Look For More M&A Action Among Strategic Data, Software Buyers
Securities Industry News
Volume 14, Number 13
Monday, April 1, 2002
by Editorial Staff
Look For More M&A Action Among Strategic Data,
Software Buyers
Ken Marlin is managing partner of Marlin & Associates LLC, a New York City-based boutique mergers-and-acquisitions advisory firm focused on middle-market firms (under $100 million in revenue) that provide digital information, software tools, databases or technology. Marlin, who most recently was a managing director at media M&A advisory firm Veronis Suhler Stevenson & Associates, was president and CEO of market data vendor Telekurs NA from 1992 to 1995. Marlin and his partners acquired the vendor in 1995, as a key component of a new company called Telesphere, where Marlin assumed the posts of president and CEO. Telesphere was sold to Bridge Information Systems in 1997, and Marlin became EVP with the vendor. In the following article, Marlin discusses the M&A market for digital information, software, technology and transaction services firms, and how it is beginning to recover from the slump of the last few years.
The M&A market for digital information economy firms-online content, tech and transaction services providers-is back. You may not have noticed yet. But the signs are there-particularly the market for "middle-market" firms in the digital information economy.
In recent months, in addition to Reuters buying most of the Bridge assets, Moneyline buying Telerate, and SunGard buying both the former ADP brokerage business and Tradeline, there have been other deals among middle-market securities information firms. Among others, these include Screaming Media buying Stockpoint; FT Interactive Data buying Merrill Lynch's securities pricing business; McGraw-Hill buying the FT-Energy group; Thomson buying Newsedge and Worldstreet.net; Ziasun and Telescan merging; Yellow Brix acquiring iSyndicate; Divine buying Northern Light as well as ePrise and Open Market.com; and Multex buying the Barra global estimates business. I could name another dozen small, but interesting, deals. The point is that, after nearly two years of inactivity, M&A activity among middle-market firms in our sector is back. However, the purchase price multiples are-and will remain-closer to those of 1997 than those wonderfully irrational values of 1999-which isn't too bad, actually.
Throughout much of the 1990s, credit was relatively loose, the stock and IPO markets were strong, the U.S. economy was healthy, strategic revenue was growing and financial buyers were flush with money. Is it any wonder that M&A transaction volume and values were strong? In the 1990s, the digital information and software-related market was seen as the vanguard of the world economy. Small and middle-market M&A transactions in this space were stronger yet. During the 1990s, strategic buyers in this area-firms such as Automatic Data Processing, SunGard, Dow Jones, Bridge, Primark, FT Group, Reuters and McGraw Hill-acquired scores of digital information firms, including content, software and transaction-oriented companies. At the same time, financial buyers-the leveraged buyout and venture capital firms-found that they could often compete with (pay purchase prices competitive with) the "strategics"-firms for whom an acquisition could bring both revenue synergies and cost sharing. Values soared as demand exceeded supply.
Then the world changed. First, Nasdaq crashed, with the tech- and Internet-related world falling on top of it. Then the rest of the US stock market followed. Reduced capital availability is often blamed for the apparent death of M&A during this period. But I blame fear; fear that resulted in an IPO market that disappeared, banks that stopped lending, investors that stopped to lick their wounds.
The situation was exacerbated by the US economic recession and capped by the events of Sept. 11. The result was that, for the latter half of 2000 and all of 2001, both financial and strategic buyers largely moved to the sidelines. Although cash was available, the market psychology from both buyers and sellers was characterized by fear.
The buyers, including investors, had fear about how low the market could go (at one point, more than 100 publicly-traded information firms had seen 90 percent or more declines in their market values.) There was fear about making a mistake and fear related to past investment and acquisition decisions that, in light of the current market conditions, looked as if they might have been foolish. (Did you see that AOL Time Warner might take a $50 billion write-down on the value of that merged information company?!) Serious losses were incurred by lenders or investors in companies such as Dow Jones Markets (Telerate), Prodigy, Dialog and Bridge Information Systems, not to mention a host of tech, teleco software and Internet content companies.
There were a few deals done. In 2001, for example, Thomson Financial acquired both Dialog and NewsEdge-both good companies, albeit with their own issues and challenges. Both were acquired at values well below their highs. But overall, in 2001, M&A was the weakest since 1994.
In 2001, some potential sellers in this sector were also ruled by fear-mostly a fear of selling too cheaply. Some believed market conditions were temporary and that to sell during the market downturn would be foolish. For 18 months, buyers didn't want to buy and sellers didn't want to sell at the price a rational buyer wanted to pay. Examples included Track Data's publicly announced decision in mid-2000 not to sell itself, as well as the more recently announced decision by Thomson Corp. to withdraw a number of its securities information publishing businesses (including Securities Industry News) from the market, rather than accept offers it considered to be inadequate.
According to Securities Data Corp., the total number of transactions declined 30 percent in 2001, to the lowest level since 1994.
A few months ago, however, we began to see the psychology change. The rabbits started coming out of their holes. The sellers started to talk about transacting at rational values. The hunters-mostly the strategic ones-began proactively hunting the sellers. Right now, there are at least six transactions being actively negotiated in this sector that I am aware of. That's a lot more than we saw in the first quarter of last year.
Values are down from the exuberant highs of 1999 and 2000. But for the most part, transaction values have not over-corrected, as some have asserted. Instead, they have simply returned to rationality. It reminds me of 1997, when values were set by realistic expectations of future cash flow.
While I'm reasonably clear as to why the M&A market wilted, I'm not sure I can completely answer the question as to why the market is coming back. However, it does seem clear that there has been a recent shift in the psychology of both sellers and buyers.
As we talk with prospective sellers, it seems that their willingness to transact may be being driven by some combination of a pent-up desire for liquidity and fatigue. For those who were ready to sell two years ago, it's been a long time to wait. For those running struggling businesses, it's been a tough two years. Now sellers seem to be taking a more realistic outlook on their own future revenue and profit expectation, bringing their view more in line with that of prospective buyers. At the same time, prospective sellers seem to be more open to a discussion of realistic transaction values. Additionally, sellers who are controlled by financial investors may also want to transact in order to lock in internal rates of return (IRRs) or to focus on other portfolio companies.
One interesting side note is that, under some circumstances, sellers of small, private firms may actually prefer to be acquired by (or merged with) companies that are themselves small, private firms-as opposed to selling to a cash buyer. This twist on the more common preference for a cash transaction comes about, in part, when owner/investors are less than thrilled with the potential cash price. When confronted with a price that represents a fraction of their buy-in price, they may prefer a chance to roll their investment into a significant equity interest in a larger, better-capitalized firm. This could still leave them a chance for a later exit, at a higher value. Of course, it helps if the small private acquiring firm has a decent business model, some cash, and, most importantly, the opportunity for immediate revenue and cost-sharing synergy. Real profit would be an added plus.
Analyzing the new psychology of buyers is a bit more complex. In fact, the pure financial buyers still aren't fully back in the game-at least not in this sector. It's the strategic players who are leading the way. Don't get me wrong, the private equity and VC funds are talking a good game; they are proactively hunting for opportunities. But so far, the evidence seems to be that they have not yet concluded that the market has bottomed. Also, in my view, many have not yet accepted the fact that 50 percent IRRs may be a thing of the past. Financial players will be back, but it may take them awhile.
One big problem for the financial players is that capital markets are still tight. This applies not only to the IPO and broader stock markets, but also to the debt markets. While the leveraged credit markets may be improving slightly this year, overall, tight credit policies are still the rule. I don't see that changing soon. Loans at the high multiples of cash flow that we saw in the late 1990s are not likely again for a long time. That means that financial investors will have to pay lower purchase prices, or expect lower returns, or some combination of the two.
In 2002, the action is going to be with strategic buyers. At least four factors seem to be at work: Means, motive, opportunity and a reduced fear about what the future may bring.
Means: After restructuring and refocusing internally for much of the past 18 to 24 months, many of these strategic firms again have the "means" to acquire businesses. For most, this not only means that they have the cash (or stock) to do small and middle-market deals, but also that they have and are willing to devote the management resources required. A subsidiary factor seems to be that, after having sat on the sidelines for two years, many of the people charged with implementing strategy at these firms are bored with pure organic growth. As one vulture said to the other, "Forget patience, it's time to go kill something."
Motive: In speaking with many of these strategic buyers, it is clear that their motive to do deals, while strong, is different from the motive that we were hearing two years ago. Then, the talk was about how the larger acquiring company could bring resources to bear to help the smaller target company grow and become more valuable. Now the motive for the strategic player seems to be mostly about how the addition of the target company can help the acquirer become stronger and more valuable. It is more than a subtle shift. But the motivation is still strong. Synergies are again in vogue. But, the "synergy" must be real, and must help the acquirer. The good news is that, from the perspective of purchase price, strategic buyers again seem willing to share some (not all) of the value of these synergies with prospective sellers.
Opportunity: For strategic firms looking to acquire small and middle-market digital information companies, the opportunities are plentiful. By our count, in the United States alone there are more than 1,000 digital information economy firms with revenue of under $100 million. Some portion of those should transact.
Finally, many potential buyers and sellers seem to have a renewed confidence in the future. Yes, financial services firms on (and serving) Wall Street are still laying off employees, and are still very cost-conscious. But the momentum seems to have shifted in the right direction. There now seems to be a growing sense that the worst is behind us-that we will be back to growth in the not-too-distant future. There is a growing sentiment that the capital markets will be back-well before the strategic player is ready to exit-and a strong feeling that they had better acquire attractive properties now, before their competitors do and before values rise.
Someone wise once said everyone knows that the secret to getting rich is to buy low and sell high. The problem is having the courage to act in a manner that is consistent with that philosophy. It has become clear that, for the smart strategic players in the digital information economy, the time to have that courage is now.