Look before you leap: M&A vs. IPO?August 19, 2010: 2:47 PM ET
By Michael Orbach, contributor
Technology companies that are looking to take the plunge and go public might benefit from thinking twice. In many cases, they may be better off with an M&A or private equity transaction.
Lest we forget the lessons of our past, CEO's must remember that an IPO is a financing event in a recapitalization process, not a liquidity event. While it is encouraging that the number of information technology IPOs year-to-date has reached 112 worldwide (up from 79 over the same period last year), we shouldn't jump to the conclusion that an IPO is the best exit strategy for every company.
In fact, when you look deeper into the data, the IPO picture appears much less appealing. As of July 31, of the 17 tech IPOs in the U.S. and Canada, approximately 80% are currently trading below their offer price and approximately 40% are priced at the lower-end of the pricing range.
Some of the most noteworthy poor performers include Vringo (VRNG) trading at 46% below its IPO price, TeleNav (TNAV) at 37% below, QuinStreet (QNST) at 33% below, Meru Networks (MERU) at 24% below, Motricity (MOTR) at 20% below, and Convio (CNVO) at 9% below its IPO price. These are just a few examples of the IPO casualties we're seeing pile-up on North American stock exchanges.
So what does this all mean?
There is no "one size fits all" approach. In many cases, it is premature for a company to go public because of its size and growth, and more often, M&A or private equity could actually be a better option.
Let's begin by looking at the current deal volume and multiples for M&A in various technology sectors and the availability of private equity for technology companies. Then, compare that with the performance (or lack thereof) of many of the technology IPOs this year. Against that backdrop, it's clear that shareholders of many newly-public companies would have seen better outcomes by exploring alternative options to an IPO.
According to The 451 Group, there were 310 technology M&A deals involving the purchase of a private company by a strategic acquirer or private equity firm in the U.S. and Canada during the first half of 2010. This represents the highest run-rate for M&A in the last 10 years, with most of the activity coming from the software, digital media and technology-enabled services sectors. The median value of disclosed private technology deals is $37.5 million and median revenue multiples is 2.8X, compared to 2.1X for companies that have gone public during the same period this year.
The have's and have not's
An IPO should only be an option for the few companies that have stellar growth records -- it's a case of the "have's" and "have not's." The "have's" are companies with revenues in excess of $100 million and management teams that have the experience and fortitude to operate public companies in today's public markets. These are the companies that will attract the attention of underwriters capable of generating fees sufficient to maintain their interest and the coverage of security analysts that will promote the company's stock through the recapitalization process.
Furthermore, since the IPO market is cyclical, it may not always be open, even for the most suitable companies. The expenses associated with being a public company, including D&O insurance, Sarbanes-Oxley and audit expenses, BOD compensation, governance and legal costs are all additional factors that companies considering an IPO should taken into account. These costs can range from $1.5 million to $3 million on an annual basis. Investors and management teams seeking liquidity or those who are concerned about the costs of being public should consider M&A as a more attractive and less complicated option.
Competition spurs promising exit options
After almost two years of near-record lows in M&A and buyout activity, conditions are predictably ripe for companies to attract strategic acquirers and private equity interest. For the majority of the prospective strategic acquirers, the recession severely hampered their ability to develop technology and hire people. However, they continued to accumulate cash; large amounts in many cases. Consequently, strategic buyers and private equity firms are recognizing the value of mature private companies, even if the public markets do not.
Each company should be evaluated based on its own merits. M&A can be a meaningful alternative to an IPO for technology companies. One must consider the volume and size of recent deals, the likelihood that strategic acquirers will pay more than the public markets due to anticipated synergies, and the opportunity for private companies to take advantage of the competition between strategic acquirers and private equity. In the current market, shareholder liquidity can often be achieved at a much higher value through an M&A process, private equity transaction, or by simply waiting it out.
Michael Orbach is a Managing Director at Cascadia Capital, a Seattle-based boutique investment bank that serves domestic and global clients. Orbach leads the firm's information technology practice.