Acquisitions typically lead to one of three scenarios:
- The acquired company's stock rises and the buyer's falls, as the market assumes that the premium being paid is too rich.
- Both stocks rise, as the synergistic benefits of the purchase outweigh the buyout terms.
- In rarer cases, the acquired company's stock falls and the buyer's climbs, as the acquirer found a way to nab a distressed seller at a discount.
SINA and Focus Media yesterday fell 17% and 16%, respectively, after Focus Media announced that it would hand over its digital outdoor advertising business for 47 million shares of freshly minted SINA stock.
The negative reaction to the deal by SINA shareowners dropped the value of the deal from $1.4 billion to $1.1 billion. That may explain some of the carryover carnage to Focus Media investors. Since Focus Media will immediately distribute those 47 million shares to its investors, many of whom are likely to dump them in the open market, it's easy to see why SINA is getting hit there, too.
This deal is an M.C. Escher painting, where all the stairways lead down but ultimately go nowhere.
Up is down
A new-media company like SINA now becomes an old-media juggernaut with Focus Media's fleet of digital billboards, ad-backed television monitors, and elevator poster frames. If you buy into the move, it will give SINA greater leverage with advertisers as it reaches China's gargantuan citizenry through physical and online channels.
However, isn't that what Focus Media already had? It had opportunistically acquired display ad specialist Allyes in a $225 million to $300 million deal last year. If being a conductor of new- and old-school music resulted in a cacophony for Focus Media, why would it work any better for SINA?
And what does this mean for Focus Media? The deal's value at the moment is essentially the company's market cap. Focus Media has nearly $3 a share in cash, so the deal is actually worth more than its enterprise value. A fan of SINA may want to buy Focus Media for the SINA shares, and wind up with the bonus of Focus Media at no additional cost.
The remains of the fray
So what will be left of Focus Media once it hands over its digital outdoor empire? SINA is getting a slice of Focus Media that accounted for 52% of revenue and 73% of gross profits through the first three quarters of 2008.
It may come as a surprise to see that its digital outdoor business is generating chunkier margins than its dot-com pursuits, but it isn't even close. In its latest quarter, Focus Media's digital outdoor business generated a non-GAAP gross margin of 64.7%, way ahead of its online realm's 23.7% gross margin.
This would naturally lead one to believe that Focus Media is stuck with misfit toys, but not so fast.
Once the handoff is complete, Focus Media will have:
- 47 million shares of SINA that it will distribute to its shareholders.
- The online advertising arm, anchored by Allyes. Its margins are way below what Sohu.com (Nasdaq: SOHU ) and paid search giant Baidu (Nasdaq: BIDU ) are generating, but the growth is there. Online ad revenue of $70.8 million in the third quarter is a 67% year-over-year improvement.
- Nearly $3 a share in cash.
- A movie theater advertising network, similar to this country's National CineMedia (Nasdaq: NCMI ) .
- Some of its more traditional billboards. This may not be exciting stuff, but conventional billboards seem to be just fine to stateside players like Lamar Advertising (Nasdaq: LAMR ) and Clear Channel Outdoor Holdings (NYSE: CCO ) .
In other words, as long as Focus Media's cash and its eventual allotment of SINA shares are worth more than Focus Media in its entirety, investors today are getting a lot of stuff for free. They can even eliminate gobs of risk by shorting the equivalent of SINA shares that they will be receiving if all they want is the non-SINA bag of goodies.
Yes, there is a free lunch to be had out there, but it won't last forever.
Other ways to see things: