, man" over "Excuse me, Mr. Smith" will impact productivity at the acquired business unit. Likewise, an acquired company that is great at stretching a dollar may not be ready to manage large budgets. These factors should not always prevent a merger, but you should be ready to address such cultural differences soon after the merger has been completed.
Even though the process of finding and buying a company can be tricky and fraught with risk, it is a reality that has to be faced. Instead of avoiding the topic, master it. Before embarking on mega-mergers, dip a toe into a small deal. Learn from it. Only then should you become more aggressive. Becoming comfortable with M&A early will lead to a competitive advantage over the next few years. When it becomes time for your company to be bought, the payout may be higher if you've done some buying first.
-Tom Johansmeyer
This article originally appeared in the May 2008 edition of AVN Online. To subscribe, visit AVNMediaNetwork.com/subscriptions .
