Cisco raises another $4b in cash and looking for acquisitions

Ashlee Vance from the Bits Blog has a nice piece on why Cisco raised another $4b of cash through a debt offering yesterday even though they have $30b in cash. 

"As word of Cisco’s debt sale hit Wall Street, the standard chatter surrounding possible targets began anew. As usual, companies like EMC, NetApp, Sun Microsystems, Red Hat and BMC were discussed as desirable properties."

Regarding Cisco I have heard the same acquisition rumors.  On the smaller private company side, my two cents would be platform consolidation opportunities in the security space (software that can help tie their disparate security products together), bolstering their Scientific Atlanta acquisition by adding more interactive and ad targeting products for the digital set top box, and tuck-in acquisitions for their EOS or social networking initiative (see CNET article for more on this initiative)

I would love to hear your thoughts on this as well.

Top tech M&A advisors for 2007

I just got the 451 Group’s summary on the top M&A bankers for 2007.  As with 2006, Goldman Sachs was #1 on the list.  Take a look:

Top five overall advisers, 2007


Adviser Deal value Deal volume 2006 ranking
Goldman Sachs $79bn 43 1
Credit Suisse $75bn 29 3
Morgan Stanley $74bn 29 6
Citigroup $61bn 23 5
Lehman Brothers $56bn 21 4

Of course if you break down the numbers, you can see that the average deal size for all of these banks range from $1.75 to 2.75 billion.  Let me translate back for the startup community.  As I have written before, I am a firm believer that companies are bought, and not sold (see an earlier post).  In other words, I am not a fan of hiring a banker to shop a company around but rather find it better when a portfolio company receives an unsolicited offer and you then bring a banker in to leverage that bid to create a more competitive situation.  Assuming you are in this position, every startup I know says, "Let’s go get Goldman or Morgan Stanley."  While in theory we would all love to have these guys as advisors, the chances are that you are not going to get them on board.  First, they typically have high minimum thresholds of exit value typically in the $300mm plus range and secondly even if you fit that criteria you may not get all of the attention you need since a $5 or $10 billion dollar will clearly trump yours.  What I would advise is that you find a banker that has the recent experience selling companies in a price range that you are seeking, will give you the PERSONAL attention that you need to make the transaction successful, and has the network to reach out to the right people on a timely basis.  Based on my experience, I have found that some of the firms like Thomas Weisel Partners and Jefferies Broadview who are not bulge bracket but with strong reputations in the technology markets can be a good fit.  I am sure there are many other great firms that I am missing but you get the idea.

Is the bar lower for a tech IPO?

I am not sure if you saw the news, but recently filed for an IPO to raise up to $50 million. On the book is Thomas Weisel Partners, William Blair, Needham, Pacific Crest, and Wachovia. According to the S-1 filing: is a leading provider of on-demand compensation management solutions. Our comprehensive on-demand software applications are integrated with our proprietary data sets to automate the essential elements of our customers’ compensation management processes….

In addition to our on-demand enterprise software offerings, we also provide a series of applications through our website, which allows us to deliver salary management comparison and analysis tools to individuals and small businesses on a cost-effective, real-time basis…

We offer our solutions principally on an annual or multi-year subscription basis. Our direct sales group markets and sells our solutions primarily using the telephone and web-based demonstrations. From the introduction of our solutions in 2000 through September 30, 2006, our enterprise subscriber base has grown to approximately 1,500 companies who spend from $2,000 to more than $100,000 annually, including companies such as Wal-Mart, Home Depot, Procter & Gamble, Merrill Lynch, UPS and Cisco Systems. We also sell to both individual consumers and smaller businesses through our website.

From April 2001 through June 30, 2006, we achieved 21 consecutive quarters of revenue growth. During the years ended March 31, 2004, 2005 and 2006, we achieved positive operating cash flows of $0.3 million, $0.9 million and $1.8 million, respectively, and used $0.7 million of cash in the three months ended June 30, 2006. During these periods, we have consistently incurred operating losses, including $0.8 million for 2004, $1.9 million for 2005, $3.0 million for 2006 and $0.8 million for the three months ended June 30, 2006. As of June 30, 2006, we had an accumulated deficit of $21.8 million.

I would usually put IPO filings in the nonevent category but as I dug deeper into the company and financial performance, it did raise some interesting questions for me.  First and foremost, the traditional rule of thumb that most investment bankers have quoted me in the last couple of years was that in order to go public a company needs to have an annual run-rate of $40-50mm of revenue and a couple quarters of profitability.  While the numbers are strong (read the S-1 here), they are not close to those metrics.  In fact, during the last 3 fiscal years for the company, it did $6.4mm, $10mm, and then $15mm in revenue.  The trailing twelve month number is closer to $20mm in revenue.  While slightly cash flow positive, the company is not GAAP profitable.  So the natural question for me is to ask whether or not the barrier for a private company to go public is much lower today and whether or not this will signal an ongoing trend in the future.  This is obviously relevant for a number of reasons.  Outside of a few outliers, most of the returns generated for VCs have been from M&A transactions.  If the IPO markets open up again, it would give investors and entrepreneurs another option to create value.  Using a back of the napkin analysis, most companies sell about 20% of their stock to the public, so one could assume that is valued at around $200mm pre-money implying a 10x multiple on trailing twelve month revenue.  I must say that sounds quite appealing.  Anyway, we should all watch this company as it goes through its paces because if it does well, it could open the door for plenty of other companies like it.  There must clearly be an appetite from the institutional money managers who are looking for more upside from rapidly growing small cap companies.  By the way, one other interesting point about is that is an on-demand application play with some web-based advertising thrown into the mix.  It is also mostly a subscription-based business which means it has a highly predictable revenue stream which is great for forecasting future performance.  Finally, the company only raised $5mm of VC dollars so it is highly capital efficient.  If you read from the S-1 above, most of the sales are generated through the telephone or through web-based demos, all of the traits for a nice frictionless sale and great business model.

Why cash is king

Oftentimes I am asked what my plan for exit is when I invest in a company.  Sure I have a plan when I invest, but it is impossible to predict the future.  The best plan in my mind is to make sure that any company we invest in has a tremendous market opportunity with a real business model and high operating margins that can eventually generate real cash flow.  As an entrepreneur, it is important to invest for the long term and not make short term decisions because you think you will be acquired (see an earlier post – Companies are bought and not sold).  Ultimately what will give you the best chance for success is focusing on the things that you can control – building a real business with a real economic model that can generate cash from internal operations vs. through external financing.  Yes, this is easier said than done, but when this happens you can do things like Bob Parsons, CEO of GoDaddy, recently did (via Techmeme)- pull his IPO.  As he discusses in his blog post:

Why I decided to pull our IPO filing.
You might ask, why, if Go Daddy’s situation has never been better, did I decide to pull our IPO filing? There are three reasons for doing so:

1. Market conditions
2. The Quiet Period
3. We don’t have to go public

Market Conditions.
The state of the stock market for an IPO is as uncertain as it could be. In fact, the USA Today published an article that IPO stands for “Investor Pain Overload.”   This is due, in large part, to the overall "bearishness" in the market.

Consider the situation from a global perspective and follow it all the way to Wall Street.
We have war and escalating hostilities throughout the Middle East, with no end in sight. Oil prices are skyrocketing. Tech stocks, in particular, are once again taking a beating on Wall Street, due in part to some investment banks cutting their ratings on the U.S. technology sector. Rising interest rates have played a key factor. Their steady rise over recent months has put adverse pressure on stocks overall.

In a bit of irony, last week when the SEC informed us our filing was accepted as being ready-to-go, market conditions were a terrible mess. In fact, inflation worries, say analysts, are bleeding into the tech sector. For all these reasons, I liken the timing of us getting the ‘green light’ to a person being told his car is in perfect condition just before it’s about to be driven into a wall.

I don’t expect market conditions to correct themselves for sometime.
I feel we owe it to ourselves to withdraw our filing until better and more stable times arrive

What if you were a cash cow and nobody noticed?
This seems like an excellent time to address an issue that has bugged me since the moment we filed our S-1.

After we did our filing, I was surprised that not one journalist took the time to look at our cash flow statement to report our actual results. Instead, each and every one of them hastily reported that Go Daddy filed to do an IPO and that we had never turned a profit. Not one of them took the time to look at our cash flow statements to see that we generated significant operating cash flow during each reporting period.

The accounting method we are required to use.
Because sells domain name registrations, we are required to use an accounting method that is ultra conservative.

So one of the principal reasons that Bob lists for pulling is that he doesn’t have to go public because his company is a cash cow.  When you print cash like GoDaddy, you can control your own destiny.  While the company doesn’t look profitable on an income statement perspective because GAAP requires GoDaddy to recognize a domain name registration over the effective period of registration, GoDaddy is in a wonderful cash position because it collects the cash upfront when someone buys the domain.  This is quite similar to a lot of SAAS oriented businesses that may sign up customers for one year contracts and collect the cash today but recognize the revenue over the life of the contract.  When these types of companies grow quickly GAAP numbers may not tell the full story.  And as I am sure many entrepreneurs know, you can’t spend GAAP Net Income but you can spend cash.  As Bob Parson summarizes:

To date, Go Daddy has been completely self-funded –we have been cash flow positive since October 2001, and – whether anyone has noticed or not — continue to generate healthy cash flow from operations. We’ll manage just fine without the IPO money — thank you.

When in doubt, remember cash is king.

Google – look at the bigger picture

As we all know, Google got whacked because it missed Wall Street’s projections.  Sure, investor expectations are quite high for Google especially when they are paying 90x earnings.  However, the reality is that the company is still performing quite well.  From my perspective, when investors pay such high multiples for these companies, the inevitable correction in market price will happen.  That being said, let’s focus on the numbers that really matter, revenue and profits. Google still did deliver $372mm in earnings on $1.92b of revenue up from $204mm in earnings the year before. 

Sometimes we all focus on the short-term at the expense of looking at the long term.  Sure Google is overvalued now but the company is delivering some impressive results.  Remember the First Law of Technology:

"A consistent pattern in our response is to new technologies is we simultaneously overestimate the short-term impact and underestimate the long-term impact."

Well, we did that starting in 1995 when Netscape went public and are doing it again today. And remember Scott McNealy touting "the network is the computer" years ago. Somewhere lost in the translation was this comment from Eric Schmidt when asked about Google’s entry into consumer electronics (thanks to David Jackson who runs the Internet Stock Blog and has been posting transcripts of investor calls):

There’s an awful lot of speculation about Google playing in those markets. The Google PC, those kinds of things. To me, most of those are people projecting the last one, not the next opportunity on us. And from my perspective, those are not very interesting business opportunities; they’re well covered in the market, we partner with many of the players and we would much prefer to deepen our partnership with them than to go into competition with them.

We are relentlessly focused on this new end-user experience, which is multi-platform and based on the internet and that’s where our future is. That’s where the growth is, that’s where the revenue and monetization is. And, as I mentioned earlier, it’s so large, it makes no sense to divert our resources to these other and somewhat smaller opportunities.

Sound familiar?  The network is the computer, the web is a platform, the browser is the OS, services will live in the cloud, and we will access information from anywhere, anytime, and any place.  Once again, sometimes we overestimate the short-term impact of new technologies and underestimate the long-term impact.  This is why I am so excited to be investing now because if you believe services will live in the cloud and anything that can be digitized will be digitized (media, voice, etc.)then I am sure you will agree with me that we are just in the second inning.  And this is not just a consumer-driven change, this will affect enterprises as well.  So Google missing its incredibly high expectations is not all that bad because when looking at the bigger picture, Google is still delivering some spectacular results and causing the old guard to get with it and respond to the changing times.

BTW, it doesn’t mean I would buy the stock at these valuation numbers and nor do I own it now but the point is that there is still plenty of significant opportunities for startups to create value in the years ahead, especially since Google will not and cannot do everything.

What does Sarbanes-Oxley have to do with donuts?

I had lunch with a friend of mine yesterday who is an officer with a public technology company.  As we started discussing his business, one of the topics of conversation was Sarbanes Oxley.  His company just went through an expensive Sarbox audit to get into compliance and while his company passed with flying colors on most of the important issues, his company failed the audit.  Why?  Here is the short story.  One of his sales reps was hosting a client meeting and bought $15 worth of donuts.  The rep got a signature and approval from the CFO on the purchase.  Why did they fail?  The accountants said that the rep needed to get 2 signatures, one from the VP Sales and one from the CFO.  If the rep could buy $15 worth of donuts with only one signature, then think about what else he could buy.  That too me is quite inane and ridiculous.  There has to be some threshold, for example, on when 2 signatures are necessary for an expense report.  This is a perfect example of why Sarbox is expensive for public companies.  While I believe that Sarbox is a good thing and better and more stringent accounting is necessary, I also think that there is alot of waste ineherent in the regulations and that it needs to be reexamined.

This brings me to another point.  I had the opportunity to speak on a panel the other day hosted by Venture Scene New York.  The panel focused on exits or liquidity events and how VCs thought about them.  The clear trend that I am seeing is that companies really have second thoughts about going public these days due to the costs and requirements of Sarbox.  That obviously is not the sole reason many companies that can go public choose to be acquired but it is one of the top few.  In addition, it is no surprise that you see many public companies, particularly smaller ones, looking to go private as well.  Something has to be done to make Sarbox more relevant and less onerous, particularly for smaller companies.

Cisco, a value play?

I was reading Barron’s this morning and came across an article (sorry-need subscription for this) claiming Cisco’s potential appeal as a value stock.  It is hard to believe that this high flying company which once was the largest market cap company at $600b is now potentially a great value play.  The hot growth sector these days is energy and now Exxon Mobil is the largest market cap company at $400b.  Anyway, this table from the article says it all.  The P/E ratios (range from 18.7 to 19.6)of the tech giants like Cisco, Microsoft, Intel and Oracle are equal to or less than non-tech large caps like J&J, Wal Mart, and Coca Cola (range from 19.4 to 21).  In fact, Cisco’s 2005 P/E at 17 is less than that of the S&P 500’s at 17.4.  When most people think tech, they think high growth but this chart and these P/E ratios should really bring us back to earth.  I don’t disagree with Larry Ellison’s assertion a couple of years ago that the technology markets are maturing.  That is one of the reasons we see all of these huge mergers happening as companies seek to expand their markets, their product lines, and revenue.  That being said, there are still large pockets of growth which will provide startups with plenty of opportunity to succeed.  Cisco, for example, is spending heavily in new markets like security, VOIP, storage, and wireless.  The great news is that in pursuit of growth many of these big players are not afraid to pay up for the right products (think of the $450mm Airespace acquisition in the wireless area as an example).

Consumer growth and globalization

I was catching up on my Barron’s this week and a quote from Ajay Kapur of Citigroup caught my attention.  When discussing his macro investment themes Ajay said, "The world is driven by Asian exporters and U.S. consumers.  In the future, it will be Asian consumers and U.S. exporters."  Given that perspective, it is no surprise that VCs have been pouring dollars into consumer technology plays over the last 18 months in addition to investing in China and India to tap into their consumer bases in the future.  Many VCs seem to be down on the enterprise space.  Corporations are hoarding cash and are risk averse in terms of spending on new technology.  That being said, there are some major trends occurring like the move to a service-oriented architecture and automation and virtualization of the data center.  Given the amount of time VCs are spending on global and consumer investments, I believe it is the right time to continue investing in enterprise start-ups developing product 12-24 months ahead.  As for the consumer globalization trend, I have been quite happy with my investment in the the Vanguard Emerging Markets Stock Index fund (VEIEX) which has been up 19.75% YTD.

Subscription accounting

Ok, now for some boring accounting stuff. Red Hat (RHAT) recently restated its financials. Its auditor, PWC, suggested that it change its revenue recognition policy. According to a CBS Marketwatch article:

Under the accounting method used in the past, the company would recognize a full month’s revenue from a subscription agreement, even if a deal was sealed in the middle of the month, for example.

The effect of the accounting change is to defer a portion of the revenue that had previously been recorded during the month that the subscription started to the end of the contract.

So what it comes down to is a timing issue. In the example above, a full month of revenue gets recognized even only if the customer signed in the middle of the month. I don’t really think that this in and of itself caused such a huge selloff in the company. One could argue that the company is overvalued at a $2.8 billion market cap and a 20.5 TTM revenue multiple.

Anyway, I checked around with my portfolio companies which sell hosted software and it seems that we are taking a conservative approach by recognizing a set up fee in the month that we sign a deal and do the work and then begin recognizing the subscription revenue the following month. Anyway, while a boring and mundane issue, I believe this will impact a number of other companies in terms of revenue recognition. My general rule of thumb is to always have portfolio companies prepare for success – this also includes making sure our accounting is conservative and inline with best practices.

Jamdat Mobile files for IPO

Russell Beattie has a thorough post on Jamdat Mobile’s IPO filing. This is significant because this is the first so-called “wireless application” play to hit the market. For those of you that don’t know, Jamdat is a provider of global wireless entertainment applications and enabling technologies that support multiple wireless platforms to wireless carriers, handset manufacturers, media companies, and independent content developers. Looking at Venturesource, I see that Jamdat was first funded in March 2000 precisely the time when VCs thought wireless was the next big thing. Many of these companies are no longer around, but it is nice to see Jamdat make it through such turbulent times, only with $33 million in VC funding.

As an investor, the difficult part of any consumer wireless play is that the wireless world is a walled garden and not an open network like the Internet. This means you are dependent on the carriers for deals and access. This is starting to change but even if you want to go to your own sites through your wireless phone, it is not easy. In addition, imagine the competition to get distribution from the carriers-there are lots of little guys knocking on the door. On the upside, if you are able to get the deals, you have an incredible ability to scale. Just look at Jamdat’s numbers: $90k revenue in 2001 with a $5mm loss and $7mm revenue in Q1 2004 with $740k profit which is an annualized revenue runrate of $28mm-not too bad in a few years. As Russell points out, I am sure a successful Jamdat offering will spur renewed interest in wireless companies. That being said, I just view wireless as another pipe, an increasingly important one that every software or web-based company will have to be aware of and leverage.

Speaking of wireless, there has been lots of talk about Time Warner launching its own branded wireless service over someone else’s wireless network. Not only does this make a ton of sense in terms of the phone company/cable bundle packaged wars but also from a content and programming distribution perspective. If you believe that wireless devices and phones will continue to become an increasingly important way for end users to access data and eventually music, photos, and video, then what better way to control the economics of distribution then by reselling your own service.