What Made Oak Fall So Hard For Divine? Just Ask Flip

Oak Investment Partners spent six months and made three bids before it could convince Divine Inc. (Nasdaq: DVIND) to accept $61 million in equity financing, says Divine’s chairman and chief executive officer.

The deal is the 11th largest private investment for public equity (PIPE) out of 390 PIPEs done this year and is unusually large for a venture capital firm, according to DirectPlacement Inc., a San Diego research firm that tracks PIPEs. Oak’s investment also signals continued growing interest among venture firms to troll for deals in the depressed public markets.

Oak first approached Divine last November. “This was the third time they submitted a term sheet to us,” explains Andrew “Flip” Filipowski, CEO of the enterprise software company, which emerged from the rubble of failed incubator Divine Interventures. “We turned them down the first two times. …I think they started out with an at-market [price], then they increased it to a 30% premium, then yesterday [May 29] to about a 50% premium.”

He adds that Divine had held talks with other venture houses including Battery Ventures, and that a competing term sheet had even been submitted.

Filipowski and famed investor Peter Lynch together plan to invest up to $14 million more in the next 30 days, for a total round of $75 million, Filipowski says. The additional investment by Filipowski and Lynch is subject to shareholder approval.

Divine expects to be profitable by the fourth quarter and have in excess of $200 million in cash at the end of the year. It made more sense to do a PIPE than try a secondary, since the public markets are so unstable right now, Filipowski says.

Oak is putting up the entire $61 million investment, Filipowski says, contrary to a company press release that states that the amount is coming from “a group led by Oak Investment Partners.”

Why would Oak take such a large stake – when the average PIPE is $10 million to $30 million? “Obviously Oak sees some value in the stock that the rest of the market isn’t seeing,” says Robert Kyle, executive vice president of DirectPlacement. “And they have a better look at the inside of the company than the rest of the market.”

Under the agreement, Oak will buy $23 million in convertible preferred Divine stock immediately. The shares will be converted into common stock at a price of $6 per share. Oak will buy $38 million more in convertible preferred stock after Divine’s stockholders approve the second purchase in a vote scheduled for July 31. After the second tranche, Oak will get warrants for $9.5 million in Divine common stock.

Oak gets two board seats under the deal. It has agreed not to sell its shares for one year.

News of the Oak investment drove up Divine’s stock price 23% to $5.12 on May 30.

Out Of Step?

The Oak deal is a little surprising on two counts, says Jesse Reyes, vice president of Venture Economics, publisher of Private Equity Week. First, “They’re buying into a market that’s trending downward,” he says. Second, it’s “unusual” for one private equity investor to put up such a large amount of money; it would be more typical for three investors to put up $25 million each (for the total amount Divine is raising), he says. In fact, that’s exactly what Oak did on May 16 when it pumped $20 million into a $45 million PIPE for Wireless Facilities Inc. (Nasdaq: WFII).

Reyes adds that Filipowski’s comments about Oak’s zeal for the deal don’t jibe with the market environment. The reason that more venture firms are considering PIPEs is because they’re able to buy into companies at very favorable valuations, he notes.

Oak’s partners, who were in an annual meeting May 30, could not be reached for comment.

Oak’s venture into PIPEs is part of a growing trend among venture firms, which have lots of cash but can’t take on many new investments because of bloated portfolios. Besides Oak, other VCs that have done PIPEs in the past seven months include General Atlantic Partners, Sutter Hill Ventures and Technology Crossover Ventures.

“The trend is going to continue for VCs to get more involved in the PIPE market,” Kyle says. “Valuations are getting more attractive as the market gets killed. Plus, you have the added benefit of the fact that the stock is more liquid.”

Instead of waiting two to five years to take a company public or sell it, a VC can sell the stock it purchases through a PIPE in three to six months, on average.

Filipowski, not known to mince words, puts it this way: “You have to be a candidate for a lobotomy to do venture capital.” He says that Oak partner Fred Harman has indicated that the firm is more inclined to do “special situations” rather than straight VC deals right now. Harman could not be reached for comment.

Preliminary data shows that the number of PIPEs has actually fallen substantially in the second quarter to 144 deals worth $1.9 billion from 246 deals worth $5.4 billion in Q1, according to PlacementTracker.com, a PIPE tracking service owned by DirectPlacement. The number of Q1 deals was down slightly from Q4, but the value of the deals was $160 million greater, coming in at $5.6 billion. And while there were 21 fewer PIPEs done in Q1 of this year vs. Q1 of 2001, the value of the deals more than doubled, according to PlacementTracker.com.

Contact Lawrence Aragon at: Lawrence.Aragon@tfn.com