Rainmaking investors finance tomorrow's media powers


FUNDING THE FUTURE: Rainmaking investors finance tomorrow's media powers.
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Where there are people on the Internet, chances are there will soon be money.

Social networking and user-generated content sites, online advertising optimizers, casual video games, and virtual worlds are not only attracting growing numbers of consumers, they've caught the eye of forward-thinking investors.

Whether affiliated with big industry players or not, consultants, venture capitalists and others funding hot media and entertainment sectors say they are already pumping big chunks of their disposable capital into such companies. Many expect to continue doing so over the midterm.

"We are interested in spaces that are driven by consumer usage," says Thomas Byrne, managing director of Peacock Equity Fund, a $250 million joint-venture investment vehicle launched earlier this year by GE Commercial Finance's Media, Communications & Entertainment business and NBC Universal. "Everywhere people congregate, especially in the digital space, is interesting for us. ... Where consumers go, there is the opportunity to sell advertising."

The financiers of the future of entertainment indeed seem to follow this simple logic: Let the money follow the consumer migration early on, and you will be rewarded.

In its Global Entertainment and Media Outlook: 2007-2011 report, PricewaterhouseCoopers noted that in 2006, for the first time, digital/mobile spending streams contributed more to global entertainment and media spending growth than did directly competing revenue streams -- a $16.4 billion digital gain in 2006 compared to an $11.4 billion gain elsewhere.

And for the 2007-2011 period, PwC projects the digital/mobile space to expand fastest of all entertainment sectors, with a compound annual spending growth rate of 21.3% worldwide and 18.7% in the U.S.

Judging by venture capital investments in the media and entertainment space, money flow in the sector is booming. According to the MoneyTree Report by PwC and the National Venture Capital Assn. based on Thomson Financial data, venture capitalists pumped $1.7 billion into 320 media and entertainment deals in 2006, up from $1.1 billion and 194 deals in 2005.

And this year, growth has continued apace, both in terms of dollars amount and deal volume, with $1.5 billion invested in 252 deals through the first nine months.

Popular networks

Social networking has clearly been one of the focus sectors in media and entertainment. News Corp.'s acquisition of MySpace, the Walt Disney Co.'s takeover of Club Penguin and investor buzz over potential initial public offerings for the likes of Facebook are just the tip of the iceberg.

"Whenever you have a few success stories like YouTube and Facebook, you have copycat money flowing," warns David Snow, U.S. editor of Private
Equity International.

But others say most money is going to the next generation of networking sites as financiers look for firms taking the phenomenon to the next level.

"Media and entertainment in the past was about mass media without trying to understand a particular niche audience and its needs," says John Kim, managing director of venture capital firm H.I.G. Ventures, in explaining the recent injection of capital into hot digital properties. "The next wave is more customized social networking centered around some passion-driven interest. You will see more (such) investments in more focused communications."

One such recent H.I.G. investment is Batanga, an online destination for bilingual Hispanics looking for their favorite music, entertainment, cars and the like. Its users say, "I am Latino, but also American. I speak Spanish and English. I like reggaeton, but also rock," explains Kim. "There wasn't a good way to reach this bilingual community before."

If you need more evidence of the draw of online communities, look no further than video Web site Metacafe, which in late August raised $30 million in a funding round led by Highland Capital Partners and DAG Ventures. Also participating were previous investors Accel Partners and Benchmark Capital.

Metacafe, which boasts more than 25 million unique visitors every month, is "defining the next generation of online video, moving away from simple video sharing and hosting to delivering an exceptional entertainment experience for short-form content," Highland partner Richard de Silva said in unveiling the investment.

Another recent example of the hot sector is a $44 million funding round for Ning, which allows consumers to create their own social network. Netscape pioneer Marc Andreessen, one of its co-founders, gathered early investments from friends and colleagues. Investment bank Legg Mason led the latest round.

Another example: uPlayMe, whose desktop application automatically connects people through their shared tastes in music, movies, TV shows and other digital content. It recently pulled off a multimillion dollar funding round, including investments from Warner Music Group, Village Ventures and others.

WMG will work with uPlayMe to include its applications on its artists' and labels' Web sites and in their partnerships with social networks, says Alex Zubillaga, WMG's executive vp digital strategy and business development. "uPlayMe will enable us to have a deeper relationship with consumers, as well as drive additional discovery of our artists."

Game for gaming?

Meanwhile, investors are already starting to pump funds into companies that add social components to the gaming space.

A recent example is a small Greylock Partners-led $5 million cash injection for Kongregate, which allows users to upload games and use community features to boast about their gaming skills. In unveiling the deal, Greylock partner James Slavet said: "Kongregate is quickly establishing itself as one of the most viable new social communities on the Web -- and as the go-to site for the current generation of independent game developers."

Gaming, especially casual and massively multiplayer online gaming, is also a standout when it comes to attracting financiers' dollars.

"The Nintendo Wii has demonstrated that not everyone is interested in the best graphics. It attracts casual gamers because it is social, easy to use and entertaining," says Kim. "Some (consumers) are replacing TV time with games. And maybe we will see the blending of both" in the next step.

Virtual worlds also continue to attract headlines and money.

PwC advisory services partner Michael Kelley says the rising popularity of communities like Second Life means that media and entertainment firms must look for ways to integrate them into their offerings. "We are at the dawn of a new age," he explains. "There is not only technological change, but also sociological and psychological change" that drives new consumer behavior.

With that as a backdrop, Doppelganger, which operates a music-focused virtual world where users can hang out with bands, host parties and make their avatars dance, recently raised $11 million from ComVentures and existing financiers Draper Fisher Jurvetson, Greycroft Partners, Draper Richards, Trident Capital and KPG Ventures.

Some hot companies bridge multiple categories, such as Web sites that enable users to cooperate on content creation a la Wikipedia. For example, Kim's H.I.G. Ventures has invested in FanLib, which works with entertainment companies to let fans suggest storylines for popular TV franchises such as "Star Trek" and Showtime's "The L Word."

Similarly, Trion World Network develops online games and worlds with gaming and networking aspects. In July, the company got $30 million in funding led by LA venture firm Rustic Canyon Partners. Time Warner Investments, Peacock Equity Fund and Bertelsmann Digital Media Investments also joined, as well as existing venture backers.

"Trion's network service model for connected entertainment has the potential to dramatically impact how our industry creates and monetizes content and how consumers participate in the entertainment experience," according to Rachel Lam, senior vp and group managing director of TWI.

The six-year-old investment arm of the world's second-largest media company works closely with other Time Warner divisions to help develop business partnerships. "The spaces that are the most important for us currently are the ones where there is a lot of engagement for the consumer," says Lam.

Lam says that at the end of every year, her team surveys about 30 top Time Warner executives from across the company to see what businesses and categories they are interested in. Focus areas have changed gradually.

For 2007, TWI added the newly hot category of casual virtual worlds and massively multiplayer online games. This compliments previous categories: online advertising/advertising technologies, mobile consumer offers and next-generation content.

All about ads

Online ad plays remain high on the list for people who deploy capital into hot media sectors, with many arguing that while the Web ad boom has long been evident, there is much room left to optimize performance.

Better monetization is a phrase often used by insiders. "The Web is still less than 10% of the overall ad market, which is not in line with the time spent by people," says Kim. "And video advertising in particular is growing strongly."

Kelley says PwC focus groups have found that "people disdain pre-roll ads, hate interstitials and dislike pop-up." Shaping future ad work based on user needs and preferences is the industry's current challenge.

Online advertising is also an example of how certain fields of hot interest and investment can lose steam with the industry's deep pockets. Several experts say online ad networks have cooled recently. Kim says this space, which includes companies that promise users an iPod or the like if they fill out a certain number of surveys, has been consolidated and has matured, leading to reduced margins.

Providers of wireless applications are also money magnets, according to Lam and Byrne. "Wireless (service) is a mature industry at this stage, but the next generation of wireless is of interest to us," says Byrne. "Mobile games, mobile content -- we see growth in that area," especially with continued expansion of mobile reach.

Kelley says there is room for increasing content delivery as well as ad and commerce revenue as PwC projects that the worldwide number of wireless subscribers will rise from nearly 2.3 billion in 2006 to 3.4 billion in 2011.

"The iPhone was a tipping point, and there is a slew of new devices that will come out" and further expand mobile penetration, he predicts.

Snow says development money has also been flowing into international businesses that are aping successful start-ups in the States -- no surprise given that the domestic media market is more mature than those in emerging countries.

An obvious example is Baidu, a now-public Chinese Internet search company that had no problem raising money once it started drawing comparisons with Google.

Beyond the future

Do the people who put money into the future of entertainment ever worry that they may not think futuristically enough? Many say there are clear limits on where they will put their cash.

"There is no real interest in things that are out there and not rooted in reality and a business," says Byrne. "We try to do a lot of thinking about what's hot five years from now. And much of it is simply about seeing consumers migrate to new platforms and applications. Sometimes people think things will be so different in five years. I don't think that's necessarily the case."

Investors also question whether the recent global debt market crunch will affect capital flow into hot media and entertainment sectors.

Byrne and Kim agree that the crunch has mostly hurt the financing of takeovers of more-established companies rather than the early-stage investments they target.

"The vast majority of venture investments is in equity form," Kim explains. "We don't really see the crunch affecting us at all."

Jim Rutherford, executive vp at media-focused private capital firm Veronis Suhler Stevenson, says that despite the crunch, smaller amounts of funding for young media companies are still happening.

"We still have an active deal pipeline," he says.