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| Buying bounces back |
March 14, 2006 |
By Mark Evans
If the tech industry of the last several years has been characterized by a general slump left over from the popping of the tech bubble, then the next few years will be recognized as the time the industry began to believe again.
That rediscovered optimism will be felt particularly in the mergers and acquisitions (M&A) arena. According to industry watchers, increasingly upbeat companies want to prepare for the coming good times, and they will do that by buying capacity and talent.
“The buyers are back,” said Rick Nathan, managing director with the Goodman Venture Group and president of the Canadian Venture Capital Association.
M&A is seen as a quick way to get at the new growth every firm wants.
“Industry spending is a catalyst for everything,” said David Ferguson, a managing general partner with VenGrowth Private Equity Partners Inc. “The larger companies start to see their share prices and revenue go up, and they go from defensive mode, which is where they have been for the past four years, to thinking strategically again about what new technologies the customer will need.”
In 2005, there were plenty of signs of strategic acquisitions as major players started to fill holes in their portfolios.
> IBM acquired DWL, a Toronto-based customer relationship software maker and Victoria, B.C.-based PureEdge Solutions, an electronic-forms software firm.
> SAP, which rarely makes acquisitions, bought Toronto-based Triversity, a leading point-of-sale software maker whose customers include The Body Shop, Indigo Books and Trader Joe’s.
> Fitch Group purchased Toronto-based Algorithmics, an enterprise risk-management software maker, for $175 million.
> Google made its first Canadian acquisition by quietly buying Waterloo, Ont.-based Reqwireless, which makes e-mail and browser software for wireless devices.
While Canada has become an attractive place to make high-tech acquisitions, Canadian companies have also been doing deals outside the country.
> Nortel Networks, which stayed out of the M&A market while it worked through an accounting scandal, acquired Fairfax, Va.-based PEC Solutions for US$448 million, and recently bought San Jose, Calif.-based Tasman Networks for US$99.5 million.
> Meriton Networks acquired Mahi Networks of Piscataway, N.J., to enhance its competitive position in the metro-optical market.
Strategic buys
For buyers, there are clearly plenty of opportunities to make strategic investment moves. A particularly active company has been Toronto-based Fun Technologies. In the past year, the online sports fantasy and skills-based games company has made several acquisitions to gain a bigger foothold in the fast-growing market.
These include Fanball Interactive for US$22 million, Don Best Sports for US$47 million and Octopi LLC for US$6 million. Fun’s growth caught the attention of cable television mogul John Malone’s Liberty Media Corp., which acquired 50.1 per cent of Fun in November for US$195 million.
Lorne Abony, Fun’s chief executive, said the sports fantasy and skill-based games market is ripe for consolidation as owner-operated businesses that lack management depth, growth capital and strategic partnerships explore their options. For larger companies such as Fun, Abony said there are appealing operating synergies.
“We have benefited from these acquisitions to take advantage of the fact that these markets are fragmented, there are attractive acquisition candidates and competition for these companies is low and valuations are low.”
The challenges facing high-tech companies encouraged Robert Offley to co-found EnterpriseOne, which focuses on providing capital and management services to privately owned companies trying to get to the next level. Offley said in most cases his firm will aim to take a majority stake in a business.
“There are a lot of people who have good ideas and grow businesses to a certain point but tend to be technology driven rather than market driven,” he said. “Quite often these companies do have revenue with a key customer or geographical area but there is real opportunity to broaden their market and help tune up their sales and marketing focus.”
Offley expects there is promise in the idea of bringing together several companies selling products in the same market. Consolidating their operations, he said, provides critical mass and makes it easier to generate new growth opportunities.
John Albright, a partner with venture capital firm J.L. Albright Venture Partners, said the strategic focus for many high-tech companies is determining where to find organic and non-organic growth. Many large players, he said, are looking for 10 per cent sales growth per year. This means a $1 billion company needs $100 million of new revenue.
“They are looking to fill the void with new companies and new products that have revenue, sales and EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization),” he said. “If these companies don’t have positive EBITDA and pre-tax revenue, they’re not being bought.”
Prices up, VC slow
Since there isn’t a huge pool of Canadian companies that meet this criteria, Albright said the demand has caused the average sales price to jump to $75 million in 2005 from $50 million in 2004.
One of the biggest issues encouraging M&A activity is lukewarm demand for high-tech IPOs. Last year, only a handful of Canadian companies were brave enough to do an IPO—Canadian Satellite Radio, Miranda Technologies, Vcom, Tranzeo Wireless Technologies, Ascalade Communications and March Networks.
In fact, the March Networks IPO was the first for the Ottawa technology community in six years, according to the Canadian Advanced Technology Alliance.
Montreal-based Miranda, which makes hardware and software for the television industry, had the biggest IPO by raising $141 million—one of the largest high-tech deals in the past five years.
Another challenge facing high-tech companies is that the venture capital market has not come back to life as fast in Canada as in the U.S. where, for example, there is growing interest in the new wave of Internet start-ups. According to the Canadian Venture Capital Association, total venture investment during the first nine months of the year fell 10 per cent to $1.23 billion compared with the same period in 2004.
Nathan said more venture capital is needed, particularly from large institutional investors such as pension funds that allocate very little to the high-tech sector.
Hungry to sell
Without access to the public and private equity markets, many companies have found themselves between a proverbial rock and hard place to get the capital they require to survive and grow. Faced with few financing options, they come to the conclusion a sale to a stronger company is a strategic necessity.
“I think for Canadian companies, an IPO is not really there unless you’re an income trust or an oil and gas company,” Nathan said. “I get the sense today that the IPO market is not available for Canadian companies, which means if you are looking for liquidity, you have a strong appetite to be acquired.”
If Canada’s IPO market continues to have a low appetite for high-tech deals, Nathan said he expects more companies will explore a public listing on the London Stock Exchange (LSE) Alternative Investment Market. AIM has attracted an increasing number of small and growing high-tech companies, including several controlled by entrepreneur Terry Matthews, because it has no minimum valuation requirements and less onerous listing rules than the LSE.
Another factor stimulating the M&A market is coming from VCs, who are looking for liquidity opportunities, particularly if a company has been in their investment portfolio for several years. In many cases, VC funds have a five- to seven-year term, which means companies financed from 1999 to 2001 during the dot-com boom have to be liquidated or given another round of funding.
John Ruffolo, a partner with Deloitte Touche in Toronto, said some VC deals include clauses that give a company three to five years to do a “qualified IPO.” If this fails to happen, he said, VCs can compel the company to purchase their shares at a premium. “There’s huge pressure,” he said. “Many companies don’t have the money, which has been triggering a lot of technology sales.”
Future growth
So what’s the M&A outlook for 2006 for the high-tech sector?
John Albright said the action will continue to be robust—easily matching the 40 per cent growth in deal flow last year. In particular, he expects to see plenty of transactions in the online sector where the big players such as Google, Yahoo! and News Corp. look to establish stronger footholds.
“Potential acquirers are sending us e-mail and making phone calls about what we have in our portfolio and what we’re going to do,” he said.
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