Ad-tech: Could COVID be the making of this enigmatic sector?

Ad-tech is a historically topsy-turvy sector that has experienced several peaks and troughs over its short existence which have contributed to it being somewhat maligned and viewed as unstable, unsustainable and risky.

Lately, however, ad-tech has begun to evolve and show signs of sustained growth. In 2019, M&A in the media and marketing-tech sector (which covers ad-tech) rose more than 35 per cent over 2018.

This recovery stalled somewhat due to COVID-19, with 2020 seeing a 31 per cent year-on-year drop in M&A activity from 2019. Although this relatively steep overall decline was due to dealmaking virtually ceasing in the first half of the year during the onset of the pandemic.

The sector then bounced back in the second half of the year, with growth resuming and being driven by ad-tech’s natural responsiveness to life spent in lockdown. This culminated in Q4 2020 recording a 20 per cent increase in dealmaking compared to Q4 2019.

The strength of ad-tech’s recovery prior to and, eventually, during COVID-19, has led to assessments that it is now a more stable and attractive sector and that this time its return to prominence could be permanent.

Numerous factors affecting the sector also mean that the uptick in dealmaking looks set to continue and perhaps even gather pace during 2021.

What is ad-tech?

The ad-tech sector is an umbrella term referring to any company that produces the software or tools used to facilitate advertising through digital or online channels or that produces tools or analytics utilised in advertising campaigns.

The breadth of the term means it can refer to, for example, pop-ups ads that appear during mobile video games, or back-end systems that use sophisticated data analysis to target specific audiences.

Ad-tech has been around as a sector for well over twenty years, but has really taken off since e-commerce became widely popular. As a sector, it runs the gamut from massive, well-known companies to small start-ups developing disruptive advertising technologies.

Why the historic turmoil?

Like most tech sectors, ad-tech experienced a boom in companies over the last decade, with a huge influx of startups and small businesses flooding the sector. However, this has also created new challenges for the sector and it has taken a very bumpy ride in recent years.

Perhaps most significantly, the sector’s lack of proper regulation and glaring differences from traditional advertising led investors to regard it with caution, with many viewing its rapid growth as unsustainable.

The growth in programmatic advertising (the automated buying and selling of online ad space and data) has proven particularly problematic in this time. During the 2010s, programmatic drove huge revenues for ad-tech companies, but its growth was almost entirely unregulated and this raised numerous troubling issues, from data privacy to fraud.

In the UK and Europe, in particular, ad-tech’s reliance on programmatic advertising was plunged into turmoil due to tightening data restrictions in the wake of GDPR guidance, which has led to a clampdown on the practices previously employed by many ad-tech firms.

According to some estimates, companies began spending around 30 per cent less on programmatic ad exchanges in the immediate aftermath of GDPR’s introduction in May 2018. For UK companies, the conflict between data regulation and programmatic has culminated in an ongoing probe into the UK’s online advertising industry by the Information Commissioner’s Office.

This investigation began in the wake of a 2018 complaint regarding the real time bidding (RTB – a component of programmatic advertising) process, through which ad-tech companies trade consumer data for use in predictive advertising. The allegation at the centre of the investigation is that the data of UK citizens was being leaked to thousands of UK companies, in what has been called potentially the biggest data breach ever.

With such an unstable environment (regularly compared to the Wild West) within the sector in its early days, it’s no wonder that many investors and business buyers were minded to steer clear.

What’s behind the latest growth?

Streaming and gaming in the stay-at-home economy
There are a number of factors driving the renewed growth of ad-tech, as well as fuelling predictions that this time the growth isn’t a bubble. While much growth can be put down to the impact of COVID-19 and the sector inevitably evolving, the reasons also go beyond this.

Perhaps the most obvious driver of growth in ad-tech is the rise in streaming, which is rapidly taking over from linear TV. Linear TV has been a stronghold of traditional advertising for decades and remains a hugely important market for advertising, but the focus of advertising is increasingly moving towards digital channels as streaming eats into TV’s market share.

This has accelerated within the last couple of years. Key drivers have included: sporting events (such as football and boxing) moving to streaming sites and connected TVs (CTVs) which integrate streaming and online channels. On top of this, COVID-19 has solidified these trends by boosting the popularity of streaming even further.

The same is true of the rise of audio ad-tech, with the rise of audio streaming sites and the exponential growth in podcasting driving huge spend on ad-tech in the audio space. Similarly, mobile gaming has become ever more popular during lockdown and offers constant opportunities for pop-up advertising.



The rise and rise of e-commerce
One of the most dramatic shifts precipitated by COVID-19 has been the rapid acceleration of the shift from brick-and-mortar retail to e-commerce. Not only does the shift from traditional advertising towards ad-tech mirror this, it also benefits from it due to the integration of ad-tech into e-commerce.

As with brick-and-mortar retail, traditional advertising is being steadily usurped by its more digitised, responsive, data-driven cousin ad-tech. At media group DMGT, which distributes the popular free Metro paper, advertising revenues from traditional streams have fallen 30 per cent during the pandemic.

Meanwhile, according to a forecast made in Autumn 2020 by eMarketer, ad spend on e-commerce in the US was set to hit $17.37 billion (£12.5 billion) last year – a 38 per cent increase from 2019. As discussed in our previous insight on e-commerce during COVID-19, while shoppers will undoubtedly return to shops once the pandemic has passed, e-commerce will see a huge lasting benefit from COVID-19 and ad-tech will be directly in the tailwind of this.

A more stable, slimmed-down sector
One of the key drivers of M&A activity in ad-tech is the natural consolidation that has occurred as the sector has matured. This is largely as a result of two factors. Firstly, the natural thinning out of that has occurred following the initial boom of hundreds of companies in the early 2010s, as small companies either collapse or are acquired.

According to Luma Partners CEO Terrence Kawaja, there is an inevitability to this consolidation. Kawaja refers to this as a “rationalization push” that has been ongoing in the sector for around five years and has been accelerated by COVID-19. Ultimately, Kawaja says: “This will clean the ecosystem, with fewer players that are more sustainable with a better market cap.”

Secondly, deals are being driven by what is termed “horizontality”, which occurs as bigger companies look to improve their all-round offering, increase their competitiveness and stay abreast of the latest breakthroughs in ad-tech through strategic acquisitions of smaller, disruptive companies.

Kawaja claims that a key driver of horizontality deals is the dominance of the big tech firms: Google, Facebook and Amazon. These firms have flourished in the ad-tech world in the wake of tightening data restrictions, due to their comprehensive offerings across numerous platforms.

Whereas, prior to strict data regulation being imposed, companies could essentially freely trade customer data to power their advertising, this has now been curtailed massively. The advantage that the big-tech firms, especially Google and Facebook, have is “logged-in identity”.

Because these firms control numerous platforms (e.g. Google owning YouTube, Facebook owning Instagram) they can use data from logged-in users on each site (such as their search activity, pages they follow and posts they like) to offer targeted advertising across their entire platform.

This is referred to as the “walled garden”, in which data, privacy and identity concerns are minimal as the information has been freely provided by the users. The goal for firms looking to break the big tech stranglehold in the new, more regulated ad-tech world is to diversify their offerings to tap into the success of the walled garden approach.

To do this, Kawaja says, firms are willing to invest billions in horizontality deals that can give them a more comprehensive ad-tech offering. For example, AT&T’s 2018 $1.6 billion (£1.1 billion) takeover of AppNexus, a cloud-based programmatic advertising provider.

Will ad-tech’s growth last this time?

Given ad-tech’s tumultuous history, it’s understandable to question whether its growth this time around will be sustainable, or another false dawn. While it does seem that the sector is far more stable than it has been during previous growth cycles, there are still some factors that could threaten this.

Primarily, there is the issue of the ongoing crackdown on the kind of data practices that still form a key part of many ad-tech companies’ business models. The GDPR-related ICO investigation has only just resumed after being paused by COVID-19, while Google is reportedly planning to block third-party cookies (which many ad-tech firms use as their primary means of gathering data). While this move is being scrutinised by US authorities over suspicions that it may be an attempt to stamp out smaller rivals, there is still a widespread belief that the use of third-party cookies has a limited lifespan.

From an M&A standpoint, the kind of pressure that these moves could put on small and mid-size ad companies could prompt further consolidation as their cash flows suffer and they face the need to restructure their business.

Looking into the longer term for dealmaking, though, it is possible that the wave of consolidation identified by Terrence Kawaja will eventually run its course and see M&A slow down drastically, with just a few big players left in the industry.

However, like e-commerce, ad-tech is likely to see a lasting positive impact from COVID-19, which has driven shifts towards streaming and online retail that are likely to be permanent. Furthermore, as a tech sector, ad-tech lends itself to disruption by innovative firms, which should ensure ongoing horizontality deals, as well as the possibility of new, acquisitive leaders emerging.

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