At his firm’s annual investor conference last month, Tom Hicks, chairman and chief executive of buyout giant Hicks, Muse, Tate, and Furst, offered something of a mea culpa. Standing in front of about 350 attendees, he promised not to make any more rash investments in areas like technology and telecommunications. After all, his firm, as well as other well-known buyout funds like Forstmann Little & Co. and Kohlberg Kravis Roberts & Co., had lost billions of dollars in the tech sector. From now on “we are toeing the line” and investing in food and media companies, Hicks was quoted as saying.
His timing may prove to be terrible. A growing number of people in the buyout industry believe that now is exactly the time to be purchasing technology companies. “Technology is ripe for buyout activity,” says David Mussafer, managing director of Advent International, a buyout firm with $1.9 billion actively under management. “As we look out, we’re starting to see more attractive opportunities than we’ve seen in the last 15 years.” That’s largely because the correction has been so deep in the tech industry that there are many interesting companies that can be acquired at very attractive valuations. “We are seriously looking at two deals in the pipeline right now that fall exactly in that category,” says Mussafer. “The next three years promise to be a lot better than the last three years when it comes to tech buyouts.”
Tech buyouts look a lot different these days than they did at the peak of the bubble, when firms were pouring a massive mixture of debt and equity into capital-intensive companies like telecom providers XO Communications Inc. and ICG Communications Inc. These firms often had negative cash flow, an unstable customer base and unproven technologies. Today, the goal is not to invest in the company with the latest optical switch or greatest whiz-bang gadget, but in companies with mature technologies and steady, incremental growth potential.
This was clearly the model followed by buyout firms Silver Lake Partners and Texas Pacific Group. Two years ago, when Internet deals were still all the rage, these investors executed a bold $2 billion purchase of old-school disk-drive maker Seagate Technologies Holdings. Now the buyout firms are about to be rewarded for their foresight. Seagate has regained the top spot in the disk-drive market for desktop PCs and has tripled its net income to $110 million from a year earlier. Despite a near-dormant IPO market, Seagate has filed to go public and many believe Silver Lake and Texas Pacific stand to triple their money.
Other firms are now trying to follow a similar model when it comes to technology deals. “We won’t invest in technology for technology’s sake,” says Patrick Blandford, a principal with Frontenac Co., a buyout firm with $600 million currently under management. “We look for technologies that can solve business problems and can provide operating leverage.”
True to form, Frontenac participated in $25 million buyout of 3E Co. at the end of October. 3E provides outsourced information management services related to the handling, storage and disposal of hazardous materials.
The buyout industry as a whole is experiencing something of a resurgence. Buyout firms closed an impressive 54 deals totaling $10.8 billion in the third quarter, compared with less than half that amount in the year-ago period. And on the fundraising side, 14 buyout firms raised some $5.5 billion in the third quarter, or more than double the amount from the previous quarter, according to Venture Economics (publisher of PE Week).
Technology deals are playing a greater role in the overall upswing. One reason is that prices are becoming more and more attractive each day. Sellers who were quietly anticipating a market rebound have grown tired of waiting and are now ready to accept lower valuations. Meanwhile, large publicly traded technology companies are eager to shed non-core units to erase debt and bulk up their anemic coffers. Technology buyouts make sense for yet another reason: “There are about 150 tech companies with more than $50 million in the bank trading below net cash,” says one buyout specialist who asked not to be identified. “Most of these companies went public during the bubble and now would rather be taken private. We see a real chance to pick and choose from the best of this crop.”
Despite a raft of new opportunities, most mainstream buyout funds are returning to basics and shunning any and all technology deals. That leaves the sector wide open to a handful of tech specialists like Silver Lake Partners, Francisco Partners, and Golden Gate Capital, as well as a number of brave mainstream firms like Texas Pacific and Advent that still believe in technology and are not intimidated by complex products or rapidly changing markets.
These players are now shifting into overdrive. After not doing a single deal in all of 2001, Francisco Partners has bounced back in 2002 with three deals totaling about $1 billion. Golden Gate Capital has completed eight buyouts in the last 15 months. And Roger McNamee, a founding partner of Silver Lake Partners, says he has seen more compelling ideas in last few months than the past few years combined. “In 2000, we told our investors we would focus internally and optimize the investments we already made,” says McNamee. “Toward the end of this year, we went back to investors and said that several circumstances, such as the prolonged bear market, have combined to make lots of new investments possible.”
Still, there are few obstacles preventing a wild upsurge in technology deals. The biggest roadblock is the lending environment. To most major banks, technology is still a four-letter word. As such, lending institutions are extremely hesitant to provide the leverage, or debt, needed to complete many of these deals. “Banks love the more mundane companies, but they hate technology companies,” says John Lutsi, a general partner with Morgenthaler’s buyout group.
He makes a good point. In September, Francisco Partner’s $800 million acquisition of General Electric Co.’s Internet unit, Global eXchange Services, reportedly almost hit the skids when investment bank Credit Suisse First Boston balked on its commitment to lend $235 million. The deal was finally saved when another GE unit, GE Commercial Finance, stepped in and bought the bonds in place of CSFB.
Another big question mark, of course, is timing. Though it feels like we’ve hit the bottom of the market, many buyout specialists are not fully convinced. They don’t want to jump in prematurely and pick up distressed assets just to watch them fall even further in price a few months down the road. Still, for those who have the stomach, technology just may be the best place to play these days.
This story was reprinted with permission of Investment Dealers’ Digest.