Why Answers.com is Not Completely Crazy

I am going out on a limb here. Answers.com (where I served on the board at the time of the IPO and where I was a venture investor from my previous firm Israel Seed Partners.) announced last night that it was acquiring Dictionary.com for $100 million in cash. Aside for the obviously salient question of where a company with $12 million on its balance sheet will find $100 million in cash, I think i see the strategic rationale for this deal and can explain why it is not expensive if you are a current holder of Answers.com's stock.

Answers.com currently trades at a pretty rich price to revenue multiple of about 10 and a fairly infinite P/E multiple. That means if you own this stock you are betting that the company will deliver some pretty leveraged growth over the long term or will become a strategic asset that is an attractive acquisition target. Here is why acquiring dictionary.com both reduces the risk in Answers.com and increases the long term upside.

1. Google dependence. All investors in Answers.com should have been aware that the company was overly dependent on the definitions link on Google search results for its traffic . Dictionary.com has incredible organic traffic (by the way, they had the definitions link on Google before Answers.com replaced them). This will make the preponderance of answers.com traffic organic (maybe as much as 70%) and reduce the dependency on Google.

2. Increased monetization. I buy Answers.com claim that Dictionary.com's monetizes its pages at 1/3 the rate that Answers does because I see the leap Answers has made in that area in the last couple of years. Monetization optimization requires discipline and expertise. if you believe that Answers can simply double Dictionary.com's EBITDA, that would begin to put the Company's PE multiple in a reasonable range (still high but more reasonable) for a high growth company since almost every dollar will drop to the bottom line (I am sure there are enough tax losses at Answers to keep the taxes reasonable).

3. Scale is Valuable in ad sales. Becoming a top 30 web site is nothing to sneeze at. It is easier to increase CPMs and get a higher share of ad dollars as you move up the rankings. You are buying 3X the traffic and a catapult to top 30 site status for approximately 40% of market cap. This is not eyeballs economics; it is advertising economics where scale matters. Answers also becomes the #2 reference site after Wikipedia which is a good place to be since Wikipedia is essentially not for profit.

Neither the stock or the deal is without risks. How Answers raises funding is a big question mark and could be very dilutive to current shareholders. This is a very bold move that will likely have short term negative consequences but could put the company on more solid long term footing. Those that have been quick to drive the stock down in the aftermarket may want to think twice.