ebMD Inc. was just a step away from going public last summer when something better came along: Healtheon Corp. offered to buy it out.
Deciding to forgo an initial public offering might have been an unlikely scenario just a few years ago. But it is more common in this age of proliferating high-tech companies, where being acquired by a bigger, more established market leader can be an equal, if not, more attractive exit strategy.
Certainly, M&A activity among venture-backed companies is nothing new. But the sheer number of such deals last year was extraordinary, thanks to the stock performance of information technology companies – particularly those Internet-related.
“Historically, it has been far better to take a company public, but given the current valuations in the market [for acquirers], there may be circumstances where it’s better to sell and get liquidity faster,” says Jake Reynolds, a general partner at Technology Crossover Ventures.
In the case of WebMD, an aggregator of physicians and consumers on the Web, the company had already filed to go public when it pulled the plug at the eleventh hour. And the reason was simple: Healtheon was a leading brand name in the e-health space and complemented WebMD with a strong subscriber base and a focus on the back-office side of business. Also appealing was the $7.86 billion price tag, the largest venture-backed acquisition last year – not exactly something to thumb your nose at.
As a result of the merger, Healtheon/WebMD is now credited as the only company that connects the entire health-care community of physicians, consumers, hospitals, insurers and employers, says Jim Mann, managing director of PTEKVentures, one of WebMD’s earliest venture backers.
“At the end of the day, they just saw more potential value for their shareholders by being part of the larger Healtheon/WebMD organization, as opposed to just being WebMD,” he adds.
There is no doubt that VCs and entrepreneurs alike still prefer to exit through an IPO, especially given the high valuations ascribed to certain public IT companies. Besides, going public is considered the ultimate validation of a company’s business strategy. But now tech entrepreneurs – especially those with one or two companies already under their belts – are increasingly drawn to acquirers willing to pay top dollar to eliminate competition or fill holes in their business strategies. Even more important than dollar signs, however, is that a dominant market player can provide a smaller company with a host of “intangibles” such as breadth of experience, a proven track record and a major head start in their respective businesses.
Proof in the Numbers
As a result, tech companies once again led the venture-backed M&A market last year, with the top 10 deals in terms of dollar size being dominated by Internet-related companies, according to Venture Economics. Apart from WebMD, top deals included Lucent Technologies’ $896 million purchase of Nextabit Network, a developer of technology to support massive volumes of Internet traffic, and Digital Island’s $826 million acquisition of Sandpiper Networks, a developer of software that delivers inexpensive bandwidth to Web publishers.
In fact, of the record 210 venture-backed acquisitions in 1999 – representing an aggregate value of $35.3 billion – 71 were Internet-related, of which 25 were Internet software developers. Indeed, IT companies were also the driving force behind skyrocketing valuations, with the average purchase price for venture-backed companies at $148 million in 1999, up from $73 million in 1998 and $66 million in 1997.
“It certainly feels like the pace of technology M&A has accelerated over the last six months,” Reynolds says. “The valuations that the markets have put on these companies have made them able to go out and pay significant premiums for private companies.”
To give a broader perspective, the explosion of the Internet has led to a dramatic increase in the number of M&A deals globally, as mature companies scrambled to cement their business models. The value of M&A transactions worldwide in the IT, communications and media sectors mushroomed by 154% to more than $1.2 trillion in 1999, with the total number of those deals rising nearly 26% to 6,008, according to a report by Broadview Holdings LLP, an M&A investment bank.
“The question for both emerging and established companies isn’t whether to have an Internet strategy, it’s choosing how to achieve significant presence and scale on the Internet as rapidly as possible,” says Paul Deninger, Broadview’s CEO.
Moving Toward Codependency
Unlike the past, when a lackluster IPO market usually meant a rise in M&A, today both liquidity events are stronger than ever. Venture-backed IPOs made a dramatic comeback last year, with 269 companies entering the public market, more than three times the 77 companies in 1998 and just shy of the record-breaking 280 recorded in 1996 (VCJ, February, page 40). In fact, a strong IPO market in this technology-driven era has a direct impact on a surge in M&A, says David Cowan, a managing partner at Bessemer Venture Partners.
“The market often values [newly public companies] highly enough that they can execute very bold missions by acquiring technology and sales and marketing capacity from smaller companies,” he says. “These companies have to acquire in order to meet the growth expectations of public investors.”
VeriSign Inc. acquired one of Cowan’s portfolio companies, Network Solutions Inc., for $21 billion in early March. Both had been business partners for years and decided to combine Network Solution’s exclusive registry of Internet domain names with VeriSign, a provider of secure online infrastructure, to build a stronger company, Cowan says.
When it comes to M&A, it’s big companies with high stock prices that are most eager to use their stock as currency to buy related businesses. What drives such deals is appetite on the buyer’s side, and if a company opts to take the IPO route instead, there’s always more than a handful of similar companies eager to be acquired, Cowan says. Meanwhile, sellers can gain higher valuations for their businesses if they have the option of going public, but must be compensated for being acquired.
Big tech companies weren’t that discriminating last year, snatching a host of venture-backed enterprises ranging from Internet content providers to infrastructure to business-to-business and business-to-consumer e-commerce sites. And with the ongoing popularity of tech stocks in the public markets, it should be no surprise if venture-backed tech-related acquisitions remain in favor, at least for the near future.
“Any time you see companies in highly competitive markets with very high stock prices and lots of other companies out there with unique technologies that they can exploit, you’re going to see a lot of consolidation,” says TCV’s Reynolds.
TCV, which invests in Internet, infrastructure, applications and services companies, historically sees about 75% of its portfolio companies exit through an IPO and the remainder through acquisitions. In the last six months, however, that figure has shifted to 50%/50%.
“There are so many public companies today that have leadership positions in their market and far greater resources that it almost makes sense to combine the two entities, rather than trying to take one public even though you know the company could be successful on its own,” he says.
The firm, in the midst of investing its $1.25 billion-targeted TCV IV (story, page 18), still feels it’s best to build companies with solid management teams, strong products and stable balance sheets, with the assumption they will one day go public. Later down the road, the company will still have the option of choosing its liquidity event, Reynolds says.
Solect Technology Group Inc., a provider of Internet protocol billing systems to a range of service providers, was about to enter the public market when Amdocs Ltd. approached it to team up against its formidable competitor, Portal Software, Reynolds explains. Amdocs had a similar market cap to Portal, a great market presence and a strong customer base, but lacked the services that Solect had to offer.
“While Solect would have been a very strong public independent company, the combination of Amdocs and Solect just made so much sense to compete with Portal Software,” he says. The $1.35 billion acquisition closed in early March.
Weighing the pros and cons of a particular exit from various standpoints, however, is not always that easy. There are strong upsides to both choices, and unlike the past, returns from both liquidity events can be equally rewarding. An entrepreneur can sell a company for an attractive price, which might result in additional stock appreciation following the acquisition. And while taking a company public could lead to extraordinary financial gains, poor timing could also prove disastrous.
A VC must consider that it can take up to two years to completely exit his position in a company following an IPO. With an M&A, however, the VC can gain liquidity as early as two months after an investment, depending on the size of the buyer, the number of shares involved and how the deal was structured.
On the buyer’s side, a merger can be faster and cheaper than trying to broaden a product line through internal research and development.
Of the nine companies in PTEK’s portfolio, the two that have held liquidity events so far have chosen to be acquired, says Mann, who expects the balance to be evenly split between IPOs and mergers.
“It’s going to be a big M&A year in the whole space because of people’s need to continue to grow and because there are a lot of great companies out there being formed,” he says. But of course, that will depend on whether public technology stocks continue to lead the market.
Venture-Backed M&A 1999
Total Value Average Deal
Industry # of Co’s ($mil) Value ($mil)
Biotechnology 10 633.19 79.15
Communications 31 12,771.57 532.15
Computer Hardware 9 726.86 103.84
Computer Software and Services 58 3,880.83 102.13
Consumer Related 15 980.25 122.53
Industrial/Energy 13 422.50 60.36
Internet Specific 28 12,718.49 508.74
Medical/Health 14 581.70 64.63
Other Products 23 1,211.30 110.12
Semiconductors/Other Elect. 9 1,316.10 219.35
Totals 210 35,242.79
Source: Venture Economics
Top 30 VC-Backed M&A Deals 1999
Target Acquirer ($mil) Deal Value
WebMD Inc. Healtheon Corp. 7,865.30
Cerent Corp. Cisco Systems Inc. 6,862.50
Nexabit Networks, Inc Lucent Technologies Inc. 896.00
Sandpiper Networks Inc. Digital Island 826.66
WNP Communications Corp. Telecommunication Nevada LLC 695.00
BabyCenter eToys 652.00
I-Cube Inc. Razorfish Inc 611.05
NetCore Systems Inc. Tellabs Inc. 575.00
Lightera Networks Inc. Ciena Corp. 552.34
Monterey Networks Cisco Systems Inc. 500.96
IPivot Inc. Intel Corp. 500.00
Favorite Brands International Inc. Nabisco Inc. 475.00
Torrent Networking Technologies Corp. LM Ericsson Telefon AB 450.00
Telogy Networks Inc. Texas Instruments Inc. 437.16
Omnia Communications Inc. Ciena Corp. 429.00
U.S. Bioscience Inc. MedImmune Inc. 418.87
Abrizio Inc. PMC-Sierra Inc. 415.62
Assured Access Technology Inc. Alcatel SA 350.00
ConvergeNet Inc. Dell Computer Corp. 340.69
Shasta Networks Inc. Northern Telecom Ltd. 340.00
WebLine Communications Corp. Cisco Systems Inc. 325.00
Epigram Inc. Broadcom Corp 316.25
Castle Networks Inc. Siemens AG 300.00
Andromedia Inc. Macromedia Inc. 285.84
Service Metrics Inc. Exodus Communications Inc. 280.00
SQRIBE Technologies Brio Technology Inc. 270.00
Connectify Inc. Kana Communications Inc. 261.80
Exchange.com Amazon.com Inc. 248.04
Xedia Corp. Lucent Technologies Inc. 246.08
Argon Networks Inc. Siemens AG 240.00
Source: Venture Economics