Wednesday, February 16, 2011

Are Technology M&A Prices Getting Out Of Hand?

Here is an interesting article from today's Wall Street Journal. We have heard many bidding wars among tech titans last year with multiples exceeding 6 times revenues. I don't understand why anyone would be shocked at such hefty premiums when most Fortune 500 firms spent last several years in religious cost-cutting including research & development and innovation. I tend to think Oracle and IBM have been the most disciplined deal makers.

Cash-rich technology companies are increasingly scouting start-up acquisition targets, but prices may be climbing too high for some buyers’ tastes.

Executives speaking Tuesday at a conference held by investment bank America’s Growth Capital in San Francisco say they’re starting to get wary of sky-high valuations as they shop for start-ups, though they don’t appear to be pulling back. “Transaction multiples are really getting way up there,” said Monty Gray, director of mergers and acquisitions at SAP AG.

Business software giant SAP paid a hefty $5.8 billion last year for fellow software maker Sybase Inc., and in recent years has stepped up its acquisition pace of start-ups after historically growing organically. It plans to continue its start-up acquisition binge, but only if the price is right.

“Every year there’s a couple of competitive deals that drastically skew the multiples in the market,” Gray said. “We’re sensitive when there’s a given topic that will have high multiples that are well-known–we know that going in.”

The median acquisition size of venture-backed companies soared to $95 million in the fourth quarter, the highest three-month total since the fourth quarter of 2009 and the second highest since the second quarter of 2000, according to Dow Jones VentureSource. That brought the 2010 median total up to $46 million, the highest since 2007.

Jeff Becker, a partner at investment bank America’s Growth Capital, told VentureWire recently that the upward trend should continue. “Everyone agrees that the level of activity has picked up since the summer,” he said. “Bigger players are being more active and back to playing offense.”

With valuations generally higher than they were two years ago, venture capitalists are more willing to part with companies, leading to more M&A deals in the $50 million to $200 million range.

Ken Gonzalez, a senior vice president of corporate development at McAfee, said the run-up in acquisition prices has put a damper on transactions. “Last summer there were a lot of big deals with a lot of big multiples. The average tech transaction multiple in the first and second quarter (of 2010) was 2x trailing (revenues) which went to 6 times trailing in the last quarter of 2010.”

Gonzalez then jokingly gestured to panelist Ted Schlein, a managing partner a venture firm Kleiner Perkins Caufield & Byers. “He says I’m cheap,” Gonzalez said. “I say I’m disciplined.”

Antivirus software maker McAfee itself is in the process of being acquired for $7.68 billion by Intel Corp., an active buyer of start-ups.

In another panel, executives discussed the value of using earn-outs when an acquirer cannot see eye-to-eye with a target about its growth prospects.

“In some deals it make sense, in some it would be a disaster,” said Elaine Paul, senior vice president of corporate strategy at Walt Disney Co. “Where it can be a useful tool is when there’s big price expectations based on future growth, but you’re not necessarily comfortable paying for that upfront.”

Nish Jain, a director of corporate development at Adobe Systems Inc., said his company tends to stay away from earn-outs, while Mike Foley, a vice president and head of corporate development at Electronic Arts Inc., said it depends on the company and the type of technology.

“If it’s about accessing a new platform, in that case an earn-out can work,” Foley said. “You have to do it very carefully. It can end in litigation. Getting the incentives aligned is very important.”

Meanwhile, Zynga Inc.’s head of corporate development, Terence Fung, said he’s “not a big fan of earnouts,” while Jain of Adobe said his company tends to stay away from earn-outs as well.

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