FOOL PLATE SPECIAL: An Investment Opinion
VitaminShoppe and AOL announced on Wednesday that their multimillion-dollar advertising deal had been amended and shortened. This is not the first of the smaller, weaker online companies to renegotiate its marketing deal with one of the Internet's big boys: The days of "junk contracts" look to be numbered.
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The VitaminShoppe deal previously called for the online store to be one of AOL's "anchor tenants" in several of its proprietary online areas. The exact terms of the old deal made last December were never revealed, but the contract was a "multi-million deal" that was to last two years. The renegotiated deal now calls for VitaminShoppe.com to appear only in ads on AOL's Health Channel and only until mid-October, a much shorter term than the original agreement. The gross amount of money to be exchanged undoubtedly also took a significant haircut.
Renegotiating marketing deals with online partners is something AOL is becoming painfully accustomed to. The most infamous example of this is AOL's dealings with Dr. Koop (Nasdaq: KOOP), famously and giddily tracked by the investment media as the health information site became the poster child for Internet excess.
In April, AOL was forced to scuttle a four-year, $89 million contract with the ailing website and take a 10% stake in the company in order to recoup at least some of its potential losses. Koop was quickly running out of cash, and the old marketing deal was one of the largest drains.
AOL is far from alone in being forced to renegotiate previously lucrative deals. Amazon (Nasdaq: AMZN) recently altered its marketing agreement with partner and investee Drugstore.com (Nasdaq: DSCM). While Drugstore will remain a premiere Amazon partner in the so-called Amazon Commerce Network, the terms of the new deal are much more in Drugstore.com's favor.
Amazon also recently saw what could potentially happen if a marketing partner's health falls below critical. The company saw a five-year, $145 million marketing deal go down the tubes when Living.com closed its doors and filed for bankruptcy last month. Also down the tubes went Amazon's 18% equity stake in the online furniture store. You can't extract payments from a dead partner, as they say, and Living's bloated advertising budget was certainly a contributing factor to its demise.
Junk contracts
Junk bonds are bonds that pay an extremely high interest rate but have little chance of ever having their principle repaid. There is a striking similarity to junk bonds and many of the marketing deals the premiere online sites have been signing with the small, upstart e-commerce firms. The terms of the old deals were extremely attractive to the online portals, but the chance of contract fulfillment has been quite low.
Now what?
Signing a big marketing deal with AOL, Amazon, or Yahoo! (Nasdaq: YHOO) worth many times more than the cash available used to be all the rage among the smaller online firms playing the virtual land-grab game for online eyeballs and wallets -- not to mention short-term trading momentum. This is not the case anymore. With Wall Street and venture capitalists alike demanding a clearer path to profitability before handing over funds to upstart online companies, the money to sign such deals has dried up considerably. Moreover, recent history has shown that an online company needs much more than a large marketing budget to be successful.
This is not to say that marketing deals with the Internet's big boys are going to stop completely. Rather, their size and length are likely to be smaller, with terms not as lucrative as they once were. At least in the future the chances of the contracts actually being fulfilled will be much higher.
Your Turn:
Should investors in the online leaders be worried about renegotiated marketing contracts, or is this merely a tangential issue to their success? Post your thoughts on the AOL Discussion Board.
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