Bill Gurley’s excellent piece on Silicon Valley IPO Anxiety inspired me to take a companion look at the East Coast, particularly Massachusetts and New York, and evaluate the health of the local IPO economy and prospective pipeline. Today I’ll cover Massachusetts—tomorrow New York. I first came across Bill when he was a Wall Street analyst and covered my company Open Market (IPO 1996). I always admired his perspicacity, even if he didn’t like our stock all the time! For purposes of this blog post, I am only focused on companies involving technology, whether software, Internet, health care or energy – which I’ll define as members of the Innovation Economy. Note also that, for obvious reasons, I leave out any Flybridge Capital portfolio companies in my analysis.
We really wanted to like Basel III. Frankly, anything with a Roman numeral commands our immediate attention and respect: Super Bowl I, World War II, Rocky III. Ok, maybe not Rocky III. The name alone implies a certain tradition combined with a sense of progressive improvement. First there was Basel I (1988). Then came Basel II (2004). Now we have Basel III. Add the gravitas of a Swiss city and, well, we’re buyers. But it’s a rough world we live in. All things once sacred are under scrutiny. Even as governments worked frantically over the past three years on a succession of plans to plug systemic cash leaks and bolster weak balance sheets, the unprecedented velocity of change in the financial sector made the best and brightest regulators look clueless.
Rumors swept through trading floors last Friday that a “big deal” was launching of a kind rarely seen in this market. But by day’s end, those reports appeared unfounded. “We heard a loan was coming with no sponsor dividend,” one syndicator noted wistfully. “But we knew it was too weird to be true.” Ok, maybe we were hearing things, but you can’t blame us for being distracted. First, there was Ireland. Yes, the Emerald Isle (or the Land of Ire, as it’s now known in the eurozone) was back in the news as the poster child for sovereign budgetary woes. And in a flashback to this past spring, capital markets reacted by taking a brief powder. Seems investors aren’t quite as cozy as the rash of bank/bond issuance would indicate.
When we last left off, our valiant private equity firm had just signed a letter of intent to buy their favored widget company for 7.0x EBITDA and was off trying to find the financing. The company, with $300.0 million in sales and $20.0 million of EBITDA, did have a few blemishes. It had some customer concentration, 2009 was a down year (but who didn’t after the throes of a recession), and 2010 earnings were after $3.0 million in adjustments for the elimination of some unprofitable business lines and a plant closing. But with a substantial equity contribution and a good backlog heading in to 2011, the PEG was confident that obtaining 3.0x senior debt and 4.0x total debt was a cake walk. Or so they thought!!
The world is divided between those who think that the leveraged debt market is overheated, and those who know it is. And for both camps, as surely as the arrival of pumpkin pie mix on supermarket end caps heralds turkey day, the appearance of ranks of dividend recaps on loan and high-yield shelves is a vivid sign of investor over-exuberance. PE sponsors recapitalizing portfolio companies just to take out cash they had put into the original LBO were once features of a late-stage market. But the velocity of market cycles is such today that recaps occur at the beginning. It took six years after the dot com crash for leveraged wackiness to return. This round it’s taken six months.
Limited partners in private equity funds can be a skeptical group when it comes to unrealized returns. And that can be a problem for the many general partners looking to come back in 2011 to replenish their war chests. The increased focus on cash-on-cash returns became apparent to me at the annual meeting of a well-known growth equity fund. One of the fund’s star portfolio companies presented a detailed account of how it had grown revenue and EBITDA in a very difficult economy. The fund had already distributed roughly half of its cost basis in the investment and had written up the value of the company by threefold. During cocktails, while speaking with the representative from a mid-sized college endowment invested in the fund, I remarked that the company was still quite conservatively valued. The LP responded, “I’ll believe the valuation when I see the exit.”
Fed officials who don’t see signs of inflation haven’t been watching loan prices. As credit markets healed over the last two years, investors saw loans behave in a recovery as they were designed to. Default rates fell and recovery rates rose, proving the asset class could withstand a hundred year flood and come out barely moist. Three months after Lehman failed loan prices in the secondary market reached a record low of 65 cents on the dollar. At the time, no one knew whether a bottom had been reached. Anxiety reigned and markets had no clear guidance on a path to recovery.
“The food in this place is really terrible,” one elderly woman complains to her friend at a Catskill mountain resort. “Yeah, I know,” replies the other one, “and such small portions.” That’s where investors find themselves today in the broadly syndicated market. With leverage up and spreads falling, deal quality is eroding. Yet thanks […]
I’ve lived in Boulder for 15 years after living in Boston for a dozen. While I’ve spent a lot of time in Silicon Valley — both as an angel and venture capital investor — I’ve never lived there. While the firm I’m a partner in — Foundry Group — invests all over the United States, […]
As anyone trying to get a mortgage these days knows, leverage isn’t what it used to be. The Great Deleveraging, begun in late 2007 as the credit crunch took hold, affected the entire corporate and consumer financial services community. Debt became a four-letter word, thanks to the unmasking of sub-prime mortgages as the true villain of the era. Those no-income-no-equity loans took leverage to its theoretical extreme, coming to represent all that’s bad about structured credit and securitization. The carnage it brought to Main and Wall also made it impossible to appreciate all the benefits – liquidity, low cost, diversification of risk – of those off-balance sheet financings.