Published by Turnaround Management
The dot.com phenomenon is streaking back toward Earth in a fiery display even more spectacular than its meteoric rise just a couple of years ago. In the rush to capitalize on readily available venture capital and the promise of huge payoffs through initial public offerings, thousands upon thousands of companies were created in just a few short years.
Some recognized the Internet’s potential as perhaps the most pervasive and flexible media to come along so far and developed truly unique business models, created innovative new tools or simply muscled their way to powerful first-mover advantage in their respective markets. But for every company with a product people will actually pay for and a truly promising revenue model, thousands were just along for the ride.
In just over a year, the market for dot-com companies has become a very different place. Burned by promises of profits that have yet to materialize, the investing public lost its appetite for the stocks of high-flying Internet IPOs and began to severely punish those who turned in quarter after quarter of lackluster performance. In the first quarter of 2000, 128 companies went public. In that same period this year, less than 20 braved those now shark-infested waters. Today, venture capitalists are more circumspect about the deals they will fund. Second-round funding is harder to get and is being doled out in smaller pieces.
Declining valuations for those that have managed to go public are causing follow-on funding problems for many firms, too. Dozens of dot.coms have been delisted by NASDAQ with many more teetering on the brink. Delisting can be the beginning of a slide down a very slippery slope. Most institutional investors and mutual fund managers won’t touch a stock that has been relegated to “pink sheet” status. Dire predictions abound about the eventual fate of some 400 public dot.coms and an estimated universe of as many as 10,000 companies.
Disappearing Equity Deals
Those sinking valuations have changed the mergers and acquisitions landscape in another fundamental way. High-flying stock valuations enabled buyers to use those shares as currency to acquire other firms. In the late 1990s most of those huge acquisitions were stock-for-stock transactions. Today, “There are no equity deals. People don’t want stock,” notes Robert Boehm, an attorney with Akerman Senterfitt and Eidson in Miami, who specializes in middle-market mergers and securities transactions.
That leaves many fledgling Internet companies with limited options. One of the few remaining opportunities to create a “liquidity event” is to merge or be acquired. That option, too, is neither as easy nor as attractive as it was just 18 months ago.
In today’s volatile marketplace, acquiring companies have grown cautious. Deals are being made, but not for the sky-high valuations that were typical just a few years earlier. The attitude of buyers has changed from what was perceived as a pressing need to establish a foothold in the Internet space at any cost, to one where there is little pressure to buy.
Today’s buyers are biding their time, waiting for the best deal at the right price. They’re less interested in funding ongoing operations, the experts say. Companies with a hefty burn rate and no clear path to profitability will find deals elusive. Those with promising business models, technology that sets them apart from the crowd and real revenue streams are the most likely acquisition candidates.
Down, But not Out
Just as the promise of the dot.com company’s potential was over-hyped on the way up, rumors of the sector’s wholesale demise are greatly exaggerated. More than twice as many dot.com companies were acquired than closed their doors in the first quarter of 2001, according to Webmergers.com, a consulting firm that tracks merger and acquisition activity among what it calls “significant” Internet firms those that have received at least one round of funding from venture capitalists, angels or other external sources.
Buyers spent $13 billion to acquire 380 Internet companies during the first three months of the year, Webmergers reports. In that same period, 147 companies closed their doors, compared to just five in the same period a year earlier.
While comparable data for the entire dot-com industry is not available, the San Francisco-based research firm offers an eye-opening look at one sector: destination web sites. Buyers spent about $2.2 billion to buy 132 Internet destinations in the first quarter of 2001, a significant decline in both valuation and number of deals from the same period a year earlier. Then, a whopping $52 billion was spent to acquire 231 destination companies, and that figure does not reflect the blockbuster acquisition of Time Warner by America Online for $157 billion. In the first quarter of 2001, only five deals were valued at more than $500 million, half as many as in the same period last year.
The Webmergers data shatters yet another myth of the Internet world. “The revenge of the bricks’ never happened” company President Tim Miller said recently. While a chart of the largest deals of the first quarter shows almost exclusively broader technology firms acquiring dot.coms, the vast majority of deals are Internet companies acquiring other Internet companies. Sadly, this strategy has not always panned out. Case in point: last year’s acquisition of Petsstore.com by Pets.com. Only a few months later, the sock puppet itself landed on the discard heap. Last fall Pets.com approached 50 prospective buyers and backers to no avail, according to published reports.
Yet one more example that shows the new reality in stark contrast to the Internet’s heyday: In the spring of 1999, fledgling e-tailer eToys merged with BabyCenter in a stock-for-stock transaction that gave BabyCenter roughly 15 percent of eToys. Two months later, when the much-anticipated eToys IPO closed its first day of trading at $77 per share, BabyCenter’s value on that ephemeral paper, at least was worth well north of $1 billion. In March of this year, Johnson & Johnson acquired BabyCenter from the now-defunct toy seller for $10 million.
Investment banker Phil Harris, managing director of New York’s Alterity Partners, thinks the acquisition amounts to little more than an inexpensive way for Johnson & Johnson to acquire customers.”If they had a million customers, it’s worth it at $10 per consumer, when you compare that to traditional media and what they’d have to spend to develop that relationship,” Harris said. That’s the kind of hard-nosed evaluation of a dot.com’s assets that buyers are making today, he notes.
Cash Rules Once More
Cash is king, Harris points out, and in an uncertain economy, prospective buyers are watching their cash very carefully. There’s a lot of tire-kicking, a lot of companies are looking, but few companies outside the Internet sector are stepping up to the plate, Miller agrees.
No one wants to take on a company with an unproven business model and a hefty burn rate, Harris said. “At the end of the day, even larger companies do not want to take on a money-losing operation–¦they’re just going to cherry-pick the best assets.”
An issue that slows the prospects for getting some deals made is that seller expectations have not yet adjusted to the new reality of the marketplace, Boehm said. Many are still pinning their hopes on a stellar IPO. “You have to drag the sellers, kicking and screaming, into it,” he commented.
One more difficulty faced by Internet firms seeking a buyer is that they often don’t start the process early enough. In a recent report, Webmergers.com’s Miller relates the story of Evite Inc., which announced last fall that it was seeking a buyer or strategic partner while the company still had $17 million in its coffers. Ticketmaster topped several other bidders and acquired Evite in March. All too often, Miller wrote, dot-com firms recognize the need to begin restructuring and seek a partner when it’s too late for the process to have much hope of succeeding. He recommends that firms begin their turnaround efforts, including looking for a partner or buyer, six to nine months before the cash will run out and suggests restructuring to pare operating costs and focus on the company’s core capabilities.
Buyers are being more careful with their due diligence and that can mean a lengthier process. When external financing is involved, banks are more cautious, willing to lend against lower multiples than those offered just a few years ago. And that, of course, assumes there are any revenues on which to base the traditional EBITDA analysis. Trendy Internet measures of worth such as page views and cost per customer carry far less weight with buyers today.
The lesson, experts say, is that executives of troubled dot.coms need to recognize the need for assistance as early as possible, understand what they really have to sell and be realistic about the price it will bring. With those goals realized, the groundwork for creating successful transactions will be in place.