David Drummond has a simple explanation for why Alphabet Inc., one of the more acquisitive technology companies, has been sitting on its hands for more than a year.
“Have you seen the valuations?” Drummond, the corporate development chief for Google’s parent company, said in an interview after the Alphabet annual shareholder meeting June 8.
That’s about to change as stratospheric startup valuations fall to earth, luring Alphabet and other big technology companies back into the market for mergers and acquisitions and forcing startup founders and investors to take offers more seriously.
“You are seeing changes in the valuations of unicorns and decacorns,” Drummond said, referring to startups worth more than $1 billion and $10 billion respectively. “It’s not all up and to the right now.”
Veteran Silicon Valley executive Meg Whitman feels the same. After focusing on a company reorganization, the chief executive officer of Hewlett Packard Enterprise Co. said she’s ready to buy because startup “valuations will be more reasonable.”
Apple CEO Tim Cook said in late April that the iPhone maker “would definitely buy something larger than we’ve bought thus far.” Salesforce.com Inc. CEO Marc Benioff said this M&A season “is the most intense, most exciting I’ve ever seen.”
Big US technology companies accumulated mountains of cash for years and often use acquisitions to bring in talent or expand into new businesses. The 360 technology and telecommunications companies in the Russell 3000 Index hold a combined $870.2 billion, the most in at least 16 quarters, according to data compiled by Bloomberg. But a flood of money from venture capital firms, hedge funds and mutual funds in recent years pushed startup valuations beyond what many public acquirers were willing to pay.
Annual US VC funding more than doubled to $63 billion from 2013 through 2015. That pushed the median valuation of startup financing rounds to $68 million in the third quarter of 2015 from $17 million at the start of 2013, venture capitalist Mark Suster estimates. The unicorn herd has grown from 13 at the start of 2013 to more than 150, according to research firm CB Insights.
“For the last three to four years a lot of public companies stood back and watched all the drama and bubble, bubble, bubble in Silicon Valley,” said Marc Andreessen, co-founder of venture capital firm Andreessen Horowitz. “There were a lot of deals that should have happened that just didn’t.” Alphabet has made less than $300 million in acquisitions so far this year and the number for 2015 was $380 million.
From 2011 through 2014, the company then known as Google Inc. averaged more than $5 billion worth of deals a year. After spending more than $20 billion on acquisitions of WhatsApp and Oculus in 2014, Facebook’s deal-making has focused on much smaller targets, according to data compiled by Bloomberg.
The $18 billion purchase of revenue-light WhatsApp and a failed Facebook attempt to buy Snapchat for $3 billion in 2013 emboldened other startup founders and backers to ask for high prices when discussing potential acquisitions, according to investment bankers and corporate M&A executives. Some Google executives started jokingly measuring unicorn valuations based on multiples of Snapchat, because there were few serious ways to value expensive startups with little or no revenue.
So a startup might be 2x Snapchat, or $6 billion, or 3x SC, according to a former Google executive, who didn’t want to be identified discussing internal M&A strategy. An Alphabet spokeswoman declined to comment.
But capital has begun to flow more slowly to startups now and valuations are falling. In the first quarter, there were 14 down rounds or exits below the previous financing valuations. In the fourth quarter of 2015, there were 16. That compares to six and seven such events in the previous two quarters, according to CB Insights.
Jawbone, Foursquare and DoorDash were notable down rounds in the first quarter. Gilt Groupe, once worth more than $1 billion, sold to Hudson’s Bay Co. for $250 million earlier this year. Yodle, once valued at $600 million, was purchased for half that in February. Good Technology sold for $425 million in September, after getting a $1.1 billion valuation previously. This year, mutual funds including Fidelity Investments and T. Rowe Price marked down the value of their holdings in startups such as Hootsuite Media, Dropbox, CloudFlare, Cloudera, DocuSign and Zenefits.
This hasn’t sparked a rash of acquisitions of startups yet because valuations only truly reset when new financing events happen. This is a contrast to public equity markets, where technology company stocks trade every second and valuations have already dropped enough to trigger an M&A revival.
LinkedIn Corp. lost almost half its market value in the first quarter, luring Microsoft Corp. on June 13 tooffer $26.2 billion for the professional network, its largest acquisition ever. Despite a big premium, the per-share price was 24 percent below LinkedIn’s 52-week high. “For the public companies the adjustment has happened. For private companies, it’s just beginning,” said Byron Deeter, a partner at Bessemer Venture Partners, which has backed startups including LinkedIn, Pinterest, Blue Apron and Yodle. He expects Google, Facebook, Alibaba Group Holding Ltd., Salesforce, Adobe Systems Inc., International Business Machines Corp. and Microsoft to be “very aggressive” acquirers.
More than 60 percent of unicorns, including WeWork, BuzzFeed, Domo and Credit Karma, will probably need to raise another round of capital during the next three quarters, CB Insights estimates. That may crystallize lower valuations, bringing them closer to public market rivals, Deeter said, citing Dropbox and Box Inc. as an example.
Box shares trade in the public market at about 4.4 times sales, according to data compiled by Bloomberg. Dropbox was valued at $10 billion, or about 25 times estimated 2014 sales of $400 million, when it raised money from investors including T. Rowe Price that year, according to CB Insights analysis. By early 2016, T. Rowe Price had cut its valuation of Dropbox by more than 50 percent, suggesting it is worth less than $5 billion. Revenue has grown since 2014, so the startup likely has a multiple from 5 to 10 times sales now. That’s still a premium to Box, but a lot closer.
Falling valuations present startup founders with difficult choices: They will have to reduce their cash burn and try to grow to earn back a richer valuation, accept a down round or complex, onerous new financing terms, or consider acquisition offers, Deeter explained. “There’s been a little denial, just like at the start of drug addiction treatment programs,” he said. “Now we’re rolling into the coping-and-reaction phase. For some, the best option may be entering into M&A discussions.”
Big companies in the tech industry are getting a higher volume of interest from venture capitalists who’d like to see their startups bought, according to the CEO of a large public company who asked not to be identified. An M&A executive at another big US technology company has had at least four exploratory meetings with founders of late-stage startups in recent months. Before this year, initial asking prices were too high to even get in the door, said the person, who asked not to be identified because the meetings were private.
Andreessen, whose firm has backed startups including Foursquare, Oculus and Facebook, said he tries to get startups to a position where they’re the buyers, not the targets. But sometimes companies make offers that are a good strategic fit, he added. “Public companies have piled up a lot of cash and they have to go shopping. There will be a whole run of M&A this year and next year,” he said.
© 2016 Bloomberg L.P.
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