Leveraged-buyout firms have traditionally steered clear of technology. After all, why mess with highly volatile, complicated businesses that sometimes burn through investors' cash fast when there are plenty of underperforming mattress makers to buy and sell? Ten years ago, buyouts of tech companies accounted for just 0.34% of all U.S. acquisitions by value, according to Thomson Financial (TOC ).
That era is long gone. Now, as private-equity firms amass huge war chests and scour Corporate America for deals, the tech sector has landed in the crosshairs of some of the largest buyout shops in the world. In March, seven firms announced they will buy tech-service provider SunGard Data Systems Inc. (SDS ) for $11.3 billion. Another, Silver Lake Partners, said on Apr. 22 that it is joining the NASDAQ Stock Market in a $2.2 billion acquisition of electronic-securities broker Instinet Group Inc. (INGP ) And three days later, Hellman & Friedman said it will lead a $1.2 billion buyout of Internet-advertising company DoubleClick Inc. (DCLK ) So far this year, 9.34% of all acquisition dollars have gone into tech buyouts, vs. 2.67% for all of 2004.
Why the sudden interest? The industry is maturing, so many tech companies are starting to fit the profile that buyout firms look for: steady cash flow, predictable sales, and sluggish growth. Buyout firms purchase such companies and bet on a mix of asset sales, restructuring, and other operational improvements to jump-start growth or bolster profits. In 1998, only 21 tech companies worldwide had annual revenues of $1 billion or more and revenue growth of 10% or less, according to researcher Capital IQ (MHP ). Today, 52 companies fit that description.
Just as important, many of the big, sluggish tech companies are throwing off steady streams of cash. In the past, says one senior banker, "Buyout firms have shied away from deals in tech for a good reason -- the volatility in cash flow." But that's changing. Consider Computer Associates International Inc. (CA ), a software maker with $3.5 billion in sales last year. While revenues have risen 6% on average over the past three years, its annual cash flow from operations has hardly budged, rising 1.4% on average. The company collects ongoing revenue from multiyear software maintenance contracts. Such predictable cash flow is ideal for making regular payments on loans, which private equity firms typically use to finance part of their buyouts.
Banks are more willing to make loans than they used to be. Like private-equity firms, they have gotten better at analyzing tech companies. Compared to industries like telecoms, tech has produced few major bankruptcies. So banks now give more weight to tech companies' cash flows than their assets, normally used to secure loans. "Lenders have started to develop their thinking so they better understand the recurring revenue streams," says Mark Zanoli, head of tech-investment banking at JPMorgan Chase & Co. (JPM )
The increased borrowing power enables private-equity firms to leverage their funds, which are larger than ever. Last year, buyout firms raised $45.8 billion, up 35% from 2003, according to Thomson Venture Economics (TOC ). In the SunGard buyout, the private-equity investors borrowed three times the cash they contributed. With several firms now managing $5 billion-plus funds, a consortium can quickly bring a lot of money to bear. "Today, a $20 billion buyout is a reality," says a partner at a large buyout firm. That suddenly makes a whole class of once-untouchable tech companies very attractive targets.
By Justin Hibbard in San Mateo, Calif., with Emily Thornton in New York