What a difference a year makes.
Twelve months ago, venture-backed M&A was limping out of a deep downturn. Now deal volume is at record levels and venture investors see an even better 2011.
Almost certainly 2010 will be remembered as a year of solid recovery. Valuations rose slower than overall deal volume, keeping a lid on returns, but low interest rates and corporate balance sheets flush with cash created an improving environment that could gather momentum for several more quarters.
“I would absolutely expect M&As to continue at the same, if not an increased, pace,” says Sierra Ventures Managing Director Tim Guleri, who was reflecting a widely held view. Transactions are likely to get more competitive and valuations will drift up, he adds.
Big technology companies helped fuel 2010’s deal flow as such companies as Google Inc., Hewlett-Packard Co., IBM, Oracle Corp. and Cisco Systems Inc. used acquisitions to reach into new markets. Google alone purchased 40 companies during the first three quarters of the year, including mobile advertising company AdMob Inc. for $750 million.
The search giant says it remains on the acquisition prowl.
Google had plenty of company in 2010. Through September, a total of 322 venture-backed companies were purchased, putting the year on track for the largest annual total since records were kept in 1970, according to data from the National Venture Capital Association and Thomson Reuters (publisher of VCJ).
Technology saw most of the action, while M&A deals involving health care and cleantech remained lackluster. Of the M&A activity, about 190, or 59%, involved Internet and software companies.
The uptick is a welcome change for investors. Acquisitions continue to be the primary road to liquidity for venture-backed companies and their greater pace is likely to have an important impact on fund returns. What’s more, M&A momentum appears to have increased through the year, stoking optimism, as the global recession’s lock on exits markets gradually waned.
The late summer and fall saw two of the year’s most talked about deals, the $2.4 billion bidding war for 3PAR Inc., a public company with substantial VC ownership, and Google’s $6 billion flirtation with Groupon Inc., which Groupon spurned in early December.
Meanwhile, a wide gap appeared between deals at the top of the market, where acquirers paid big sticker prices and attractive premiums, and those on the low end, which brought in $5 million, $10 million, or $15 million and sometimes little gain.
This bifurcation restrained deal values. In the 80 deals with a disclosed value, $12.4 billion changed hands generating an average transaction value of $155 million, up 5% from last year but down 12% from 2007, the NVCA and Thomson Reuters data show.
Some VCs expect better valuations in 2011. Prices remained low in 2010 because there were few liquidity alternatives. But with a slowly improving IPO market, “median valuations will pick up,” says Robert Ackerman, managing director at Allegis Capital. “You could see the average consideration move up 50% or more.”
Cash Rich Balance Sheets
At the heart of last year’s market were cash-rich, big company balance sheets. More than $250 billion in cash sits on the balance sheets of technology’s ten largest companies, and after trimming spending during the recession to prop up margins, boards of directors have shifted their focus to growth. They see M&A as critical to their strategies to broaden maturing product lines and capture a greater share of their customers’ technology spending.
To fill product holes and move into adjacent markets, small companies are increasingly a source of research and product development.
“Everybody is sort of getting into each other’s historic territory and that is part of what is fueling transactions right now,” says Douglas Cogen, partner at Fenwick & West LLP and co-chair of its mergers and acquisitions group.
One beneficiary of a big company deal is Guleri of Sierra Ventures. In July, EMC agreed to buy Sierra-backed Greenplum Inc., the San Mateo, Calif.-based maker of data warehousing software, in an all cash deal. It was a push into a new market for the tech giant and the company has been investing heavily.
Guleri says the price paid was attractive, but declined to provide details. Speculation puts the deal at more than $300 million. Greenplum raised $129 million in venture funding from Sierra Ventures, Mission Ventures, Dawntreader Ventures, EDF Ventures, Hudson Venture Partners, Meritech Capital Partners, SAP Ventures and Comerica Venture Capital Group, according to Thomson Reuters.
A Gulf In The Market
It’s kind of a perfect storm for mergers and acquisitions. I think it will last for a little while longer.
Michael StarkGeneral PartnerCrosslink Capital
The gap between big and small deals was especially pronounced in 2010. The 3PAR bidding war that broke out between HP and Dell Inc. drove its transaction value to 12 times fiscal year revenue. Mayfield Fund, Menlo Ventures and Worldview Technology Partners held substantial stakes in the public company at the time.
On the other end of the market, small companies were snapped up by acquirers, such as Google, which in September purchased Quiksee, an Israeli developer of location-aware video software, and then mobile keyboard software company BlindType Inc. of San Francisco the following month. If Google’s three top acquisitions of the year are excluded, the remaining 37 it made through September had an average value of $17 million.
Also getting into the act was Facebook, which in August bought the mobile applications company Hot Potato for a reported $10 million to help with its location-based services that the social networking giant launched last year. Hot Potato, a New York-based provider of check-in technology, launched just 10 months earlier with backing from First Round Capital and RRE Ventures.
Michael Brown, corporate development manager at Facebook, said that the social networking company would look at doing maybe 15 acquisitions in 2011. Brown made that prediction while he participated on a panel last month with other corporate development managers at the “Startup Exit Seminar” in San Francisco, put on by the startup consulting firm VentureArchetypes. Brown said the target acquisitions “will be a mix of talent acquisitions, where we’re looking for people to run important parts of our product [and] who have a really strong vision.”
Altogether, Facebook announced eight acquisitions in 2010, including Hot Potato; Drop.io (another RRE Ventures-backed company snapped up for about $10 million); Divvyshot (a photo management tech company that grew out of Y Combinator and was bought for an undisclosed amount); Chai Labs (acquired for $10 million); and Nextstop (bought for $2.5 million). Its largest acquisition was the $40 million it paid to take ownership of social networking patents from Friendster.
Throughout the industry, many of last year’s smaller acquisitions, such as Hot Potato, took place during the second half of 2010, and many more will follow in year ahead, says Marcus Ogawa, managing partner at Quest Venture Partners.
Ogawa says that despite their small price tags, the deals can be lucrative for investors. If an angel puts in $1.5 million to $3.5 million and sells a startup for $20 million to $50 million, the return on capital can be three to five times the investment, he says.
Many suggest that the smaller acquisitions in 2010 came about because VCs were clearing portfolios of unwanted property. But the deal making also reflects the lower costs of starting Internet companies and software businesses, as well as private company consolidation.
No Spark For Life Sciences
The busy pace of technology M&A didn’t carry over into life sciences. Big pharma needs to fill its product pipeline, but the tolerance for risk remained low in the wake of health care reform and a cautious Food and Drug Administration.
The result was a 2010 M&A environment that didn’t feel much better than 2009, says Stephen Krupa, managing director of Psilos Group.
“There has been an awful lot of uncertainty in the health care market over the past few years.”
Krupa says that next year could bring a modest uptick as economies strengthen and corporate buyers become more active. More established companies will be the most sought after targets, especially those with products that offer cost improvements.
Hot Areas In 2011
Among the hottest areas for M&A were companies addressing the social Internet, security needs and software as a service.
Looking ahead, VCs see more of the same. Security companies will attract interest, as will developers of mobile infrastructure and social Internet companies, where consolidation is taking place among a first generation of pioneers. Storage also should continue to be a big story, says Ackerman.
New areas will emerge as well. One potentially attractive group of startups take social Internet features and services and adapt them for business use.
Another hot area will be cloud computing, particularly startups working on new “layers” of software to broaden functionality and add stability to cloud infrastructure. There are startups now two to three years old starting to get to get traction and generate tens of millions in revenue, says Sumeet Jain, a principal at CMEA Capital.
Other attractive targets are likely to be companies that meld ecommerce and the social Internet, Jain says. New promising business models have emerged for shopping, with coupons and price comparisons.
There are good reasons to think the M&A market is looking up. For one, economies around the globe are perking up and innovative products continue to reach the market. Meanwhile, low interest rates make holding cash an unwelcome alternative.
“It’s kind of a perfect storm for mergers and acquisitions,” says Michael Stark, general partner at Crosslink Capital. “I think it will last for a little while longer.”