M&A cools as IPOs heat up, but expect a rebound

The number of acquisitions involving venture-backed companies dipped in the first quarter of 2007, but industry observers say the downturn is unlikely to last, as M&A activity ramps up in hot sectors like interactive advertising and consumer Internet.

According to a report released last week by Thomson Financial and the National Venture Capital Association, M&A deals declined significantly in the first three months of 2007, with only 62 transactions completed, as compared to 104 in the first quarter of 2006. Of the completed deals with disclosed terms, the two largest—Currenex and St. Francis Medical Technologies—brought in $564 million and $525 million, respectively.

Venture returns from the deals also dipped. Deals bringing in the top returns—with disclosed values greater than 4x the venture investment—made up 50% of the total, down from 65% in Q4. In one bright spot, deals that returned less than the amount invested by VCs accounted for 25% of the total, an improvement from 28% of the total last quarter.

Top dogs

HarbourVest Partners and Polaris Venture Partners were rewarded with the top return in February when Laird Group bought Cushcraft Corp., which makes wireless LAN antennas. The purchase price was about $90 million—or more than 40 times the $2.2 million investment from HarbourVest and Polaris.

The M&A picture looks significantly brighter, however, after factoring in deals that were announced in the first quarter but have yet to formally close. These include Cisco Systems’ planned $830 million acquisition of network security provider IronPort and Microsoft’s purchase of voice-enabled search developer Tellme Networks, which has a rumored price tag of more than $800 million.

A growing appetite among investors for tech company IPOs also bodes well for exits of all types, says Kevin Harvey, a general partner at Benchmark Capital, one of the backers of Tellme.

“A strong IPO market always helps the M&A market,” Harvey wrote in an email to PE Week. “Having alternatives helps companies realize value.” He adds that he’s optimistic about prospects for acquisitions in the consumer Internet space, and sees the M&A market growing more active.

Media madness

Interactive media also promises to be a popular sector for transactions, says Scott Peters, managing director of The Jordan, Edmiston Group Inc. (JEGI), which provides investment banking services for media and information industry deals.

“Media M&A is certainly at a very frothy sort of pace right now,” Peters says, with activity fueled by the growth of Internet advertising revenues. He pointed to Reed Elsevier’s purchase of venture-backed online lead generation company BuyerZone, a deal that closed at the beginning of the year, as indicative of a broader trend involving big “old media” companies buying innovative new media players.

Buyers lined up

Another factor likely to boost M&A returns, Peters says, is the sheer volume of capital available to acquirers, including private equity and buyout funds. A few years ago, he says, lenders would typically issue debt equivalent to 4 or 5 times EBITDA of an acquisition target. Today that multiple can be as high as 7 times EBITDA, as competition among lenders and sharp revenue growth rates pushes valuations skyward. Those higher valuations, in turn, bring more sellers to market, further bolstering acquisition activity.

Corporations plan to spend more on M&A this year. That was the finding of the recent Duke University/CFO Business Outlook survey of 741 CFOs of global companies. About 40% of respondents said they expect to increase their deal-making activity, 53% expect their pace to be the same as last year, and only 7% say they will do fewer acquisitions than last year.

As for venture-backed companies, slower volume of completed deals in Q1 is counterbalanced by a rise in disclosed deal valuations. More than two-thirds of the companies acquired did not disclose sale prices. Of the 20 that did, the average deal size was $161.2 million, one of the highest quarters in the last five years, according to the NVCA.