Quora Question: Do Verizon's Acquisitions Make Strategic Sense?

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The ticker and trading information for Verizon is displayed on a screen at the post where it is traded on the floor of the New York Stock Exchange in New York City. Brendan McDermid/Reuters

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Answer from Jeremy Arnold, analyst who focuses on SV, VC and tech:

Scrutiny is the great clarifier—and this deal doesn't hold up well.

Do Yahoo and AOL each come with a measure of value? Sure. Enough to justify a collective $9.2 billion price tag? I can’t even get close.

Worse, the Yahoo deal involves other downsides that are more concering, if less obvious—representing losses that will go beyond the inevitable financial write-downs.

To give context, let’s briefly deconstruct what Verizon has purchased and the attending ROI of each line-item.

The Age of Platforms

The most common argument is that Verizon is over paying for two things: a competitive content platform and better ad tech. They know the risks, but their core business is facing a future of diminishing returns and they have the cash to gamble.

We’ll get to the wisdom of that proposition at the end, but it might help to first explain why the probabilities of success aren’t very high.

Beginning with content—if you include subsidiaries, we have four kings of the mountain at present: Google, Facebook, Snapchat and Netflix. Then we have a distinct second tier: Twitter, Quora, Reddit, Hulu, Amazon and Microsoft.

Could Verizon crack that lower rung? They have one significant obstacle in the way— they don’t have a unified platform that can tie their disparate media properties together.

They have a great set of diamonds, just without the necklace. Which is a problem.

The Age of Fuzzy Buzzwords

Vagueness is the enemy of clarity. I’ve read some 30 to 40 reports about this deal thus far. Most of them included the word “synergy” at least once. But not always in a way that makes sense.

Getting specific might clarify. When Verizon bought AOL, it was buying two distinct collections of things: a few media properties and a handful of ad tech plays.

The media group had three crown jewels: The Huffington Post, Techcrunch, and Engadget. All good assets—though offering little if any cross-value.

It might also surprise you to learn that Verizon’s original plan was to spin off HuffPo along the way. They had no grand vision that included mastering the content game. They just wanted the tech.

That itself makes sense. AOL had already done the hard work of acquiring and rolling other startups together into a single platform. This included Gravity (personalized native ads), Convertro (ROI deconstruction), Millennial Media (mobile ads), Vidible (distribution), and AdaptTV (programmatic video).

The resulting product was ONE by AOL, which represented $877m+ in price-tags and several years of effort.

Two Deals, Two Values

It isn’t unreasonable to look at ONE and argue that the whole was greater than the sum, and that a unified platform was worth in the $2 billion range. When you add in the media pieces (HuffPo alone was valued around $1 billion), you’re within striking distance of the $4.4 billion that Verizon paid.

So applying that same formula with Yahoo makes sense, right?

Sadly, more isn’t always better. What Verizon is again buying is a mix of media plays (Tumblr, Flickr, Polyvore) and ad tech (Brightroll and Flurry). They’re also getting Yahoo’s branded properties, including Search, News, Sports, Finance, and Mail.

The problem is in the synergy—or, more precisely, the lack thereof.

The Anatomy of Chaos

If building a platform out of handpicked acquisitions is difficult, how do you describe the task of building one out of two sets of redundant if not competitive outfits?

Verizon already has AOL’s ONE. Now, sure, adding Brightroll might improve their capabilities in limited areas — but it’s never as simple as mixing-and-matching your favorite pieces. You have to account for different cultures, visions, leadership structures—for human politics in general.

Ultimately, this is a more expensive and less efficient way of recruiting. Optimal platforms are built holistically, by a coordinated set of high-performing teams united around a shared vision. Adding in new teams of engineers who run finished products and telling them to find a compromise never works well.

Now, you might argue that bringing them together is unnecessary. Perhaps, as much as possible, each can and should continue to run at arm’s length. Except, of course, that’s the exact opposite of synergy…

The Value of Old Money

Turning to the other parts of the deal for a minute, we’re faced with a depressing conclusion: those branded properties are all burning cash and showing nothing for it.

Yahoo only has exactly one profitable division at present: Search. Unhelpfully, that’s not really theirs. It’s been a Bing skin since 2009. Essentially, Yahoo is just milking money from people who haven’t changed their browser homepage in a decade — a pretty thin strategic proposition.

Worse, that same dynamic applies to most of Yahoo’s other divisions and properties (except perhaps Polyvore, which is fresh, but ultimately too niche to offer much value).

Legacy services like Finance and Mail are years behind. Sports is a value-add that doesn’t generate much cash. Their News app is fairly slick — but does nothing for their core demographic, who don’t really use mobile for news.

And sure, Flickr, is still (somehow) a top-200 website in terms of traffic (196th, per Alexa). But it costs a lot to run and has no real path to long-term profitability.

In sum, Yahoo’s audience is old—made up of people who mostly don’t understand that better options are out there. Being too unaware to have demanded more, they accepted and supported products that stopped being great some time ago.

Would you really want to own a bucket of “assets” like that?

The Rocks Ahead

I’ll admit this one thing: there is certainly massive value to Verizon in terms of customer data synergy. The Yahoo network has some 1 billion users. That’s a goldmine. In fact, that alone could almost justify the deal.

Trouble is, the FCC is taking an increasingly dim view of cross-company data-sharing. Chances are high that user data “firewalls” will be mandated within the next year or so, which would severely limit the advantages such a trove might offer.

And then we have the compounded challenges that stem from Verizon’s own landscape problems.

We can see most of these in action with Go90, Verizon’s first major product of their new media era. It’s basically a walled version of YouTube designed for the 30-and-under crowd, composed of original content and exclusive streaming.

Because there was no public demand for another video service, Verizon baited new customers with a shiny lure: zero-rating on all plans (i.e., no data cost to users).

Two problems (beyond the fact that few users seem to like the service):

  1. Verizon has a looming spectrum deficit. Making Go90 too successful would be a Pyrrhic victory, with any significant revenues outweighed by the acquisition costs of new spectrum licenses.
  2. Verizon has (yet another) FCC showdown ahead—who have been increasingly clear that zero-rating is a net neutrality problem.

Also, bear in mind that content which is both exclusive and free is inherently structured to invite parasites. Sure, when you’re the only platform streaming a premium sports event, you’re going to get viewers. But that’s only a win if they stay and pay after.

Thus far, no company in the modern era has successfully made money from that strategy except Facebook (who has unusual, incredible advantages). Loss-leaders that don’t lead to eventual high-margins sales are just losses.

The Road Ahead

Verizon’s own core business is looking gloomy. Smartphone adoption has plateaued. Users are demanding better infrastructure and lower bills. Spectrum is getting more expensive. As the shareholders begin to howl, their c-suite feels that pressure.

And, sure, this is a deal that Verizon can afford to see go sideways (they could write-off both investments in entirety and still make a $8 billion profit this year).

But that’s not a very inclusive calculus. Bad deals have deeper consequences.

  • Acquisitions come with an attention cost. For every Yahoo acquisition, you’re pulling talented executives from more profitable arenas that build on core strengths—like mbrace, where Mercedes-Benz owners pay subscription fees for full-stack services built on in-vehicle internet access.
  • There is a shortage of STEM talent in the world. Yahoo has thousands of top-shelf graduates. How motivated are they going to be to produce good work when they know their division might be axed? More urgently, what is the world losing by keeping them from more productive work?
  • Verizon shareholders won’t want to eat a $4 billion loss. They’re going to defer some amount of the markdowns into higher service pricing to preserve margins. This means that everyday smartphone users will foot the real bill.

So, sure, this acquisition makes sense as far as keeping the wolves at bay. Making a move—any move—tends to accomplish that.

But the piper must be paid. When a full accounting of all the future markdowns and externalities is tallied up, we’ll all be poorer off for it.

How strategically valuable are Yahoo and AOL to Verizon? Do these acquisitions make sense? originally appeared on Quora—the knowledge sharing network where compelling questions are answered by people with unique insights. You can follow Quora on Twitter, Facebook, and Google+. More questions:

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