December 2004/ January 2005

Traditionally, leveraged buyout firms tend to invest in mature companies with stable cash flows. Because of this, many buyout firms have ignored the technology sector. Recently, a number of buyout firms have emerged to invest in technology buyouts.

Some of the large players in tech buyouts include Gores Partners, Platinum Equity, Francisco Partners, and Silver Lake Partners. Silver Lake recently led a successful buyout and subsequent IPO of Seagate Technologies – a California disk drive manufacturer. Some buyout firms invest in traditional industries as well as technology, but technology buyout investing requires a unique skill set.

David Helfrich is a Managing Director of Garnett & Helfrich Capital, which recently raised a $250 million fund to pursue mid-market venture buyouts in industries such as communications, networking, and semiconductor. Helfrich says of the technology buyout space:

Technology is a multi-trillion dollar industry, and much of the growth is fueled by M&A activity. Over the last ten years, there have been approximately 4000 communication and software deals over $100 million... As companies grow, some of the acquired assets don’t fit the core business. We work with some of these larger companies to spin out some of these orphan divisions into free-standing companies. Technology buyouts have occurred all along, but the volume really increased in the third and fourth quarters of 2000 as the opportunities became more visible.

After the crash in 2001, there was an abundance of distressed tech companies. To survive, some of these firms concentrated on improving their core businesses and adjusting their business models. The following table outlines the number of major Internet/Computer and Telecom bankruptcy filings from 1996 through August 2004.

As these companies either restructure or liquidate, there will continue to be opportunities for private equity firms and strategic buyers to purchase orphaned divisions or whole businesses.
Scott Yen, a Vice President with Capstone Partners LLC says of the industry, “We have recently seen many buyout firms acquire distressed telecommunications assets. After the telecom bust, there were a number of quality assets, some of which had clear paths to cash flow break-even.” 
The following table outlines some representative technology buyouts.

As technology M&A and restructuring picks up, there will be increased opportunities for buyouts. Technology buyouts pose some unique challenges as compared to traditional buyouts. Technology companies are highly dependent on intellectual property and innovation, whereas traditional companies are less so. Technology companies tend to have short product life cycles, offering less stable earnings visibility. Tech companies also tend to be equity, rather than debt, financed. Some of the key technology buyout success factors include:

1. Effective management teams to turnaround and grow the business
2. Core technologies and customers that can be quickly developed
3. Appropriate use of leverage
4. Clear strategy that balances targeted research and development expenditures with harvesting cash flows

Technology Buyouts are challenging because they combine the operational and market risks of traditional buyouts with the added complexity of research and development. By considering these key tech buyout success factors, investors can increase their chances for positive returns.

Matt Thompson, CIRA, is a Senior Associate in Alvarez and Marsal’s Turnaround practice in Los Angeles and can be reached at mthompson@alvarezandmarsal.com.

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