January 22, 2007 Tech Sector Anticipates Another Busy Year For Mergers By Mark Boslet of Dow Jones Newswires PALO ALTO, Calif. (Dow Jones)--By most measures, 2006 was a good year for technology mergers and acquisitions; 2007 could be even better. A solid economy, low interest rates and buyers flush with cash are setting the stage for a year that could top 2006's $215 billion of worldwide transactions. Investment bankers say the pace of activity is high and that an improving market for initial public offerings could help lift prices. A surge of M&A activity isn't unusual for the later stage of an economic growth cycle. Organizations often are confident enough about their prospects to go on the prowl for acquisitions to spur growth. With corporate profits strong, businesses have plenty of money and high stock prices to use as currency. But fueling this year's activity, as well, is an army of private-equity firms loaded with their own cash and showing an increased interest in technology deals. Several of these firms made big news in 2006 with multibillion-dollar deals for Freescale Semiconductor Inc. (FSL) and Philips Semiconductor, which is now called NXP Semiconductors. More such transactions are expected. What also could set 2007 apart is the recovering market for technology-based IPOs in the U.S. If startups believe they have an alternative to selling themselves - as early signs of renewed investor interest in technology IPOs might suggest - competition for acquisitions could increase, and prices could rise. While no one knows how 2007 will turn out, "activity continues to be very strong," says John Brew, managing director at the investment bank RBC Capital Markets. As long as capital remains relatively cheap and corporations are buoyed by a steady economy, the IPO and M&A markets could feed off one another, says Brew. "It appears to be a pretty robust year." The rebound in the M&A market isn't new. Technology acquisitions have been on the increase since the financial meltdown of 2002. According to financial data from Dealogic LLC, there were 4,302 transactions worldwide last year with a 21% annual increase in dollar value. The jump in deal value was an even greater 31% in the U.S. The year also saw a resurgence of big deals. Seventeen high-tech transactions took place at over $1 billion, more than double the eight in 2005, says market monitor FactSet Mergerstat LLC. Deals like Google Inc.'s (GOOG) $1.65 billion acquisition of YouTube drew worldwide attention. But smaller companies saw accelerating activity, as well. Venture firm Foundation Capital of Menlo Park, Calif., sold five of its portfolio companies in 2006 - and turned down an extraordinary five offers for every one it accepted, says Warren Weiss, a general partner. The interest in startups should continue in 2007, Weiss says. Acquirers have a lot of cash to spend - including private-equity firms, which raised a record $103 billion in 2006 - and will be under pressure from investors to put the money to work, he says. M&A As Growth Strategy The solid global economic growth "gives people a lot of confidence to go out and do M&A," adds Ned Hooper, vice president of corporate business development at Cisco Systems Inc. (CSCO). Cisco made eight acquisitions in 2006 and expects to maintain a similar pace this year. With the year just three weeks old, the company already agreed to buy email security vendor IronPort Systems Inc. of San Bruno, Calif., for $830 million of cash and stock. "We've always been focused on using M&A as a growth strategy," says Hooper. What is different now is the company is looking at larger acquisitions as a way to more quickly enter new markets, he says. The strategy first took shape in 2003 with Cisco's acquisition of consumer-networking company Linksys and continued through its purchase of Airespace in 2005 and its planned buy of IronPort. Private equity's interest in technology M&A has gone hand in hand with the availability of credit and debt financing, says Peter Chung, managing partner at Summit Partners, venture and private-equity investors. Banks have shown a willingness to do deals, and there are no signs of this changing. "I think you'll continue to see aggressive transactions in the tech sector" in 2007, says Chung. "Investors are thinking more creatively about companies and how to finance them." Private-equity funds are attracted to high-tech companies because their cash flows can often easily cover bank financing as low as 7% or 8%. The deals are typically highly leveraged, meaning a high percentage of the purchase price is borrowed. Several of their 2006 deals involved billions of dollars. NXP sold itself for about $9.5 billion to a consortium of private-equity investors made up of Apax Partners, AlpInvest Partners NV, Bain Capital LLC, Silver Lake Partners and Kohlberg Kravis Roberts & Co. A second group, including Blackstone Group, Carlyle Group LP and Texas Pacific Group, bought Freescale Semiconductor for $17.6 billion. More big deals are expected. Speculation around public company buyouts in the software market frequently focuses on BMC Software Inc. (BMC), CA Inc. (CA), McAfee Inc. (MFE) and Symantec Corp. (SYMC). "We see a significant number of public and private companies in discussions with PE firms," says Stephen O'Leary, senior managing director at Jefferies & Co.'s Jefferies Broadview, an investment bank. In addition to big deals, it wouldn't be a surprise if private-equity firms begin to play a larger role in the midmarket, where an estimated 300 or so companies presently in venture-capital portfolios will generate deals of $100 million or more, says O'Leary. Venture investors like Gordon Ritter, general partner at Emergence Capital Partners, expect M&A deals among venture-funded companies in 2007 to top 2006. A big reason is the improving IPO market. Startups may consider holding out for the larger financial reward an IPO can bring. That will put pressure on eager acquirers to raise prices to keep a target from going public, says Ritter. Prices already have moved up. In 2006, 273 venture-funded startups were sold or merged, a 7% increase from 2005, say researchers at VentureOne, a unit of Dow Jones & Co. Yet the value of those deals rose a more substantial 38%, according to VentureOne data. This increase is reflected in median prices, as well, says VentureOne Senior Research Manager Jessica Canning. The median deal size was $50 million in 2006, compared with $36 million in 2005. The higher price tags are already visible to some acquirers. "We've definitely walked away from some deals," says Cisco's Hooper. "We've definitely started to see the expectations of startups increase."