Deal Radar 2008: Federated Media Needs to Focus

I was recently at a dinner party where a venture capitalist asked me about Federated Media, and whether his firm should invest in the company. Federated, if you haven’t yet figured this out, is on the funding trail at the moment, trying to raise money.

Federated Media(FM) is a vertical ad network, so far with maximum success in the business vertical. It connects medium sized publishers with advertisers.

Federated Media was founded by John Battelle, the co-founding editor of Wired Magazine and author of the widely acclaimed book, Search. Battelle started the company when he came to the realization that the commercial aspect was missing from his blog and his friend’s site BoingBoing, in spite of the high readership that these sites attracted. Google AdSense was inadequate and compelled him to conceptualize what has now come to be known as a Vertical Ad Network. Battelle clearly pioneered a trend, and deserves tremendous credit.

FM deals in both banner and text ads. It distributes ads to a number of sites, including blogs, eliminating the need for advertisers / agencies to individually negotiate with a large number of publishers. The price they charge varies from publisher to publisher, and can reach upwards of $30 per thousand impressions (CPM). TechCrunch, BoingBoing, Ars Technica, GigaOm are some popular blogs using FM as their ad sales channel.

In 2007, Federated Media lost the prestigious and lucrative Digg account to Microsoft. FM claims to continue to partner with Digg on integrated sponsorships. When the Digg defection happened, FM tried hard to differentiate itself by positioning their core competency as “conversational marketing”. I don’t think this strategy has really worked, so competition continues to build up. While it continues to be the leader in the Business / Technology Vertical Ad Network space, competition is developing inside major publishing houses including Forbes, IDG, etc.

Over the last year, FM has expanded its range of vertical ad networks beyond Business and Tech, Battelle’s personal comfort zone, and are now trying to also play in Automotive, Parenting, Travel & Leisure, Sports, etc. For example, they represent a site called Makeupalley, which offers beauty product reviews, and gets 2.4 Million page views a month. I am scratching my head, wondering why the publishers of this site signed up with FM and not Glam Media, a hard-core fashion / women focused network. Travel is already much further along with Travel Ad Network leading the way. I don’t see how FM competes with Cree Lawson’s flawless execution either.

What I also don’t understand is why FM did not try to really “nail” the business / tech verticals first, before going for this diluted strategy. For example, I don’t understand why Seeking Alpha is not a FM client.

And you may also be wondering why I am not a FM client, but that is a slightly different story. I decided to work with Forbes, primarily, because of the brand value and reach it offered me. And since Forbes, IDG, and several other networks are being powered by Adify, my interest has been to be able to access ad inventory across all those networks, as and when those networks start to gain their stride. Adify has the attractive value proposition of being able to optimize ads across multiple networks.

In 2007, FM raked in a revenue of $22 million, out of which $14 million went to the publishers. That indicates a gross margin of 36%. After deducting the operating expenses, what remains is a thin operating margin, not one that should bring forth a very large multiple.

On the positive side, some of the blogs that FM represents are earning over $50,000 per month, although Mike Arrington (Techcrunch) keeps complaining that they don’t sell enough of his inventory.

FM started with $750k from Omidyar Network, The New York Times, Mitchell Kapor, Andrew Anker, Mike Homer, and Tim O’Reilly, and subsequently raised $2 million in Series A funding with JP Morgan Partners as the lead investor. In 2007, FM again raised $4.5 million in a Series B round from its previous investors including JP Morgan and Omidyar Network. FM is now out looking for money again, and wants a valuation in the $400+ million range like Glam. This comes after it claims to have turned down an acquisition offer for $100 million (from whom?).

Well, there are many reasons why Federated is not nearly as valuable as Glam, the foremost being that it has diluted its value proposition. It represents many verticals, dominates none, and the accumulated page views that an advertiser can access within a single vertical by using their network is still relatively low.

In my assessment, Federated would do well to not raise any more money, and if indeed it is getting acquisition offers in the $100 Million range, it should sell. Given its thin margin business model, I am surprised by the valuation number, but if someone is willing to pay that amount, they should simply take it and not ask any further questions.

Companies like NY Times and Forbes that harbor ambitions of building business ad networks would find Federated Media a very attractive acquisition target. Wall Street Journal will also, sooner or later, build one, as would, most likely, CNNMoney / Fortune. To get acquired at a serious price, FM would need to focus and build competency in one or more synergistic verticals, and veer away from the spray and pray strategy that they have followed so far.

Also, to really get acquired, the price has to be right, and I get the feeling that the expectations around the table at FM are getting out of whack.

One final point: FM could also explore a roll-up of a group of its high-traffic publishers including GigaOm, ReadWriteWeb, etc. so that it can both get to a higher margin business model, and also be able to use the “traffic” and “brand” currencies to compete with emerging competition from mainstream media. Otherwise, what prevents Om Malik from going back to Forbes, where he started his online journey?

Going back to my own experience, I went with Forbes because of the brand. I now write a column for Forbes, which has helped me raise visibility for my own site. Presumably, in the future, to recruit quality publishers, ad networks would need to offer not only high CPM ads, but also brand and traffic “currency”.

Thus, if it wants to position for the long haul, Federated Media should take a good look at its strengths, weaknesses, threats, and the dynamics of its ecosystem, and be creative about its moves.

This segment is a part in the series : Deal Radar 2008