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Ad Tech Spotlight: Buyout funds circle market for depressed valuations

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Ad Tech Spotlight: Buyout funds circle market for depressed valuations

This is the second installment of a multi-part series on developments in the advertising technology market. Part 1 introduced a renewed push in targeted TV advertising, while part 3, covering Facebook-Google's ad tech duopoly, will be made available Aug. 16 and the final part, discussing fraud within the sector, will be published Aug. 17.

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When Rocket Fuel, an ad-buying software business once worth $2 billion, sold for a fraction of its peak market value this summer at a paltry $125.5 million, it marked a new dawn for ad-tech exits and private equity investors eager for a bargain.

Acquired by Sizmek, an ad-tech company which itself was sold to private-equity firm Vector Capital for $122 million last year, the deal price demonstrated how buyout firms are taking advantage of depressed valuations to purchase the market's high flyers.

Widespread rumors of industry giant Rubicon Project's impending sale to a private equity firm earlier this year only exacerbated this trend.

There is a growing drift in private equity funds either investing in ad-tech companies or making outright acquisitions in efforts to scoop up undervalued assets, according to Chris Kane, founder at New York-based programmatic consultancy Jounce Media.

"In the years 2010 and 2011 when the likes of Alphabet Inc.'s Google Inc. and Yahoo! were making enormous bets in the ad-tech space, private equity investors thought this was crazy," he said. "Now that valuations have come down to earth, deals feel more reasonable for private equity investors."

JC Uva, managing director at New York-based strategic advisory firm MediaLink, agreed, adding that valuations had come down to the point where buyout funds can be more opportunistic.

"Now that some of the euphoria around ad tech has calmed down, [investors] are starting to get their heads around where the business models are today and where they can go," he said in an interview.

Until recently, the industry had been characterized by a large proliferation in startups with identical business models and colossal levels of VC funding, followed by a grimmer period of reckoning and some rocky IPOs.

As a result, the ad-tech industry really fell out of favor, according to Matt Nally, founder and managing partner at programmatic consulting firm Labmatik.

Much of the pessimism stemmed from the initial wave of ad tech, which produced a number of companies whose value and products were merely "smoke and mirrors," resulting in "flawed and unsustainable" business models, he added.

With far more companies than opportunities for a successful exit, VC funding into the industry declined and valuations followed suit.

VC funding for ad-tech startups crashed to a five-year low in 2016, with the number of deals down 17% compared to 2015, according to research firm CB Insights. In the U.S. alone, ad-tech volume fell to 33 deals as of May this year, a far cry from the 241 deals recorded in the year 2014, according to PitchBook, a firm specializing in venture capital and private equity data.

Amid a more challenging environment for raising money, ad-tech startups are faced with little choice but to become profitable, or find a buyer, explained Ratko Vidakovic, founder of Toronto-based ad tech consulting firm AdProfs.

However, when it comes to strategic investors such as Google, Facebook Inc. and – more recently – Snap Inc., there are relatively few buyer options in comparison to the number of ad-tech firms out there, he argued.

"This makes it a perfect opportunity for private equity firms to come in, reduce inefficiencies, and possibly even roll some of these ad-tech companies up into more attractive offerings," Vidakovic explained.

As a result, high profile private equity acquisitions into the ad-tech sector last year include China's Orient Hontai Capital $1.4 billion buy of AppLovin, a San Francisco-based ad-tech startup.

Meanwhile, in the closely related marketing tech sector, private equity firms Vista Equity Partners and Golden Gate Capital both took two publicly traded companies private for a combined $4.7 billion.

Yet, for buyout funds targeting the sector, ad-tech assets are more than just a bargain.

The fundamental appeal for private equity firms comes from the ability to tap into a large and fast-growing market which continues to undergo structural change, explained Simon Nicholls, London-based partner at tech investment bank GP Bullhound.

"The sector as a whole is starting to mature and the wheat is being separated from the chaff," he said, noting that programmatic advertising, in particular, has taken off.

Programmatic advertising is set to grow 31% in 2017, according to forecasts from media agency Zenith, while data firm eMarketer estimated that programmatic will account for nearly four of every five U.S. digital display dollars this year.

"There's a huge amount of growth for good companies [and] pockets of opportunities to make a lot of money," Nicholls concluded.