Tilman E. Pohlhausen
Technology Buyouts
GABLER EDITION WISSENSCHAFT
Tilman E. Pohlhausen
Technology Buyouts
Valuation, Market Screening Application, Opportunities in Europe
With a Foreword by Prof. Dr. Roswitha Meyer
Deutscher UniversiUits-Verlag
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ISBN-13: 978-3-8244-7758-6 e-ISBN-13:978-3-322-81456-2 001: 10.1007/978-3-322-81456-2
Foreword v
Foreword
The public market valuation of technology companies throughout the 1990s is
probably one of the most interesting phenomena in recent financial history. No
sector has generated more enthusiasm among investors, and no sector has created
more millionaires, albeit mostly on paper. Once the bubble burst, the correction
process was brutal. The price of technology companies dropped by over 70
percent on average, and a significant number of companies went out of business,
while others were simply avoided by the investment community. I
Tilman Pohlhausen asks a valid question: Did this downturn in valuation lead to
some companies being unjustly undervalued, given their past and expected cash
flows? If so, he continues, would such companies be suitable for a concept rarely
heard of previously for technology companies: a buyout, possibly even financed
to a high degree by debt?
The idea is not new. In contrast to Europe, a number of well-financed private
equity funds in the United States exclusively target the technology sector for
buyouts. What is new, however, is that many more technology companies,
because of their lower valuation, could become targets of buyout investors in
Europe, as well.
Ultimately, with his analysis of the buyout attractiveness of European technology
companies, the author attempts to estimate the validity of this perception.
Keeping in mind that the applied model clearly has both practical and theoretical
limitations, its findings appear to support the view that buyout opportunities in
the technology sector might now exist in Europe. As part of his analysis, the
author also provides a Microsoft Excel-based tool to screen markets for
companies with certain buyout attractiveness characteristics.
The NASDAQ composite drop from its all-time high in March 2002 to July 2002 was over 70 percent, while its much smaller German equivalent, NEMAX, lost over 90 percent during the same period.
VI Foreword
It is too early to tell whether we can confidently speak of technology buyouts as
an established concept. What we can say. however. is that technology companies
are increasingly valued in the same manner as companies in any other sector.
Today we know that the same rules apply; why. then. should there be no buyouts
in technology?
Prof. Dr. Roswitha Meyer
Chair of Decision Sciences
European Business School, Schloss Reichartshausen
Acknowledgments VII
Acknowledgments
The following text is entirely based on a master's thesis I wrote in early 2002
while studying at the European Business School, Schloss Reichartshausen,
Germany. It was created in a short period of time, and being the first significant
textual work of a student it is of course far from perfect. I nevertheless decided to
make the thesis available by publishing it, mainly for two reasons: First, when I
started exploring the field of technology buyouts, I was stunned by the lack of
available public information, be it in form of academic, press, or professional
publications. 1, personally, would have liked to read any even imperfect thesis
about "technology buyouts". The second reason is the encouragement I received
during various conversations with banking and private equity professionals.
There seems indeed to be an actual interest in this topic - particularly for the
European market where technology buyouts have not been given as much
attention as they have in the US.
Given the encouragement and support I received, I would like to express my
gratitude to those involved with my thesis at various stages. I would not have
been able to write about "Technology Buyouts" had not Professor Roswitha
Meyer of the European Business School accepted my proposal. I would like to
thank her for her support throughout the writing process; I would also like to
thank her research assistants Heiko Rhode and Andre Kleinfeld who gave their
time and effort when I "tormented" them.
The thesis was written with the support of Dresdner Kleinwort Capital, the
private equity group of Dresdner Bank. Thomas Wiegand provided me with
crucial guidance and feedback for which I am truly thankful. His understanding
of technology markets and equity as well as debt financing was of great value to
my conceptual efforts. Additionally, the Technology Group at Dresdner
Kleinwort Wasserstein provided me with essential access to their resources. I
would like to thank Cornelius Clotten, Rainald Roth, and the whole team for their
kind support.
VIII Acknowledgments
Furthennore, I thank research assistants Hady Farag and Mischa Ritter of the
Chair of Investment and Risk Management at the European Business School for
their help at some stages, as well as Konstantinos Karamanlis for his diligent text
review. Finally, I would like to express my gratitude to Professor Omesh Kini of
Georgia State University, who generously provided me with his feedback and
advice on some key points of the text.
appreciate comments and feedback. My email address IS
Tilman E. Pohlhausen
Table a/Contents IX
Table of Contents
List of Figures ..•.•..•••••....••••••••..•••••...•••••••••••...•••.•••••••••••••.....••••••..••....•••••............ XI
List of Tables ..••••••••.••••.•...••••••••....•.•...•••••.•...•..••••..........•••.••...•..•.•..••••..•....•..••• XIII
List of Abbreviations .•.••.•..........•.••.........••.••.....•••••••....•...•.....••••....••••.••••.••.•.•••• XV
1 Introduction ••••••.......•••....••......••••...•....••••••••.....••••••..•.•.••.•...••••....••••..••........•.. 1
1.1 Theoretical Fonnulation .......................................................................... 3
1.2 Method and Procedures ........................................................................... 4
2 The Market for Leveraged and Management Buyouts ......••••.•••••...•••••••••• 5
2.1 Definitions ............................................................................................... 5
2.2 History ..................................................................................................... 7
2.2 Value Generation ..................................................................................... 9
3 The Emergence of Technology Buyouts ................................................... 15
3.1 Definition ofa Technology Company ................................................... 15
3.1 Investment Rationale ............................................................................. 17
3.2 Technology Buyout Investors ............................................................... 20
3.2 Current Trends ....................................................................................... 23
3.3 Findings and Interpretations .................................................................. 26
4 Overview of Leveraged Buyout Valuation ............................................... 29
4.1 Weighted Average Cost of Capital Method .......................................... 30
4.2 Adjusted Present Value Method ............................................................ 31
4.3 Changing Costs of Capital Method ....................................................... 32
4.4 Equity Cash Flow Method and Internal Rate of Return ........................ 33
5 Simplified Valuation Model •............................•.•.•...................••••.............. 39
5.1 Inputs ..................................................................................................... 41
5.2 Leverage ................................................................................................ 45
5.3 Projections ............................................................................................. 49
5.4 Valuation ............................................................................................... 52
5.5 Special Cases ......................................................................................... 57
5.6 Model Limitations ................................................................................. 61
x Table of Contents
6 Adjusting for Technology Risk and Return ............................................. 63
6.1 Technology Risk ................................................................................... 64
6.1.1 Increase Hurdle Rate ...................................................................... 65
6.1.2 Lower Cash Flow Projections ........................................................ 66
6.1.3 Increase Cost of Debt ..................................................................... 67
6.1.4 Plan for Investments ...................................................................... 68
6.2 Technology Return ................................................................................ 69
6.2.1 Increase Growth Rate ..................................................................... 69
6.2.2 Add Real Options ........................................................................... 70
6.3 Implications ........................................................................................... 72
7 European Technology Market Screening ................................................. 75
7.1 Model Extension ................................................................................... 75
7.2 Model Application ................................................................................. 80
7.1 Top European Technology Buyout Candidates .................................... 84
7.2 Findings and Interpretation ................................................................... 86
7.3 Suggestions for Further Research ......................................................... 88
8 Summary and Conclusion .......................................................................... 89
References ........................................................................................................... 91
List of Appendixes ............................................................................................ 101
Appendix A: Field Description Sheet ............................................................ 103
Appendix B: Excel Instructions ..................................................................... 107
List of Figures XI
List of Figures
Figure 1: Increase in LBO equity contribution ...................................................... 8
Figure 2: Estimated sources of value in buyouts ................................................. 13
Figure 3: Development of public technology stock markets ............................... 23
Figure 4: European technology buyouts by value ................................................ 26
Figure 5: Common business valuation techniques ............................................... 29
Figure 6: Equity cash flows in a typical buyout .................................................. 34
Figure 7: Model overview .................................................................................... 40
Figure 8: Inputs & assumptions (data from Software AG) .................................. 42
Figure 9: Projections (data from Software AG) ................................................... 50
Figure 10: Valuation (data from Software AG) ................................................... 53
Figure 11: Extended model overview .................................................................. 79
Figure 12: Parameter weightings ......................................................................... 82
List of Tables XIII
List of Tables
Table 1: Rates of past LBO returns ...................................................................... 10
Table 2: Technology diverstures and public-to-private
transactions 1998-2002 ........................................................................................ 21
Table 3: Fundraising activity ............................................................................... 21
Table 4: Model assumptions ................................................................................ 44
Table 5: Synthetic rating estimation .................................................................... 47
Table 6: Additional attractiveness parameters ..................................................... 77
Table 7: Applied weights and scales .................................................................... 81
Table 8: Analyzed indices .................................................................................... 82
Table 9: Highest negative EV technology companies ......................................... 83
Table 10: Highest negative EV communications companies .............................. 84
Table 11: Top 20 European tech buyout opporunities given model assumptions
and Bloomberg historical data ............................................................................. 85
List of Abbreviations xv
List of Abbreviations
a
AG
AIM
API
APV
BIMBO
CapEx
CAPM
CF
CFBDR
CHF
CMBOR
CSFB
CY
D
DCF
E
e
ed.
Ed.
EASDAQ
EBIT
EBITDA
EBO
ESOP
EUR
EV
FTSE
GBP
HLT
actual
Aktiengesellschaft
Alternative Investment Market
Application Programming Interface
Adjusted Present Value
Buy-in Management Buyout
Capital Expenditures
Capital Asset Pricing Model
Cash Flow
Cash Flow Before Debt Repayment
Swiss Francs
Center for Management Buy-out Research
Credit Suisse First Boston
Calendar Year
Debt
Discounted Cash Flow
Equity
estimated
edition
Editor
European Association of Security Dealers Automated
Quotations
Earnings before Interest and Tax
Earnings before Interest. Tax. Depreciation and Amortization
Employee Buyout
Employee Share Ownership Plan
Euro
Enterprise Value
Financial Times and London Stock Exchange
British Pound
Highly Leveraged Transactions
XVI
IIBIEIS lAS
IPO
IRR KKR
LBO
LMBO
m
M&A
MBI MBO
MC
MDAX
MS
n.a.
NASDAQ
NEMAX
P2P
PE
PEG
PLC
R&D
S&P
SMAX
SWX US-GAAP
vol.
vs
w/oa.
w/o pg.
w/o pI.
Institutional Brokers Estimate System
International Accounting Standards
Initial Public Offering
Internal Rate of Return
Kohlberg Kravis Roberts & Co.
Leveraged Buyout
Leveraged Management Buyout
million
Mergers and Acquisitions
Management Buy-in
Management Buyout
Market Capitalization
Midcap Deutscher Aktien Index
Microsoft
not available
List of Abbreviations
National Association of Security Dealers Automated
Quotations
Neuer Markt Index
Public-to-private
Price Earnings
Price Earnings to Growth
Public Limited Company
Research and Development
Standards and Poor's
Smallcap Aktien Index
Swiss Exchange
United States Generally Accepted Accounting Principles
volume
versus
without author
without page
without place