Interesting Article about IPO's and Acquisitions...Directly relating to DBCC
upside.com
September 29, 1998
The IPO-Funding Feeding Frenzies, by Norm Alster
Once upon a time, companies, like children, grew up slowly, nourished on numbered spoonfuls of venture capital until they proved profitable. Only then might they raise modest sums by going public. Typically, these funds would be applied to operations. If everything went right--a well-executed business plan, timely product development, a favorable economic background and a reasonably strong equity market--in 10 to 20 years these companies might be grown up enough to use their carefully accrued capital to begin making acquisitions.
These days, though, corporate childhood and adolescence seem like vestiges of a slower-paced era. Now, lavishly valued high-tech industry initial public offerings (IPOs) fly out of the gate with the will and resources to buy out real and potential rivals, often solidifying markets in a matter of months.
For deal maker Joe Firmage and others who've learned to leverage lofty stock valuations, the IPO is now a cold-cash version of steroids, morphing baby-toothed startups into prowling raptors almost overnight. May as well call them initial predatory overtures.
Just 28 years old, the energetic Firmage has already bought 34 companies. Co-founder and CEO of Internet service outfit USWeb Corp. in Santa Clara, Calif., Firmage is just getting up a head of steam. Among those 34 deals, he has announced 13 since February. (On Sept. 2, 1998, USWeb announced it would merge with CKS Group Inc. of Cupertino, Calif., and rename itself Reinvent Communications Inc.)
Has anyone noticed that USWeb/Reinvent went public in December 1997 with a cumulative deficit of $53 million and hasn't yet turned a profit? Is it appropriate to point out that USWeb/Reinvent's revenue growth is paralleled by equally impressive growth in quarterly losses?
No, as Firmage, his underwriters and investors will unanimously attest, it's not appropriate. This isn't 1978 or 1987. None of the old rules about markets or equity valuation applies. Firmage, in fact, is a prime practitioner of the game as it's now played.
For several years, Cisco Systems Inc., 3Com Corp. and other prominent tech companies have aggressively used their richly valued stocks to fund acquisitions. Now, startups with little operating history or management depth are doing the same. In essence, they're using the public's "seed money" to gobble up the seed corn in their industries, acquiring key technologies, market share or both. "We saw the opportunity of going public [as a way] to create two kinds of currency--cash to fund operations and stock to do acquisitions," says Brett Bullington, an executive vice president with Internet search company Excite Inc. in Redwood City, Calif.
The strategyis dependent on high stock valuations and is especially suited to Internet players that believe they MUST MOVE QUICKLY. It will be years before anyone knows whether acquiring companies, often called "consolidators," will have done well by the assets and technologies they acquire. Many investors have already done well because these stock deals are often seen as accretive--meaning they'll improve earnings. Thus, an acquisition strategy sets off a chain reaction in which the shares of the acquiring company keep going higher, allowing it to make more and more deals using stock that stretches further and further.
Of course, small companies that take stock as payment, along with investors who pay dearly for secondary offerings, face two heightened risks: There's no guarantee that management, which is typically in short supply and inexperienced, can successfully integrate so many disparate operations. They also hold stock that's richly valued, on the assumption that the acquisition or "roll up" strategy will work. If it doesn't, they're left holding the bag.
Although Firmage dropped out of the University of Utah before he could earn his degree in physics, he may well be remembered for what we'll call Firmage's Theorem:If my stock's worth more than yours, you're history.
Of course, if you, like Firmage's USWeb/Reinvent, are a provider of services that help corporate clients make the best use of the Internet, your stock has been highly valued. This allows you to use your stock's inflated currency to ingest private companies with more modest valuations.
Rubles for dollars
It is, as Firmage, a former Novell Inc. executive, concedes, a nifty arbitrage: "The only way you can sell a strategy to Wall Street that factors in a significant number of acquisitions is if there's a significant arbitrage--a significant delta--between the price you pay and what you get on Wall Street." USWeb/Reinvent shares, selling at slightly less than three times the $7.50 offering price this summer, were valued at 10 times the annualized rate of the company's past six months of revenue. But Firmage manages to find small private businesses that sell from "1.8 to 2.5 times trailing annualized revenues." It's like trading rubles for dollars.
Cristina Morgan is managing director at San Francisco-based Hambrecht & Quist LLC, the lead underwriter for USWeb/Reinvent's IPO. Morgan points out that USWeb/Reinvent's strategy has worked because the company has executed well. But "if they screw up and don't execute, [the company's stock price will] be $2 a share," she suggests. Asked whether USWeb/Reinvent could have been brought public when she started in the business, Morgan, an investment banker for 16 years, replies, "Probably not."
But these days, cash is in hot pursuit of ideas. With 401(k) plans diverting paychecks into mutual funds, Internet concepts have been cash magnets. Observes Excite's Bullington, "The Internet phenomenon is happening at a good time to raise money."
No kidding. Though still in search of its first black ink, Excite has, since its 1996 IPO, signed off on eight acquisitions totaling nearly $210 million in value. Excite competitors such as Lycos Inc. of Framingham, Mass., and Yahoo Inc. of Santa Clara, Calif., have also been aggressive buyers. In August, for example, Lycos announced it would acquire Web-based directory-services company WhoWhereInc. of Mountain View, Calif., for $133 million in stock.
Though public Internet companies have been the prime beneficiaries of high public market valuations, kid gunslingers are shooting up other industries as well. Miami-based CHS Electronics Inc. has built itself into an international powerhouse in PC distribution with more than 50 buyouts--largely stock--of overseas distributors. On a smaller scale, recent IPOs such as RealNetworks Inc. and Visual Networks Inc. bagged prey just a few months after first publicly baring their teeth.
Meanwhile, lofty valuations have made possible unimaginably large acquisitions. Stock was the chief currency for upstart WorldCom Inc. of Jackson, Miss., in its startling $37 billion buyout of MCI Communications Corp. And Qwest Communications InternationalInc. of Denver (see "Vision Qwest: Can the fiber-optic upstart make it in the telecom big leagues?" Upside, July 1998, page 92) is absorbing LCI International Inc. of McLean, Va., a long-distance carrier more than twice its size, using its richly valued stock.
For the company that chooses to sell its shares to the public, the arithmetic is compelling. "The seller [of public shares] is always selling on the prospect of future earnings," explains Edward McCann, managing director of the technology investment banking group for Hartford, Conn.-based The Advest Group Inc. "He's buying with a different set of glasses--his price to buy is based on past performance."
Norm Alster is a contributing writer to Upside.
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