May 19, 2001 Joe Dews [email protected]

May 19, 2001Joe Dews

[email protected]

“M&A Banking for the Best Deal in the Current Market”

Including an Overview of the Technology IPO, Private Equity and M&A markets in

Q1 2001

The M&A Market in Q1 2001The M&A Market in Q1 2001

What a great time - Q1 2000What a great time - Q1 2000

• Large companies, with huge market caps and sky high stock multiples were bidding incredible prices for early stage companies

• There was unlimited and practically free cash available in the public and private equity markets – so what did burn rates matter?

• “You snooze, you lose” was the mantra

Only a year ago…

M&A in Q1 2001M&A in Q1 2001

• M&A came to a virtual halt: Buyers don’t know what to pay Buyers have seen their own stocks punished Buyers are focused on figuring out their own businesses Burn rates and earnings dilution are again a focus

• There will be no buyers for many venture backed companies without clear business models

Q1 2000

477

373

284246

103

0

50

100

150

200

250

300

350

400

450

500

Q1 00 Q2 00 Q3 00 Q4 00 Q1 01

No. of Deals

Source: SDC disclosed value global technology M&A deals over $20MM

Where have all the buyers gone?Where have all the buyers gone?

Where are the big deals?Where are the big deals?

1422

63

2

135

0

25

50

75

100

125

150

1997 1998 1999 2000 Q1 2001

Source: SDC.

Tech M&A over $1 billion in value.

Acquisition currencies have been damagedAcquisition currencies have been damaged

($ in billions) 3/31/00 Market

Cap

3/31/01 Market

Cap Decline Ariba 43.8 1.6 -96 %

Cisco 523.0 118.3 -77 %

EMC 226.6 85.6 -62 %

Intel 509.3 195.8 -62 %

Lucent 215.3 34.9 -84 %

Oracle 260.9 95.3 -63 %

Sun Microsystems 210.8 55.7 -74 %

Yahoo 84.8 10.2 -88 %

M&A Deals

Year 2000 Q1 2001

Cisco 28 0

EMC 3 0

Intel 18 2

Lucent 10 0

Microsoft 11 0

Nortel 9 1

Sun Microsystems 8 2

Number of M&A Deals Completed

The great buyers have stopped buying in 2001The great buyers have stopped buying in 2001

Where we are today?Where we are today?

What was in - 2000 What is in - 2001

• PowerPoint presentations

• “Press Release” companies

• Multiple of pro-forma forecast 2005 revenues

• Investors who “got it”

• Public venture capital

• Momentum investing: Buy on chart moves and sell quickly

• “0 to IPO” in under a year

• Promoting the stock the primary focus

• ‘Twenty-something” fund managers

• “Twenty-something” IPO jockeys

• Real Businesses and Managements

• Demonstrated success

• Multiple of historical earnings and balance sheets

• Investors who didn't “get it”

• Tested companies

• Value investing: Buy on fundamental analysis and hold

• Long-term company building

• Operations the primary focus

• Adult supervision

• Experienced advisors

M&A Banking for the Best Deal in M&A Banking for the Best Deal in the Current Marketthe Current Market

Points of DiscussionPoints of Discussion

(a) Leading firms working with software and Internet companies, and how to identify and engage a banker,

(b) Typical fee arrangements,(c) The range of services provided by bankers in the M&A

process, (d) How valuation is set from the target’s perspective – and how

valuations have changed over the past few months, (e) Issues in selecting the best acquisition partner,(f) Assistance, if any, that acquisition bankers might provide

following completion of the deal, (g) What type of companies Needham is now working with, and(h) What kind of deals we are turning away.

Just in case I run out of time, here are the short answersI Leading firms working with software and Internet companies, and how to identify and engage a banker,

In general, more important than the firm is the people you will be working withII Typical fee arrangements,

Be aware that in general you will get what you pay for. The fee structure should provide incentive for the desired outcome

III The range of services provided by bankers in the M&A processVarious, but an overlooked point is that the M&A process is a process, a complex multi-

variable processIV How valuation is set from the target’s perspective –

No acquirer will pay more than they have to, so it is ALL about leverage.and how valuations have changed over the past few months,

LOLV Issues in selecting the best acquisition partner

Depends on a lot of things – big difference between a cash and a stock dealVI Assistance, if any, that acquisition bankers might provide following completion of the deal.

If you are counting on someone who gets paid when the deal closes to help you manage the integration process, you may want to think some more about that

VII What type of companies Needham is now working with (Broadly speaking)Representing buyers – Public Companies buying private or public companies that are a

strategic fit and are affordable with their current currency.Representing sellers – Adequately-funded private or public companies that don’t need to be sold, but for strategic or liquidity reasons want to be sold, and which have strong market

position, technology and customersVIII What kind of deals they are turning away.

Fire sales; companies which we think are unlikely to be sold due to high losses or lack of significant market position, technology and customers; companies where the valuation or our ability to add value will not support our minimum fee.

Who are leading firms working with software and Internet companies, and how to identify and engage a banker

• There are many investment banking firms that have both a strong effort in technology and focused M&A expertise

• There are a group of firms that have historically had a purely or heavily technology focus

• There has been a lot of change in the industry

• There has been a lot of consolidation

• Recently, there have been layoffs at most investment banks

• I think you should look for a firm that has expertise in your industry, expertise in M&A, with people that you feel good about working with, were you feel you will be a valued client and get the effort you want and deserve on your behalf. At the end of the day, as in anything else, you are working with a group of people.

• Sources of introductions/information: professional introductions (from your lawyers, your accountants); personal references (other entrepreneurs); seminars like this; advertising.

Independent National Emerging Growth Firms

Needham & CompanyThomas Weisel Partners Wit / Soundview

Emerging Growth Firms NowOwned by Major Commercial Banks

Fleet / BancBoston / Robertson StephensBank of America Securities / MontgomeryChase / H&Q / J.P. Morgan / FlemingsDeutsche Bank / BT/ Alex. BrownSG / Cowen SecuritiesRoyal Bank of Canada / Dain Rauscher / WesselsFirstar / US Bancorp/ Piper JaffrayCIBC World Markets/ OppenheimerABN Amro / ING / Barings / Furman Selz

Major Bracket Institutional Firms

Bear StearnsUBS / Warburg / PaineWebber

Structure of the Investment Banking IndustryStructure of the Investment Banking Industry

Special Bracket Firms

Citigroup / Salomon / Smith Barney / SchroderCS / First Boston / DLJGoldman SachsLehman BrothersMerrill LynchMorgan Stanley / Dean Witter

Regional Firms

A.G. Edwards (St. Louis)Adams Harkness & Hill (Boston)First Union (Richmond)Janney Montgomery Scott (Philadelphia)McDonald & Company (Cleveland)Morgan Keegan (Memphis)Raymond James Financial (St. Petersburg)Robinson-Humphrey (Atlanta)Stephens Inc. (Little Rock)Sutro & Co. (San Francisco)Tucker Anthony Sutro (Boston)Wells Fargo/FSVK (San Francisco) William Blair (Chicago)

What are typical fee arrangements

• Case by case basis

• Typically a front end or retainer, and back end or success fee

• Typically related to the size of the deal, as through a success fee based on a percentage or variable percentage of the transaction value

• Typically subject to a minimum in the event of a completed transaction

• Be aware that in general you get what you pay for. The fee structure should be designed to provide incentive for the desired outcome.

• “M&A” can cover a range of advisory services to clients on:

Mergers

Acquisitions

Divestitures

Fairness Opinions

Going Private

Recapitalization

Restructuring

Share Repurchases

Strategic Positioning

Takeover Defense

The range of services provided by bankers in the M&A process

Sale Process and Transactional IssuesSale Process and Transactional Issues

Valuation

Steps to successful transactions

Structuring

Negotiations

Due Diligence

•Analyze financial statements•Discuss business history and prospects with management•Analyze comparable public companies’ trading multiples•Analyze comparable transactions•Value shares offered for consideration (public co. only)

•Determine ability to use either cash or stock•Analyze respective proforma effects of a stock or cash acquisition

•Balance sheet•P&L•Goodwill•In-process R&D Write-offs

•Financial advisor or principal•Cash or stock preferable•Understand potential synergies•Employee issues such as:

•Acceleration of options•Employment agreements•Non-compete agreements

•Key issues to be negotiated:•Condition of closing•Financing outs•Reps & warranties•Break-up fees•Shopping restrictions•Topping offers•Material adverse change•Shareholders’ vote required (either company)

•Interview key management•Financial due diligence including analysis of historical and projected financial statements; interview independent auditors•Third-party interviews and reference checks•Facility visits•Legal due diligence

Financial Positioning

•Press release announcing transaction•Backgrounder on the acquisition•Guidance for analysts’ forecasts•Prepare and conduct conference call•Plan and execute roadshow to sell the deal, if necessary

What is some of the value a banker can provide

•Smooth orchestration of a process, saving time and energy, and increasing the likelihood of a successful deal

•Convert a serial process to a parallel process, to increase leverage and get a better price

•Credibility – implicit or explicit “threat of an auction”, to increase leverage and get a better price

•Ability to outsource the difficult negotiations, preserving the relationship of a CEO and the Buyer, to increase leverage and get a better price and have a harmonious relationship after the deal

•Experience and insight •Relationships and introductions

Resources an Investment Bank can ProvideResources an Investment Bank can Provide

- A highly knowledgeable research analyst can be a resource, circumstance permitting

- Industry bankers with a strong understanding of the industry

- An M&A team experienced with the M&A process

- Contacts with the “right” individuals at potential acquiring companies

- Ability to leverage expertise and capabilities of various areas of the firm, including underwriting, research, mergers & acquisitions, and potentially private placements and venture capital, to produce maximum transaction value

How valuation is set from the target’s perspective and how valuations have changed over the past few months

• Valuation is set by what the buyer believes they need to, and can afford to, pay to get the deal.

• Metrics (price/sales, price/earnings, price/book, premium to stock price) can measure valuation, can guide expectations, can at some level be constraints, but do not determine valuation.

• Valuation impacted by alternatives to the seller, such as the availability of, and cost of, private or public equity capital

• Valuation impacted by how the acquirer is valued, by the public or private markets

• No acquirer will pay more than they believe they have to, so it is ALL about leverage. Get the leverage on your side


• Competition

• Desire

• Necessity

• Resources

• Time

NegotiatingLeverage

(5 key elements)

Multiple Elements Drive Negotiating Leverage


NegotiatingPlan

CollectingInformation

AchievingResolution

DeterminingResponse

EstablishingExpectations

AssessingLeverage

Planning is an Important Component of Successful Negotiations

Issues in selecting the best acquisition partner

• Think about this before you start the process, because depending on the answer the process may change

• Different stake holders may have different objectives and criteria, which needs to be managed

• Big difference between a cash deal and a stock deal


ValuationStructureLiquidity

Fina

ncia

l Ter

ms

CultureCorporate Strategy

Non - Financial Terms

Buyer’s Minimum Terms

Seller’s Minimum Terms

Successful Negotiation Can Usually Result in aBroad Range of Outcomes


• Probability of Successful Sale Low Medium High

• Maximization of Sale Proceeds Low Medium High

• Time

- required to canvas prospective purchasers Low Medium High

- from canvas to conclusion High Medium Low

• Confidentiality High Medium Low

One-on-one negotiation

Full auction

Potential Tradeoffs

Sale Process Continuum

Assistance, if any, that acquisition bankers might provide following completion of the deal

• If you are counting on someone who gets paid when the deal closes to help you manage the integration process, you may want to think about that some more

• Strategize on positioning

• A lot of issues that appear after the deal is completed, depend on the due diligence, negotiation, pricing and structure of the deal, so make sure you get those right

• Liquidity

• Any surprises

• Integration

• Long term success

What type of companies Needham is now working with

• Representing buyers – Public Companies buying private or public companies that are a strategic fit and affordable with their current currency.

• Representing sellers – Adequately-funded private or public companies that don’t need to be sold, but for strategic or liquidity reasons want to be sold, with strong market position, technology and customers

• Situations where we believe we can add a lot of value

What kind of deals we are turning away.

• Fire sales – don’t wait until the last minute, leave yourself plenty of runway

• While deals can happen quickly, a full sale process can take 4 to 6 months or longer to close, and being almost out of cash does not help your leverage

• Companies without significant market position, technology and customers

• Companies where valuation or our ability to add value will not support our minimum fee

Perspective on the current tech stock Perspective on the current tech stock marketmarket

NASDAQ CompositeDaily Closing Price

November 5, 1984 - April 24, 2001

0

600

1200

1800

2400

3000

3600

4200

4800

5400

11/5/84 9/3/86 7/1/88 5/1/90 2/27/92 12/27/93 10/25/95 8/22/97 6/22/99 4/19/01

The current market for tech stocksThe current market for tech stocks

• The late 1990’s was an aberration in the public markets unlikely to reoccur in our generation

Forget this ever happened!

Welcome to 2001!

Where have all the billions gone?Where have all the billions gone?

($ in billions)

Highest Market Cap

Current (5/2) Market Cap % Change

Akamai 35.7$ 1.0$ -97 %

Ariba 42.6 1.6 -96 %

Crossroads 12.2 0.2 -98 %

Inktomi 29.5 0.8 -97 %

Internet Capital Group 56.0 0.6 -99 %

Sycamore 51.9 2.4 -95 %

VA Linux 13.0 0.1 -99 %

Ventro 11.1 0.1 -99 %

Versata 3.8 0.1 -97 %

VerticalNet 13.5 0.2 -99 %

Vignette 23.8 1.5 -94 %

• In the first half of 2000, the flow of cash into stock mutual funds reached an unprecedented pace. However, turbulence within equity markets during the second half of 2000, particularly the fourth quarter, has caused a sharp decline in mutual fund flows.

Overview of the Equity MarketOverview of the Equity Market

Net New Cash Flows Into Stock Mutual FundsJanuary 1997 through March 2001

(20.0)

(15.0)

(10.0)

(5.0)

-

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

55.0

Jan-

97

Mar

-97

May

-97

Jul-9

7

Sep-

97

Nov

-97

Jan-

98

Mar

-98

May

-98

Jul-9

8

Sep-

98

Nov

-98

Jan-

99

Mar

-99

May

-99

Jul-9

9

Sep-

99

Nov

-99

Jan-

00

Mar

-00

May

-00

Jul-0

0

Sep-

00

Nov

-00

Jan-

01

Mar

-01

($ B

illio

ns)

• Large decreases in margin debt coincided with broad market sell-offs in the late summer/fall of 1998, in April 2000 and in the fall of 2000. Decreases in margin debt were of a higher magnitude in these periods than positive net cash flows into mutual funds.

Overview of the Equity MarketsOverview of the Equity MarketsOverview of the Equity MarketOverview of the Equity Market

Mutual Fund Flows and Net Change in Margin DebtFrom January 1997 Through March 2001

-40

-20

0

20

40

60

80

100

Jan-

97

Mar

-97

May

-97

Jul-9

7

Sep-

97

Nov

-97

Jan-

98

Mar

-98

May

-98

Jul-9

8

Sep-

98

Nov

-98

Jan-

99

Mar

-99

May

-99

Jul-9

9

Sep-

99

Nov

-99

Jan-

00

Mar

-00

May

-00

Jul-0

0

Sep-

00

Nov

-00

Jan-

01

Mar

-01To

tal o

f Flo

ws

into

Mut

ual F

unds

and

Net

C

hang

e in

Mar

gin

Deb

t ($

Billi

ons)

Mutual Fund Flows Change in Margin Debt

Historical Bear Market ComparisonHistorical Bear Market Comparison

Date P/E Bull/Bear Ratio* 12 Mo. Fwd. EPS Growth

06/26/62 13.8x

10/07/66 12.7x 33%

05/26/70 12.4x 34

10/03/74 7.1x 36

03/27/80 6.7x 29

08/12/82 6.8x 43

07/24/84 9.7x 45

10/11/90 13.8x 37 13.6%

12/08/94 16.3x 36 18.6

10/08/98 24.5x 47 15.8

03/23/01 24.2x 63% 7.4%

S&P 500 Bear Market Bottoms

*Among investment advisors.

Source: MSDW, MSCI, Datastream, Investors Intelligence, IBES

Will history repeat itself?Will history repeat itself?

• This crash was the “big one” for tech stocks

• The market crash of 2000 - 2001 makes the earlier post WW II tech stock crashes looks like mere fender benders

• A frightening thought - The recovery time from the two prior tech stock crashes was each 8 years

Boom period Bust Time required for the market to recover

1960’s 2 decade boom Big iron computers

1969 8 years: 1969 – 1977 Economic misery

1980’s

1980 - 1983: small-cap growth stocks

The Mini and the Micro

Mid-1983 8 years: 1983 – 1991

MSFT, CSCO, SLR go public at $5.00-$6.00

1995 - 2000

Internet Networking Optics

Q2 2000 Early 2001: The

maelstrom?

Eight-years? Three years? One year?

Over already?

And, which history?

Will history repeat itself?Will history repeat itself?

Where is the market for tech stocks going?Where is the market for tech stocks going?

Positive factors Negative factors

• Favorable monetary, and fiscal outlook

• Continuing rapid obsolescence

• Productivity gains continuing based on recent information technology investments

• Strong world position of the US

• Interest rates lower than in previous downturns. Inflation tame

• Investors have not given up on equities

• Mutual funds have not yet seen significant outflows.

• Technology stocks have been trading at a slight discount to non-techs

• Still no “surprise” shock from left field

• Some renewed life in the stock and IPO markets in Q2

• Housing and automotive market sectors likely to weaken in 2001

• PE ratio’s are still not historically low. In 1973-74 stocks sold at less than book value (albeit, in a different inflation environment)

• High levels of consumer debt

• World economy weakening further

• No real capitulation yet by investors

• Tech stocks not truly cheap yet

• The NASDAQ has still doubled over the past 5 years and quadrupled over the last 10 years

• Still no “surprise” shock from left field

The IPO Market in Q1 2001The IPO Market in Q1 2001

Year to year change in volume of IPOsYear to year change in volume of IPOs

The number of IPOs in Q1 2001 was 15% of the 2000 level

* Nearly 50% ($3.6 Billion ) of the Q1 2001 IPO dollars were from one transaction, the IPO of Agere

1 Q 2001 1Q 2000

Deals $ Millions Deals $ Millions Change

IPO 20 7,347* 128 22,274 (67)%

ADR IPO 1 1,423 12 12,071 (88)%

Total 21 8,770 140 34,345 (74)%

The tech IPO market dried up in Q1 2001The tech IPO market dried up in Q1 2001

Source: Securities Data Corporation

Total # of Completed Tech IPO Deals

102

70

114

33

9

0

20

40

60

80

100

120

Q1 00' Q2 00' Q3 00' Q4 00' Q1 01'

Tech IPO backlog dropped awayTech IPO backlog dropped away

10

48 3663

44

195

134

88

388

0

50

100

150

200

250

Q1 Q2 Q3 Q4 Q1 01

# of IPOs Withdrawn # of Filings

Source: CommScan.

If this one didn’t work . . .If this one didn’t work . . .

Loud Cloud Inc.

Top Underwriters: Joint Leads: Morgan Stanley Goldman Sachs

Excellent Investors: Benchmark Capital Capital Research Integral Capital

Sizzling Story:

Top customers:

Internet Infrastructure

Ford, Nike

“Name” CEO: Marc Andreessen

Last Round Valuation: $800 million

If this one didn’t work . . .If this one didn’t work . . .

Filed September 2000Price Talk: $1.5 billion at the open

Priced March 8, 2001Price: $6.00 per share

$252 million pre-money

Trading March 30, 2001

Price: $5.50 per share$218 million pre-money

The private equity market The private equity market in Q1 2001in Q1 2001

Impact of the markets on Impact of the markets on private equity investmentsprivate equity investments

• The “Crossover” hedge and mutual fund, foreign and corporate investors that gave the edge to valuations in 1999 - 2000 are largely on the sidelines

• Many private equity investors are wondering what exactly is it that they bought in 1999 and 2000

• Private equity funds face massive needs to continue to support existing portfolio companies that were expected by now to be public or be sold

• As a consequence, many established funds are focused on the needs of existing portfolio companies and not on adding new investments

Private equity returns are coming downPrivate equity returns are coming down

• Expect time to liquidity now of 4 - 5 years

• Expect dramatically lower returns than over the past five years

• Many 1999 and 2000 funds will show negative returns

US venture investmentsUS venture investments

11.713.7

16.818.919.4

0.0

5.0

10.0

15.0

20.0

25.0

Q1 Q2 Q3 Q4 Q1

2000 2001*

The impact is being felt in funding

* Preliminary Estimate. Source: VentureOne

Dollars invested by quarter (in billions)

US venture investmentsUS venture investments

The impact is particularly felt in new financings as funds focus on existing portfolio companies

290

386

445

606618

0

100

200

300

400

500

600

700

Q1 Q2 Q3 Q4 Q1

2000 2001*

* Preliminary estimate. Source: VentureOne

New first venture rounds by quarter

Valuations are coming down in many sectorsValuations are coming down in many sectors

• New rounds are difficult to raise at last round or, in many cases, at any valuation

• Desperate efforts to avoid write-downs on new rounds (e.g. 3x or more preferences on new rounds, large warrant packages) serve to reduce the effective valuation while still keeping the last round nominal price

• Pre-money valuations are dropping dramatically when new investors are needed

It is a good time to be a private equity investorIt is a good time to be a private equity investor

• It is a much better time to invest in new investments than for the past three years (if you have any money and time left after caring for your investments of the past two years)

May 19, 2001 Joe Dews [email protected]

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Transcript of May 19, 2001 Joe Dews [email protected]