M&A Heats Up

Four big deals jolted the M&A market last month, but observers can’t agree if the burst of activity is an anomaly or a sign that buyers really are getting active again.

VCs, as you might imagine, see brighter days ahead.

“We can feel it heating up,” says Jim Watson, managing general partner at CMEA Capital. “Corporate M&A has come alive. [Potential acquirers] are actually taking calls and looking at the technology. Six months ago they weren’t picking up the phone.”

Steve Fredrick, a general partner with Grotech Ventures, also expects to see more acquisitions next year. “I have a sense that it’s increasing currently and that next year will be pretty good. Part of that is driven by the view in the corner offices of acquirers that the worst is behind us.”

Fredrick adds: “Many companies have generated sizeable cash hordes and want to grow their business. The calculus is, if you wait too long to go on the offensive to buy and acquire, the price goes up, so it’s an ideal time to pursue companies.”

November saw a mini burst of acquisitions that whet the appetites of VCs with aging portfolios.

Accel Partners saw two of its portfolio companies get acquired on a single day (Nov. 9), with Google agreeing to pay $750 million in stock for mobile ad network AdMob, and Electronic Arts agreeing to buy social gaming company Playfish for $300 million, plus a possible $100 million in milestone payments.

Just one day after the AdMob and Playfish deals, Logitech International said it would pay $405 million for venture-backed LifeSize Communications, a maker of high-definition video communications products.

I have a sense that it’s increasing currently and that next year will be pretty good. Part of that is driven by the view in the corner offices of acquirers that the worst is behind us.”

Steve Fredrick

The following week, American Express Co. agreed to pay $300 million for Revolution Money, a VC-backed operator of a secure online payment network.

At least two of the deals, AdMob and Playfish, produced respectable returns for venture backers. Accel, Draper Fisher Jurvetson, Northgate Capital Group and Sequoia Capital had put a total of $46 million in AdMob. Assuming they owned half the company, they saw a return of 8.15x. Accel declined to discuss its ROI for both AdMob and Playfish.

Accel and Index Ventures put a combined $21 million into Playfish, meaning the pair will see a return of 7.14x, assuming they own half of the company. And if Playfish performs well enough to earn the additional $100 million from EA, Accel and Index are looking at a return of 9.5x, assuming 50% ownership of the company.

Despite the big ticket price of LifeSize, VCs didn’t fare as well on that deal because they had invested $90 million in it. As a group, assuming they owned half of LifeSize, Austin Ventures, Norwest Venture Partners, Pinnacle Ventures, Redpoint Ventures, Sutter Hill Ventures and Tenaya Capital saw a return of just 2.25x.

The Revolution Money deal also didn’t produce a big payoff for VCs. The company had previously raised a total of $107 million from Citigroup Private Equity, Deutsche Bank Corporate Investments, Goldman, Sachs & Co., Morgan Stanley Private Equity, RRE Ventures and U.S. Venture Partners, according to Thomson Reuters (publisher of VCJ). Assuming the VCs owned 50% of the company, they saw a return of 1.4x.

There was other good news for VCs in the November purchase of Starent Networks (Nasdaq: STAR) by Cisco Systems for $2.9 billion. Even though Starent is publicly traded, at least three venture firms remained large shareholders: Highland Capital Partners, Matrix Partners and North Bridge Venture Partners. At the per-share price of $35, the VCs’ shares were worth about $779 million, according to share ownership data from a January proxy statement.

Starent, which went public for $12 a share in 2007, had previously raised $95 million from VCs. Focus Ventures, Highland, Matrix and North Bridge collectively held about 34 million shares, which were worth a little over $406 million at the IPO price. Northbridge reaped the biggest reward from the sale to Cisco, since it was the only VC that didn’t sell any of its shares after the IPO, according to a proxy statement filed by Starent in January. North Bridge held 10.54 million shares as of January, which would be worth $369 million at $35 per share. Matrix held about 8 million shares, which would be worth about $282 million, while Highland held 3.6 million shares, which would be valued at about $128 million. North Bridge did not respond to calls for comment.

Despite those big numbers and the surge of large deals in November, the pace of M&A for venture backed companies still lags 2008, which itself was nothing to write home about. Just 69 VC-backed companies with disclosed valuations were purchased or have agreed to be bought for a combined $9.6 billion between Jan. 1 and Nov. 18 (including deals that haven’t officially closed), according to Thomson Reuters. For the same period in 2008, there were 111 VC-backed deals with disclosed valuations totaling $12.9 billion.

Corporate M&A has come alive. [Potential acquirers] are actually taking calls and looking at the technology. Six months ago they weren’t picking up the phone.”

Jim Watson

In looking over M&A data from 2008 and 2009, VCJ was able to find just one bright spot. The median purchase price for the top 10 deals of this year was $500 million vs. $400 million for the top 10 deals of 2008. The average sale price for the top 10 was a little lower, coming in at $551 million this year, compared to $562 million last year.

While the high prices paid for some of the companies in November had VCs giddy, others voiced concern about another Internet bubble.

“I never thought [AdMob] would get that kind of a price; it’s truly amazing,” says Linda Gridley, founder of investment bank Gridley & Co. “But who thought Intuit would pay $170 million for Mint.com?”

(The sale of Mint.com officially closed on Nov. 3, but it wasn’t a big payday for the backers of the company, which makes online personal finance management software. Benchmark Capital, DAG Ventures, First Round Capital, Founders Fund, Shasta Ventures Management, Sherpalo Ventures and angels had invested $31.6 million in Mint.com. Assuming they owned 50% of the company, the VCs as a group saw a return of 2.7x.)

Gridley predicts that Google, Microsoft, Yahoo, Adobe and other large media companies will continue to buy more Internet ad networks, but she says that she sees a danger of price distortion, with the AdMob acquisition pushing many potential buyers out of the market.

“Google and Microsoft can’t buy everything,” she says. “So the downside is that everybody thinks they’re an AdMob, but not everybody is.”

Indeed, it’s not surprising to see Google on an acquisition tear. Google CEO Eric Schmidt told Reuters in September that the worst of the recession is behind the company, and he expects the company to start doing about one acquisition a month.

“My estimate would be one-a-month acquisitions and these are largely in lieu of hiring,” Schmidt at that time. “There may be larger acquisitions, but they really are unpredictable.”

I never thought [AdMob] would get that kind of a price. It’s truly amazing. But who thought Intuit would pay $170 million for Mint.com?”

Linda Gridley

That’s particularly good news for startups, since AdMob is the first VC-backed company it has purchased since 2006, when it acquired three VC-backed companies, including YouTube.

However, Gridley tempers that optimism as she notes the fear is now that everybody will think all their portfolio companies can go public or sell to Google.

“For some, that will work,” she says. “But for the vast majority, it will screw pricing again. Investors were just starting to get more in line, thinking they can sell their companies again at reasonable prices.”

Jim Goetz, a partner at Sequoia Capital, which led the $4 million Series A round in AdMob in 2006, says that he considers the AdMob acquisition price as undervalued. After only three years, the company had a run rate of $100 million in revenue and still had most of the cash it had raised, he notes.

“That’s one reason why we pushed for stock [instead of cash from Google],” Goetz says. “So there’s a meaningful upside in AdMob’s future.”

In terms of which segments look the most promising for acquisitions, there is no consensus.

After Playfish was reeled in, ThinkEquity LLC analyst Atul Bagga said there were a number of small gaming companies that could be acquisition candidates. “It’s like a domino effect. If one falls there’s a chance the others could fall soon,” he says.

Grotech’s Fredrick predicts M&A “will happen across the board, there are not particular hot sectors.” Given how many software startups have been funded, it stands to reason that that segment will see M&A activity, he says. He adds that telecom could see a number of deals. “It’s more cost intensive to build a company, and the number of [telecom equipment companies] have gotten to a plateau,” Fredrick says. “How do you get from $30 million or $40 million to $100 million? You can merge with somebody else that has $20 million of revenue on the table. It’s a faster way to grow.”

Additional reporting by Lawrence Aragon and Joanna Glasner of VCJ and David Lawsky of Reuters