February 3, 2009

The Way We See It: M&A Business Climate

To Our Friends and Business Colleagues:

As professionals in technology M&A we are asked, on a daily basis, our thoughts about M&A exits in the current financial climate.  We wanted to provide some qualitative and quantitative assessment to our friends and colleagues in the hopes that this will assist those who need to make decisions regarding business sales in the near future.

By way of background, GrowthPoint provides M&A advisory services to emerging technology companies around the world.  All of the directors at GrowthPoint have prior engineering and operational experience in technology businesses and have been doing technology M&A for an average of 10 to 15 years.  We have lived through several technology business cycles (the 1998 “Asian Flu”, the 2002 “Dotcom” and Optical Telecom Crash and now the current Banking Debacle).  Our clients are typically venture-backed technology businesses that we represent in sales to large and mid-sized technology firms.  GrowthPoint’s average deal size is about $70M but there is a wide dispersion in values.  Many of our clients are pre-revenue and are sold for their technology, team and the “up-side” market potential that their products and technology offer.

Are Deals Getting Done
To the basic question of “Are any deals getting completed?” the simple answer is “Yes.”  We recently announced the sale of Q-Layer (a cloud computing business) to Sun Microsystems on January 7, 2009 and we have several other transactions in process.  While we are experiencing delays, the good news is that the tech sector learned a valuable lesson in the 2002/2003 tech downturn and many of the strategic buyers have excellent balance sheets with no debt and significant cash positions.  So the resources to do deals exist.

Qualitative Assessment
A more detailed answer is that the market has had a wide range of strategic buyer responses to the current business situation.  Our qualitative assessment is that buyers are segmenting into three distinct groups:

·Conservative
·Aggressive
·Business-as-usual

The conservative group has adopted a “go slow” approach.  This group may be 25% of the potential buyers.  The conservative group is evaluating deals with a view of actively engaging in and closing transactions when it becomes obvious that we are exiting the recession.  The aggressive group is opportunistic and is using the current environment to buy at reduced prices.  The aggressive group is actually looking for higher deal flow in terms of absolute number of deals.  We think the aggressive group may constitute another 25% of the buyer community.  The remaining 50% of the buyers are conducting business as usual and are evaluating opportunities and closing deals consistent with past practices.
While the majority of buyers remain active, deal values are reflecting discounts that mirror the decreases in the buyer’s stock price (30% to 70%).  Under these scenarios we expect to see some decrease in the number of deals that we have seen on a historical basis with valuations reduced 30% to 50%.  We do not expect to see a return to the 2002/2003 situation when technology M&A decelerated dramatically.

Quantitative Assessment
We reviewed, on a monthly basis, both the number of deals that have been completed (Graph 1) and average deal prices on announced deals (Graph 2).  This data was derived from Capital IQ for the Information Technology (“IT”) sector for the last 9 years.  Capital IQ’s Information Technology definition is quite expansive and includes a large majority of the high technology sectors.

M&A Transaction
Volume Graph 1 shows the number of M&A transactions that have been completed, by month, for all IT deals since the beginning of 2000.  The worldwide number of transactions is shown in blue and the deals that were done with US buyers are shown by the red line.

M&A Average Deal Value
Graph 2 shows the average deal value for reported IT transactions where 100% of a business was acquired.  Not all deals have reported transaction values and we can surmise that, in general, the smaller deals do not have the deal value reported and consequently the monthly values in Graph 2 are likely to be elevated.  Typically we see approximately 60% of transactions report deal values.  Certain months also show “spikes” in the average deal value.  This occurs when very large deals are completed.
Graph 2 is somewhat surprising to us in that we expected to see a decrease in average deal value for the last few months.  In fact, the average deal values for November and December have not fallen dramatically and are larger than about 50% of the reported months.

Future Reviews
Since the question of M&A climate and activity is currently a topic of interest, GrowthPoint plans to monitor the number of technology M&A transactions and the Average Deal Value as we progress through 2009. We send periodic updates supplemented with our first-hand experiences and commentary to our friends and colleagues.

Preparing for M&A
If you are considering a sale of a technology business, we like to remind potential sellers to anticipate a six to eight month process.  In addition, the more time you spend preparing and positioning your company for a sale, the better.  In the event that the buyers who have adopted a “wait and see” attitude aggressively re-enter the market, those who are prepared and are ready to go to market will enjoy a significant benefit.

Please feel free to contact us with comments or questions

Robert Horstmeyer
Managing Director

Mika Tanimoto
Analyst

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