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The Starting Line: Falling techs turn to buyouts

So the market's down, your company needs money and your investors are panicking. What can a self-respecting company do? Sell the whole thing to insiders.

6 min read
So the market's down in the dumps, your company needs money, your investors are panicking and you can't find an outside buyer.

What can a self-respecting company do? Sell the whole thing to insiders--it's a move that's happening more frequently these days.

The buyout trend is growing, but the numbers are only part of the tale. Some insiders are purchasing their companies after seeing quarter after quarter of losses, both financially and in terms of investor confidence. Are these insiders too emotionally attached or do they see something the average observer doesn't?

Last week alone saw a pair of buyout-related events. Buy.com founder Scott Blum closed his purchase of the online retailer after months of negotiation. And Emachines announced plans to sell itself to a group led by John Hui, a member of the company's board of directors.

Other notable buyout attempts in recent months include AT&T's would-be purchase of assets from bankrupt Excite@Home, of which AT&T happens to be the largest shareholder.

"I wouldn't say (insider buyouts are) typical," said Jamie Grant, managing director of corporate recovery services for investment bank RCW Mirus. "But it's a common theme."

It's a theme that has been more prevalent in the overall U.S. economy in 2001--in the technology industry in particular.

According to statistics compiled by Thomson Financial, this year through Nov. 6, 31 insider-led leveraged buyouts were announced in the technology industry--19 percent more than all of last year. Of the 26 insider buyouts unveiled in 2000, six---or almost a quarter of the overall total--came in the final month of the year.

Most insider buyouts are leveraged--private acquisitions financed at least partly by adding to the acquired company's debt.

The term "buyout" conjures up visions of Wall Street sharks circling around a fat corporate carcass a la Barbarians at the Gate, but these days buyouts may not be a product of greed so much as desperation. Many times it's the only way to keep a business going, especially in the tech industry.

The stock market's long decline from the peak of early 2000 has helped fuel the increase in buyouts. With many publicly traded companies now trading at their cash values or lower, and private companies unable to find a public market at all, a sale is often the only way for a company's board to find any value for investors. And often insiders are the only ones willing and able to buy.

A fair price?
Critics believe some corporate boards that agree to management buyouts are all but giving away the company to executives and abandoning directors' duty to find the best return for shareholders and bondholders. Just this month, at least two shareholder lawsuits have been filed to stop the Emachines buyout, and outcry from bondholders
sank AT&T's bid for Excite@Home.

But you'll get a different view from buyout firms such as Silver Lake Partners, Texas Pacific Group and Thomas H. Lee Partners. These companies put up the cash used to finance many of these deals, and they believe they're simply paying fair prices, especially in the wake of the technology investment bubble.

Some companies are starting to accept more realistic buyout prices, buyout fund managers said.

"I think we're finally breaking the backs of those boards of directors who have unrealistic expectations," said Glen Hutchins, a founder of Silver Lake Partners. "We're starting to see a lot of very interesting opportunities."

Silver Lake is one of the biggest, best-known buyout firms focused on the tech industry. Along with Texas Pacific Group, Silver Lake led one of the technology market's biggest management buyouts--the multibillion deal last year that transformed hard disk drive maker Seagate Technology into a private entity.

Although there are more companies looking for a private, often insider, buyer, the percentage of quality companies making themselves available remains low, said Hutchins and Justin Chang, a partner at Texas Pacific. Buyout funds that want to invest in "real businesses"--a term used by both Hutchins and Chang to describe the established, proven, market-share-leading companies that comprise their typical buyout targets--reject the vast majority of companies they look at.

Silver Lake invests in perhaps one out of 100 companies it examines, Hutchins said. Texas Pacific might hear from 1,000 companies in a year but bid on just five or six of them, Chang said.

"It's a very low-yielding business," Chang said. "That's never going to change."

Yet the sheer number of companies now trading at levels that buyout funds consider more reasonable means there's more total business available. Texas Pacific closed two deals in the past two months, after an 18-month drought following the announcement of the Seagate deal.

"Our deal flow is busier today than at any time over the past two years," Chang said. "We think the values are starting to get interesting, so we're starting to get active. It's a good time to be a buyer right now."

However, despite plummeting Internet and technology stock prices, buyout deals with depressed public companies such as Emachines and Buy.com will probably be common. Shareholders are sometimes unwilling to accept prices that look like pittances compared to the company's market value last year, and some boards of directors simply don't want to yield control.

"I think there's still something of a romance to being a public company," Brown said. "Which I don't understand."

Why insiders bother
Financiers have an obvious motivation for buyouts: making money. But why do managers go to the trouble of owning their companies? Why not let a sagging company die?

Some say it's ego. Entrepreneurial stereotypes often paint company founders as people who don't want to sever ties with their corporate creations.

Blum, for instance, holds strong paternal feelings for Buy.com. He left the company's management and board in 1999, but he never stopped being the company's largest shareholder. And he wants to prove his faith in e-tailing.

"It was my baby, and I felt emotionally tied to the business," Blum said. "There's a huge vindication factor (in returning to the company), and it's a company that I know very well."

Buy.com has already slashed costs drastically, and could start increasing its cash by the first quarter of next year, said Blum, who has a two-year plan. Beyond that, he admits, no one knows if Buy.com will turn into a company that will be profitable on its own in the long run.

Other insiders have non-emotional reasons for buying out a company. For example, directors of a public company may make it private because they believe it's the best way to build a long-term plan. Seagate, for instance, used its private funding to make a huge investment in research and development, the kind of investment that public stockholders might reject because of the short-term effect on earnings.

And some private buyouts are little more than thinly veiled arbitrage--buying an undervalued asset because you know you can sell it for more. Company insiders see the books, so they know the true value of a corporation's holdings, even if Wall Street doesn't.

Hui hasn't publicly said why he wants to buy Emachines, and Averil Capital, which is leading his $161 million bid, didn't return messages for comment. Regardless of what Hui's plans are for the maker of cheap PCs, the deal may end up paying for itself: Emachines' last quarterly report indicated the company had $258 million in assets, including $189 million in cash, at the end of September.

Management or director buyouts usually happen because the buyers know when they can get a good deal, Grant said.

"I think that not wanting to let go when they should is a very small percentage of these deals," Grant said. "People don't make these decisions out of ego. Management is often at the right place at the right time."