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Tech companies vanishing from the "public" eye

With valuations down and out, a number of publicly traded companies are deciding to go private.

With valuations down and out, a number of publicly traded companies are deciding to go private.

From disk drive maker Seagate Technology to smaller players like technical software and services company MathSoft Engineering & Education, several companies have made the switch. Web-surfing appliance company Netpliance was going to go private, but it withdrew its plan last week.

Last year, the tech-heavy Nasdaq closed down 40 percent, after having nearly a whopping 85 percent gain the previous year, sending company valuations into the basement. And for some management teams, that low valuation got them thinking.

"We've gotten a lot busier since the downturn has happened," said Ken Hao, a partner at Silver Lake Partners, which invested in the complex $20 billion Seagate deal. "A lot of high-quality companies that have seen their valuations fall are interested in building up their operations or making investments" in research and development, he said.

"But their investors are short-term momentum players who won't reward their stock for taking the action, so some are looking at going private," Hao said.

Last year, 11 tech companies went private, one less than in 1999, according to Thomson Financial/Securities Data. But the number of companies exploring the option has jumped significantly, industry watchers say.

"Five years ago, we would get about three proposals a year, but it's about 10 a year now," said John Martinson, managing partner with Edison Venture Fund, which invested in the $7 million management buyout of MathSoft. MathSoft had been a division of publicly held Insightful.

Going private may also give a company the breathing room it needs to regroup, or let it ride out a slumping sector that does not look like it will rebound in the short term.

"A company may miss a quarter and it drives their stock down. Management considers the valuation unjustified and they see taking their company private as a way to potentially get a nice return later," said Ethan Topper, managing director with Credit Suisse First Boston Technology Group. "They'll buy it back, fix whatever problems exist and hope to take it public again at a later date."

Robert Thornton, head of Deutsche Banc Alex Brown's West Coast mergers and acquisitions, said management also usually holds the view that while their company is performing well, its industry is in a market slump that can last for a year or more. And with that type of time horizon, waiting for the market's recovery may not be worth it, he said.

Public companies are also beginning to question the downside of being a public company: dealing with the short-term quarter-to-quarter pressures from investors and the difficulty retaining and attracting employees with a low stock price, Hao said. Buyout investors tend to take a longer view and focus on cash flow, as opposed to earnings, and they can provide greater flexibility on compensation issues.

But the path from public to private is a tough one, investment bankers and venture capitalists say. Companies considering a switch need hard assets, as well as cash flow, or high growth potential.

"When a company wants to become private, it ultimately needs to find someone willing to put up significant amounts of capital to buy back the shares," Thornton said. "And these investors need to see a sustainable business model and one that is generating cash flow."

In exchange, those investors expect to get an attractive return four or five years later by either selling the company or taking it public again, he said. Failing those two options, the investors may look to selling the company's hard assets, from manufacturing plants to offices, to recoup some of their investment and pay off loans, bankers and venture capitalists say.

The need for valuable hard assets and cash flow sharply limits the list of tech companies that can consider going private.

Semiconductor and capital equipment makers, for example, tend to have a lot of hard assets that can secure a loan an investor takes out, while software companies often have most of their assets tied up in intellectual property rights, but may have attractive cash flow potential, Topper said.

Delisted companies, or publicly traded stocks that are kicked off an exchange, also need not apply, Hao said.

"These companies are in a state of peril that make them unattractive as buyout candidates," Hao said. "They're facing issues of survival and that puts them in a different category. Their desire is more of a financing tactic, instead of a long-term strategic move."

And while this sounds like the buyout days of the 1980s, the caliber of buyout investors has changed since then.

The leveraged buyout investors of the '80s may have used $9 of debt and $1 of equity to buy a company and take it private. But because of a shakedown in the savings and loan industry that funded a number of these leveraged buyout loans and tighter capital markets, buyout investors have to kick more of their own money in these days, Hao said.

"Buyout investors tend to be long-term growth oriented now, and that puts more pressure on the company for organic or fast growth," he said.