Tech M&A Premiums Show Air Still Seeping Out Of Bubble

Dow Jones Newswires | 03-06-2003 | Janet Whitman

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Tech M&A Premiums Show Air Still Seeping Out Of Bubble

By Janet Whitman Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--Nearly three years after the burst of the dot-com bubble, the air continues to seep out of the once high-octane technology sector.

Highlighting the ongoing slump in the value of technology companies, premiums paid for mergers and acquisitions in the computer sector have slipped to their lowest level since the tech boom went bust in March 2000, a new report released Thursday shows.

Acquirers paid an average multiple of 1.69 times annual revenue for computer software, supplies and services companies, down from 3.77 in the third quarter and 7.04 in the fourth quarter of 2001, according to the latest quarterly M&A report by Ernst & Young National Office, or EYNOW, a group specializing in transactional tax services.

Multiples based on earnings before interest, taxes, depreciation, and amortization, or EBITDA, also fell, slipping to 7.83 in the fourth quarter, down from 9.47 in the third quarter and 12.35 in the fourth quarter of 2001.

"The painful (questions) of how low valuations will go, and how long until we see a recovery is still up in the air," said Joseph Doloboff, an Ernst & Young partner and EYNOW co-director, based in Los Angeles.

Technology companies experienced a short-lived blip up in valuations in the middle of 2002. The sector ranked first based on both valuations and number of newly announced mergers and acquisitions, according to EYNOW. Many on Wall Street thought the sector had hit bottom.

Since then, however, already dim prospects for corporate spending on information technology, a major booster of tech valuations, have been weakened further still by lingering uncertainty surrounding a possible war with Iraq and related stock market skittishness, said Doloboff. "Consequently, sellers are increasingly forced to accept bids that would have landed in the trash in better times."

Though valuations have slumped, the computer sector remains among the most active areas for mergers and acquisitions. Of the 1,648 deals announced in the fourth quarter in the U.S., 522 deals involved companies specializing in computer software, supplies or services, EYNOW notes.

Underscoring the sector's slump in valuations, however, those tech deals were valued at a total of $10.2 billion, a far cry from the $60.3 billion in deals just before the puncture of the tech bubble in the first quarter of 2000.

"An increase in the number of tech transactions coupled with the decrease in valuations is an indication that bottom-feeding buyers are acquiring faltering companies just to get at the underlying technology," said Gregory Soukup, an Ernst & Young partner and EYNOW co-director. "There are still a lot of good technologies living in broken homes, and the price of adoption continues to drop."

The skimpy 1.69 revenue multiple for technology companies in the fourth quarter puts the sector in last place among the five most active industries in mergers and acquisitions, the study found.

Drugs and medical equipment boasted the highest revenue multiple, at 13.41, up from 10.33 in the third quarter and 10.02 in the fourth quarter of 2001.

Investment services ranked second with a revenue multiple of 12.33, leaping from 2.79 in the third quarter and 8.16 in the fourth quarter of 2001. Banking came in third with a revenue multiple of 2.52, while health services, at 1.93, ranked fourth.

Based on EBITDA multiples, tech fared a little better. With a multiple of 7.83, the sector ranked fourth ahead of banking, which had an EBITDA multiple of 3.88. Health services ranked first, with a multiple of 14.73.

In an ironic twist, the war on terrorism - one of the factors currently contributing to the drag on technology - "may actually provide the spending boost in 2003 that lifts tech out of its three-year doldrums," said Doloboff.

The U.S. has announced significant increases in technology spending to improve homeland security and defense.

Soukup notes, for instance, that President Bush's Homeland Security budget includes "an aggressive $2.4 billion research and development program to develop technologies that strengthen bioterrorism response capabilities."

Also, roughly $722 million will be spent this year for improvements on information-sharing technologies between the federal government and other jurisdictions, up from about $200 million last year and $100 million in 2001, he added.

Meanwhile, the Department of Defense is expected to invest more than $9 billion in science and technology this year in a move to develop more sophisticated intelligence systems, he said.

"Although all sized technology companies stand to gain, the companies that are expected to benefit most from this increased government spending include those that have long histories of working with the federal government," said Soukup. International Business Machines Corp. (IBM) and Oracle Corp. (ORCL) are among the most likely companies to benefit, he said.

Although the increased spending may lift technology out of its doldrums, a meaningful recovery in technology company valuations hinges on "a broad return to spending by corporate America, which represents about $2 trillion a year," said Soukup.

-By Janet Whitman, Dow Jones Newswires; 201-938-5248; janet.whitman@dowjones.com .

(END) Dow Jones Newswires

03-06-03 1007ET- - 10 07 AM EST 03-06-03

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