Happy to be stable: Despite downturn, venture-backed M&A steady in Q3

Electronic News, Nov 19, 2001 by Chalene Wibberley

In this turbulent day and age, stability is not a bad thing. In fact, it can be pretty desirable.

And in the spirit of stability, venture-backed mergers and acquisitions (M&A) activity remained at relatively stable levels during the third quarter, according to statistics from Venture Economics, a Thomson Financial company, and the National Venture Capital Association (NVCA).

Although only 70 deals were closed, down from 78 in the second quarter, the total value of disclosed deals increased more than $800 million, while the average disclosed deal increased in size to $74.6 million from $63.2 million. The increase represents the first upswing in deal values since last year's fourth quarter.

But the uptick in the total value of disclosed deals and average disclosed deal size may be more of an indication that companies are more willing to talk about deals right now, said Jesse Reyes, VP at Venture Economics, since overall values are still coming down.

"It's a buyers' market right now, you can name your price," Reyes said. That's 180-degree change from the Vcposition 18 months ago. Those looking at an M&A exit are selling companies at low prices. People can wait to buy."

But this doesn't necessarily mean bad news.

"[M&A deals and values] are well off the peak pace that we experienced in the second quarter of 2000 with $26 billion," said John Taylor, VP of research at NVCA, the trade association for the venture capital industry. "However, the $2.8 billion worth of deals done in the third quarter lives up to the first quarter of 1999."

The communications and media sector was the dominant industry category based on volume, with nine deals totaling $845 million. Included in that figure was Nokia's acquisition of data communications company Amber Networks for $421 million -by far the largest deal of the quarter.

As for the semiconductor sector, activity remained constant with five deals versus four in the previous quarter, while reported deal volume witnessed a modest decline to $444.7 million from the previous quarter's high of $534.8 million. However, the total value of software transactions more than tripled to $238 million, up from $72 million in the prior quarter. Cypress Semiconductor Corp.'s acquisition of Lara Networks for $225 million was the top value in that sector.

"Two things are happening," Taylor said. "One is that the prospects for IT spending snapping back in the next two quarters is not good; and, two, stocks are falling a bit for public venture-based companies, including large high-tech companies, who don't have the war chests to go out and buy smaller companies at this time."

Venture capitalists have to cash out their investments either through an IPO or an acquisition, by which VCs hope to exit at a higher price than what was invested. Since the IPO market is silent right now, that makes the M&A market more valuable in terms of exits and greater dollars, according to Taylor.

But, as Reyes pointed out, venture capitalists that expect to get out at a higher price through a merger and feel they can take a haircut or two on the value are selling at losses, so the value of companies and deals comes down.

This strategy reflects what is happening in public markets, which are being hammered by less-than-spectacular expectations.

Leading the way in M&A was the medical/health industry with six venture-backed companies being sold for $321 million, compared with just four deals for $9.7 million in the previous quarter. Biotechnology also rose sharply, from $51 million in the second quarter to $277.5 million in the third quarter, mainly due to the $225 million acquisition of Novazyme Pharmaceuticals Inc. by Genzyme Corp.

The fourth quarter looks to be much the same as the third. "It's still going to be a great year all around. Last year was the Mt. Everest of venture capital investments, so it's hard to put things into context," Reyes said. "However, the devaluation of companies and deals will continue well into next year, depending on the overall economic climate. My bet is [things won't change much] at least through the downturn until the end of next year."

"There's nothing on the horizon to suggest that things will snap back quickly," Taylor said. "Nothing new will happen in the fourth quarter or the first quarter of next year." He also said that there is no specific pattern to the merger and acquisition market, which is affected more by economic expansion and contraction, so what happened last year in the fourth quarter is no indication of what may happen this year. "[The year] 2000 was an anomaly, but right now we are in between the healthy pace of 1998 and 1999."

And what kind of semiconductor deals might look attractive in the future?

"Companies building out infrastructure and enabling technology," Taylor said. "The Internet market is burning out, but activity is still taking place. We'll see a shift back into traditional areas such as data storage and encryption hardware and software."

Wheeling and Dealing

Breakdown of venture-backed deals by industry

                                Toltal      Sum ($M) of
Industry                         Deals  Disclosed Deals

Biotechnology                        3            277.3
Communications and Media             9            845.5
Computer Hardware                    1              N/A
Computer Software and Services      14            237.7
Consumer Related                     2             67.0
Internet Specific                   27            315.1
Media/Health                         6            321.3
Other Products                       3            326.5
Semiconductor/Other Elect.           5            444.7

SOURCE: VENTURE ECONOMICS & NATIONAL VENTURE CAPITAL ASSOCIATION
Top 10 Deals

Q3 acquisitions with reported values

Target Co               ($M)     Industry       Acquiror

Amber Networks           421        comm.          Nokia
Lara Networks            225        semi.   Cypress Semi
Novazyme Pharma          225     biotech.        Genzyme
Blue Chip Broadcasting   190        comm.      Radio One
Jefferson Wells Int.     174        other       Manpower
Crothall Service Group   170  med./health  Compass Group
Auroranetics             150        semi.  Cisco Systems
Securant Tech.           135     software   RSA Security
Replay TV                123        comm.      Sonicblue
Meenan Oil               120  ind./energy       Star Gas

SOURCE: VENTURE ECONOMICS & NATIONAL VENTURE CAPITAL ASSOCIATION