Posted by: hdemott | April 29, 2009

Enough Is Enough (or is it?)

Seth Godin is one of my favorite bloggers/authors/speakers.

A great thinker who just throws out interesting thought after interesting thought.

Here’s todays:http://sethgodin.typepad.com/seths_blog/2009/04/infinitythey-keep-making-more-of-it.html

He really touches on a topic that has bugged me for some time. As a guy who has worked in and around hedge funds for the past decade (among other things) you see this phenomenon over and over – companies whose managements just keep trying to get bigger and bigger.

Of course we are now seeing the aftermath of those decisions. Companies that levered up to get bigger to chase bigger and bigger growth tended to buy the growth through acquisition fueled largely by debt. Or they bought growth with lower credit standards or by forgetting their consumers and ultimately turning them on to alternate services.

Consider the radio industry, which I was intimately involved with for so many years as an analyst and investor. This is a business that has been around since the 20’s and has grown at GDP +2% or so for many of those years with very few exceptions. It was a small business because of FCC limitations, but when the FCC lifted all of these limits in 1992 and again in 1996 the companies went on a consolidation orgy fueled at first by equity deals – and then by increasing amounts of leverage. As public companies (and growth companies at that) management was incented to grow revenue above all else and grow cash flow above all else. Don’t grow fast enough – your stock options will be under water and you will go back to being  sleepy little business. So what did these guys do? They jacked up the number of commercials per hour from 8 to 15 ruining the listening experience and allowing services like XM and Sirius to be born – and ultimately paving the way for websites like last.fm and Pandora – where I am on the board. To make matters worse, the cut on air talent and everything else they could to increase cash flow – but sooner or later you go a little far with that and the service starts to deteriorate even further. Add a recession and it all ends in tears. Clear Channel is essentially bankrupt – with its $16B in bank debt trading in the 40’s. Cumulus is essentially bankrupt, and its partnership with a group of private equity firms, Cumulus Media Partners is most certainly bankrupt – having bought Susquehanna at an eye popping 11X EBITDA with 9X leverage right before the bottom fell out.

Some businesses are just fine at a given scale and don’t need to keep growing – they just need to keep doing what they are doing and getting better at serving their existing base – and replacing churn.

This is particularly true on the web these days as VC’s and management teams are finding out.

With very few barriers to entry in any business, competition is fierce for any good idea that gets traction and thus most consumer facing businesses are very niche oriented and will likely get more and more so. There’s a limit to those niches, and perhaps that’ a great thing for the consumer – but it is not so great for the VC community that funds such ideas. They need exits, and exits to the public market are few and far between when you can’t scale the business to millions of dollars in cash flow.

So there is a real tension between the needs of the investor class and those of the consumer. For one, enough really is enough and for the other – well enough may not suffice – particularly when you have a lot of capital to deploy.

What side are you on? Would you rather see companies focus deeply on the niche you care about, or see them try an put resources into growing larger and larger?

Is enough, enough?

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