bridge to nowhere

When is raising a $10 million investment round a bad thing? When your company needs several times that amount to execute its business plan.

This proverbial “bridge to nowhere” scenario is where embattled gamer-focused YouTube network Machinima finds itself this week. The company is reportedly in the final hours of closing a round from Warner Brothers. The problem is the size: Machinima was asking for upwards of $50 to $70 million to go from content aggregator to content creator. Instead, the deal in the offing is for a fraction of that.

The WSJ cites sources saying Warner Brothers has until the end of this week to decide whether it wants to invest “$10 million to $15 million,” including a possible option to purchase Machinima outright. Machinima has raised approximately $50 million to date, so $10 million isn’t exactly as insignificant as if, say, Dropbox raised $10 million. But for a company that has been burning cash and has major premium content production ambitions, it won’t be enough.

All is not lost…. yet. There are a few unknowns that could shift the narrative slightly. It’s unclear whether the deal may include production assistance or access to additional financial resources from Warner Brothers that could cut the burn rate and help realize those ambitions. It’s also unclear whether there are other investors involved or whether Warner’s involvement might attract additional capital that would allow Machinima to grow the size of its piggy bank. But absent these things, adding $10 million to the pot is a bit like plugging a leak with bubble gum – it may help in the short term, but it’s not a solution to what ails the company.

Also troubling is the option to acquire provision. Strategic investors are loathed by many VCs and entrepreneurs for what are perceived as conflicts of interest and an inability to optimize for the success of the portfolio company. Often, strategic investments are described as “option payments” for the right to peak under the hood of an acquisition target and potential future competitor. That this deal reportedly includes such a provision explicitly, rather than it simply being an unspoken implication is unusual. Ten million is a nominal sum for WB and one that the company could easily part with to dip a toe in the digital video water before jumping into the deep end. If true, it shows just what a poor negotiating position Machinima is in.

Machinima isn’t the first YouTube multi-channel network (MCN) to accept funding from a strategic, so there’s precedent here. Maker Studios raised a $36 million Series C in 2012 led by Time Warner and a $26 million Series D in 2013 from French cable network Canal+ and Asian telecom company SingTel. Fullscreen also raised $30 million Series A in Summer 2013 that included The Chernin Group, Comcast Ventures, and WPP Digital.

The difference between these rounds and the potential Machinima deal as described is, again, size. Maker and Fullscreen may have taken a risk raising strategic cash, but they were at least able to raise enough cash to execute their plans. Also, both Maker and Fullscreen’s rounds included traditional institutional investors.

This isn’t even the first time that Machinima has taken on a strategic investor. The company’s $35 million Series C round was led by Google (corporate not Google Ventures), which owns its primary distribution platform YouTube. While the company has never admitted as much publicly, many within the industry have noted the conflicts that relationship creates. While most MCNs are pursuing off-YouTube strategies and publicly dressing down the video platform for its unsustainable advertising revenue sharing model, Machinima has been unable to do so.

The MCN category has struggled to find profitability and a sustainable business model, and Machinima has been no exception. While TV viewers (particularly younger ones) have flocked to the internet in droves, advertising dollars have not kept pace. Across all of YouTube, ad revenues are just $5.6 billion according to eMarketer research. At the same time, the current economics of the ecosystem see these platforms and the creators they support giving up 45 percent of all ad-revenue to YouTube. It’s unsustainable, hence the need for an off-YouTube strategy and, in many cases, an original premium content strategy. Both of these things take money, something Machinima is clearly struggling to find.

Cash hasn’t been Machinima’s only struggle. The company is in the midst of a major transition in the executive suite, including the departure of founder and CEO Allen DeBevoise with no replacement in sight, as well as the loss of COO Nanea Reeves, President Philip DeBevoise (Allen’s brother), and EVP Network Programming Aaron DeBevoise (Allen’s nephew). This is not to mention a series of rocky layoffs in the last 12 months.

As I suggested in June, Machinima has not only been seeking investors but also testing the acquisition waters. The best case scenario in this Warner deal may be that Hollywood incumbent decides to follow through by buying Machinima outright. Whether the company could attract a sum that would make its early investors happy remains to be seen. We’re told that the Google-led round carried a valuation of approximately $190 million.

Given its size – 321 million highly-engaged subscribers and more than 48 billion lifetime video views – the company is clearly worth something to someone. But the MCN business model as well as Machinima’s lack of senior leadership and internal culture issues raise questions about what an acquirer may pay. Add to that a likely down round and the impact that will have on the existing team. For comparison, Brian Robbins-led Awesomeness TV sold to Dreamworks for just $117 million (including performance incentives) in March 2013 and it was among the most successful MCNs at the time in terms of audience engagement and monetization. Plus, Dreamworks got Robbins, whereas Machinima lacks a marquee executive thanks to DeBevoise’s imminent departure.

There’s no doubt that Machinima is battling for its survival. The fact that anyone — let alone a major entertainment company — is considering writing an eight-figure check is encouraging news. Whatever DeBevoise and what’s left of his team have laid out for the future must at least be somewhat compelling. It’s possible this is the vote of industry confidence the company needs to turn things around.

Sarah Lacy is fond of saying that the only two reasons a startup fails are that it runs out of money or the founder quits. The company likely needs more than $10 million to elude the former. Meanwhile, DeBevoise and several of his senior executives are gone or on the way out. This company is far from out of the woods.

[Image via Proverb66]

  1. Machinima
    Next generation of video entertainment for the gamer lifestyle & beyond
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