Equity Firms Mull Backing One-Stop Digital Outfits

As the online ad market booms, private equity firms flush with investment capital are looking at an array of Web players with an eye toward combining them into large-scale digital marketing firms.

Gridley & Co., a New York investment bank, has taken a proposal to several top private equity firms laying out the case for creating a company that would encompass everything from search marketing to ad serving to lead marketing to ad networks. Similarly, Chicago private equity firm GTCR is dipping into a $2.75 billion fund it manages to back QFour Digital, a Santa Barbara, Calif.-based operating company formed last November to roll up tech-based online ad firms. Other private equity heavyweights are also considering similar moves, according to sources.

Both Gridley and QFour envision the creation of digital marketing services companies that would do what traditional holding companies don’t: act as a one-stop shop in display ad network, search, e-mail, affiliate marketing, Web analytics and several other specialties. The plans are still in the early stages, but they hold the potential of making it easier for companies to spend marketing dollars online, proponents said.

“We have real client dollars that are going to get spent this year, whereas before it was test budgets,” said Linda Gridley, CEO of the firm that bears her name. “The waterfall is coming. We think this is the year that size and scale will really matter.”

“There’s a lot of money around,” added Seth Alpert, managing director at AdMedia Partners, a New York M&A bank specializing in the marketing industry. “There’s a perceived opportunity to create a different sort of marketing services company.”

Any number of creations is possible in the fractured, still-immature Web marketing landscape, according to investment bankers, including versions that focus on performance marketing and others that include brand building.

In Gridley’s estimation, the model to follow is not a traditional holding company but something along the lines of aQuantive, the parent company of digital agency Avenue A/Razorfish. In addition to agency services in media buying, creative, search marketing and analytics, aQuantive has a technology business, Atlas, which is a leading ad server, and a performance media arm that operates an ad network.

In Gridley’s blueprint, obtained by Adweek, a private equity firm would earmark $400 million to take one of the still-independent interactive agencies, which include AKQA, Blast Radius and Refinery, and search and e-mail shops to combine with a technology backbone, consisting of analytics and ad-serving arms. In a sign of how important it is in today’s market to match the right message with the right consumer, a Gridley scenario earmarks the largest expenditure—up to $50 million—for a targeting firm. An IPO would follow in three years, the report states.

A key part of the Gridley and QFour plans is a vast pool of available capital, said executives. A record $215.4 billion flowed into the top 322 private equity funds in 2006, according to Dow Jones Private Equity Analyst. The equation is simple, according to banking sources: These firms see online advertising forecasts to grow at 20 percent per year for the next five years, while companies already vastly underspend online compared to the amount of time people spend there. Shares of a traditional holding company like Omnicom trade at 21 times earnings; aQuantive’s trade at 48 times.

Gridley allows that the blueprint is simply a thought exercise if a big money backer doesn’t sign on, but she sees tremendous opportunity if one does. “I don’t think people appreciate the order or magnitude of dollars that are going to come into this channel,” she said.

Jeff Pullen, former COO of ValueClick, another successful publicly traded online marketing services firm, already has a wealthy backer in GTCR. Pullen said QFour would hew closely to ValueClick’s model, which leans heavily on its performance ad and affiliate network, which it has combined with a comparison-shopping service, search marketing, ad serving and other related businesses. The difference, he said, is QFour will link its businesses more closely together to provide clients a one-stop shop for performance marketing, rather than allow them to operate more autonomously, as in the ValueClick model. Tops on his shopping list: ad serving, an ad network and a Web analytics firm. He envisions performance-oriented marketers like eBay and Circuit City coming to QFour companies for lead generation, managing affiliate networks and improving customer conversion at their sites. Pullen said QFour is at least three months away from making its first acquisition. Eventually, the company would have a public offering.

“Advertisers are asking for a more comprehensive solution,” he said. “There’s still a big vacuum.”

That’s unlikely to be filled by traditional holding companies, which have not yet shown an appetite for buying technology assets or ad networks. Moreover, the prices now commanded by online ad experts are more than holding companies like to spend.

But the payoff could be big: A consolidated company using a single data platform would allow marketers to easily target their messages across multiple digital channels, said Rich LeFurgy, principal of Archer Advisors and backer of companies like ad network BlueLithium and targeting firm X+1, often mentioned as consolidation candidates.

“Marketing is moving at machine speed, and agencies are moving at people speed,” he said.

Like most plans, however, they’re easier to put on paper than execute, industry executives said. Hurdles include finding top-rate executive talent to pull together the companies, the rising cost of buying firms in the online ad space and the need to convince entrepreneurs to take equity in the consolidated company as part of the purchase price. There’s also the issue of linking the disparate underlying data systems. The case studies of aQuantive and ValueClick notwithstanding, rollups are risky endeavors, Alpert warned.

“As they say in the prospectus, past performance is not a guarantee of future results,” he said.