Q1 recap: IPOs grow as M&A slows

There were fewer purchases of venture-backed companies in the first quarter, but industry observers predict that M&A volume will pick up, led by hot sectors such as interactive advertising and consumer Internet.

M&A deals declined significantly in the first three months of the year, with only 62 transactions completed, as compared to 104 in the first quarter of 2006, according to data gathered by Thomson Financial (publisher of VCJ) and the National Venture Capital Association. The two largest deals with disclosed prices were for Currenex and St. Francis Medical Technologies, which brought in $564 million and $525 million, respectively.

Deals bringing in the top returns—with disclosed values greater than 4 times the venture investment—made up 50% of the total, down from 65% in Q4. In one bright spot, deals that returned less than the amount invested by VCs accounted for 25% of the total, an improvement from 28% of the total in the prior quarter.

HarbourVest Partners and Polaris Venture Partners notched the biggest return in February with the purchase of portfolio company Cushcraft Corp., which makes wireless LAN antennas. Laird Group paid about $90 million for Cushcraft, or more than 40 times the $2.2 million investment from HarbourVest and Polaris.

The M&A picture looks significantly brighter if you factor in deals that were announced in the first quarter but have yet to be formally consumated. These include Cisco Systems’ planned $830 million acquisition of network security provider IronPort (whose backers include Allegis Capital, Menlo Ventures, New Enterprise Associates and others) and Microsoft’s purchase—for a reported $800 million—of voice-enabled search developer Tellme Networks (whose backers include Benchmark Capital, Kleiner Perkins Caufield & Byers and others).

A strong IPO market always helps the M&A market. Having alternatives helps companies realize value.

Kevin Harvey, General Partner, Benchmark Capital

IPOs pile up

A growing appetite among investors for tech company IPOs also bodes well for exits of all types, says Kevin Harvey, a general partner at Benchmark.

Venture-backed IPOs have taken off in the past two quarters, with 20 in Q4 and another 17 in Q1, according to TF and the NVCA. There were 10 fewer offerings in the same six-month period a year earlier.

LPs must be breathing a sigh of relief as VCs record some major returns. Ten venture firms held IPO shares valued at $100 million or more as of early April, including Sequoia Capital ($257 million), Redpoint Ventures ($245 million) and NEA ($104 million), according to an analysis by VCJ.

“A strong IPO market always helps the M&A market,” Harvey wrote in an email. “Having alternatives helps companies realize value.” He adds that he’s optimistic about prospects for acquisitions in the consumer Internet space, and sees the M&A market growing more active.

Media M&A is certainly at a very frothy sort of pace right now.”

Scott Peters, Managing Director, The Jordan, Edmiston Group

Interactive media also promises to be a popular sector for transactions, says Scott Peters, managing director of The Jordan, Edmiston Group Inc. (JEGI), which provides investment banking services for media and information industry deals.

“Media M&A is certainly at a very frothy sort of pace right now,” Peters says, with activity fueled by the growth of Internet advertising revenues. He pointed to Reed Elsevier’s purchase of venture-backed online lead generation company BuyerZone, a deal that closed at the beginning of the year, as indicative of a broader trend involving big “old media” companies buying innovative new media players.

Buyers line up

Another factor likely to boost M&A returns, Peters says, is the sheer volume of capital available to acquirers, including private equity and buyout funds. A few years ago, he says, lenders would typically issue debt equivalent to 4 or 5 times EBITDA of an acquisition target. Today that multiple can be as high as 7 times EBITDA, as competition among lenders and sharp revenue growth rates pushes valuations skyward. Those higher valuations, in turn, bring more sellers to market, further bolstering acquisition activity.

Corporations plan to spend more on M&A this year. That was the finding of the recent Duke University/CFO Business Outlook survey of 741 CFOs of global companies. About 40% of respondents said they expect to increase their deal-making activity, 53% expect their pace to be the same as last year, and only 7% say they will do fewer acquisitions than last year.

As for venture-backed companies, slower volume of completed deals in Q1 is counterbalanced by a rise in disclosed deal valuations. More than two-thirds of the companies acquired did not disclose sale prices. Of the 20 that did, the average deal size was $161.2 million, one of the highest quarters in the last five years, according to the NVCA.