Ecommerce M&A Action is Vibrant and Focused

Jun 02, 2012 7:41 AM  By

The mergers and acquisitions marketplace for ecommerce businesses is vibrant and active. As the segment matures, online retailers will reach larger scale and profitability levels will improve to levels normal for other businesses. As this maturation process continues, a larger pool of buyers will enter the market and the volumes will increase. Yet today, strategic buyers remain careful and selective when seeking the proper fit with their core brands.

So, what is happening in the world of ecommerce M&A? A lot of action, but very focused action. Strategic buyers have narrow screens for what is interesting to them, and are being extremely selective.

While there are numerous ecommerce transactions in the news, one should not assume that every available company is being gobbled up quickly. To the contrary, most sellers of ecommerce companies are finding it difficult to find interested strategic buyers, but these “dead-end” situations are never advertised.

Structure of the ecommerce industry
To discuss M&A in the ecommerce segment, we first need some definitions. Virtually all retailers are now multichannel with at least one of those channels being the Internet. However, one can also classify retailers by how they evolved into ecommerce retailers, because it speaks to their DNA—a genetic background that persists despite channel expansion. It also changes the logic for the buyer who might be acquiring a specific retailer.

From 1995 through 2000, there was an explosion of pure-play ecommerce retailers. It was a frothy time with plenty of venture capital to support unproven ideas. Although very few reached critical mass and stability before the Internet bust of 2001, some did—such as Amazon and Ebay. Since 2001, there has been rapid growth of thousands of new, independent pure-play ecommerce companies.

Interestingly, of the top-500 largest online retailers, only 205 companies, or 41%, a minority, are pure-play ecommerce businesses. Of these, few are of scale—with only 47 companies, less than 50 pure-play e-tailers, with sales in excess of $100 million. Many have sales as low as $12 million.

Over half of the largest ecommerce players are actually traditional store retailers and catalogers that have developed an Internet channel. While many of these companies have developed dynamic websites with large sales, most drive these sales through their traditional channels. For example, traditional catalog companies that may have 70% or 80% of sales online are typically driving customers to visit their websites by sending print catalogs.

These traditional retailers fall into two main categories:
Traditional store or store/catalog retailers (e.g., .Walmart, Lowes) make up 152 companies in the top-500 ecommerce companies by sales.
Traditional catalog marketers that also might have stores (e.g., Williams-Sonoma, Cabela’s) make up 83 companies in the top-500 web sales.

Consumer manufacturers with an ecommerce channel (examples include Apple, Dell, Nike, VF Corp, NBTY) include 60 companies (12% of the top 500).

Who are the strategic buyers and why are they buying?
The environment for ecommerce M&A is strong: The rate of change is creating numerous exciting new strategies that appeal to strategic buyers. These buyers are looking for new ideas that take advantage of the Internet’s rich interactive capabilities that are quickly scalable through technology. The ability to grow quickly through financially efficient online marketing is a key consideration.

According to Multichannel Merchant, the overall ecommerce sector is growing 15% annually, and buyers are generally looking for growth that meets or exceeds the growth rate of the overall sector. However, while growth is a mandatory criterion, strategic fit is equally important. As a result, strategic buyers are being extremely careful and focused in their acquisitions. Strategic buyers are looking for product and brand compatibility and technological scalability to complement existing technology.

For example, Facebook’s interest in Instagram stems from product fit (Facebook’s core business of sharing user personal information and photographs) and a scalable technology—instant sharing of photos enabled through technology.

Because of narrow strategic interest, many transactions over the next few years will increasingly involve financial buyers. The maturity of the ecommerce segment is resulting in companies with established earnings that will appeal to financial buyers.

Large pure-play ecommerce buyers can be very aggressive on value, but very selective. Amazon, Rakuten and others are acquiring other pure-play retailers that bring complementary capabilities. Amazon acquired Zappos in 2010 for a reported 24-times last-12-months EBITDA and 1.0-times last-12-months revenues; and Quidsi.com (Diapers and soap) for 1.8-times last-12-months revenues.

Zappos provided an apparel and accessories brand with a very different high-touch customer-service interface. Amazon wanted to expand its apparel offering to fully tap the huge size of the market. The Quidsi acquisition provided Amazon with a scalable, recurring revenue stream for everyday essentials.

Amazon is able to use the marketplace as its laboratory—to identify proven, fast-growing concepts without having to do the experimentation in-house, and then acquire them for immediate scale. Rakuten acquired the buy.com marketplace in 2010 for 3.8-times revenues and 50-times EBITDA to establish a U.S. platform to complement its Japanese and European operations.

Most traditional store retailers have already established their own branded websites. However, they are looking to go beyond their core brand by buying proven Internet-enabled concepts to complement their core businesses.

When Walgreens purchased Drugstore.com in 2010, it was not converted to the Walgreens brand, but was intended as a standalone online pharmacy. Michaels, which has yet to develop a transactional website, acquired Scrap HD in 2010 to develop technology for its MiDesign electronic scrapbooking tool. Walmart acquired Kosmi to develop its own social media capability. Nordstrom bought Hautelook for 2.3-times revenues and 15.7-times EBITDA to gain immediate market position in the growing “flash sale” segment.

Traditional catalog retailers are also selectively acquiring other retailers, but more often traditional catalogers with strong ecommerce growth. HSN’s Cornerstone acquired Chasing Fireflies, an example of a traditional cataloger buying another traditional cataloger.

There are now fewer catalog aggregators, which include HSN and Potpourri Group, while others, such as Orchard Brands, have had financial difficulties and have left the M&A marketplace. We haven’t seen traditional catalogers being active acquirers of pure-play ecommerce businesses, perhaps because ecommerce valuations have been robust.

Also, there have been fewer acquisitions of traditional catalogers than pure-play ecommerce, even though many have developed a strong ecommerce channel. There is a pervading concern that print marketing is destined to decline due to cost structure and lower scalability, even though print remains a critical and vibrant component of many marketing plans.

There are a few ecommerce aggregators active today. Liberty Interactive has acquired a number of ecommerce companies into a portfolio of independent brands, including Bodybuilding.com, Backcountry.com and Celebrate Express. Internet Brands is another aggregator of small brands and URLs.

Financial buyers are an increasingly important buyer category. They will show high interest in an ecommerce company with solid earnings. However, a financial buyer will be concerned about stability of earnings and will not compete with sky-high valuations from strategic buyers. Given the narrow focus of strategic buyers, financial buyers will be an increasingly important ownership group for ecommerce businesses as the industry matures.

Valuation metrics
A recent review of ecommerce transactions in the last five years demonstrates the breadth of ecommerce valuations, spanning from 0.9-times to 4.0-times the last 12 months revenues, and 11.6-times to 50-times the last 12 months EBITDA. The high EBITDA multiple transactions usually reflect transactions based on revenue multiples, where the excitement of the growth story overshadows what the buyer hopes is temporarily low earnings. The more earthbound EBITDA multiples reflect the importance of earnings, even with rapidly growing companies. It’s worth noting that valuation data isn’t disclosed for most transactions, so care needs to be taken when drawing conclusions, such as “All ecommerce companies trade for over 11x.” There are many ecommerce transactions that trade for more prosaic multiples between of 6-times to 10-times EBITDA.

Earnings are very important, particularly for publicly-held store retailers or traditional catalogers that are acquiring new ecommerce brands. They don’t enjoy the stratospheric valuations of companies such as Amazon, and must be concerned about whether an acquisition will be accretive to their earnings.

Financial buyers also are highly focused on earnings—their model is to apply leverage to help finance the acquisition of a profitable and growing business. There is less value placed on meteoric sales growth than on solid earnings growth. Financing is an important component of the financial buyer’s transaction structure.

Financing was difficult to obtain in the recent recession, but since 2010 conditions have improved. Asset-based financing is readily available to leverage assets such as inventory. Cash flow financing is also available for companies with proven and consistent earnings.

Preparing to sell and how deals are structured
An ecommerce retailer thinking of selling its business should focus on the fundamentals: the right strategy, a strong organization, growth and earnings.

Buyers are typically very interested in the current management team, and in gaining new ecommerce expertise they may not have in-house.

Many transactions are completed for cash consideration, some for stock or cash plus stock. Occasionally, where there is a big near-term growth opportunity in the selling company, sellers negotiate an earnout structure to receive additional consideration if the company hits certain targets post-acquisition.

There is no perfect fixed structure, and there is a lot of flexibility to meet special needs of both buyer and seller.

David Solomon (david.solomon@lazardmm.com)is co-CEO of investment firm Lazard Middle Market (lazardmm.com).