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October 21, 2010

My, What A Big Balance Sheet You Have!

In undiluted tellings of the tale, the Big Bad Wolf devours Little Red Riding Hood before running off into the woods. It’s worth remembering when considering the prospects for a wave of technology M&A to materialize.

Over the last few months, investment bankers have been eagerly reaching out to corporate buyers at the large public technology companies, as their burgeoning balance sheets have grown large enough to cause even a sangfroid, buttoned-down banker to salivate. 

The eight US-based technology companies with market capitalizations of over $100 billion (Apple, Microsoft, Google, IBM, Oracle, Cisco, Intel and HP) are sitting on over $200 billion in cash and short-term investments. Throw in the top three healthcare firms by market capitalization (J&J, Pfizer and Amgen) and the figure is $250 billion. Further, each of these companies is in a strong competitive position, competing in markets with positive secular trends thanks to the burst of innovation that is ahead of us. I can’t cite another time in the brief 50 years history of the technology industry when so many US-based companies were in such strong global leadership positions in so many compelling, growing markets.

With the economy modestly rebounding and fear beginning to seep out of the market-–the VIX index, a measurement of market volatility or fear, is down to as low as it was in summer of 2008–-it’s no wonder that many are forecasting a robust pick- up in M&A activity in the coming year. Private investors have held on to their good companies over the last two years when it was purely a buyer’s market. Meanwhile, large companies who have spent the last two years cutting costs and pushing for efficiencies are now eyeing growth. And the quickest way to grow? Buy it.

That said, private companies should be careful not to get too euphoric. A quick survey of my investment banker friends yields comments like, “a flight to quality”–-in other words, rational deals with market leaders get done, but unloading mediocre companies is not in the cards–-and “patience” or “inconsistent interest.” One banker reported to me that one or two buyers are at the table on deals that are getting done, not three or four. Further, no one appears to be in a rush. Strategic fit is being carefully analyzed and only top priority opportunities are being pursued.

So despite the fact that yields on cash are at a historic low, don’t expect those balance sheets to thin out anytime soon. And Little Red Riding Hood should still be very, very afraid.

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As a tech investment banker I can comfortably say you are dead on here. Deals take much longer to get done, having 2 buyers at the table is a luxury and people won't overpay (which I think is a good thing, but I'm sure in a year or two, people will have forgotten the lessons they learned about not overpaying).

If your an average company and you don't have one thing that people really want (product, people, user base, etc) you'll be lucky to sell for 5x EBITDA.

So who do you see in the Boston area as likely acquisition targets over the next year or two? Any in your portfolio?

Interesting post. Thx.

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Ian – anyone with revenue > $20m who
can’t afford the IPO burden is a good M&A candidate!  As to our portfolio, I’ll
refrain from responding for obvious reasons. J
 

is $20m a general rule-of-thumb? does that very by industry? I read about web startups with no revenue getting acquired

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