Venture-Backed M&A: More Deals, Less Value

Aug 14 2001

The number of venture-backed mergers and acquisitions rose in the second quarter of 2001 from the previous quarter, according to numbers just released by Venture Economics and the National Venture Capital Association.

But, as with many VC deals in 2001, there's a catch. While 76 deals were completed from April through June, compared to only 63 for the first quarter, the total value of the deals fell to just $2.02 billion, from $6.9 billion for the first quarter. Venture capitalists were also more reticent to disclose monetary terms on the deals, reporting details for only 43 percent, compared to 51 percent for the first quarter.

"Most of the larger deals were visible or disclosed," said John Taylor, VP of research for the NVCA. "But the increase in undisclosed value says that some haven't been happy exits due to deep discounting or companies acquired just for technology or patents."

While the drop in M&A deal value from the first to the second quarter is remarkable, the year-over-year comparisons are more astounding. In the first half of 2000, 167 venture-backed M&A deals were struck with terms disclosed for roughly two-thirds of them and a total value of more than $50 billion dollars. That's far above the roughly $9 billion value with just 46 percent disclosure for the first half of 2001.

"We're definitely in a down portion of the business cycle," said Taylor. "And there's no reason to believe that the third quarter will be up."

Jeffrey Harris, a senior managing director with Warburg Pincus, said the declining valuations were natural and "not dissimilar to what's happened in the public markets."

For example, major tech companies that fueled the early 2000 results, like acquisitive Cisco Systems and JDS Uniphase, have seen their market values plummet. Over a year-long period ending June 30, 2001, Cisco fell 71 percent and JDS Uniphase lost a whopping 90 percent. Nortel Networks fell 87 percent.

The closure of the IPO market to venture-backed companies has definitely altered VC exit strategies. In the first half of 2001, only 21 venture-backed IPOs hit the market, valuing VC-held shares at $1.7 billion. This pace can't hold a candle to the 258 venture-backed IPOs in 2000 for $24.6 billion.

"M&A activity this year appears to be taking up some of the slack left by the dearth of IPOs," said Jesse Reyes, VP of Venture Economics in a prepared statement. "With valuations of technologies continuing to fall from their pre-crash highs, there are more deals on the table at reasonable prices. But it is a two edged sword: Lower prices mean lower exit values and thus lower overall performance," said Reyes.

"VCs are spending 80 percent of their time now funding existing companies and finding future deals," said NVCA's Taylor, noting that as of June 30 more than $45 billion in "overhang," or uninvested funding, was available across the VC community.

Unsurprisingly, 76 percent of second quarter venture-backed M&A deals were either Internet related or in computer software and services or communications and media. Three communications deals - the acquisitions of Netfish Technologies, Pathlight Technology, and Kendin Communications - put nearly $750 million on the quarter's ledger.

While several tech deals are going out at lower valuations, Warburg Pincus' Harris says that M&A backed deals in sectors out of the tech and telecom sandstorm, like medical device companies, are holding up.

On the whole, the NVCA chalks up increasing deal flow over the quarter to the resolution of issues with the Financial Accounting Standards Board. The VC community had been concerned that certain FASB actions would negatively impact the way acquisitions were booked, particularly in the recording of goodwill and its effect on earnings.

However, a lobbying effort led by the NVCA prompted the FASB to reach a compromise with the M&A community on purchase-accounting methods. The board came up with an impairment test and certain triggers that would limit the rate at which acquisition-related goodwill hits the bottom line.