Business Tech

With venture-backed companies failing to launch IPOs and with mergers and acquisitions lagging, liquidity for venture capitalists fell 65 percent in the first quarter, according to a report released Wednesday by Dow Jones VentureSource.

During the first quarter, $3.2 billion in liquidity was generated--a sharp contrast with $9.1 billion from a year ago and around the level seen in 2003. Because no initial public offerings took place in the first quarter, all of the $3.2 billion was generated from venture-backed companies selling themselves to the highest bidder.

Those two types of transactions are how VCs and investors in VC funds make their money back, after nursing those companies along with funding. The fewer of those types of transactions, the less money that VCs and their investors make.

Jessica Canning, VentureSource's global research director, said in a statement:

The most disturbing part about these new liquidity figures is that we've already reached the lows seen after the dot-com bust and we may not be at the bottom yet.

The IPO market is totally closed and there's just no clear indication right now that it will revive any time in the next quarter or two, even with 43 companies currently in (IPO) registration. It's a tough time to be a venture capitalist - and likely even tougher to be an investor in a venture fund.

With no venture-backed companies launching IPOs in the first quarter, all the activity fell to mergers and acquisitions. During the quarter, 68 mergers and acquisitions took place, substantially down from the 104 completed a year ago.

"This is due to the fact that many public technology companies are focused on conserving capital and the few that are buying venture-backed companies are doing so for lower prices," Canning said of the plunge.

The median price paid for a venture-backed company was $22.1 million in the first quarter, compared with $60 million a year ago, according to VentureSource. That's a steep 63 percent decline.

While the amount of money companies raise through a sale or IPO is down, venture capitalists may find comfort in that the time it takes for their portfolio companies to provide liquidity is shrinking.

In the first quarter, the median amount of time it took for portfolio companies to provide money back to their VCs was 4.7 years, compared with 6.8 years as was the case a year ago, according to VentureSource.

Correction at 9:10 a.m. PDT: The size of the average M&A deal is lower than originally reported.

Israel's high-tech merger activity fell last year, but it's IPO market took a far greater hit, according to a report released Wednesday.

The country exited the year without a single high-tech initial public offering, a first since 2003, according to the Israel Venture Capital Research Center report.

With the global economy taking a beating and the markets leaving investors running for cover, it's not surprising to see companies pulling back on IPO plans, in hopes of receiving a higher valuation in better times.

The overall figure for Israel's high-tech mergers dropped 19 percent year over year to $2.64 billion in 2008, with the average deal size coming in around $31 million.

"Lower valuations present an opportunity to global technology leaders seeking innovative technologies at bargain prices," Koby Simana, IVC's CEO, said in a statement. "We forecast an active (mergers and acquisition) market in Israel in 2009 as a result."

But IVC's venture funding forecast for Israeli high-tech companies this year is not as bullish. Earlier this month, IVC said it expects venture funds to raise only $300 million this year, a decline of 62 percent from last year.

Investors, however, may find some comfort in the fact that the number of high-tech mergers has remained relatively stable. Last year, 84 Israeli tech companies were involved in mergers, down one deal from the previous year.

Several young companies anticipate initial public offerings this week, but there's not a single high-tech outfit among them.

There's one green-tech company however. Changing World Technologies, a company that converts waste into oil, is one of four IPOs poised to hit Wall Street this week. Changing World is scheduled to price its IPO as early as Wednesday and could raise as much as $42 million, if it prices on the high end of its $11 to $15 per share range.

Nonetheless, while the four Wall Street prospects offer some excitement to their investors, there's little reason to believe that with a recession in full swing many companies will line behind them.

"If these four companies are able to successfully complete their IPO and post positive returns for at least a couple weeks, it could motivate some of the companies that have recently filed (to go public). But I don't see the flood gates opening. It takes time for the IPO market to come back," said Paul Bard, research director of Renaissance Capital, an IPO research and investment management services company.

One of the most recent companies to file its paperwork to go public is OpenTable, an online dining reservations company. One investment banker, who requested anonymity, noted OpenTable faces a number of challenges if it moves forward with an IPO during this recessionary climate.

Fewer people are dining out, as the unemployment rate soared to 7.6 percent in January, presenting a potential slowdown in business, noted the investment banker. OpenTable's annual revenues of approximately $40 million in 2007 and the first nine months of 2008 are roughly half the level investors like to see in an IPO.

OpenTable, having just filed its paperwork, however, is still a number of months away from doing its road show to talk with potential investors and hammering out its IPO price. For many in OpenTable's situation, there's no rush: some companies have languished in the IPO pipeline for over half a year and longer.

Companies set to price their IPOs and begin trading this week, in addition to Changing World Technologies, include Mead Johnson Nutrition, an infant formula maker, and O'Gara Group, a homeland security defense company. Both Mead and O'Gara are scheduled to price their IPOs Tuesday after the markets close and begin trading Wednesday, according to their underwriters.

Madison Square Capital, a real estate investment trust, is expected to price its IPO as early as Wednesday night, as with Changing World, and begin trading on Thursday.

The disappearing IPO market
They'll be among the few in recent months to brave the public markets. The number of U.S. IPOs fell last year by 85.7 percent to 29 deals across all industry sectors, according to Thomson Reuters. Within the tech sector, that decline was even sharper--dropping a staggering 90 percent to four deals last year.

But don't entirely write off 2009 quite yet.

"If you can say there is any consensus at all, overall, it feels like investors believe the market will recover in the middle of the year and, typically, IPOs have been a lagging indicator to the overall market," said David Ludwig, managing director of equity markets for Goldman Sach's technology, media, and telecom practice. "Usually it takes a quarter or two for IPO market to become robust again once the market turns."

He noted, however, that given the IPO dry spell has lasted longer than in the past, there may be more companies willing to launch an IPO before the markets turn, especially if some of the first deals that test the market are well executed.

The last IPO to hit the markets was Grand Canyon Education, an Arizona-based online university that ended nearly a four-month IPO dought, when it debuted in late November at $12 a share. Grand Canyon's shares have outperformed the markets since its debut and the stock reached as high as $20.25 a share on Monday.

Who's on tap?
The performance of Grand Canyon apparently brightened the prospects for Bridgepoint Education, another online university, which filed its IPO paperwork with the Securities and Exchange Commission in late December. There's a reason both online schools appear to be doing well.

"Bridgepoint and Grand Canyon are educational companies and in a recession, when people are out of work, they go back to school," said Lise Buyer, founder of Class V Group, a firm that advises start-ups on preparing their companies to go public.

Other tech companies that recently filed IPO papers and remain in the IPO pipeline include Rosetta Stone, a foreign language training software maker, Emdeon, an automated payment system for the healthcare industry and Internet company OpenTable.

Although nearly two dozen companies have filed formal IPO paperwork since the market malaise in October, many are getting cold feet, Bard said. Since the start of the year, two companies have filed for an IPO while seven have withdrawn. And last year, 150 companies filed plans to go public but 184 companies withdrew, according to Renaissance Capital's IPOhome.com.

Within the technology sector, the companies that show the greater potential of offering up IPO candidates in this down market include software and services, which are viewed as defensive sub-sectors, said Cully Davis, managing director of Credit Suisse's technology practice for equity capital markets.

Meanwhile, other areas that appear to have gained some of that interest, investment bankers say, are security software, subscription-based services, network management, businesses around Netbooks, solid state drives, and clean tech.

Historically, tech and health care companies have been the lifeblood of the IPO market. Last year, tech and health care both ranked second with four IPOs each, behind the energy and power industry, which accounted for seven of the 29 deals that launched during the year. But in 2007, tech dished up the most IPOs with 40 of the 203 deals, followed by health care with 39 deals, according to Thomson Reuters.

What makes for a good IPO candidate?
Companies with lower capital costs will have an easier time posting a profit and, as a result, stand a better chance of launching an IPO, noted Buyer, who also cited annual revenues in excess of $100 million as another key item companies need to aim for.

Currently, the number of executives and venture capitalists seeking out bankers to take the companies public has substantially dropped, as they focus more on operating their businesses in the current economic and valuation environment, Ludwig said. But for those companies that are closer to being ready to access the markets, there's still interest.

There are caveats, investment bankers say. A couple years ago, tech investors wanted to latch onto IPOs that featured smaller companies with hyper-growth achieved through investing into sales and marketing, said Davis. But now, with their portfolios down, investors are less interested in hyper-growth companies and more focused on demonstrated profitability and realistic growth.

So when will the IPO market comes back again? Most likely, when investors decide a fresh face on Wall Street is a better bet than investing in an old one.

HALF MOON BAY, Calif.--When bonds are paying yields like stocks and blue-chip companies are severely undervalued, who wants to invest in equities, let alone an IPO?

Those are just some of the challenges companies face in attracting investors in this current economic climate, noted panelists Tuesday during the AlwaysOn Venture Summit West conference here.

Despite the dire economic climate and the market meltdown, the panelists noted "good companies" will still have an opportunity to go public--it just may take longer.

Investors, such as mutual funds, asset managers, pension funds and hedge funds, are holding a significant amount of cash on the sidelines, as a defensive move to guard against clients pulling money out of the funds they are invested in and as a means to keep their powder dry, noted Leslie Pfrang, a managing director and head of specialist sales at Deutsche Bank.

And investors apparently don't mind that their funds are holding onto such a large hoard of cash instead of investing in equities, given cash is now considered an asset class, noted John Rende, a partner with Weintraub Capital Management. Rende and Pfrang were both speakers on "The Buy Side Today" panel.

With the harsh economic climate washing out a number of companies that had hoped to launch an initial public offering, the survivors will likely lead to a bumper crop of stronger and more profitable IPOs, said Lise Buyer, founder of IPO advisory firm Class V Group, who also served as a speaker on the "Are the IPO Glory Days Over Forever" panel.

"Everyone should act as though there will not be another round of funding," Buyer said. "You should operate with what you have, because it may be all you get."

And as older, or late-stage, private companies seek to land another funding round, Josh Tanzer, managing director of private equity firm Revolution Partners, advised companies to demonstrate to potential investors that they not only have momentum in growing their revenue but also momentum in profitability.

Correction: The month of the company's IPO has been fixed.

Rackspace Hosting, flush with cash post IPO, announced Thursday it has acquired two companies as part of a retooled cloud hosting strategy.

Rackspace, a hosting services provider based in San Antonio, Texas, snapped up Xen-based virtual machine hosting company Slicehost and cloud storage company Jungle Disk. Terms of the deals were not disclosed.

"Cloud computing offers tremendous benefits to our customers that complement our traditional managed hosting services," Lanham Napier, Rackspace Hosting CEO, said in a statement.

With the acquisitions and deeper dive into cloud computing, Rackspace plans to integrate their technology into its hosting portfolio over time. Jungle Disk's technology allows customers to share an unlimited volume of cloud storage between multiple users through a secure, mountable network drive and automatic backup. Slicehost's technology provides on-demand, virtualized servers.

While Rackspace's success in cloud computing has yet to be seen, it is one of the rare companies that has managed to go public in the second half of the year as the economy has started tanking. The company raised $187.5 million and priced its IPO at $12.50 a share.

Since its August debut on the New York Stock Exchange, its shares have fallen to $5.

Wall Street gave a nod to cloud computing as San Antonio, Texas-based Rackspace Hosting on Friday opened for trading on the New York Stock Exchange following its initial public offering Thursday.

However, its shares fell 20 percent in their first day of trading, which came as a disappointment for the first venture-backed company to go public in nearly five months, according to a MarketWatch report. Rackspace has received backing from Sequoia Capital and Norwest Venture Partners, according to MarketWatch.

The hosting company, which boasts 30,000 customers, is trading under the ticker symbol "RAX." It raised $187.5 million in an offering underwritten by Goldman Sachs, Credit Suisse, and Merrill Lynch. Shares were priced at $12.50 late Thursday, but fell to $10.01 by the closing bell Friday.

Rackspace's cloud computing division, Mosso, recently added a new Web-based control panel and a behind-the-scenes provisioning system to its Hosting Cloud service. The control panel makes it easier for users to set up and manage hosted applications, and includes a new Web-based file manager that gives users access to stored data so that they can create and decompress archives and change access permissions more easily.