Of course, the business of pornography is by no means small. Adult Video News,
an industry trade publication, estimates that consumers spent $12.9 billion on
adult entertainment in 2006. Approximately 13,000 new titles were produced in
the $3.62 billion film business, an average of one film every 40 minute. More
than 45 million different people visit adult websites. Porn is big, and people
like it.
Somehow, this big market has failed to reach a critical mass. The top 10
companies in the business own only approximately 10 percent of the market,
based on revenue estimates from Hoovers. Only Beate Uhse (of Germany) and
Playboy have revenues north of $250 million. Porn may be big, but porn
companies are not.
Size matters. Porn is not yet big enough to appeal to the investing public,
with smaller public companies lacking the stability and liquidity that the
average investor craves.
A mere nine adult companies are publicly traded, with the majority
headquartered in the United States. Germany Spain and Australia each has one
public porn company. Further, there is no dominant market segment represented
by public adult entertainment, as three are gentlemen's clubs, three produce
content (e.g. adult films) and two are involved in branded product and retail.
One processes online payments.
Gentlemen's clubs have demonstrated the strongest performance, with
double-digit revenue growth and triple-digit profit gains. Retailers, on the
other hand, show flat sales growth while posting double-digit profit growth,
and content companies, typically, have lagged.
As smaller public companies, listed adult entertainment businesses are subject
to wild movements based on small events. A mildly positive press release can
send the stock price soaring, and one quarter of substandard revenue growth
could send it back the other way. Unusually high P/E ratios result, especially
in relation to fantastic (or fantastically dismal) year-over-year earnings
changes. The average adult content company, for example, trades at more than
400 times earnings, despite showing revenue declines of more than 60 percent.
Meanwhile, gentlemen's clubs show fantastic earnings growth on average (almost
470 percent) and a sky-high P/E (91.72), but a low average market cap of $51
million means that they still are vulnerable to the whims of investors,
especially large shareholders and insiders. Branded product and retail
companies appear to be the most stable, mostly likely a result of the $222
million average market capitalization for the sector, which shows a bit more
maturity.
There is room for porn on public capital markets, but porn itself has to change
first. A wave of industry consolidation would have to precede any meaningful
adult industry IPO trend. According to Francis Koenig, President and CEO of
adult-oriented private equity firm AdultVest, it will take time.
Koenig indicates that gentlemen's clubs have the most potential, because of
limited market penetration and the fact that the largest national chains are
still private. Following the clubs in Koenig's estimation are diversified adult
entertainment companies, such as Adam & Eve (PHE) and Hustler (LFP), which
have revenue streams ranging from films to novelty items and licensing deals.
In addition to delivering income from multiple sources, diversification shows
an operational maturity that would be helpful in public markets.
The potential exists, and some companies have the right business models. The
problem remains size.
While this has not stopped some adult entertainment companies from going and
staying public, it does limit new entries to the stock exchanges. Going public
is neither easy nor inexpensive, and the mechanics of listing on an exchange
require the support of attorneys, investment bankers and accountants. It is
easy for the price tag to reach millions of dollars, with hundreds of thousands
of dollars in annual expenses to comply with stock exchange and Securities and
Exchange Commission (SEC) regulations.
But, there is another way.
Smaller businesses can go public via the Over-the-Counter (OTC) system, which
has a more manageable regulatory structure and as a result lower compliance
costs. The cost of going public OTC can be as low as US$100,000 up front, with
recurring annual fees of tens of thousands of dollars.
Payment processing company IBD is traded OTC, attracting capital from public
investors without the rigor of formal stock exchanges. IBD is the smallest of
the world's publicly traded adult entertainment companies, with US$6.9 million
in annual revenues and a market capitalization of US$2.2 million. Given its
size, OTC is the ideal venue, as IBD does not meet the revenue minimums of most
stock exchanges.
Going public OTC is not without risk. The OTC environment attracts fewer
investors, making it less liquid than the exchanges. A good quarter will send
the stock price soaring, but disfavor with investors can lead to catastrophic
declines. Be prepared for a few tough years at first. Over time, maturing
operations, comfort with public capital markets and investor awareness are
likely to offer a bit more stability.
Entering public capital markets can be exciting, lucrative and unnerving.
Wealth is created and rescinded in minutes, and the pressure to perform is
extraordinary. For the adult entertainment business, public capital is on the
horizon. The ability to grow eventually will be limited by the availability of
capital, and public markets are the only viable long-term solution. You may be
able to go to the bank for millions, but you have to go to the public for
billions.
It will take some time for porn to go public. Consolidation must come first,
creating a critical mass that makes the stock exchanges attainable. While OTC
is an option, it will not draw the industry as a whole to public investors; the
environment is not robust enough. A few big splashes will be necessary to
trigger a trend, requiring big companies to go public on exchanges. After a few
years of mergers, though, porn will enter the mainstream portfolio; the
industry doesn't have a choice.
