Moderator: Bob Kipps, Managing Director Kipps DeSanto & Co.
Panelists: Chris Hagan, Goodwin Procter; Frank Finelli, The Carlyle Group; Wes Husted, CFO Abraxas Corporation
Wes. About two years ago there was a steady flow of acquisition candidates, then it shut down completely. It has started up again in the last few months.
Bob. There is potential regulation of private equity, as well as funding challenges. How will that affect small and medium sized technology companies?
Chris. It is still hard to get deals done. Bankers tend to go from guard rail to guard rail. In 2005-2007 they were ready to lend to anyone with a good balance sheet. Now, they’ve gone to the other guard rail and aren’t lending very much. If private equity can’t line up financing, we can’t compete.
Frank. Carlyle has $80 billion under management. Mostly we do standard leveraged buyouts, and our ability to leverage is somewhat impaired now. We try to bring companies that are profitable and have revenue growth up to become larger companies. We do have some ability to play on the financing side with mezannine funds. Our portfolio companies are important acquisitors in some of these markets. We have some with strong balance sheets. Private equity is going to remain a force out there. The ability to structure terms to compete for value is the unknown thing.
Wes. I’m hearing pain from my side. I agree completely with Frank. If there is a deal to be made, the trick to it is the financing piece. The banking side has swung so far in the other direction, you’ve got to have something very special if you want to stand a chance. It’s an irony because the money is cheaper now but it’s twice as hard to get.
Bob. There has been some reopening of the IPO market recently. IPO used to be the goal of many technology companies. What do you think of the IPO market today? Is that an option for growing tech companies
Frank. I’m skeptical. I heard a report on the radio saying the IPOs were back, but it was a single digit number. Clearly, the IPO markets have to be part of the solution here. Is there an issue with scale, given all the requirements on public firms. Small firms in the downturn really struggled. Certainly if you are privately held, everything you do is available to your limited partners, but it’s even more challenging when you are publicly held. I’d be interested in seeing if there is a way to facilitate public listings for smaller tech companies.
Chris. The IPO is not dead the way it was six months ago. When you go public you have 3 real issues: 1) you open the barn door so everyone knows what you are doing 2) you have Sarbanes Oxley which forces the management team to step up to the plate behind all the numbers, to certify to the public 3) dramatic costs you have in selling to the public. But the IPO does represent a great weapon. Many will do a dual track, so they can say, “we’ve filed to go public” to the private equity or acquirers, to get a better price.
Bob. I saw yesterday there has been $80 bilion of private equity taking companies private. There are probably more companies going private than going public.
Frank. The gap between valuations for private vs. public has probably increased overall.
Audience question: Dixon Doll said over 90% of job creation happened after an IPO. Does job growth slow down after acquisitions?
Wes. I think job creation happens a lot after acquisitions. I’ve seen many jobs created because of acquisitions.
Frank. Public companies may be viewed more favorably in the credit markets, and that may be why more jobs can be created.
Audience question. I think you said Carlyle is focusing more on growth capital than the VC stage.
Frank. It was a decision to move more later stage. It’s a function of where we were seeing value being created. This has to do somewhat with the technical and engineering requirements of being a successful investor in the early stage–to know whether you have a winner on your hands or not. It’s a tough process to go from technology to product to market. So if we work with companies that have gotten through the intial stages and are now scaling, is a good way to use Carlyle’s resources worldwide.
Bob. With all the federal government involvement and initiatives, how are you seeing the established Defense companies re-equipping themselves to play in these new fast lanes? Overall military spending is not likely to be increasing, but spending in other areas will be growing.
Wes. It looks like the 7 defense companies you mentioned are probably looking to grow by acquisitions, based on the administration’s spending agenda in these new areas.
Frank. Pentagon publishes a program objective memorandum that gives objective for next 5 years. This administration has chosen not to publish a POM for 2010-2015. So no one has seen what their funding priorities might look like. Many defense companies focused on system integration. Most of the IR&D (sic) has gone to system integration and to fixed priced contracts (instead of cost plus), consequently, they haven’t invested so much in R&D. So the BD teams are looking for white space. They are finding some areas of growth, then they have to assess inhouse capabilities (how can we be world class in this?) vs. acquisitions. If we can meld the program management and system integration capabilities of these large defense contractors with the new areas of government spending, it could be a good thing for the country.
Wes. We look for technology that can be brought into the national security space, so keeping IP in house is important to us. If you sell me an idea based on projected earnings, you won’t recognize that value except through an earn-out. 2 of our 5 deals have been earn outs.
Wes. We have acquired significant intellectual capital through our acquisitions, we have kept subject matter experts, and we are focused on developing real technology that we can take into a broad swath of customers. One product line we have, the chamelion line (used by Amex and Disney), used by law enforcement, plus some other players in national security space.
Frank said something about a new rule around organizational conflicts (OCIs) makes it so companies working with all federal agencies can’t work on both sides — recommending technology and providing it. [I didn't catch the legislation or rule he referred to.]
Bob. How do you value companies that you buy, so that you can bring their products into a bigger plan?
Wes. We are trying to find the idea — one of our acquisitions had no idea there was a government application — we will show them, you want a big check today, fine. But the real payoff is what we can do together if you join us. So we are quite generous with the equity of our company. If you buy into our vision and we buy into yours, that is where the payoff is. Most of them are young, and we can create success together. This is different than buying a services company they built over 20 years and they want a big check so they can hit the trail.
Chris. If you buy a business for what they are going to produce, you often do it as an earn out. But if you buy a company where 1+1 = 3, you can structure it with some cash and some stock. So they are motivated to make the whole enterprise succeeds.