Technology may be a dirty word among some private and public investors, but for those deal shops specializing in technology buyouts, others’ pain can be their gain.
Tech buyout enthusiasts say adjustments in the market are making valuations for “good” tech companies cheap and “great” tech companies cheaper. As a result, buyout pros are giddily sifting through the abundance of opportunities created by large technology corporations divesting non-strategic business units. They are also picking up fallen angels that were once the darlings of the Street but are now unwanted orphans.
Still, while the deal opportunities are showing up on GP radar screens, many firms are biding their time when it comes to closing transactions. After all, news from tech companies has turned from bad to worse lately, with layoff and missed projection announcements becoming common occurrences.
Gloom & Doom Makes for Tech Boom
For example, just last month, Hewlett-Packard Co., the maker of printers, computers and servers, announced it would cut 6,000 jobs from its worldwide workforce amid slumping consumer demand. In the same week, JDS Uniphase, a maker of fiber optic components, said it would shed 7,000 positions due to a drop in component orders by telecom equipment makers. In another sign of the times, fiber-optics giant Corning Inc., last month announced that it would close its aerospace plant in Scranton, Pa., resulting in the loss of 600 jobs.
As the buyout industry goes, bad times for some companies can mean a hey-day for investors. One buyout shop already taking advantage of the plight of the technology sector is Gores Technology Group, a Los Angeles-based firm headed by Alec Gores and specializing in turnaround plays. The firm in June agreed to purchase the neglected PC division of Micron Electronics, now called Micron PC, for an undisclosed amount and assuming $170 million of liabilities. At the same time, Gores Technology also agreed to purchase Hewlett-Packard’s VeriFone, a provider of electronic payment solutions to financial institutions, merchants and consumers, for an undisclosed amount.
David McGovern, an executive vice president at Gores Technology, says deal flow for the firm “remains strong” amid the technology slump and that the group is also “seeing a lot more [opportunities] in the hardware and telecom equipment” sector. “Given that we’re in the distressed business, there will be a continuous flow of opportunities for the rest of year,” he says.
Gores’ rival buyout firm, Platinum Equity LLC, which is headed by Alec Gores’ brother, Tom Gores, has also been busy scooping up technology assets. The firm recently made bets on the AMISYS 3000 and Pathways Managed Care product groups from the Information Technology Business of McKesson HBOC Inc. for an undisclosed amount (see story Platinum Gets Trio Tech). In addition, the group last month signed a definitive agreement to acquire Motorola’s Multiservice Networks Division for an undisclosed amount.
Meanwhile, long-time tech investor TA Associates has also been active in the sector. The group last month completed a $40 million investment in Ixion Technologies Inc., a provider of packaging services to satellite, aerospace and fiber optic communications manufacturers. “We have spent a lot of time in the communications area and have looked at opportunities such as component suppliers, contract manufacturers or other companies that have benefited from the growth of communications,” says Brian Conway, a managing director at TA Associates.
Conway adds that the firm is taking more of an interest in publicly traded technology companies suffering from depressed stock prices than a year ago when they were valued more highly in the public market.
Even a few buyout funds with a technology slant have had successful closings in an otherwise tough fund-raising market. Genstar Capital and Golden Gate Capital, both based in San Francisco, held final closings of $221 and $700 million respectively, this year.
Deal Flow Aplenty
Other less active firms say they’re seeing strong deal flow in the tech sector. “We’re seeing a lot of very interesting deals and are looking at subsidiaries of large technology companies, orphaned assets and undervalued but stable tech companies,” says Glenn Hutchins, co-founder of tech buyout giant Silver Lake Partners LLC. Last year, Silver Lake led the $2 billion blockbuster acquisition of computer disk drive maker Seagate Technologies Inc. “A lot of the value craziness is over,” he says.
Lindsay Hoover, a vice president in Houlihan, Lokey, Howard & Zukin‘s technology group, says tech companies’ Ebitda multiples of 14 to 15 times in the first half of 2000 have dropped off to a more moderate five times Ebitda in 2001. “Valuations are definitely off significantly,” she says.
Hoover adds that specialist buyout firms stand to benefit in this kind of environment. “When valuations go to a level where they are now, it gives financial buyers a leg up because strategic buyers, who are pre-occupied with problems of their own, aren’t able to outbid them to a certain degree,” she says.
Texas Pacific Group‘s Justin Chang says he thinks the opportunities for his firm lie in computer hardware, enterprise hardware, communications equipment, semiconductors, and electronic and optical components businesses. “Those are all of the areas we’re having a lot of interesting discussions in at the moment,” he says.
Chang adds that the firm has had “a lot of dialogue” with public companies whose stock prices have fallen dramatically from where they were a year ago.
Market observers say the opportunities of today stem from the mass exodus of generalist buyout funds swept up in the tech craze of the late 1990s, who were subsequently scorched by momentum bets on telecom service providers. This left room for tech specialists to pick and choose from a smorgasbord of opportunities.
One glaring example of tech investments gone wrong was Hicks, Muse, Tate & Furst‘s disastrous bets on ICG Communications, Rhythms NetConnections Inc., and Viatel Inc. last year. As a result, shares of each of these companies plummeted more than 50%, and ICG Communications and Rhythms Net later filed for bankruptcy.
“There were firms that didn’t have any experience in tech doing VC-type unlevered investing in telecom service PIPES because they were attracted to the growth, and they have largely been burned by those investments,” says TA Associates’ Conway.
However, despite the so-called abundance of tech deals out there, tech specialists have not necessarily been in a hurry to deploy their capital. This year, private equity buyout transactions have accounted for approximately 10% of all tech M&A deals, versus 8% a year ago, says Hoover, and that level of investing is expected to remain steady. “We talk to a lot of attorneys, funds and investors and I think it would be surprising for there to be a significant upturn before next year,” she adds.
These days GPs are taking a more deliberate approach to technology investing.
“In the past you used to be able to buy the market, but today you really have to know what you invest in,” Silver Lake’s Hutchins says.
TPG’s Chang says that firms employing focus and discipline as a part of their strategy in the current tech environment stand to benefit the most. “This is not the time when you want to be in a rush and get enthralled with momentum, growth or unproven businesses, and so at this point we’re being quite patient and disciplined in how we approach investment opportunities,” he says.