Montgomery & Co Projects Deal Volume to Grow by 167% in Just 2 Years with No End to Growth in Sight
On the third Wednesday of every month I co-chair a meeting called the SoCal VCA (venture capital alliance), which represents participants from all of the top venture capital firms in Southern California as well as prominent members of the Tech Coast Angels (TCA). We meet to discuss trends in the industry and to find ways to work together to help with SoCal deal syndication – somethings that happens automatically on Sand Hill Road in NorCal due to proximity.
We feature a prominent speaker at every event. This morning we heard from Jamie Montgomery, CEO of the venerable Montgomery & Co investment bank who is at the heart of what is going on in M&A for venture backed companies. They do around 7% of the total VC-backed deals in the US per year or just under 40 deals / year on average (present year excluded!)
I have to admit that I was greatly encouraged by Jamie’s outlook for venture backed companies, which if true will be a welcome relief for our industry. No doubt a tech M&A banker would have a bias to say that the world ahead looks rosy, but however you want to put a spin on the next 2 years I think you’ll find this data very interesting and useful. Where I add commentary from myself or my fellow VC colleagues from our discussion after Jamie left I’ll put in red.
Summary of Montgomery & Co’s views on the road ahead for tech M&A of venture backed companies: (the whole presentation is later in the post, which I suggest you look at because it has insightful data. If you want to download the document I’ve made it available at my favorite document sharing site DocStoc).
1. 2009 has been the worst year for M&A in a decade. The total number of M&A deals in the US this year is projected to be a paltry 225 transactions relative to more than 450 deals just 2 years ago, which was the norm between 2002-2007, varying only by around 3% per year. Projected IPOs for 2009 are an embarrassing 10 total deals, down from 86 just 2 years ago (it was 265 in the go-go years of 99-00) but at least up from 6 in 2008.
2. Montgomery expects M&A to rebound to the normal recent levels at 450 deals by 2010. They have data from surveys they did with corporate development officers (e.g. the people who buy companies) in Q2 of this year of technology & media companies. Nearly 50% say they will increase their activity levels in 2010 (hallelujah!) with only 19% saying they would decrease levels. Jamie believes that if he were to poll corporate buyers this month (e.g. Q4) the number of buyers expecting to pick up activity would be greater than 80%. Montgomery believes there will be 50 IPOs in 2010 as there is pent-up supply and a higher risk tolerance amongst institutional public investors harmonizing at 40 deals / year for the 3 years starting in 2011.
Fred Wilson supports Montgomery’s view in this thoughtful post on the return of the tech IPO market. Bill Gurley of Benchmark Capital hopes IPO’s will pick up in this CNBC Video but stopped short of saying it would for sure. He thinks demand for IPOs (from buyers) remains high while supply is low because Sarbanes Oxley amongst other things has made less CEOs want to go public.
3. More interestingly Montgomery expect the M&A market to grow to 600 in 2011 and 750 in 2012. This would be a whopping 233% increase from today’s levels and 66% above the average of the years just preceding the current recession. The believe several factors will drive this growth:
- VC’s have a supply of companies they need to sell: There is a huge pent-up supply of venture-backed companies. VCs are typically “closed-end” funds, which means that we are expected to sell our positions in companies within a pre-defined timeframe and return the money to our shareholders. This time period is usually 10 years (although small extensions are common). They cite 800 VC-backed companies that are now > 10 years old and this number would more than double to 2,000 within 18 months if M&A doesn’t pick up.
- It is also worth noting that the rate of attrition of startup companies once they’ve reached the three year mark is an astonishingly low 1.4% per year. The take-away is that the supply of companies out there keeps growing. As a VC group we felt that the oversupply of companies might actually hurt our industry returns. Buyers aren’t oblivious to the fact that funds need to sell older portfolio companies and an oversupply relative to demand means that prices should still be challenged going forward.
- Jamie’s view is that the healthiest company in any sector will still command outsized returns (e.g. Pure Digital to Cisco) but that even the 2nd largest will get much lover valuations.
- Strategic investors are looking to consolidate their positions: The top 6 buyers in tech & media account for 27% of all purchases. And look at this post by Paul Kedrosky showing how much cash Microsoft, Apple & Google have! With 50% of buyers suggesting in a Q2 survey (possibly 80+% now) they will increase their pace of investment and a further 33% holding flat this argument is for more deals.
- Anecdotally as a VC I can tell you that this seems right – at least for now – as our portfolio companies are receiving much more attention from buyers. We went around the room and everybody agreed that the inbound approaches to tech startups has increased significantly in the past 60 days; however, many buyers are apparently still looking for “deals.”
- Another big driver according to Montgomery is that the tech industry has matured and is returning to its vertically integrated roots. 25 years ago you had the likes of IBM and Digital who sold end-to-end solutions including hardware, OS, applications and services. When you look at the likes of Cisco, HP and Oracle (note they bought Sun) it seems a return to this model. As a result the bigger buyers will look to fill gaps in their vertically integrated offerings.
- More IPO filings will drive M&A: There is a truism that the best way to be sold is to register for an IPO. Buyers tend to come out of the woodworks and realize that it would be easier to buy you as a private company so it’s sort of one last look. A recent example would be Compuware’s $295 million acquisition of Gomez, a networking monitoring company.
- A secondary market for buying private companies will likely emerge: The final point we all discussed was a secondary market for acquiring VC positions. A secondary buyer is someone who buys either specific positions from a VC or buys their whole porfolio. What drives this is often the need for the VC to return money to its investors due to the end-of-life nature of its fund. Right now this isn’t robust because the buyers are bottom-feeders (e.g. cheap) but there was a sentiment that some funds will likely be raised in the next 3 years to buy out VC positions at more fair valuations.
What have been your experiences in the past 6 months? What are your predictions for the road ahead. Love to hear more views!
(Cross-posted @ Both Sides of the Table)