Peter Daley
Analyst, Digital Media
Tel: (415) 371-1186 x.18
Fax: (415) 371-1187
pdaley@rutbergco.com

Rajeev Chand
Director of Research

Tel: (415) 371-1186 x.17
Fax: (415) 371-1187
rchand@rutbergco.com
  
Hrach Simonian
Associate, Digital Media
Tel: (415) 371-1186 x.29
Fax: (415) 371-1187
hsimonian@rutbergco.com  

Roger Lu
Intern, Equity Research
Tel: (415) 371-1186 x.10
Fax: (415) 371-1187
rlu@rutbergco.com  

  
Rutberg & Co.
351 California Street
San Francisco, CA 94104
www.rutbergco.com

The purpose of this newsletter is to provide a concise summary and perspective on the key digital media industry events relevant to private equity firms and companies. Please note that the news and transaction items have been paraphrased from secondary literature sources. The implications include Rutberg & Company's perspectives, which may include observations, hypotheses, and/or investment theses. The perspectives expressed below are intended for use by Rutberg & Company and the firm's clients, partners, and contacts; we kindly request that this summary not be publicly distributed or published.

During the one month period from July 1 through July 31, 34 private digital media companies announced $403.1 million in venture capital financings.  Investments were primarily in the Advertising Infrastructure, Applications, and Content Publishers sectors.  There were also 24 M&A transactions announced during the period, including Motorola's acquisition of Broadbus, AMD's acquisition of ATI, and Planar System's acquisition of Clarity Visual Systems.

In this newsletter, rather than our traditional review of the previous month's news items, we discuss the venture capital, M&A, and IPO activity in digital media over the past two quarters and compare these findings to the activity of 2005. 

Venture capital activity in digital media is, by all accounts, robust.  During the first six months of 2006, private digital media companies raised $2.4 billion of venture capital through 278 financings.  This activity nearly matches that of the full year 2005, in which $2.6 billion was raised through 313 financings.  Notably, 245 venture capital firms announced two or more digital media investments during the eighteen month period between January, 2005, and June, 2006. 

The robust activity indicated by the financing totals is consistent with our conversations with entrepreneurs and investors.  On an anecdotal basis, for example, we note the formation by numerous venture firms of digital media-specific strategies, practices, and portfolios over the past two years.  Although raising capital is never "easy," we believe the current environment is healthy for private digital media companies. 

The M&A market remained steady in 1H06 with 181 transactions announced during the period, as compared to 183 and 185 in 1H05 and 2H05, respectively.  Further, the IPO market for digital media companies remains muted.  During the first half of 2006, only 6 IPOs were filed and 6 were priced in the industry, as compared to 5 filed and 19 priced in 2005.  We do not find visibility toward a substantial change in the dynamics of the IPO market in the near-term.  As such, we believe M&A remains the far more likely exit scenario for private equity investors.   

Overall, we note that venture capital activity has increased substantially over the previous 18 months, while M&A activity has remained steady over this same period.  Several venture investors in our conversations have referred to this situation as a "bubble without an exit," indicating a concern and frustration over the high investment levels but low exit numbers.  As we discuss below, we believe that this situation may be, at least partly, due to the early stage of digital media as an industry, and that there are underlying, positive indicators for future M&A activity in the industry.

I. Market Update

II. Venture Capital Investments

III. Investment Totals by Sector and by Geography
IV. Mergers & Acquisitions

V. M&A Totals by Sector and by Geography
VI. IPO Filings
VII. Upcoming Rutberg & Co. Presentations

1.

Digital Media Venture

Capital Activity

Venture Financing Totals

Venture capital activity in digital media is, by all accounts, robust.  During the first six months of 2006, private digital media companies raised $2.4 billion of venture capital through 278 financings.  This activity nearly matches that of the full year 2005, in which $2.6 billion was raised through 313 financings. 

On a quarterly basis, total venture capital raised during 2Q06 was $1.3 billion, representing 127% growth from the total during 2Q05.

Heading into 3Q06, venture investors appear poised to continue their strong pace.  The $403 million of venture capital raised in July 2006 is on par with the $398 million monthly average over the previous six months.

The robust activity indicated by the financing totals is consistent with our conversations with entrepreneurs and investors.  On an anecdotal basis, for example, we note the formation by numerous venture firms of digital media-specific strategies, practices, and portfolios over the past two years.  Additionally, we hear comments from several entrepreneurs on strong interest by venture firms and on relatively attractive transaction valuations.  Although raising capital is never "easy," we believe the current environment is healthy for private digital media companies.

Size of Financings

In terms of financing size, the average size of digital media venture transactions has remained stable since 2005.  During 1H06, the average financing size was $10.6 million, as compared to $9.1 million and $11.5 million during 1H05 and 2H05, respectively. 

Interestingly, over this period, transactions have trended toward smaller (less than $5MM) and larger (greater than $20MM) financings.  The percentage of mid-sized (between $5MM and $20MM) financings has commensurately decreased.  We believe this change in distribution is driven by two factors: 1) increased venture capital for private companies in the Applications sector, which is at an early stage of development and which typically requires less total capital commitments per company than the broader digital media industry; and 2) the emergence of private companies with late stage revenue levels in several digital media sectors, such as Semiconductors, Content Service Providers & Retailers, and Advertising Infrastructure.

Most Active Sectors

The sectors with the largest total venture capital raised during 1H06 were Semiconductors, Content Service Providers & Retailers, and Advertising Infrastructure.  Notable financings during the period were: $150 million by Amp'd Mobile, $49.2 million by Digi TV Plus, $48.5 million by MovieBeam, $48 million by AdKnowledge, and $46.6 million by Sling Media.

By number of financings, the Applications, Advertising Infrastructure, and Provisioning & Delivery Infrastructure sectors were the most active during 1H06.  In particular, the Applications sector included 46 financings during 1H06, as compared to just 9 financings during 1H05.  The significant rise in venture activity in Applications companies is driven, among other factors, by the investment theses in user-generated content and other personal media. 

Overall, as per our comments in recent newsletters, we remain bullish on investment theses related to user-generated content, casual video games, and content delivery networks, among other areas.

Most Active Investors

The investors with the greatest number of digital media investments in 1H06 were Intel Capital, Sequoia Capital, Cisco Systems, and Draper Fisher Jurvetson.  Notably, 245 venture capital firms announced two or more digital media investments during the eighteen month period between January, 2005, and June, 2006.  In our view, this demonstrates the broad participation and interest in the industry by venture firms.

2.

Digital Media

M&A Activity

Number of M&A Transactions

The M&A market remained steady in 1H06 with 181 transactions announced during the period, as compared to 183 and 185 in 1H05 and 2H05, respectively.  Notable recent transactions involving venture-funded private companies include Microsoft's acquisition of Massive, VeriSign's acquisition of m-Qube, and Viacom/MTV's acquisition of Atom Entertainment.  

The North America region saw the largest number of transactions during 1H06, with 94 M&A announcements.  M&A activity in the Asia region, however, increased significantly, representing 19% of transactions in 1H06, as compared to 8% in 2005.

Most Active Sectors

The 1H06 M&A transactions were primarily in the Content Service Providers & Retailers, Advertising Infrastructure, and Content Creators sectors.  The Retailing Infrastructure sector experienced the sharpest rise in M&A activity, with 14 transactions announced in 1H06, as compared to 4 in 1H05.  Further, the steepest decline in M&A activity occurred in the Content Publishers sector, with 19 transactions announced in 1H06, as compared to 36 in 1H05.

3.

Digital Media

IPO Activity

The IPO market for digital media companies remains muted.  During the first half of 2006, only 6 IPOs were filed and 6 were priced in the industry, as compared to 5 filed and 19 priced in 2005.  In our conversations with private company board members and CEOs, we find several inhibitors for IPO activity, including the generally unreceptive public markets and Sarbanes-Oxley compliance costs and risks.  We do not find visibility toward a substantial change in the dynamics of the IPO market in the near-term.  As such, we believe M&A remains the far more likely exit scenario for private equity investors.   

4.

Market Summary

Overall, we note that venture capital activity has increased substantially over the previous 18 months, while M&A activity has remained steady over this same period.  Several venture investors in our conversations have referred to this situation as a "bubble without an exit," indicating a concern and frustration over the high investment levels but low exit numbers.  In our view, this situation may be, at least partly, due to the early stage of digital media as an industry.  Industry drivers of broadband penetration and alternative media business models are just now emerging as visible, mass market forces, and revenues from the associated services and technologies are only recently beginning to be explored, defined, or built.  Further, we find that interest on behalf of potential acquirers exists, even if only on an exploratory basis.  Although it is infeasible to predict timing or to provide certainty, we believe the underlying dynamics are positive indicators for future M&A activity in the industry.

Table 1. Digital Media Venture Financings by Sector

Table 2. Digital Media Venture Financings by Geographic Region

Table 3. Digital Media M&A Activity by Sector

Table 4. Digital Media M&A Activity by Geographic Region

Please refer to Rutberg & Co.'s Web site for recent Analyst Quotes.

August 15, 2006
(revised 8/24/06)

   
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