IPOs cold, so start-ups look to mergers [Discussion of LU plans after 10/1/98]
mercurycenter.com
Published Monday, August 31, 1998, in the San Jose Mercury News
With the slowing in the IPO market, mergers and acquisitions are
suddenly a hot topic among Silicon Valley start-ups. Margaret
''Maggie'' Kavalaris is the managing partner of the Gray Cary
Ware & Friedenrich law firm in Northern California. With 280
attorneys practicing in Palo Alto, San Francisco, San Diego and
Austin, the firm has a specialty in securities law and mergers and
acquisition. Kavalaris talked with Mercury News Staff Writer
Scott Herhold. Here is an edited version of that interview.
Q A recent report from Broadview Technology concluded that
privately owned tech companies were choosing mergers and
acquisitions over initial public offerings by a ratio of 12:1, up from
4:1 in 1996. What accounts for that and what does it mean?
A Well, there can be no mistake that the slow, and in some
cases, non-existent IPO market is definitely feeding that trend in
no small measure. If fewer companies are getting out -- and the
statistics show the IPO market is certainly down from 1996 --
there have got to be other exit strategies.
It also relates to the fact we're a much older, much smarter valley
now. And going public is no longer the great panacea we used to
all think it was. There are shareholder suits, the market can be
extremely cruel, very demanding. Smart management teams know
that life after going public is not a bed of roses.
Q What kind of advice do you give clients about to be
acquired? What are the key points they need to be aware of to
protect their interests?
A In a very major sense, I think that the advice for a company
on the verge of a combination is really not unlike the advice you'd
give a company on the eve of a financing, and that is this: There's
no such thing as a free lunch. A merger or an acquisition is like a
marriage. It's all about people at the end of the day. And
therefore, it is fraught with all the problems that come with
combining people. You've got to make sure there's synergy there.
You'd better do your due diligence and take nothing for granted.
Q With the IPO market slowing, does that lessen the leverage of
a company that is about to be acquired? In other words, do they
have to accept a lesser valuation because they don't have a
credible alternative?
A Not necessarily. There are so many examples in our firm of
companies that, as you look at them economically, you would
think they have absolutely no leverage. They don't have much in
the way of revenue, they're not extremely profitable, they may
even be underwater. But they've got a dynamic technology, the
new bleeding-edge solution to Web-page management, or the
Intranet, or the Internet, that some company desperately needs.
The valley proves that you can be economically disadvantaged
and very advantaged in an M & A setting by sheer dint of your
creative success and forcefulness. I think if you're a player, you're
a player regardless of the IPO market.
Q A number of acquisitions today are being made by young
Internet companies that themselves have highly volatile stock and
are not yet profitable. Amazon.com is one example. What special
problems does that present in an M & A deal?
A Depending on the disposition of the shares in a
stock-for-stock deal, you have issues that are related to the
ability of the acquired company's shareholders to freely trade their
shares. On the day of the closing, you can be standing there with
highly valued stock in a wildly stock-market successful Internet
company. Those shares are worth $2 million, and the next day,
they can be worth $500,000. And so, you really are betting the
future. And you're betting the long-term future. Most Internet
companies, with a varying market cap, fluctuate so dramatically
that it really makes these mergers and acquisitions that are done
with that currency very uncertain.
Q What typically are the restrictions on being able to sell stock
in the company that is acquiring you?
A There are all kinds of laws and rules that have to be adhered
to. Depending on who you are and how many shares you own,
they can be awfully restrictive. If you're a player in a company
that's acquired, you can join the new company on the date of
close, and be fired 30 days later, and because you know exactly
what's going on with the company that was sold, and what the
strategy is and was for the company that bought you, you can be
sitting out there six months later and still not be able to sell. I've
got several clients in this situation. It was all roses while they were
courting. They got married, they realized the marriage is failing,
they get fired. They've got all this inside information about the
company they now hold stock in, and none of it's pretty. They get
in the hands of a good securities lawyer, and that lawyer says,
you can't sell because you know too much. It's the worst of all
worlds.
Q We've seen a flood of private equity money coming into tech
start-ups, often as a corporate or strategic investment. What are
the circumstances in which that strategic investment leads to an
acquisition?
A Oh, it's highly critical. I think it's the place where the strong
mergers and acquisitions get started. It's a stealth-like strategic
courtship. You're company B, and you say to Company A,
''Hey, we really like your product. We're going to buy a lot of it.
We're going to pay you a half-million in pre-paid OEM royalty
money. And you know what? You're a little short of capital.
We're going to invest a million bucks in you.'' So you've got a
strategic investment, a strategic revenue deal, and the two
companies get a chance to look at each other, and to work
together in the trenches. When a merger and acquisition plays out
like that, it is usually highly intelligent.
Q Everyone is looking at Lucent Technologies Inc. after Oct. 1,
when a change in accounting will allow them to account for
acquisitions in a pooled fashion. What do you see Lucent doing
and what kind of companies can benefit?
A Lucent has got to do a couple things to see if it can sidle up to
some interesting acquisitions. And one of those things is to define
and distinguish itself. It's about positioning. The telecom industry
used to be this industry over on the left, which had nothing to do
with networking, with software, with the Internet, with
applications, with the Web. But the truth of the matter is, as the
AT&T-TCI merger shows and the TCI-Microsoft joint venture
shows, that the telecom industry is bleeding into everything we do
here in Silicon Valley. So I think Lucent could be looking at any
number of companies, any number of disciplines in the valley --
most notably, companies developing push technology, bandwidth
companies, definitely networking companies, Web management. I
think the list is endless, and I think their appetite is probably
endless. What's unclear is what their effective merger capability is
going to be.
Q As you look back at the M & A deals you've handled, what
have been the characteristics of the successful ones, and what
have been the characteristics of the less than successful ones?
A I'm partial to remembering and admiring successes that
depend upon people. I think when there's a very innovative
management team that really understands the expanding
technology universe and really understands the people that make
it tick, you've got the infrastructure for acquiring companies in a
way that is likely to be very successful. Where it really seems to
fall on its ear is where it's a corporate strategy, it's a
balance-sheet transaction. It tends to have all the human warmth
and kindness of a bed of concrete.
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