During last week's exuberance over the sales of 24/7 Real Media and aQuantive, one of the survivors in the online advertising space disclosed that the FTC has begun a formal inquiry into their lead generation practices. "Specifically, the FTC is investigating certain ValueClick Web sites which promise consumers a free gift of substantial value, and the manner in which the company drives traffic to such Web sites, in particular through e-mail," says Valueclick in their regulatory filing acknowledging the FTC's probe. For those following the company, the filing confirms what several analysts, most notably Jordan Rohan of RBC Capital Markets had predicted. You wouldn't have guessed any threat to a significant piece of their business judging by the stock price this past week. Last Friday it jumped 7.6%, added 14% Monday, and hit a 52 week high before giving a little back yesterday.
For those of us in the direct response industry, the Valueclick attention represents a rare glimpse into the impact incentive promotion plays in another company, let alone a public company with a greater than three billion dollar market cap. Valueclick earned just north of $545 million last year, and added $156 million in the first quarter of this year. As Jordan Rohan points out in a recent publication, Valueclick's lead generation business accounts for 60% of the company's media business. The media business makes up about 50% of Valueclick's overall business, meaning that lead generation revenues comprise 30% of that Q1 $156 million, or as Jordan points out, $260 million to $280 million extrapolated for 2007. Fifty percent of their lead generation business comes from activities in the incentive promotion space. Viewed another way, 20% of Valueclick's revenue comes from incentive promotion. They do $10 million per month in the space, a number alone that puts them in the upper rungs of the CPA space.
Having a twenty-percent piece of the business looked at doesn't sound too bad, all things considered. What if, though, that 20% of revenues represented a larger than 20% portion of their profits. Those who have followed the incentive promotion space, especially those with direct business experience in it, might at first think otherwise. Why? Because it is not easy to make money in the incentive promotion space. Just ask the Useful. They most likely did more than $120 million in revenue last year with fairly healthy margins in the first half of the year. This year, they have, we suspect, shrunk if not in revenues in margin as they have let go as much as 30% of the staff. The Useful still ranks among the larger of the private CPA based Internet advertising companies, but inferring from their adjustment, you could easily assume Valueclick's Webclients division experienced similar pressure. That would be a logical assumption and one that probably worked in favor of Webclients, helping it keep a low profile, and is another reason why their FTC probe becomes so enlightening for the rest of us. Back to margins though.
Yun Kim, an analyst at Pacific Growth Equities, LLC who has done a good job covering the sector, pegs Valueclick's EBITDA margins on incentive-based activities at 20%. That's pretty good, but would imply their incentive business earns slightly below the company's overall Q1 EBIDTA percent of 26.1. Rohan on the other hand, buoyed by time spent going through the registration paths and discussions with various industry folks, thinks Valueclick earns much more than 20% by a factor of two. His estimate of EBIDTA margins in the 40% to 50% range would mean that more than 1/3 of Valueclick's bottom line profit comes from the incentive space. Having gone through their path ourselves, which we covered in "Incentive Promotion Acting Badly?" we might have to forgo our hardened view of the difficulty in earning money in the incentive space and agree with the RBC analyst's assessment.
Let's say you don't own Valueclick stock, don't really know or care about EBITDA, have no connection to the names Kim or Rohan, and don't do any incentive promotion activity. You could have easily glossed over any mention of the FTC investigation and wouldn't think twice about what happens to them. Not so fast. Incentive promotion will change, and it will touch on almost every aspect of the CPA space. These changes won't kill the incentive space, but those who promote them will see total conversions drop. This means less inventory in their path along with fewer email addresses collected. If, as is speculated, email policies change, it could mean not only fewer email address but less revenue earned by those managing lists. That means fewer impressions and less revenue for ads that rely on email distribution. This also impacts networks and their publishers that run incentive promotion ads. It impacts not only Valuclick's display business but a myriad of everything and nothing sites from whom such ads make up the majority of revenue. For those potentially impacted, do not panic yet. By running through this chain, we don't mean to alarm, but to inform on just how many parts of the direct response space incentive promotion touches. Any changes are still months out, and as with any disruption, instead of lamenting what might not be, start thinking of what opportunities will emerge if the landscape does indeed change.
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