The crowded advertising technology sector may be about to shake out some losers.
With north of 150 companies -- according to consultant and investment banker Luma Partners -- in the relatively new online advertising industry, there are simply too many competitors seeking too much of a return on capital.
Add in a drop-off in potential buyers and a declining appetite for public offerings, and the online advertising sector is due to stall, industry players and backers say.
It's just not a big enough market for all the money invested, said Will Margiloff, chief executive officer of Ignition One, the digital marketing technology unit of Japanese ad agency Dentsu.
That is a real challenge -- VCs and private equity guys are trying to figure out how to jump on the ad tech bandwagon and are really grasping. There can't be six or seven category leaders.
To Margiloff, the problem is that some of these companies frequently have more money invested in them than revenue potential, and often the revenue opportunity involves a more service-oriented action such as sales rather than a unique technological capability.
The valuations that you see are more the heyday of the Right Media sale to Yahoo -- 10 times revenue, said Margiloff about Yahoo's $680 million purchase in 2007 of the remaining 80 percent stake in the company that it did not already own. That is not reality ... Two to three times revenue is more realistic.
On top of that, the likely buyers have been sidelined dealing with their own issues.
For instance, AOL and Yahoo, both of which would be obvious buyers for online advertising start-ups, are in the midst of turnaround efforts that have left them with leadership vacuums and takeover vulnerability.
Then there are companies like Google and eBay that have already placed their bets on a few companies in the sector.
Google agreed to buy display ad company Admeld in June, for $400 million, according to TechCrunch and the New York Times, and eBay acquired GSI Commerce for $2.4 billion. Google's deal is awaiting approval from the Department of Justice.
With the usual suspects on the sidelines, there are still investors who think they can pick winners from a crowded field.
David Pakman, a partner at venture capital firm Venrock who has been investing in the ad tech space for a decade, is still bullish about the sector.
Among his investments was DoubleClick, which Google ended up buying for $3.1 billion in 2007. Venrock has also invested in online advertising companies AppNexus and Media6Degrees.
As an investor we like markets that attract lots of innovative activity, he said, adding that he considers the sector dynamic. Is everyone going to exit? No. It doesn't mean it's a bad opportunity.
Indeed, in the first half of 2011, roughly $5.7 billion worth of deals have taken place in the online advertising sector, according to JEGI Transaction Data.
John Lambros, managing partner and head of digital media at investment bank GCA Savvian, believes that the longer consolidation takes, the more buying opportunities open up for private players and unusual suspects like Oracle, IBM or Accenture.
There are a lot of companies in the sector, Lambros said. The real question is how do the market leaders gain scale and mind share. I don't think the market has shaken itself out to say who are the winners and who are the losers.
Michael Cassidy, founder and chief executive of privately held, 10-year-old display ad platform Undertone agrees, saying the lower valuations and the absence of bellwether buyers have given him room to become an acquirer. His profitable company is in the market for acquisitions of up to $100 million, he said.
According to Ian Sigalow, a partner at venture capital firm Greycroft Partners, advertising technology companies focused on the demand-side of the equation -- selling directly to agencies and marketers -- have a much better chance of flourishing.
At the end of the day, only a few platform companies will exist, said Sigalow.
During the first half of 2011, Internet ad revenues increased about 23 percent to $14.9 billion, according to the Interactive Advertising Bureau and PricewaterhouseCoopers.