More M&A Misery

More than ever, mergers and acquisitions seem the only viable path to liquidity for telecom startups. After all, it has been more than six months since the last venture-backed communications company was reported raising money in the public markets (see NetScreen's Screaming IPO).

Unfortunately, M&A volume appears to be shrinking. Venture-based startups raised some $2.1 billion in 84 mergers and acquisitions during the second quarter of 2002, according to data released this week by VentureOne. That's down from $5.4 billion in the comparable quarter of 2001, when 100 deals were completed. And in the second quarter of 2000, during the peak of the telecom and Internet boom, venture-backed startups raised $23.7 billion in 108 M&A deals.

The shrinking M&A market contributes to growing evidence that the public markets will remain shuttered for a long time and that startups are getting desperate to partner or be bought by larger public players (see Startups Pray for M&A and Can Startups Sell to Carriers?).

"The overall telecom wireline M&A marketplace remains paltry," says Robert Abbe, a managing director at Broadview International, an M&A advisor for communications, information technology, and media companies. "But a lot of the transactions that are taking place are the result of existing relationships. [Larger] vendors are taking initial steps to build relationships with startups, and that helps lessen the risks because they get to watch those companies develop."

Cisco Systems Inc. (Nasdaq: CSCO), for instance, already owned a little piece of Navarro Networks and Hammerhead Networks when it announced it would buy both companies in May (see Cisco Goes Spin-Crazy). Likewise, JDS Uniphase Corp. (Nasdaq: JDSU; Toronto: JDU) owned about six percent of Scion Photonics when it bought that company in April; and Advanced Fibre Communications Inc. (AFC) (Nasdaq: AFCI) had a minority stake in AccessLan when those two companies combined in May (see Why JDSU Bought Scion and AFC Acquires AccessLAN).

Table 1: Venture-Backed Communications M&As for 2Q02
Company Name Industry Segment Value ($M) Acquirer
Hammerhead Networks Software $173.00 Cisco Systems
Astral Point Communications Communications $126.45 Alcatel
Navarro Networks Semiconductors $85.00 Cisco Systems
Dorsal Networks Communications $49.11 Corvis
RapidStream Semiconductors $47.50 Watchguard Technologies
AccessLan Communications Communications $47.00 Advanced Fibre Communications
Scion Photonics Communications $43.00 JDS Uniphase
Source: VentureOne

Startups now are also being acquired for less money than in the past couple of years. During the second quarter of 2001, Intel Corp. (Nasdaq: INTC) bought two semiconductor companies in transactions totaling about $950 million (see Intel Snatches VOIP Startup for $550M and Intel's 10-Gig Shopping Spree). In the second quarter of 2002, however, the seven largest communications-related acquisitions totaled about $571 million.

Table 2: Venture-Backed Communications M&As for 2Q01
Company Name Industry Segment Value ($M) Acquirer
VxTel Semiconductors $550.00 Intel
LightLogic Communications $400.00 Intel
Kendin Communications Semiconductors $186.17 Micrel
Source: VentureOne

Also, acquiring companies are still using their shares as currency, even though telecom market capitalizations are at all-time lows: Even when buying startups at bargain prices, most large companies want to conserve their cash.

Suitors' behavior has changed in another way: Larger companies aren't snapping up startups until their products are attracting interest from customers. Of course, the buying company can never eliminate all the risk in a startup acquisition. Even if a startup's technology is mature, if it's not close to pulling in meaningful revenues the acquirer risks taking longer to break even on its purchase.

To some, in fact, it seems the startups are selling themselves short. "To me it is an enigma that mature startups are opting for liquidity at a valuation below the capital that was invested in the startup," says Krish Prabhu, a venture partner with Morgenthaler. "If [a startup's] revenue traction is meaningful, the right strategy for them is to get more capital -- even at low valuation -- and play another inning."

In all, though, M&A experts expect to see a steady stream of telecom startup deals this year, even if smaller than in years past. "Whether it's chip companies selling to systems companies or systems companies selling to carriers -- the number of viable customers has shrunk," Broadview's Abbe says. "This dynamic will keep forcing companies to consider M&A."

— Phil Harvey, Senior Editor, Light Reading
lightshow 12/4/2012 | 10:08:25 PM
re: More M&A Misery Anyone have any thoughts on the the LH/ULH startups like Ceyba, Innovance, Photonex? Buy out targets and by who?
the guy who sat beside the bos 12/4/2012 | 10:07:27 PM
re: More M&A Misery ....... cisco shhhh!
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