NEW YORK/MENLO PARK, Calif. – A new group formed by Glenn Hutchins, a former managing director at The Blackstone Group; Integral Capital Partners, a Kleiner Perkins Caulfield & Byers affiliate; and two executives from Silicon Valley in February launched a buyout fund with a $1 billion target that will invest solely in technology companies.
Silver Lake Partners L.L.C. is the first buyout firm to invest exclusively in technology and, therefore, is being watched closely by other G.P.s, sources say, some of which are considering raising similar vehicles.
Although Silver Lake Partners, L.P. will target buyouts exclusively and will use leverage in its investments, it also plans to incorporate elements of venture capital investing, including partnering on deals with other buyout firms, said G.P.s who have been approached about committing to the partnership and co-investing on its deals.
Silver Lake will target divisions of publicly traded companies that are not growing rapidly enough to satisfy public equity investors. The group sees tremendous opportunity among the 1,200 publicly traded companies that specialize in technology, many of which need capital but cannot hold secondary offerings because of a lack of investor interest.
Targeting divisions of mid-cap companies, Silver Lake will buy the divisions and take them private. It likely will look at divisions that specialize in software development, hardware and telephony service, said a G.P. who said he spoke to the firm. Partners at Silver Lake declined comment.
Silver Lake’s buyout-venture capital hybrid approach may help it secure deal flow, said a source close to the firm. The professionals with experience in the buyout industry, led by Mr. Hutchins, will focus on creating deal structures that employ high-yield debt, while the venture side will concentrate on finding the investments. The venture side includes Integral Capital Partners, which follows publicly traded technology companies; James Davidson, formerly an investment banker at Hambrecht & Quist who specialized in advising semiconductor companies; and David Roux, formerly an executive vice president at Oracle Corp.
The four parties all are equal partners in the firm (Kleiner Perkins has about a 50% stake in Integral and, therefore, has about a 12.5% stake in Silver Lake), a source close to Silver Lake said.
Silver Lake so far has approached Blackstone, Hellman & Friedman, Forstmann Little & Co. and Thomas H. Lee Co. to become partners, G.P. sources and intermediaries said.
Although partners at these groups declined comment for the record, a source close to Silver Lake said Blackstone had committed to becoming a partner with the firm.
However, Thomas Lee, speaking last month at The New York Capital Roundtable, indicated that his firm would not be investing in technology-driven companies. “High-tech with leverage would leave you too tempted to cut engineering, and it is dangerous, but more firms will buy high-tech companies,” he said, not referring to Silver Lake.
How Sound Is Silver Lake’s Thesis?
The reaction from several G.P.s to a firm focusing on divisions of technology companies was generally favorable, although with some reservations.
TA Associates has targeted similar investments in its $800 million TA/Advent VIII L.P. and made two investments in divisions of public companies. The firm took one of those companies public last year and the business then foundered – after making a large add-on investment – in the IPO aftermarket, Kevin Landry, chief executive at TA Associates, said, declining to name the business.
“It’s better to go in and buy an existing company. There is still something entrepreneurial about technology, and the people running divisions are not always entrepreneurial,” he said, after focusing on these businesses for the last several years.
He added there were bankers who were willing to loan capital for buyouts of technology companies, and he suspected that Mr. Hutchins could find some of those sources. Also, he said he thought Silver Lake’s thesis could work because Mr. Hutchins and Kleiner Perkins have developed contacts with large corporations.
An adviser who works with technology companies on finding strategic alternatives said he believes there is good talent at mid-size public companies that would leave with a division if a parent sold it off.
“The ideal situation is we find an idea and implementation person in one of these divisions that we want to back,” David Scheer said, who runs Scheer & Co. His firm is now raising the $50 million Scheer Venture Partners, LLC, which will invest in projects and divisions spun out by public companies.
He suggested that the key in buying, as opposed to investing in, a division would be to offer the parent company some rights to its division’s products after the sale so that the parent is not running the risk of making an embarrassing mistake and will be more willing to part with good divisions.
Mr. Landry warned that buying any technology company only works if one’s investment has a marketable product to sell immediately.
“They should be at a strong point in their product cycle, because technology companies tend to have shorter product life cycles, so that the first two years of the buyout get off to a very strong start. Hopefully, so strong that you can do an IPO and get the financial risk out of the equation,” he said, adding that a technology company without a salable product can be worthless after five years and, therefore, carries a bigger risk than investing in a widget manufacturer or even a radio station.
In one of the first buyouts of a modern technology company, J.H. Whitney & Co. in 1989 acquired Prime Computer (now Computervision Corp.) and struggled with the investment because it failed to predict the customer shifts from large machines to personal computers. The company, as a result, did not turn a profit for almost six years.
Silver Lake is offering its L.P.s terms typical of other buyout firms and has hired Merrill Lynch & Co. as its placement agent, a source close to Silver Lake said.