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For Small Net Companies, M&A Outlook Appears Bleak

Small, cash-burning companies are going to have trouble doing deals, some observers say.

Mergers and acquisitions among Internet companies may be ready to take off, say investment bankers. But a half-year after this spring's puncture of Net stock values, it's still a buyer's market, they say. But for small, cash-burning companies, the buyers are few and far between.

Bankers who work with Internet and other technology companies say M&A looks as if it will be picking up. "A lot of people are having a lot of discussions," says John Brew, managing director of technology M&A for

Dain Rauscher Wessels

. Says Ted Ridgway, director of Internet banking for

Credit Suisse First Boston

, "Right now, everybody seems to be shopping a company."

Two deals over the past few months are significant, says Mack Rossoff, head of M&A for technology specialist

Wit SoundView


Terra Networks'


acquisition of



, announced in May, and


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purchase of



, announced in July.

Chilling Effect?
Net stock prices, as measured by Internet Sector index

Source: BigCharts

These are no simple cases of small companies getting swallowed up, because both portals have major-league market caps -- over $2 billion for Go2Net, and over $7 billion for Lycos. The deals suggest further consolidation among Internet ad-supported companies, says Rossoff. "Mass is clearly a driver for any advertising-driven Internet concept, and the portals are racing forward first," he says.

But he and the other bankers are reluctant to get too specific about acquisition targets, partly because they don't want to drive up prices for clients in potential deals.


Perry Boyle, an analyst covering online marketing firms at

Thomas Weisel Partners

, says the online promotions market is ready for consolidation, though he declines to single out any specific companies as being in play. He says it's reasonable to believe that large, offline advertising firms might be buyers, because they could take online promotion technologies and offer them to their pre-existing large client bases.

Companies in

online promotion include loyalty-program firms such as


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, and online couponing companies such as





But given that


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-- two relatively large, financially healthy, ad-supported technology Web sites -- have agreed to merge, raises the

question whether any online companies smaller than them -- and there are many -- are


consolidation candidates.

Other Opportunities

Ridgway of CSFB points to opportunities for consolidation in several areas, such as online content, e-commerce and business-to-business software. The pace of deals in which large or midsize companies acquire midsize companies will probably increase, he says.

But smaller companies will have a rougher go of it, he says. "The companies that have the ability to pay in the Internet areas ... by and large, they're not that interested in acquiring small start-up operations," he says, with the exception of smaller companies that may have technologies that larger companies need.

With all the companies on the market, and with the popularity pendulum swung away from once-popular Internet sectors, it appears unlikely that the cavalry, in the form of an acquisition, will come riding out of the sunset to save the day for many smaller Internet firms running low on post-IPO cash hoards or pre-IPO financing rounds.

For that, one can thank, or blame, the now-fashionable focus on profitability. As Brew of Dain Rauscher Wessels puts it, potential buyers are not enthusiastic about buying money-losing firms if a purchase threatens the timing of profits that Wall Street expects from those firms. "That's a component of the discussions that you didn't see a year ago," he says.

Due Diligence

But there's more going on than the path-to-profitability obsession. For one, acquirers are being more careful upfront in investigating their potential purchases, says Brew. "Buyers are being more cautious and are doing more due diligence," he says, "whereas before, it was more of a feeding frenzy."

On the bright side, there are new buyers in the market for Internet companies. "A year ago, no real-world company would consider paying cash or their own stock for an Internet company," Rossoff of Wit SoundView says. But though prices of Internet companies have come down, and though there are "quite a few" Internet deals in the works, Rossoff says he doesn't expect an avalanche of transactions, as he puts it: "People are still cautious about the business models that some of these Internet companies have." Plus, though sellers have lowered their expectations for what their companies should bring, he suggests they haven't lowered them enough. "There's more adjustment in expectations that has to go on," he says.

Current conditions, in fact, have split Internet companies into haves and have-nots, says Mark McNay, co-head of Internet banking at

William Blair

. But the basic story is still the same: "Companies are still getting together the way they always have," he says. "What changes is value."