Net Firms Lean Toward M&A as Alternative to Going Public

As post-IPO stock prices show signs of cooling, young Net firms are thinking twice about going public.
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Small Internet companies awaiting their spin of the IPO lottery wheel are increasingly deciding to sell rather than go public, thanks to a cooling new-issue environment and buyers offering richly valued stock.

Last week alone saw three such deals:

WebMD

, a medical Web site that had planned to go public decided instead to sell to

Healtheon

(HLTH)

;

HomeGrocer.com

struck a deal to sell a 35% stake to

Amazon.com

(AMZN) - Get Report

; and online pharmacy

Soma.com

reached an agreement to be acquired by bricks-and-mortar drugstore chain

CVS

(CVS) - Get Report

.

Richard Lawson, a

Warburg Dillon Read

investment banker specializing in the Internet, says he spent most of a recent week discussing with a client, an e-commerce pet store, whether it should go public or sell.

"We're seeing companies that are maybe three to nine months away from an IPO realizing that maybe another strategic option makes more sense," Lawson says.

Since the beginning of the year, there have been $3.4 billion worth of deals in which private Internet companies were bought by public companies, according to

Securities Data

. And 80% of that activity has occurred in the past six weeks. At this point last year, these deals totaled $2.1 billion.

mergers&acquisitions.com
Volume of weekly M&A for public companies acquiring
private companies in the Internet sector

Source: Securities Data

This shift represents a change from yesterday's environment in which IPOs seemed inevitable for most small Web companies and their venture-capital backers. The change is occurring because of two factors: an IPO market that appears to be weakening and a market for big Internet stocks that remains strong.

Although the IPO market is far from weak -- there have been seven times more Internet IPOs so far this year than last year -- there's a perception that stress cracks are starting to show. And that perception is enough to spook some companies into moving away from offerings.

Look at

IPO Monitor's

after-market index for the week ended May 14, which is up 14.9 points to 60.8. That makes the market exceptional, IPO Monitor says. But the index, which represents the average percentage after-market price change of the 30 most recent IPOs with a market capitalization of at least $100 million, was down from the week ended April 9, when it was 142.35.

IPOs' Cooling Reception
Average percentage increase in the 30
most recent IPOs of companies with a
market capitalization of at least $100 million

Source: IPO Monitor

"I think the market has reached the point where not all .coms are so well received," says Paul Cook, fund manager for

Munder Capital's

$595 million

(MNNAX) - Get Report

NetNet fund, an Internet specialty fund.

"I think looking at an IPO as the easy path, as the no-brainer, is dead," adds Pat Landers, Warburg's head of global tech banking. In the past few weeks, the reception of Net companies, especially second- or third-tier companies, has cooled, Landers notes. For example,

CareerBuilder

(CBDR)

, which operates a job search Web site, went public earlier this month but then fell below its initial price of 13 within days. The stock closed at 12 3/8 Friday.

It's basically what prescient IPO watchers have been saying for months. The new issue market tends to love the first hats in the ring in a particular online sector, but by the time you get to the ninth online music seller or the 18th Internet service provider, investor enthusiasm tends to droop.

One thing that may be different now is that private companies tend to hold their options open a lot longer than in the past, possibly to encourage the purchase price upwards.

"I think there are a number of companies being bought with a S-1 sitting at the SEC," says Scott Sipprelle, president of

Midtown Research

, an independent IPO research firm. "They're considering the choice between M&A and an IPO right up to the last minute." One of the most anticipated Internet IPOs of last year,

Erol's Internet

, was pulled after the company agreed to a buyout from

RCN

(RCNC)

.

And buyers are waiting with hefty stock prices, making it easier for companies like Amazon and

America Online

(AOL)

to convince private company owners and their venture capital supporters that it's better to sell.

"Some of these private companies are besieged by offers from the big guys," says David Enzer, head of the tech banking group at

Everen Securities

.

Bob Kagle, venture capitalist at

Benchmark Capital

, is glad he bought into that line of reasoning. His firm helped guide

When.com

, a private company it was funding, into the fold of AOL last month. When.com, an online calendar service, was headed to an IPO but accepted the stock swap offer from AOL instead.

"We made the decision that AOL was an attractive stock to hold," he adds. Benchmark is no slouch in such decision-making -- the firm was the sole financier of

eBay

(EBAY) - Get Report

before it went public.

Several bankers say that the coming changes in merger accounting rules and an expected push from European companies to establish a presence on the Web, possibly by buying U.S. companies, are also stoking merger urges.

The

Financial Accounting Standards Board

said in April it plans to eliminate pooling of interest accounting, which allows acquirers to avoid goodwill charges. The rule changes are expected to have a huge negative impact on merger activity.

However, at the end of the day, it's still about surviving on the hyper-competitive Internet. "It used to be that you had to have the right venture capitalist firm behind you to make it on the Internet," says Warburg's Lawson. "Now, companies would rather find the right big Net player to ensure their futures."