MA Activity Holds Steady Wait for Q1 Decision on Pooling –

Venture-backed mergers and acquisitions eked out another record high last year as the total number of deals completed notched to 209, up from 196 in 1998, according to Venture Economics. During the first two quarters of 2000, 114 venture-backed companies merged, or were acquired, compared with 102 during the same period last year, according to Venture Economics.

The total value of all reported M&A deals reached $33.1 billion during the first two quarters, rivaling the $35.3 billion spent during all of 1999, Venture Economics reported.

As theory states, when M&A activity is hot, it is often because initial public offerings are not. The two preferred exit strategies for venture-backed entities generally have an inverse relationship, and after the market correction in April, it was expected that the number of M&A transactions would clearly exceed the number of IPOs. But the almost even amount of M&As and IPOs done during the first two quarters – 114 and 131, respectively – came as a bit of a surprise.

When the two exit options are balanced, public companies have currency to make purchases, opening up possibilities for acquisition targets, while holding an IPO is a viable option as well, said Tom Bredt, a managing director at Menlo Ventures. Under this scenario, “investors have the best of both worlds,” he said.

When investors don’t have reasonable alternatives because the IPO market is completely dry, there might be a large number of acquisitions, but they would be at lower valuations, Bredt said. “Today, investors clearly have a choice.”

As predicted, venture-backed computer software and services companies took the lead, with 42 M&A deals completed during the first two quarters, Venture Economics reported. The sector has consistently had more acquisition activity than any other category since 1990.

Internet specific companies came in a distant second, with 24 deals done during the first two quarters, followed by 18 communications deals, eight semiconductor and electronics acquisitions and seven other products companies sold. The remaining sectors, computer hardware, consumer related, medical and health and biotechnology, trailed at the bottom of the list, with a combined total of 15 acquisitions during the first half of the year, Venture Economics reported.

When comparing purchase price, computer software and services sector maintained the lead, garnering $8.7 billion in the first two quarters, followed by Internet specific companies with $7.7 billion, and the semiconductors and other electronics space with $7.7 billion.

Price Tags on the Rise

In March, Redback Networks Inc. purchased Mountain View, Calif.-based Siara Systems, a developer of routing and switching equipment, for $4.3 billion, the largest price paid for a venture-backed company during the first two quarters, of the disclosed purchase prices, Venture Economics reported. Kleiner Perkins Caufield & Byers and Norwest Venture Partners were backers of the acquired entity.

The two largest prices paid for a venture-backed company in 1999 – Healtheon Corp. paid $7.8 billion for WebMD Inc. and Cisco Systems Inc. bought Cerent Corp. for $6.9 billion – far exceeded the highs for the first half of this year. However, the valuations of companies other than those two anomalies, start at only $896 million, Venture Economics reported.

Nortel Networks Corp. bought XROS Inc. for $3.3 billion in June, the second largest reported venture-backed acquisition completed during the first half of the year. The firm backed XROS with $10 million, over several rounds, Menlo’s Bredt said.

An undisclosed company approached XROS in February with an unsolicited offer to buy the company, Bredt said. Credit Suisse First Boston represented XROS in its search to determine interest of other potential acquirers, and after a competitive bidding process, Nortel Networks tendered the best offer. Other venture backers included Greylock and New Enterprise Associates.

Placing a close third on the high-end price tags, E.piphany Inc. spent $3.2 billion, in May, to acquire Octane Software Inc., a San Mateo, Calif.-based applications software company, backed by Compaq Computer Corp., Greylock, Integral Capital Partners, Lucent Venture Partners Inc., Norwest Venture Partners, Sigma Partners and Vignette Inc.

Pooling Potentially Dunked

The Financial Accounting Standards Board in mid-July formally announced that it will delay issuing a final ruling on its pooling proposal until the first quarter 2001, leaving the accounting method, favored by most of the venture community, in place at least until that time. The decision was supposed to be completed by the end of the year, but the board was put under pressure to reconsider the proposal based on industry objections, the National Venture Capital Association reported.

If pooling – an accounting method by which two companies combine their balance sheets – is eliminated, the purchase method will be the remaining viable alternative. The purchase method is unpopular among venture capitalists because it requires the acquirer to put the acquired company’s goodwill, or intangible assets, on the buyer’s books and amortize it over time. (VCJ, June, page 5)

In theory, eliminating the pooling method would impact the probability of an acquisition, because a public company would be discouraged to do the deal, knowing that it would have to amortize the cost of the acquisition over time, said Bart Schachter, a founder and general partner at Blueprint Ventures. Under the pooling method, the acquirer can write off the purchase as a one-time event, making it easier for Wall Street analysts to palate, Schachter said.

“At the end of the day, deals have got to make sense,” said Scott Perper, a managing partner at First Union Capital Partners. “It can’t just be an accounting game.” Acquiring companies fear analysts’ reactions when they see earnings deplete over time, rather than just having a one-time event.

If pooling is eliminated, investors predict Wall Street analysts will adapt to the situation by changing the metrics by which acquiring companies are judged, placing emphasis on other numbers such as after-tax cash flow (“ATCF”), which is already an accepted data point for many media and communications companies. “It’s like a balloon,” said Deric Emry, a principal at ABS Capital. “You squeeze one end and it comes out somewhere else.”

Even with the threat that pooling will be eliminated, there hadn’t been a slowdown of merger and acquisition activity until the second quarter 2000, when the total number of venture-backed M&As dropped to 53, from 61 in the first quarter. During 1999, M&A activity reached 57 in the fourth quarter, up from 54 deals in the third, 53 in the second and 49 in the first.

“I think in the end, we will work through this and it won’t have a big impact on mergers and acquisitions basically because the analysts won’t let it,” Emry said. “It could have a short-term impact, [but] mergers and acquisitions that make sense will continue to get done and those that don’t, won’t.”

Industry Breakdown of Venture-Backed

Mergers & Acquisitions

For the First Two Quarters of 200

No. of

M&A Deals

Computer Software and Services 42

Internet Specific 24

Communications 18

Semiconductors/Other Electronics 8

Other Products 7

Computer Hardware 5

Consumer Related 5

Medical/Health 3

Biotechnology 2

Top Ten Price Tags


Company Sold Buyer ($millions)

Siara Systems Redback Networks Inc. 4272.45

XROS Inc. Nortel Networks Corp. 3346.42

Octane Software Inc. E.piphany Inc. 3186.41

Tradex Technologies Inc. Ariba Inc. 2133.04

CoreTek Inc. Nortel Networks Corp. 1915.11

SplitRock Services Inc. McLeodUSA Inc. 1758.27

Riverbed Technologies Aether Systems Inc. 805.22

Trading Dynamics Inc. Ariba Inc. 756.55

Cronos Integrated Microsyste JDS Uniphase Corp. 750.00

SiTera Inc. Vitesse Semiconductor Corp. 750.00