How to Value an Internet Marketing Company

As we consider approaching the market for investment, I thought it was worth spending a few cycles to share our perspective on the Internet Marketing segment. Internet marketing companies fall into a variety of labels: search, lead generation, banners, classifieds, email, rich media, etc. According to GP Bullhound’s March 2007 Report, lead generation is the fastest growing segment of online advertising (71% year-over-year)while search marketing still represents the largest segment of the Internet Advertising market (40%). Despite the various labels, Internet marketing companies are all traffic arbitrages, facilitating the delivery of customers to advertisers.

Two fundamental characteristics distinguish one internet marketing company from the next: how is the traffic acquired, and how is the traffic monetized.

Hands down, the easiest way to get traffic is through cost per click. It’s easy, quantitative and there’s plenty of inventory. Unfortunately, if it looks like a duck, and it quacks like a duck, it probably won’t give you the best marketing ROI. Most advertisers are finding it harder and harder to get an attractive ROI on cpc marketing spends. Some companies are still finding success in the long tail, but few understand it. Big Kudos to Business.com getting $345M at 23x EBITDA. I don’t know what they have behind the curtain that justifies that valuation, but I’m not sure I’d feel comfortable betting on futures on a CPC ad directory.

I’m a big fan of email list management - when it’s your list and there’s a strong affinity with the end user. Email is cheap, direct & effective. Spammers understand that too, which is why the FTC is inevitably going to have to crack down even more on unsolicited email. 85% of the email delivered to inboxes each day is sent by spammers. If an Internet marketing company is delivering customers to advertisers from the inbox, they’ve got to start diversifying. A few changes in regulations can mean a few million in fines, or put a company out of business altogether.

Organic search traffic is hands down the best traffic on the web. Although the debate is still out on whether organic search traffic converts better than paid search traffic, there a two huge advantages to organic search. It’s free and there’s no fraud. Businessweek reported earlier this year that click fraud represents 10% to 15% of all clicks on paid search, costing advertisers more than a billion dollars annually. The challenge, of course, is how to develop relevant, quality content to get a site ranking at the top of the search results. Despite all the grumblings about Google, I like the model. Sure a few spammy sites slip through the cracks, but for the most part, their algorithm promotes the development of quality information on the web. If an Internet marketing company isn’t heavily focused on driving organic search traffic, I think their missing the upcoming cruise ship.

In terms of monetizing traffic, many Internet marketing companies are still addicted to the cpc windfall. It’s been good for a lot companies for several years, but I don’t see how the model is sustainable. Consumers are tired of seeing cpc ads and advertisers are tired of buying them. To me, that’s a formula for a bottoming out. I really like the lead generation space and am already starting to see segmentation in the industry between the old guard and the new. What’s out? Incentivized offers (see FTC crackdown), selling leads to multiple advertisers, ad networks with no fraud controls and aggressive marketing tactics. What’s in? White hat, quality verification, consultative selling, values-based marketing, live transfer, consumer transparency. If an Internet marketing company tells me that they are trying to provide the best experience for advertisers & consumers to interact, I’m engaged.

I’m always curious how a company is using technology to differentiate itself. I haven’t seen anything really exciting in this space for a while. It seems to me that most media networks and marketing companies are simply touting their own cpc platform. Look, you’re simply not going to beat Google Adwords. Unless an Internet Marketing company has a technology that says ‘this helps me deliver higher quality customers for less’ – I’d be concerned. If you’re operating on the web, you’ve got to make technology a differentiator.

Let’s spend one quick paragraph on diversification. Internet marketing companies are too tied to financial services, specifically mortgages. Nextag has been looking real pretty to private equity, touting $200M in revenues primarily driven by mortgage lead generation. Look, I really like the mortgage lead generation space, but if want to ride high on the bubble you better be able to jump to something else when it bursts – or have a strong foreclosure or debt consolidation lead generation segment as well! Just ask Countrywide.

Quick Recap on what I look for in an Internet marketing company that’s poised for success:

• What type of Internet company are they? I’m partial to lead gen.
• How much of their traffic comes from cost per click ad buys? Are they successfully buying in the tail?
• Do they leverage organic search – if not, do they at least appreciate that they must begin to?
• Do they differentiate themselves with protectable technology? Is it different than everyone else’s protectable technology?
• Do they adhere to the Direct Marketing Associations Guidelines for Ethical Business Practices? Remember, white hat is coming back, strong.
• Are they diversified across multiple categories? If not, can they quickly do so?