Thursday, July 12, 2007

Technology Buyouts: A Primer

While many predict that the BCE LBO marks the beginning of the last of the mega LBOs, few believe that there will be any slowdown in buyouts of technology companies. Here's an overview of the basics, taken from the mouths of investment bankers I've worked with in the last 18 months:

The Appeal of Technology Companies: An LBO is financed by a combination of equity investment, long term debt and higher yield short term debt. Technology companies have been historically viewed as too unstable and unpredictable to service and retire debt of the size required for an LBO. This view has been shifting as technology life cycles mature, and customers have moved beyond 18-24 month "rip and replace" cycles, generating predictable maintenance revenue streams for their suppliers.

The End Game: LBO sponsors seek 20% return (far less than VCs). Getting there depends on a combination of: the current trading multiple (the rule of thumb is that stock must trade at 10-15x editda or less if the acquisition price is to be reasonable), and the ability of the Company to improve the bottom line as a private company (by cutting costs,growing revenue, and investing in growth of new revenue streams out of the public eye).

The Ideal Candidate: Technology companies who are in a transitional phase, and therefore have the potential for transformational change and growth when taken private. Attributes that sponsors often look for are:

- Solid, top line revenue growth of 10-15% year over year (good, but not a driver of real growth)

- Annual recurring maintenance revenue

- Core business of the company is in sectoral decline

- There are embedded growth options within the business which cannot be pursued aggressively without compromising profitability (and impacting stock price)

- Managment is solid, with a strong cost conscious mentality

Ideal Stock Market Conditions: An attractive candidate also needs certain shareholder dynamics to build the business case for why it should not be in the public markets:

- Lack of street sponsorship (the company has no analyst coverage, or the coverage is too small to have focus and generate the interest of marginal buyers)

- Low liquidity (the company's stock float is thin, making it hard to bid up stock)

- A large block of stock is held by one group or institutional investor who could galvanize support for the LBO.

The Players
: This is a rapidly growing pool that includes old guard players such as Silver Lake and Golden Gate Capital. In the US, an increasing number of VCs have joined in, including Technology Crossover Ventures, Austin Ventures and Battery.

The Canadian Potential: Still a question mark. Alias and GEAC are examples of larger successes. On the smaller end, many Canadian companies have been bought as part of the growth strategies of other LBO companies. Will Canadian companies harness LBO money? Can they? What's next? Maybe Wellington will tell us.

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