Back to basics for PE

-Contact Thomas Rasmussen, Brenon Daly

Coming off a dealmaking binge fueled by cheap credit, private equity (PE) shops have been investing much more soberly since the debt market collapsed late last summer. Highly leveraged multibillion-dollar buyouts have gone the way of the collateralized derivatives. As financing has become much more expensive, PE shops have in turn become more price sensitive. Deals are much smaller and generally done with equity these days. The heyday of the PE buyout boom saw dollars spent on deals balloon from $56bn in 2005 to $98bn in 2006 before peaking at $118bn in 2007. Last year saw a drastic ‘normalization,’ with disclosed spending by PE firms falling three-quarters to just $26bn. Spending on buyouts has plummeted this year, with just $3bn worth of deals through the first five months of 2009.

Even as the aggregate value of LBOs has declined sharply, we would note that the volume remains steady. (The 90 PE deals announced so far this year is roughly in line with the totals for the same period in three of the past four years.) We might suggest that this indicates a return to basics for PE firms. Instead of bidding against each other in multibillion-dollar takeouts of smoothly running public companies, buyout firms are returning to more traditional targets: unloved, overlooked public companies as well as underperforming divisions of companies.

In terms of recent take-privates, we would point to Thoma Bravo’s pending $114m acquisition of Entrust, which valued the company at less than 1x sales. And looking at divestitures, we would highlight the recent buyout and subsequent sale of Autodesk’s struggling location-services business. Hale Capital Partners acquired the assets in February for a very small down payment and what we understand was a $10m backstop in case things went awry. New York City-based Hale Capital put the acquired property through a pretty serious restructuring. (The moves got the division running at what we understand was an EBITDA run-rate of $5m on approximately $20m in trailing sales.) Hale then sold the assets for $25m in cash and stock in mid-May to Telecommunications Systems following a competitive bidding process. Through the terms of the divestiture, Autodesk also had a small windfall in the sale of its former unit, pocketing an estimated $5m.

PE spending falls of a cliff

Year Average deal size (total known values/total deals)
2005 $218m
2006 $305m
2007 $395m
2008 $106m
2009 $26m

Source: The 451 M&A KnowledgeBase

Spring cleaning

Contact: Brenon Daly

For many tech companies, it’s time for a bit of spring cleaning. Specifically, there’s been a fair amount of sweeping out of corner offices. Last week saw Time Warner turn over the reins of its struggling AOL unit to a former Google sales executive. (Yes, we share the puzzlement around Tim Armstrong’s move.) Today, Internap Network Services got a fresh face at the top as wheeler-dealer Eric Cooney had his first day as chief executive at the beaten-down networking company. And in just two weeks, John Thompson ends a decade-long run as CEO of Symantec, turning over the security and storage giant to current COO Enrique Salem.

Amid all these moves, we wonder if the sweeping changes in companies’ executive suites will be accompanied by some sweeping out of companies’ portfolios. In the case of AOL, we’re pretty sure that the new appointment will hasten a sale of the unit. (My colleague Thomas Rasmussen noted last summer the concerning ‘lack of urgency’ at Time Warner over AOL, even as subscribers continued to plummet.) When Symantec announced last November that Salem would take the top spot, we speculated that NetBackup, Symantec’s backup and recovery unit, could find its way onto the auction block.

But what about today’s appointment at Internap? We wonder if the new leadership might not take a fresh approach to its underperforming content delivery network (CDN) unit. Internap’s big move into CDN came in October 2006, when it paid $217m in stock for VitalStream Holdings. Internap has acknowledged that it overpaid for the company, writing down a chunk of the purchase price.

And, as my colleague Jim Davis noted in a Tier1 report last week, the performance of Internap’s CDN business has lagged that of its rivals. In fact, Internap’s CDN unit has posted revenue declines for three straight quarters. We would hasten to add that the company’s just-appointed CEO has a solid M&A record behind him. In his previous post as head of Tandberg Television, Cooney oversaw a number of acquisitions before selling the company to Ericsson in early 2007. Could he be planning some dealmaking around Internap’s CDN business?

Paper trade

Contact: Brenon Daly

To get a sense of just how tough the M&A environment is right now, consider LookSmart’s divestiture Monday of online bookmarking property Furl. When we last spoke with the company a year ago, it was hoping to pocket a few million dollars for Furl. Instead, it ended up trading it for paper.

In return for giving up ownership of Furl, LookSmart scored an undisclosed slice of equity in privately held Diigo. (We would estimate that LookSmart picked up maybe 10-15% of Diigo, which offers online bookmarking and annotation services.) The outcome may not be as lucrative – or as liquid – as LookSmart had hoped, but at least it didn’t initially overpay for Furl. LookSmart handed over less than $1m in stock for the startup in the September 2004 acquisition.

The planned sale of Furl ran into trouble as some of the marquee social bookmarking deals foundered as the market became overcrowded. (We would point to Yahoo’s purchase of for an estimated $35m in December 2005 and eBay’s $75m acquisition of StumbleUpon in May 2007 as examples of deals that underperformed.) But mostly, the planned divestiture ran into a grizzly bear of a market. Over the past year, LookSmart itself has lost three-quarters of its market capitalization and is now valued on the Nasdaq at just half of the cash that it holds in the bank.

LookSmart slims

Divestiture Announced Market Deal value
Furl March 2009 Social bookmarking Traded for undisclosed amount of equity in privately held Diigo
Net Nanny January 2007 Web filtering Not disclosed
FindArticles November 2007 Information retrieval $20.5m

Source: The 451 M&A KnowledgeBase

Cutting the ties that bind

Contact: Brenon Daly

As the business prospects for this year continue to deteriorate, companies are increasingly looking to shed underperforming divisions. VeriSign, for example, has already divested two units so far this year and still has a handful of others on the block. As drawn-out and money-losing as divestitures can be, it’s almost always preferable to the alternative of actually hanging on to the struggling businesses. At least that’s the view from Wall Street, which rarely dings a company for pruning.

We’ve been thinking about this in recent weeks as we’ve seen the projections for PC sales in 2009 get pulled back again and again. The bearish outlook has caused most PC makers to overhaul their strategies for selling boxes. For instance, Lenovo has scaled back its expectations for selling PCs in Europe and North America, and will instead focus on its home Chinese market, particularly the rural sector. The shift essentially undercuts the need for IBM’s PC business, which Lenovo picked up four years ago. (IBM took payment for the divestiture in cash and stock, booking a pre-tax gain of about $1bn.)

Of course, it’s hard to know how that division would have fared if Big Blue hadn’t shed it. And, it’s virtually impossible to calculate how much of a drag PCs, which accounted for about 10% of IBM’s sales, would have been on the overall company’s performance. But consider this: Since IBM closed the divestiture in mid-2005, Dell shares, which stand as the closest proxy to the PC industry, have lost 75% of their value and are trading at their lowest level since 1997.

Divesting at any costs

Contact: Brenon Daly

We recently noted how VCs are having to settle for scrap sales as they go through a bit of portfolio clean-out. But, hey, at least the value destroyed in each of the companies is only in the tens of millions of dollars. Companies that have been recently cleaning out their own portfolios in the form of divestitures have been eating hundreds of millions of dollars. Even billions of dollars.

Last week, two companies were in the news for what we would consider ‘divest at any cost’ transactions. First up, Motorola unwound its two-year-old purchase of Good Technology. After paying about $500m in November 2006 for Good, we would guess that Motorola almost certainly received less than $50m in selling the mobile messaging infrastructure vendor to privately held Visto. (At least there was something left to sell. The same can’t be said of Intellisync, which Nokia bought three years ago for $354.3m but recently said it will be shuttering.)

More dramatically, Nortel Networks looks likely to pocket just two pennies for every $1,000 that it handed over for Alteon WebSystems in mid-2000. (Keep in mind, however, that Nortel paid the $7.8bn total is stock, not cash.) The bankrupt telecom equipment vendor has put Alteon on the block, and the reported frontrunner is Israel-based Radware, which has put forward a bid of some $14m. (Since Nortel filed for Chapter 11, Alteon is being sold under an auction process run by the bankruptcy court, and other bidders could emerge.) As a final thought on both the Motorola and pending Nortel divestitures, we would note that both castoff divisions are landing in other companies, rather than a buyout shop.

Divestitures and deal flow

Contact: Brenon Daly

Qualcomm’s recent pickup of graphics and multimedia assets cast off by Advanced Micro Devices continued a trend toward divestitures by major technology companies. Nokia, Verisign, Rackable Systems and Symantec, among others, all sold parts of their business in 2008. And, more specific to the chip industry, AMD’s rival Intel has done more selling than buying over the past three years. (For the record, AMD sold technology to Qualcomm that the wireless company had licensed for several years. Qualcomm will hand over $65m for the unit.)

We expect that more companies will look to sell off segments in 2009, as Wall Street increases the pressure on them to focus on their core business. (We have noted in the past that Symantec, which will have a change at the chief executive spot in April, is a prime candidate for further divestitures.) In 2008, spending on divested business units accounted for some 11% of all M&A activity. That’s up from just 7% in 2007. We wouldn’t be surprised at all to see divestiture spending remain in the double digits in 2009.

Unclipping Click Commerce

It turns out that software doesn’t really fit in a toolbox, after all. Illinois Tool Works, which reports third-quarter earnings Thursday, said recently that it plans to divest its Click Commerce division. (With the process just beginning, we don’t expect ITW to say much about the divestiture during tomorrow’s call.) The move would unwind ITW’s puzzling purchase two years ago of the supply chain management vendor. It paid $292m in cash for Click Commerce in September 2006.

ITW is a 96-year-old company that makes everything from commercial ovens to industrial packing tape to arc welders. It has inked more than 50 acquisitions during each of the past two years, spending about $1bn in 2007 and $1.7bn in 2006. And the company is on pace for a similar number of deals this year, having notched 26 buys in the first two quarters. Acquisitions are key for ITW, since the additional revenue picked up represents virtually the only growth at the company. In 2007, its core business expanded just 1.8%.

In announcing the divestiture, ITW indicated that Click Commerce had sales of $67m last year. (That was down slightly from the $74m the company posted in the four quarters prior to the acquisition.) And although ITW hasn’t broken out updated cash-flow figures for Click Commerce, the company has, historically, been a profitable operation. (In the two quarters leading up to the acquisition, Click Commerce had run at a solid 24% operating margin.) We suspect that any number of buyout firms – perhaps those that missed the sale of i2, another big supply chain management company – would be interested in taking a look at the book on Click Commerce.

Chipping away

It’s one down and (at least) one to go for AMD. The battered chip maker moved earlier this week to dump its digital TV (DTV) chip business to longtime partner Broadcom. AMD will pocket $193m in cash from the divestiture. Although the unit had been on the block for some time, AMD got a decent price for the cast-off. We understand the DTV unit was generating in the neighborhood of $150m in sales, meaning AMD got more than the typical ‘1x and done’ divestiture multiple. Further, we would note that the valuation of the DTV business at 1.3x sales is about twice AMD’s own price-to-sales valuation.

With one of the legacy ATI Technologies businesses off the books, AMD can move on to unwinding yet another part of that disastrous acquisition. (Since AMD spent $5.4bn in cash and stock on graphics chip company ATI two years ago, shares of the second-largest chipmaker for computers have plummeted 70%.) The next unit on the auction block: Processors for multimedia applications that run on mobile phones. Rival Intel made a similar move two years ago, selling its communications processor unit to Marvell Technology for $600m, which valued the unit at an estimated 1.5x sales. We suspect AMD would be perfectly happy with that kind of valuation in any divestiture of its mobile business. As to who might be on the other side of the deal, two companies come immediately to mind: Qualcomm is always on the lookout for more IP, and communications chipmaker Atheros has done three acquisitions in the past two years and is said to be looking for more.

UBS: You buy us?

As it reported an ‘unsatisfactory’ loss of hundreds of millions of dollars, UBS AG also said Tuesday that it will carve off its investment banking business. The move represents a retreat from the ‘universal bank’ model the Swiss giant has pursued. And despite management’s statements, it makes a sale of the banking unit more likely. (Just as Time Warner splitting AOL’s legacy Internet access division from its online advertising business clears the way for a sale of the dial-up unit. That is, if there are any AOL subscribers left to sell.)

Washed away by the gallons of red ink spilling from the investment banking department is that UBS actually has a fairly robust advisory business, particularly for transatlantic tech deals. In terms of deal value, it ranked fifth in our recent league tables covering transactions between North America and the EU from mid-2007 to mid-2008. The previous year, UBS placed fourth. (An executive summary of the report is available here; download the full report here.)

Far and away, UBS was the busiest bank, advising on 13 transatlantic transactions over the past year. Both Lehman Brothers and Deutsche Bank advised on eight transactions. And UBS has kept its momentum, already claiming another tombstone since we closed our survey period on June 30. (UBS served as sole adviser for IBM in its purchase of Paris-based ILOG for $340m.) But given how things stand now, the next big deal UBS advises on could be the sale of its own banking business.

Selected UBS-advised transatlantic deals

Date Acquirer Target Price
July 2008 IBM (sole UBS mandate) ILOG $340m
April 2008 Apax Partners TriZetto Group (sole UBS mandate) $1.4bn
Feb. 2008 Reed Elsevier (co-adviser UBS) ChoicePoint $4bn
April 2008 Diodes (sole UBS mandate) Zetex Semiconductors $176m

Source: The 451 M&A KnowledgeBase