Sunday, February 15, 2009

Assessing the M&A Environment in 2009

Today's Globe column is headlined 'Fire sale for struggling start-ups.' It got cut rather drastically for space reasons... so I'm publishing the "director's cut" here, along with this week's video: a chat with i-banker Paul Deninger.

Fire sale for struggling start-ups

Last summer, in the clubby, wood-paneled confines of the Oak Bar at the Copley Plaza Hotel, Chris Cabrera and Mike Torto got together for drinks.

It wasn’t the first time the two chief executives had met – Cabrera’s San Jose company, Xactly Corp., competed directly with Torto’s Lowell-based business, Centive Inc. – but it was the first time they seriously discussed combining the two companies. “We realized that the only deals we were losing were to them, and vice versa,” says Cabrera. Both companies sell Internet-based software for managing the way salespeople are paid. “There seemed like a lot of synergy to bring the two companies together.”

Synergy, perhaps. But when Xactly’s acquisition of Centive was announced last month, there didn’t seem to be much upside for the investors, founders, and employees of the Lowell company: after nearly a dozen years of work building Centive, and more than $92 million in venture capital raised, they handed their company over to Xactly in exchange for stock in the San Jose start-up, which is privately-held and not yet profitable.

Entrepreneurs, team members, and investors work insanely hard under the expectation that they’re creating something of value. The dream is that eventually, the stock market or a deep-pocketed acquirer will repay them for all that work. But right now, public offerings are at a standstill, and the types of acquisitions that have been happening over the past few months don’t look too alluring.

“Investors are looking at their portfolios, and trying to decide which companies can cut costs and survive, who’s going to die, and who they can sell,” says Paul Deninger, vice chairman of the investment banking firm Jeffries & Company. “And sometimes when they sell, they’re happy to just get their bait back, and maybe make a tiny profit.”

Centive isn’t the only recent example of the lackluster market for tech companies. Earlier this month, a bargain-hunting Oracle Corp. snapped up Burlington-based mValent, Inc. for an undisclosed sum. mValent, which helps customers keep track of the way computer systems are configured, had raised more than $26 million from local investors like Polaris Venture Partners, Flybridge Capital Partners, and Charles River Ventures. In January, San Francisco-based Riverbed Technology, Inc. paid $25 million in cash for Mazu Networks of Cambridge, which makes software to help optimize the performance of their technological infrastructure. Only problem is, investors like Waltham-based Matrix Partners, Greylock Partners, and Pilot House Ventures of Boston had poured $47 million into the company.

There’s a possibility that Riverbed may shell out another $22 million for Mazu, if the acquired company hits certain business targets over the coming year. But analyst firm The 451 Group opined that achieving those targets will be “unlikely” given the current economic situation.

Somewhat incredibly, the banker who handled the Mazu transaction dubs it “a huge win.” How’s that? “When you have interested parties at the table in this market, and you have a company that has momentum and is doing well, you sometimes say, ‘Let’s take advantage of this now,’ versus taking the risk that the company will either require further funding, or the company may lose its momentum,” says Ben Howe of America’s Growth Capital in Boston. In other words, the price could get worse in six months, or would-be acquirers could vanish.

Venture capital firms are holding on to their best companies – the top prospects – and wouldn’t consider a low-ball offer. But when it comes companies that seem like black holes for funding, or the time and attention of their VC board members, the attitude is, “Any semi-serious offer will be considered.”

“You’ll see a whole bunch of investors just getting rid of stuff this year,” says Giles McNamee, co-founder of the Boston investment bank McNamee Lawrence & Co.

Liz Cobb founded Centive, then known as Incentive Systems, in 1997 to help companies better calculate the commissions that are paid to sales reps, and inform the sales reps about how well they were performing. She wrote the business plan and raised a first round of $2 million to build the product. Eventually, the company promoted Mike Byers, its chief financial officer, to CEO, and Byers went on a fund-raising tear. The company also started chasing big, million-dollar deals with customers like General Electric, Kinko’s Analog Devices, and Computer Associates. But every deal, Cobb says, was a custom job requiring lots of individual attention.

A big shift happened in 2005 and 2006, when a new CEO, Torto, was brought in. The company sold off its original enterprise software business in order to focus on software-as-a-service, or delivering its sales compensation software over the Internet, which reduced the cost of acquiring customers and also the amount of hand-holding they needed. Torto also recapitalized the company, which wiped out many of the earliest investors and gave a larger stake to those who were willing to stay in the game and keep funding Centive.

Xactly was founded around that era as well, and Centive started bumping into them in the marketplace. “For the past four years,” says Cabrera, “we’ve been battling each other for #1 and #2 in the market.” Xactly also opened up a Boston sales and marketing outpost.

By last year, Torto had nearly nudged Centive into profitability. After the Oak Bar meeting, Torto discussed the potential deal with his board, and the two companies began the due diligence process. “We always figured it would be an all-stock deal,” says Cabrera, “but a lot of time was spent on the delicate subject of valuation.” It was determined that Torto and most of the rest of the Centive management team wouldn’t stay on after the acquisition closed. But Xactly plans to retain the Centive engineering team in Lowell – at least for the foreseeable future, while they combine the best features of the two products.

For their part, even if they don’t have any cash to show for it, Centive’s investors are trying to remain optimistic. They’re now minority shareholders in Xactly, and that company could turn out to be a big winner. Right?

John Gannon is a partner at Polaris Venture Partners in Waltham, which backed Centive from its genesis to its most recent $10 million round, in 2005. “I think there’s a higher likelihood that by putting these two companies together, there will be a really positive exit from an IPO or an acquisition,” Gannon says.

Cobb, Centive’s founder, had split from the company in 2003 after some differences of opinion about its direction. So she wasn’t at the Oak Bar meeting when the two companies began exploring an acquisition. She learned that her old company had been sold a few weeks ago, when a colleague at Makana Solutions, the company she now runs, sent her an e-mail with a link to the announcement. Her founding stock in Centive had been so diluted over the years that she didn’t wind up with a stake in Xactly.

“It’s not fully what I had imagined,” she says.

In 2009, she’s not the only entrepreneur who’ll be feeling that way.

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