Management buyouts have traditionally been viewed as transactions involving enterprises in mature sectors with relatively low investment needs. Increased performance following buyouts has also often been attributed to rationalisation and restructuring. As the buyout market has become more competitive, private equity players have had to seek deals offering increased returns through growth. In this environment, buyouts in high technology sectors have emerged as an important part of the market. Developments in high technology buyouts in the UK, US, and Europe are examined in this article.
The UK venture capital industry has recently seen a sharp increase in investments in high technology companies. According to the BVCA, 1999 saw a 55 per cent increase in the value of venture capital investment in this sector. Management buyouts (MBO) and buy-ins (MBI) represented the largest share of the value of this high technology investment at 41.2 per cent of the GBP1.1 billion invested (Fig. 1). However, MBOs and MBIs accounted for only 14.2 per cent of the number of investments in high technology.
CMBOR’s own monitoring of this sector over the past decade shows that the total number of buyouts in high technology sectors has shown notable growth over the past four years, especially in 1997 and 1999 (Table 1). In 1999 a tenth of all deals were in technology sectors. Although attracting little attention, buyouts have been undertaken in technology sectors such as computer software and telecommunications over the past decade. While significant numbers of deals continue to be completed in these sectors, recent years have seen marked activity in computer services, biotechnology, Internet technology and medical-pharmaceutical sectors.
A record value for technology buyouts was achieved in 1999 when nearly GBP1 billion (GBP947 million) worth of transactions was completed (Table 2). This amounted to 5.6 per cent of the total buyout market value.
Notable technology deals in computer software so far in 2000 include Sanderson Group (GBP115 million), Smartstream (GBP82 million), Instem Computer Systems (GBP31 million) and Q Group (GBP27 million). E-commerce deals have tended to be smaller and include McClaren Consulting, The Net Imperative, Thinkdigital Solutions and Ask-technologies.com. In the biotechnology sector, Oxoid Holdings was bought out for GBP112 million. In telecommunications, notable deals include Alpha Telecom (GBP20 million), Storm Telecom, F H Brown Office Technologies and Europacom.net.
In continental Europe, 1999 was also a record year for the number of transactions involving buyouts in high technology sectors, with 53 completions (Table 3). This was half as great again as the number recorded the previous year, which had also been a record.
The value of technology based buyouts in continental Europe has surged dramatically in the past three years, with e2 billion worth of deals completed in 1998 (Table 4). Following a drop to e1.8 billion worth of transactions last year, the year 2000 to date has already seen a remarkable e5.6 billion of technology based buyouts. Larger deals have been especially noticeable in the telecommunications and medical pharmaceutical sectors.
The German market has been boosted this year by several big-ticket divestment transactions in the telecommunication and electronics sectors. Among the more noteworthy of these was the sale of the Bosch Telecom Private Networks Division in January 2000 to a management team backed by Kohlberg Kravis Roberts in a transaction valued at approximately DM720 million. Senior debt for this transaction was provided by Credit Suisse First Boston and Salomon Smith Barney. In February an international equity syndicate, led by the international communications, development and operating company Callahan Associates International, acquired a 55 per cent stake in the North Rhine Westfalia telecommunications network from Deutsche Telekom. The transaction value for the 55 per cent stake is estimated at around DM4 billion. The debt providers for this transaction included Salomon Smith Barney, Bank of America and Dresdner Kleinwort Benson.
Three of the main buyouts in Italy in 2000 represent divestments in technology industries: I&T from Pasqualino, Agora from Partitio Radicale, and Italtel from Telecom Italia. Clayton, Dubilier and Rice led the buyout of 81 per cent of Italtel’s equity for e857 million. Italtel is the telecom equipment unit of Telecom Italia. Other syndicate members included Advent International and Brera Capital, along with Cisco Systems. The deal is expected to receive regulatory approval in the third quarter. Further notable telecommunications buyouts this year include Telnet group in Belgium and Export Telecom in France.
In Denmark, the Internet service provider Cybercity was a e41 million buyout while in Spain the e-commerce business Euroconsulting Informatica was bought out for e4 million. In the pharmaceutical sector, Spain also saw the e1.3 million buyout of Software de Medicina.
Technology buyouts in the US had a low profile following the failed buyout in 1989 of minicomputer manufacturer Prime Computers. Occasional deals were subsequently completed such as Kemet Electronics (1990), Spectra Diode Labs (1992) and Berg Electronics (1993) and Qunitus Corp (1995). The last five years have seen something of a resurgence in US technology buyouts, with notable deals in the semiconductor sector in particular – see table 5.
It has been estimated that over $14 billion was raised in 1999 for investment in technology buyouts, with the trend continuing into this year. A search carried out by CMBOR identified over 25 firms active or interested in the technology buyout market. One of the most highly publicised fund raising efforts for this sector was by the newly established Silver Lake Partners which raised $2.2 billion for a first time fund after setting out to raise less than half that amount. Silver Lake aims to invest the fund in between 10 and 15 transactions over the life of the fund.
Among the more experienced traditional buyout players, Texas Pacific Group announced in 1999 that it had earmarked $2 billion for technology deals, planning to complete four to six transactions per year. At the beginning of 2000, the buyout firm Thomas Weisel Partners closed its debut technology-focused buyout fund at $1.3 billion. Hicks, Muse, Tate & Furst has also launched its first new economy fund targeted to raise $1.5 billion to $2 billion. The Blackstone Group, an established LBO fund has launched a telecommunications fund with a target of $2 billion. One of the longest established players in technology buyouts has been Sprout, which led the 1988 buyout of Norand, an underperforming division of Pioneer Hi-Bred. Since then, its technology deals include Spectra Diode Labs, Quintus Corp, Comm Vault Systems, Viewlogic Systems and, in conjunction with TPG, Paradyne Networks and Globespan. Other venture capital and buyout firms active in technology buyouts include Citicorp VC, Francisco Partners, Fox Paine, CDR and Summit.
Investors in this segment of the market recognise the unique demands of investing in technology deals, but different approaches are discernible. Recruitment of financiers with technology expertise is seen to be crucial. Silver Lake has assembled a team that includes three partners with extensive backgrounds in technology investing and one with buyout experience. TPG, as a more experienced buyout player moving into technology deals, has a balance of partners with more buyout than technology expertise but has recruited venture capitalists with technology expertise.
In addition to hiring investment executives with technology expertise, both Silver Lake and TPG utilise partnerships with other private equity and venture capital firms to augment their position in the market. Silver Lake is closely affiliated with the technology-focused venture capital firm Integral Partners. TPG has sought the advice of both venture capital firms and the management of its existing technology based investments to analyse potential deals.
Non-core divisions of large technology companies are seen as offering major divestment opportunities for buyouts. For example, the semiconductor manufacturer Intersil was bought out from Harris in 1999. Under-performing technology based public companies or venture-backed deals, sometimes referred to as “Busted Techs” also offer prospects for buyouts. Some players, such as TPG appear to be targeting companies with turnaround potential with the aim of making efficiency gains. For example, TPG led the buyout of Zilog in 1998, with the turned around company announcing that it planned an IPO in the near future. Others, such as Silver Lake, stress their desire to identify technology businesses with unrealised growth potential.
One of the most notable technology based buyout deals in the US to date involves Seagate Technology. Seagate designs, manufactures and markets products for storage, retrieval and management of data on computer and data communications. Seagate, founded in 1979, is the world’s largest manufacturer of disc drives and disc drive components, magnetic discs and read-write heads and a leading developer of business intelligence software. Seagate was hit particularly hard by the downturn in the high technology industry in the late 1990s. The recovery in profits in 1999 came only minimally from rationalised operations and it was predominantly a result of a gain related to the sale of part of the software division to Veritas, which was paid for in Veritas shares. The subsequent increase in Veritas share value meant that by March 2000 Seagate’s stake in Veritas was worth more than Seagate itself. However, none of its investment in Veritas was reflected in its own market capitalisation. Seagate needed to find a way to let its own shareholders benefit from the wealth increase in a tax efficient manner. Silver Lake Partners proposed a complicated buyout arrangement to address this problem. The taking private nature of the buyout was also held to enable Seagate to pursue more aggressive strategies involving investing in new technologies, which received negative reactions when the company was listed.
The transaction was effected in two nearly simultaneous steps. In the first step, a new private company, Suez Acquisition Company would purchase all of Seagate’s assets and liabilities for cash, excluding its holdings in Veritas Software and other specialist storage companies. The new private company would assume the name Seagate Technology, and a new board of directors would be formed, consisting of Seagate executive management members, members of the investor group, and new outside directors.
Immediately following step one, Veritas Software would acquire the remaining assets of Seagate through a merger agreement, which would include the cash proceeds from the buyout transaction. In addition, Veritas would issue approximately 109.3 million Veritas shares to Seagate shareholders for a price representing a 26 per cent premium over the 30-day average share price, and the transaction would be structured such that the issuance of Veritas shares would be tax-free to the Seagate shareholders. The purchase price will be funded with half equity and half debt, and Seagate would emerge from the buyout with $800 million in working capital as a cushion against downturns. Veritas will pay approximately $18 billion in stock and cash for what is estimated to be $20 billion worth of securities. Currently Seagate officials are awaiting approval from the SEC for the deal to proceed. The transaction will then require approval from both Seagate and Veritas shareholders. At present there is some disagreement about whether the offer represents a fair price to existing Seagate shareholders, with lawsuits being filed alleging that directors broke their fiduciary duties.
Recent technology deals in the US have already seen a significant level of exit activity. Paradyne, Globespan, On Semiconductor, Intersil, E-Tek Dynamics and Spectra Diode Labs were all subsequently floated on the stock market. Spectra Diode Labs and E-Tek Dynamics were later acquired by JDS Uniphase. Viewlogic Systems was sold earlier this year.
The prospects for growth in technology sector buyouts are certainly becoming more favourable. Over the last 12 months a number of US and UK funds have been raised, which have been specifically targeted at this market. The number of US players developing a European presence has also increased.
One of the key questions concerns pricing, especially involving technology buyouts of companies that have run into problems. Are the problems down to sectoral problems, poor management or poor products that are being left behind by technological advances? Financiers may need to be sure that entrepreneurs with the requisite skills and appropriate incentives are in place where there is a need for further technological innovation. Alternatively, they may need to be clear that adequate returns are achievable without being eroded by new technology where the company is moving into a more mature phase. There may thus be a need for financiers to ensure they have the appropriate technical skills to appraise, structure, and subsequently monitor these deals.
This need has been behind changes to traditional modes of operation by buyout players, such as the creation of new specialists in this sector, the recruitment of technology specialists by mainstream buyout players and the development of alliances between buyout players and venture capital firms. The need to focus on growth possibilities is emphasised given the recent adjustment to the ratings of technology-based stocks and which has implications for exit valuations of buyouts in this sector.
Despite the potential problem, there is no question that the technology sector profile has increased since the launch of the Techmark index in the autumn of 1999. A recent study carried out by CMBOR of 58 UK venture capitalists revealed that 25 percent of all proposals received are for technology-based companies. Almost three-quarters of respondents indicated that they had invested in technology-based companies in 1999, compared to only 42 per cent of respondents to a similar survey in 1991. Furthermore over 85 per cent of the VC companies surveyed in 1999 indicated that they would probably invest in technology-based companies in the following year. Given the developments also taking place in continental Europe and the US, the medium term prospects for technology buyouts appear to be positive.
The Centre for Management Buy-out Research is sponsored by Barclays Private Equity and Deloitte & Touche at Nottingham University Business School.
N.B. For copies of all tables referred to in this article please call evcj subscription line on 0207 369 7000. Or, refer to page 12 onwards of your Dec/ Jan 2001 copy of evcj magazine.