Buyout Specialists Target Tech Fallen Angels: Orphan divisions of large tech firms are seen returning to their glory days if extracted and nurtured

As the larger companies in technology sputter and miss earnings targets, some tech acquisitions specialists are taking aim at smaller units that are no longer considered core to the giants or must be sold to raise cash. These buyers hope to profit from the kinds of problems that have hit a number of large software companies and drew attention when second quarter earnings targets proved elusive at several. In early July, Veritas Software Corp., Sybase Inc., PeopleSoft Inc., Siebel Systems Inc., and BMC Software Inc. reported earnings losses. Venture capitalists Terry Garnett and David Helfrich are among an emerging breed of entrepreneurs who have launched funds to invest in unwanted divisions or parts of divisions of larger companies. Their fund, Garnett & Helfrich Capital, starts off with a $250 million shopping purse, and they plan to look for orphan units, unhappily nested within larger enterprises. The fund’s largest investor is Harvard Management Co., the investment arm of Harvard University. Garnett is a former senior executive of Oracle Corp. who has also worked as a general partner at Venrock Associates, the venture capital arm of the Rockefeller family foundation. Helfrich was a member of the founding team at Copper Mountain Networks Inc. He has also worked at 3Com Corp. and Ascend Communications. Garnett says he expects to parcel out the $250 million in six to eight buyouts over the course of three years at the rate of one or two a year. He adds that Garnett & Helfrich, located in Menlo Park, Calif., will eschew the approach of some buyout shops, which is merely to take control of companies, reduce head count, and slash costs. Instead, his shop plans to be an active owner with the goal of taking a company that might have been registering revenues of $50 million a year, hold it for a few years, and grow it to $150 million before unloading it. Charles Mills, a principal at Strategic Due Diligence, a San Francisco-based firm that follows the software industry, says that the impact of Sarbanes-Oxley will assist ventures that seek to develop tech firm carve-outs. “In the past, companies were reluctant to sell assets for less than they paid. But the new law forces companies to write down their investments to reflect their true values,” he notes. This means, he adds, that selling off divisions that are no longer perceived to be core at lower prices than were paid has become more palatable. Small Deals Universe? One California-based investment banker notes that Garnett & Helfrich and others face several major obstacles as they shop for carve-outs from tech companies. The universe of the kinds of assets they are looking for – underperforming parts of large software and other technology companies – has been thoroughly picked over, he says. “Funds getting into this now are coming to the market late. In the wake of the bubble’s bursting in 2001, larger companies have already reevaluated their strategic direction and made whatever divestitures they’re going to make.” A second problem for shops like Garnett & Helfrich, he adds, is that companies feel an inherent reticence to sell assets to an unproven entity because they’re afraid that the newly independent company will neglect their customers. This is a concern because there is considerable overlap between their remaining customer base and the customers of the spun-off or carved-out unit. Another challenge for the new carve-out shops is that at the high end of their deal range – around $50 million – they will butt heads with larger venture capital entities looking for management buyouts. “There is a lot of money chasing these kinds of deals,” he states. Garnett says his fund plans to target assets in technology sectors where the founding partners have worked, such as business enterprise software and business-to-business applications. Helfrich will contribute his expertise in networking applications and anything in the systems stack area. A third member of the Garnett & Helfrich team, Mike Guthrie, spent 10 years servicing semiconductor industry clients as a Credit Suisse First Boston banker. As a result, the new carve-out shop will target units that do anything from the IT side of the industry to applications to semiconductors. It hopes to find companies it can buy for less than one times revenues and that have the potential to double or triple sales while Garnett & Helfrich reestablishes the brand. Part of this process will be to install new managers to grow the business. Garnett notes that in some cases the new management will include people from the original team that developed the company and who have become frustrated at the stagnation it has suffered. Another service that Garnett & Helfrich will be able to provide to the market is to create companies that have audited financials. “Many of our targets, because they are a $50 million business locked inside a $500 million division of a larger entity, don’t have audited financials,” Garnett states. Numbers to Show Buyers While Garnett & Helfrich will have to do considerable work when it does pre-deal due diligence, things will be easier at exit because there will be readily available numbers to show buyers. This will make them attractive to a larger universe of buyers, he adds. Garnett says that the hiring of CEOs like Edward Zander at Motorola Inc. and Klaus Kleinfeld at Siemens AG signals that more large technology companies will be taking aggressive steps toward reorganizing their mid-sized divisions, which will increase the number of targets available in the market. Garnett says that, among other things, he will look for units that have great customer relationships. “For these kinds of companies, the technology doesn’t necessarily have to be state of the art, but we know that customers are prone to stay with vendors if they have a rewarding relationship with them.” Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com