Technology Investment Banking: Bubbles, Failed IPOs, and Unprofitable Billion-Dollar Companies?
If you want to lose a lot of money very quickly, few sectors can beat technology during a bubble.
Not only can you potentially lose your life savings on spectacular failed IPOs, but you might even get lucky and invest in a company with no revenue and no profit that somehow still gets acquired for $1 billion.
And as an investment banker, you get to be in the driver’s seat and make it all happen.
Today, we’re speaking with a banker who’s been there during both bubbles and downturns – and you’ll get to hear his take on:
- How the technology world is divided, industry-wise.
- How the deal and modeling work differs.
- What sorts of assignments and deals you work on.
- Where tech bankers go when deals dry up or when they need a quick exit.
And maybe he’ll even reveal the secrets of how to push over-hyped companies to get acquired at huge premiums.
Bootstrapping Your Way In
Q: So were you interested in technology to begin with? Or did you just end up in a tech IB group randomly?
A: It was pretty random. I was actually more interested in finance from the start and took the most finance-oriented classes I could: international financial markets, financial accounting, corporate valuation, corporate finance, and so on.
I also did a sophomore rotational program at a bank, and then a junior year internship that I converted into a full-time offer. And then I just happened to be placed in the tech group.
Q: So how was the sophomore rotational program? Was it useful in landing this role?
A: There is something to be said about having a broad experience and learning how a bank’s different departments work, and in turn work together. And having a bank’s name on my resume helped lot with winning future internships.
Looking back at my experience, though, it probably would have been more useful to work at a 3-5 person boutique running through tasks.
Q: So based on your experience, it sounds like banks aren’t necessarily looking for people from tech backgrounds to work in technology investment banking – is that correct?
A: It can definitely help, and you do see quite a few former engineers and tech people here.
Interviews are all about your “story,” so the more interest in technology you can show, the better… assuming that you’re actually interviewing for that specific role, or for a boutique firm that specializes in technology.
If you’re not, and, like me, you’re just going to be placed somewhere, I don’t think it matters as much.
Raising Funds to Expand the Team and Build the Product
Q: How are technology IB groups divided at banks? What are the most common sectors?
A: The one constant in technology is change. The tech landscape looked a lot different in 1980 or 1990, and it will look even more different in 2050.
But here are the most common sectors I’ve seen throughout the years:
- Communications Equipment: This area is largely driven by macroeconomic factors, such as economics, service providers, customers’ behaviors and preferences, and purchase timing and related deployment. It’s not as “sexy” as other areas, but it’s critical for almost everything else Software / Internet-related.
- Computer Systems: Previously, computer makers focused on developing faster and faster computers. Offerings there have expanded to include enterprise solutions such as servers, networking, and storage. Similar to the healthcare sector, in which big companies acquire start-ups to speed up the R&D process, firms that compete in the computer systems space often do the same thing so they can improve their existing products.
- Internet/Digital Media: Mary Meeker’s annual “Internet Trends” presentation (do a search to get the latest version) provides a great update on what’s going on these days. This one of the key growth areas in the technology space, and it’s where most of the startup and venture financing activity has been taking place.
- Semiconductors: The area is driven by the demand for computational power; chips get smaller and faster, and even collaborate with other types of chips now. Previously processes would run on CPUs, but the trend is to move away from that, which helps improve processes outside of imaging and traditional graphics. There are some start-ups and growth opportunities here, but overall it’s definitely a more mature market than Internet.
- Information Technology Services and Payments Processing: This area is home to the Software-as-a-Service (SaaS), itself based on a subscription approach to pricing. The players vary greatly, as do the applications. For example, in the accounting function, you’ll see Microsoft GP, SAP, Sage, Blackbaud (nonprofit), as well as smaller companies.
- Software: Software is increasingly moving towards availability on both in-cloud and on-premise formats. Pricing naturally has moved from individual licenses to concurrent users and the subscription model. The old model of one-time licenses and yearly maintenance fees for complex software installations is going away, and that market has already matured and consolidated to a large extent.
Q: Thanks for that overview… where do you see the most deal activity? And what types of deals are most common?
A: I don’t think any one area dominates all the time – I’ve seen waves where there were a bunch of semiconductor deals, then acquisitions in cyber-security (a subset of Software), and then a bunch of financings in the Internet and social media space.
But generally, M&A deals are the most common in technology.
The IPO market never fully recovered after the dot-com crash following the 1990s, and companies there tend not to perform well. A company is going to raise equity capital when necessary, not necessarily out of convenience.
If you’re interested in some bad examples, here’s a gallery of some of the worst tech IPOs.
Debt financings can be common in mature tech markets, but you tend to see them more when credit is easy to come by and when leveraged buyouts are happening left and right.
Q: So what drives valuation in technology?
A: It’s hard to generalize because it depends on the specific market you’re in, plus the stage of the company you’re analyzing.
Early-stage companies in growth areas like Internet tend to be all about the user base, getting eyeballs or mobile users, and don’t even worry about making money at first.
They often use “Freemium” models where they give away a product or service for free and then attempt to charge a smaller portion of the customer base for premium features (see: Dropbox and Evernote back in their early days).
Sometimes that leads to hype and bubble-like valuations when you start using user growth metrics and non-financial criteria to value companies – just look at the failed IPOs above for more examples there.
In more mature areas, like Semiconductors and Enterprise Software, valuation starts to make more sense and you focus on more traditional metrics like efficiency, market share, and profit margins.
Real cash flow becomes more important and analyses like the DCF become far more applicable.
And then there are macroeconomic factors at work – if the economy is in a slump, for example, both consumer and enterprise spending will be affected and businesses will be reluctant to upgrade to the latest software and hardware.
Raising Funds at a Valuation of…
Q: One common question we get is, “What industry-specific valuation multiples and methodologies are there for technology? How do you value companies differently?”
Any thoughts on that?
A: Honestly, valuation is not that much different despite what you might have heard.
For profitable companies, you still use similar multiples: EV / Revenue, EV / EBITDA, and sometimes P / E… and the usual comparable company analysis, precedent transactions, and DCF analyses.
And then there are the less common methodologies like M&A Premiums, Sum-of-the-Parts, Future Share Price Analysis, LBO Valuation (finding the minimum price a firm can pay to achieve a certain IRR), and so on.
If you don’t believe me, take a look at these examples:
- Atari Software (Lazard) ; Atari Software (Duff & Phelps)
- Smart Modular Technologies (Barclays)
- Logility (VRA Partners)
- Oracle / Autonomy (Qatalyst Partners)
From these presentations, two valuation measures pop up that you haven’t covered before:
- Net Asset Value: Simply Assets Minus Liabilities. If this is lower than market capitalization, it might provide a signal for growth. Like any other valuation metric, it’s all comparative. If the NAV is greater, it might be worth it to liquidate the company rather than continue operations.
- Liquidation Analysis: More art than science. Assign a percentage that the creditors can reap from the sale of inventory, physical assets, and accounts receivable. Don’t forget to include discount if you are pursuing a bankruptcy process (see page 41 of the Duff & Phelps presentation).
These methodologies are more applicable for firms on the brink of bankruptcy or whose values have declined greatly, as was the case for Atari here – you normally don’t see them used for healthy companies.
Q: Right, that makes sense… but going back to the example before this with Internet companies going all-in for user growth and not even caring about monetization, don’t you see different methodologies used there?
A: Not so much different methodologies as more “creative” multiples. For example, you’ll see Enterprise Value / Unique Visitors, Enterprise Value / Registered Users, and other variants like that with those companies.
And you may see multiples like EV / Subscribers for software and telecom, and sometimes even Gross Profit multiples (EV / Gross Profit) for hardware companies since margins are so important there.
Outside of those, though, valuation is quite standard.
Q: I’ll have to object once again here because I noticed in those presentations above that they draw special attention to a “Net Operating Loss” in one section – can you clarify that?
A: Sure, that’s a good point… many tech companies are unprofitable early on, or even in the late stages if they’re struggling financially as Atari was.
If they consistently lose money, they’ll accrue Net Operating Losses (NOLs), which allow them to save on taxes in the future by deducting the NOLs from their taxable income.
If the NOLs are significant, sometimes you factor them into the valuation as well, usually by calculating their tax-saving value to an acquirer.
Normally after an acquisition you can only use a small portion of the target company’s NOLs to offset your own taxes, so that’s what you look at and value.
Since NOLs reduce taxes and save you money in the future, they’re sometimes viewed as a “cash-like item” and may be subtracted from Equity Value to calculate Enterprise Value.
Q: OK, great – anything else we should know about valuation-wise?
A: Not really. The methodologies, again, are very similar but you may see a few industry-specific metrics and some more advanced nuances like NOLs depending on the company you’re analyzing.
Making a Billion-Dollar Exit?
Q: So do you like being in tech banking?
A: It depends what you’re looking for and what your team is like. In tech, you’ll never work on the kind of massive deals that you see in other industries like metals, mining, and oil & gas – companies are much smaller and deals are much smaller as a result.
Some people claim that you don’t develop in-depth technical skills here because tech companies have simpler capital structures, but I don’t necessarily think that’s true; you’ll do plenty of modeling if you work with more mature companies.
And, of course, if you’re interested in tech and in going into venture capital this is a great group to be in.
Q: Any recommended resources for learning more about tech?
Q: Thanks for those. Most tech start-ups are aiming for that billion-dollar exit, but I’m guessing most technology investment bankers aren’t so lucky.
Where do most tech bankers go after their time in banking?
A: Definitely venture capital and private equity.
Working with early-stage companies makes it ideal to continue working with early-stage companies, so VC is a natural fit.
And there are lots of growth equity PE firms that focus on technology, or at least have made many investments there (ex: Silver Lake, Francisco Partners, Summit Partners, TA Associates, Technology Crossover Ventures, Accel-KKR, Vista Equity, Vector Capital).
Finally, the mega-funds (KKR, Blackstone, TPG, Carlyle, etc.) also have dedicated tech teams, so there are plenty of opportunities for tech analysts and associates there.
And some bankers also move to boutiques – over the past few years a lot of tech-focused boutique banks have emerged, such as Qatalyst Partners, Allen & Co., Union Square Advisors, GCA Savvian, CODE Advisors, etc.
This has happened because many deals and financings in tech tend to be small, but the bulge bracket banks need to focus on winning huge deals – that leaves a gap in the market for these smaller firms to sprout up and win business.
Needless to say, if you’re in the US and want to do tech banking, you need to be in San Francisco. It’s the biggest hub and where most of these boutiques as well as the top groups at larger banks tend to be.
Q: Great, thanks for your time. Enjoyed the chat!
A: Sure thing. And thanks for running this site – it has been so helpful in my own career development! Feel free to leave any questions or comments here. And thanks for creating the financial modeling program you offer, the modules there have been worth their weight in gold.
Keep up the good work!
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