SAN FRANCISCO – A growing number of early-stage venture-backed companies are passing up the Holy Grail of an initial public offering in favor of lucrative merger offers from their newly public and richly valued Internet brethren.
Recent announcements of three high profile deals – Digital Island Inc.’s purchase of Sandpiper Networks Inc., Excite@Home Corp.’s acquisition of Blue Mountain Arts Inc. and Stamps.com Inc.’s purchase of iShip.com Inc. – illustrate the extent to which public Internet companies are feeding on still-private firms to speed development, acquire management expertise and augment content.
Of the 803 companies that have gone public since the beginning of 1998, about one-fourth subsequently have acquired private concerns, according to Thomson Financial Securities Data. While more than half of the 214 targets were too small to complete the IPO process any time soon, the rate at which these companies are accepting acquisition offers is reducing the ranks of future IPO candidates.
Sandpiper Networks had already chosen Goldman Sachs & Co. to underwrite its planned IPO. But instead, the investment bank found itself on the sidelines as Credit Suisse First Boston advised Sandpiper on the company’s acquisition by Digital Island, which initially valued Sandpiper at about $630 million. By the time the market finished driving up Digital Island’s shares following the deal’s announcement, the 27.4 million Digital Island shares that Sandpiper received were worth $1.81 billion. Although the companies didn’t disclose financial details about Sandpiper, venture capital sources said that its sales are below the $3.7 million that Digital Island generated in its fiscal third quarter ended June 30.
“For Sandpiper, this is essentially their IPO,” said Frank Drazka, head of the technology group at PaineWebber. “It’s indicative of some things that we’re seeing on the horizon.”
Like almost all Web-based companies, Sandpiper competes in an industry niche – replicating frequently requested content on many different parts of the Internet – that is still taking shape. “There’s such a race to be first, to be thought of as a comprehensive provider, that companies are willing to forgo an interim IPO to attempt to achieve that status,” said Jim Crystal, managing director in the telecommunications group at Bear, Stearns & Co., lead manager for Digital Island’s June IPO and its adviser in the acquisition.
Public Markets Show Mixed Reaction
But while the market applauded Digital Island for its deal, other Internet companies have been punished for paying what the market sees as too high a price to acquire private targets. For example, after Excite@Home agreed Oct. 25 to pay up to $1 billion in stock and cash for Bluemountainarts.com, a heavily trafficked Internet property, its stock tumbled 5.4% to a close of 36 15/16 on Oct. 28, although the stock has rebounded some to $38.9375.
While PaineWebber’s Drazka said that the jury is still out on whether Excite@Home overpaid, there’s little doubt that the deal was a coup for Bluemountainarts. “The question is, what is their long-term sustainability?” he asked. Bluemountain’s market of free electronic greeting cards has become considerably more crowded, with traditional heavyweights American Greetings Corp. and Hallmark Cards Inc. both entering the fray in recent weeks.
The question of sustainability lies at the core of the scramble among Internet companies for audience, content and technology. Just as it is for companies in the IPO process, the yardstick used to value Internet properties in an M&A environment is far from established, increasing both the risk and rewards for acquirers.
For example, Stamps.com, looking to gain an edge over rival eStamps.com Corp. in the online stamp-selling business, recently used eight million shares of its newly minted stock to acquire iShip.com, which itself was on course for a public offering. The deal valued iShip.com at $406.3 million, 35.4% more than the company’s $300 million target.
Indeed, Internet companies as divergent as community operators Xoom.com Inc. and EarthWeb Inc. and e-mail outsourcers Mail.com Inc. and Critical Path Software Inc. have used inflated share prices to cherry pick the private markets. Given the powerful currency such companies wield, there’s every reason to think that this trend will continue.