Digital media in dire straights

The collapse of Melbourne-based digital business Swish Group in August shone a harsh light on a sector under huge pressure. Over the past 18 months, the business models of the companies in the space vaguely described as “digital marketing and media” have been torn apart.

Destra and Swish have collapsed, BlueFreeway has been privatised, CommQuest is fighting for survival and Q Limited has performed poorly.

Just a few years ago, these companies were seemingly on top of the world, riding the broadband revolution and using easy credit to buy dozens of small private companies, roll them into one entity and float on the sharemarket.

Just sit back and feel the synergy, was the message from these new dotcom kings.

Then the credit crunch hit. The debt used to fund the acquisitions turned toxic, earnings targets were missed and investors fled in droves, leaving behind the shattered dreams of company founders and battered reputations at the holding companies.

The collapsed Swish Group has again thrown open a question that was supposedly solved during the first dotcom crash: Can these roll-up business models really succeed?

The dotcom boom saw numerous aggregation plays around software and internet companies, including Powerlan, Sausage Software and Solution 6. None of these delivered on early expectations and all saw their share prices demolished in the tech wreck.

The most ambitious of the latest round of aggregation plays was BlueFreeway, an amalgamation of 25 digital companies which raised $45 million in debt and $36 million on the ASX in December 2006. BlueFreeway’s share price doubled in its first year, with the company reporting revenue of $43.5 million and earnings of $2.1 million.

Then something went terribly wrong. In February 2008 co-founder and chief executive Richard Webb was ousted, and in March 2008 the company emerged from a trading halt to announce that it would post a $4.5 million loss for the year.

Investors deserted the already devalued stock, setting BlueFreeway on a path that eventually saw it privatised by Michael Hannan’s media group IPMG in June this year.

Former chairman Greg Daniel blamed the poor performance on overspending by management on infrastructure and executives for the holding company, along with a multimillion dollar investment in a centralised marketing services technology called Blu.

But Webb is adamant that the model could have worked under his leadership. He contends that the strategy of a consolidated sales force and operating systems is a viable business model.

“The year I ran the company we beat our profit prospectus by 30%, and the following year when the chairman [Daniel] elected to run the company, the company fell apart,” Webb says. “And it fell apart primarily because there was no centralised sales force, there was no consolidation, and no accretive value from merging 25 companies.”

BlueFreeway now accounts for around $80 million of IPMG’s $600 million turnover and is in the hands of IPMG’s chief executive officer for digital media and marketing, David Burkett. Blu is long dead and the new strategy abandons much of Webb’s aggregation philosophy.

“Our role is to help them be better companies, and we do that through commercial advice, operational support and investment,” Burkett says. “The strategy is to get everyone focused back on the customers, and to get back to business.

“A parent company can provide support and synergy, but it’s not the reason for being. Our role as the parent company is to take those businesses to the next stage.”

If BlueFreeway was audacious in its scope, the activities of fellow listed aggregation play CommQuest were positively bizarre. In 2008 it spent up big bringing Paris and Nikki Hilton to Australia for the New Years Eve launch party of its SMS information service, Bongo Virus.

By February the company was reporting a $46.5 million half-year loss as the company’s goodwill was written off. The company reported a full year loss of $52.2 million on revenue of $66.1 million.

CommQuest has restructured its debt and disposed of a bunch of its acquisitions, and four businesses have been closed. It has also disposed of its chief executive officer William Scott, who will leave full-time employment on September 30.

Among the asset sales was Bongo Virus, which was picked up by digital media entrepreneur Domenic Carosa for $2.35 million.

The former chief executive of Destra knows about the vagaries of drawing together numerous technology businesses into a listed entity. His first tilt at the aggregation model saw him stitch together more than a dozen web hosting businesses, which he subsequently sold for $26 million. The $15 million profit from that sale was used to fund Desta Mark II, this time focused on digital services businesses.

Carosa says the success of the first incarnation came from the successful execution of a five year plan.

“We spent the first two years aggressively acquiring, we then spent the second two years integrating, and spent the final year focusing on selling the assets,” Carosa says.

He was two years into the strategy for Destra Mark II when the Opes Prime debacle saw him lose much of his shareholding and control of the company to Prime Media Group, before he stepped down as chief executive in April 2008. Destra was placed in voluntary administration in November that year.

“In the first years we built the largest independent media and entertainment company in Australia, with revenue of over $100 million,” he says. “The second phase, which was integration, got cut short when Prime Media took control of the company.”

Now Carosa is back with Dominet, his vehicle for investing in a dozen early-stage start-ups. Rather than bring them together for a listing however, Carosa’s strategy is to build them up for trade sales into larger listed entities, preferably for cash. He has no intention of listing Dominet.

“At the moment our core focus is to keep each individual company running separately, but we do some integration from a back office perspective,” Carosa says.”

There are signs however that there is life in the aggregation model yet. The chief executive of another aggregation play, Q Limited, Paul Choisalet, is adamant that his business is on the rebound, pointing to its stronger performance in the second half of the year to June 30, 2009.

He blames the economy for many of Q’s woes, with the loss of support in the stock market from December 2007 meaning that companies are trading on multiples that he describes as “almost embarrassing”.

“We bought a number of business during the 2005 to 2007 period, and I guess you could say we got caught out by the change in valuations,” Choiselat says. “To have business trade on one or two times EBITA would have never been expected anytime in the three years leading to January 2008 when there was a big meltdown. But there is an underlying business that is beginning to perform.”

The company has made substantial changes to its portfolio, including merging numerous businesses under five specific brands.

“Those businesses have not been running as a whole at the level of margin that they should be,” Choiselat says. “There is margin improvement to be had which will feed into the profit.”

Many of these changes have come from the expiration of earn-out arrangements which had prevented Q from merging its acquisitions. When asked whether he would have liked to have made these changes three years ago, Choiselat says: “It’s not a perfect world.”

Choiselat has begun talking to analysts again, which he says until now would have been a waste of time.

Not everyone has been pleased with how Choiselat and his team are running the company. West Australian businessman Tom Crage has run a campaign to bring greater transparency to dealings between Q and a company owned by Choiselat, Beconwood Securities, and raised questions about the role of the holding company.

“I remain concerned that a non-independent company is being paid fees for providing management services, when those same services could be done internally by the organisation,” Crage says. “It is my view that that is an inappropriate way to run a company.”

Indeed, the performance of Q, Swish, CommQuest and BlueFreeway raise questions about the value that the holding company model brings. An insider at one says the situation is what happens when accountants run creative businesses.

But as the market starts to come back, it is likely that the model will be tried again. Already rumours are circulating that the media services aggregator Photon Group is preparing to float its internet division following its strong yearly earnings growth.

For Webb at least, he is adamant that the model can work, despite his own experience.

“It was an amazing learning experience, that not everyone should go through in their life,” he says. “But as I look back on it, I think the strategy was sound. I think I’ve been vindicated two years later with Publicis and WPP and Omnicon all launching similar consolidated models for their digital marketing services platforms.”

Webb has rebounded with another aggregation strategy, under the name Red Ocean. The company has invested in or is working with eight businesses to create what he describes as a next-generation advertising network. A sales force is being put together across the top, and the details will emerge before Christmas. This time however, Webb is building the business without a cent of debt.

“I think there is a huge opportunity for a consolidated digital marketing service business, and the model will be proven some day,” he says. “The only way you can really effectively execute a rollout is to try to get some accretive value to cross selling the services with less sales people.”

“We had time to do it doing the frothy capital markets to put the platform in place, but we never had time to finish. I still believe there is room to consolidate and bring together marketing services companies in the digital space, because they can reside on a common platform.”