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2008 Software M&A: Year in Review



# of Public Software Company M&A Deals






2008 Public Internet M&A: Year In Review




           2008 Acquisitions of Public Internet Companies

Closed Target Acquirer $ Size
1/17/08 Visual Sciences VSCN Omniture OMTR $394
2/4/08 Traffix TRFX New Motion NWMO $159
3/18/08 Audible ADBL AMZN $300
4/16/08 Varsity Group VSTY Follett Group   $4
6/30/08 CNET CNET CBS CBS $1,800
8/6/08 Hostopia H.TO Deluxe DLX $124
10/15/08 Greenfields Online SRVY Microsoft MSFT $486
10/30/08 Napster NAPS Best Buy BBY $121


December 31, 2008 in Internet, Wall Street | Permalink

2008 Software IPOs: Year in Review





2008 Internet IPOs: Year in Review

This is going to be an easy review.  That's because 2008 will likely go down as the first year in the modern "web" era of the Internet that there wasn't a single Internet related IPO in the major US stock markets.  That's right, not a single one, zippo, nada.  There were a few spin-offs and a couple cross listings but as for brand new spanking public Internet companies there wasn't a single one.  It's enough to make a make a grown VC cry.

As it stands, the last IPO of an Internet focused company was arguably NetSuite, which went public on 12/20/08 at a price of $26/share and closed today at $8.44.  And that 68% price decline, ladies and gentlemen, is all you need to know on why there hasn't been an Internet IPO since then.

That makes it 377 days without an Internet IPO.  I modestly suggest that Sand Hill VCs should tie a ribbon made of $100 bills around a Redwood tree outside their offices until such time that the market stops holding their late stage deals hostage.

Granted there were only 30 IPOs in the entire market in 2008, but you'd think that what is supposedly one of the fastest growing, highest technology sectors in our economy would be able to contribute at least one good IPO.  Oh well, maybe next year.

December 31, 2008 in Internet, Venture Capital, Wall Street | Permalink


Madoff Madness: Seven Things You Might Not Know

When I was a Wall Street analyst I got to know Bernie Madoff by reputation because I covered the whole online/electronic trading industry and Madoff was a big actor in that space due to his market making operations and his constant fights with the NYSE.

Given this experience as well as the fact that I currently manage a hedge fund, I can’t resist making a couple of points that I don’t think have been widely discussed in the media so far:

  1. Madoff’s investment firm was not a hedge fund, it was what’s called a “managed accounts” business in which each investor had their own separate account that was supposedly managed by Madoff.  That’s why press reports indicate the investor’s got statements that listed individual trades in their account (something you don’t get with a hedge fund).  The reason why this is important is that, like many managed accounts, Madoff only charged a relatively small flat management fee (1.5% a year according to reports) compared to hedge funds which typically charge at least a 2% management fee plus 20% of the profits.  This fee structure made Madoff’s fund very attractive to fund-of-funds because it made their “double fee, double carry” structure look a lot less onerous.  If you are wondering why so many fund-of-funds bet the farm on Madoff’s fund, look no further than this.
  2. Madoff was not only the investment adviser to these managed accounts, he was also the broker, custodian, and administrator.  This is a huge red flag that anyone with even a basic understanding of investment management should have noticed immediately.  A firm structured like this is essentially a closed loop with almost no external checks and balances.  Even an outside auditor would find it difficult to uncover fraud because there’s no independent entity to verify trades, assets, etc.  It’s amazing that this kind of structure didn’t raise more alarm bells at places such as the SEC and the fund-of-funds.
  3. What makes this fraud truly genius is that everyone on the street, including I suspect most of his investors, assumed all along that Madoff was a crook, in fact that’s why they invested with him in the first place!  The rumor was always that he made his money by front running the order flow from his market making business so if things didn’t add up people must have just figured, “Well of course they don’t add up, wink wink nudge nudge, because we all know this whole split strike strategy is just a lie to cover up the fact he is screwing his order flow customers”.
  4. The fund-of-fund managers who invested heavily in this fund should probably go to jail before Madoff.  Not only did they invest in a firm with a operating structure that should have raised just about every due diligence red flag in the book, but it delivered amazing returns at fees that were “too good to be true”. 
  5. It’s highly ironic that people are shocked a market maker would be doing something illegal.  Market makers, including Madoff, conspired for years to rig spreads on the NASDAQ market before they were caught (by two professors, not the SEC!).  To this day market makers continue to front run their customers on a massive scale (why else would they pay for order flow?).  Why anyone would trust such firms with their investments is beyond me.
  6. Making the rather generous assumption that it didn’t start out as a fraud, it will be very interesting to learn just when and why the scheme crossed over from investment fund to ponzi scheme.  I am guessing that the advent of decimalization plus electronic trading (both on the equity and options exchanges) plus the rapid expansion in funds under management took most of the juice out of the original model and ultimately led to the collapse of the fund’s strategy.  If that’s the case it will be highly ironic that some of the market “improvements” that Madoff help champion ultimately undermined his firm.
  7. Finally, I am sure that the government will enact all kinds of new regulations as a result of this fraud but the truth is that this could all have been prevented if investors had insisted on the most basic of check and balances including an independent broker, an external custodian, a third party administrator, and a reputable auditor.  These simple, common sense controls would have easily prevented this fraud from ever taking place.

December 17, 2008 in Wall Street | Permalink


Buffet Makes It Official: Even Goldman Sachs is Junk

Lots of press this afternoon on Warren Buffet's investment in Goldman Sachs.  For $5BN it looks like he will receive $5BN face value in perpetual preferred with a 10% coupon callable at 110, plus 5 year warrants on another $5BN worth of stock @ $115/share (which equates roughly to warrants on about 43.5 million shares @ $115/share).

I am not an options guy, but if you take the take the implied volatility on Goldman 120 Jan-2011 calls and apply that out to 5 years (which I realize is a generous leap of faith), it looks like the warrants are worth in the neighborhood of $50-$55/share depending on your assumptions (options pros please correct me if I am way off here) which means the 43.5M in warrants are worth around $2.2BN to $2.4BN at issue.  That means that Buffet is really investing only about $2.8 to $2.6BN at a yield to maturity (assuming 5 years) of around 27% to 29.5% and that's not even counting the 10% preferred redemption premium. With the 110 call on the preferred and the upfront warrant coverage, the YTMs are even higher if Goldman decides to call the preferred earlier.

Obviously, Buffet is getting a healthy discount because he's the ultimate in smart money, but still, when Goldman, the Gold standard in investment banks, is selling perpetual preferred at theoretical yields to maturity of 25%+ you have to wonder what the market rates really are for your average investment or commercial bank.

I assume the market will heartily applaud this deal, but I don't know if I should be excited that Buffet thinks it is finally a good time to buy or scared to death that the best global franchise in investment banking has to raise money at interest rates that would make a sub-prime credit card issuer blush.

September 23, 2008 in Wall Street | Permalink


Fannie Mae Is Saved! It's Shareholders ... Not So Much.

As I chronicled in my last post about Fannie Mae's Golden Goose, the struggles of Fannie Mae and Freddie Mac were clearly putting to the test the bond market's long held assumption that both companies had the implicit backing of the US Government and were "too big to fail".

With tonight's announcements from the US Treasury and the Federal Reserve, it looks like the bond market was right all along and much more credible that the consistent denials of Washington's politicians (imagine that!).  After tonight's action there's nothing implicit about the government's guarantee of Fannie and Freddie's debt; you might as well print in on the legend of their bond certificates and take it to the bank (or perhaps the Fed).

Be Careful What You Celebrate
There are probably a lot of cheers going through halls of Fannie Mae's Georgian-style mansion on Wisconsin Avenue tonight, but before they crack open the bubbly, they might want to read fine print of today's press releases, because while Fannie and Freddie will indeed survive to live another day, they will be living in a very different world.

Specifically, as part of getting the Fed to sign off on this rescue package, the Treasury and OFHEO have (undoubtedly at the Fed's insistence) agreed to give the Fed "a consultative role" in "setting capital requirements and other prudential standards".  For anyone who has followed the Fed's view of the GSE's over the past 15 years, this means the party's over for Fannie Mae and Freddie Mac.

Payback Is A Bitch
The upper echelons of the Federal Reserve, including almost its entire Board of Governors are typically populated by very serious economists, almost all of whom have PhDs and illustrious academic careers.   Fed economists tend to be very smart, very logical, and very cynical.  Thus they have for some time understood the huge moral hazard inherent in the basic structure of Fannie and Freddie.   This is why both Bernanke, and Greenspan before him, have been one the few voices in Washington DC consistently almost literally begging politicians to reign in both agencies.   Up until now, those pleas have largely fallen on deaf ears thanks to the masterful political coalitions built by both Fannie and Freddie.  That Fannie Mae and Freddie Mac fended off the Fed, arguably most Washington's most powerful independent institution, for so long is a true testament to the power of the political coalitions that they built.

Unfortunately, for Fannie and Freddie, those political coalitions are currently collapsing at light speed as politicians run as fast as they can from ground zero before Fannie and/or Freddie go super-critical. Fannie and Freddie now not only find themselves without their vaunted political air cover, but at the mercy of one pissed-off Fed.  Economists are generally not prone to anger, there's very little utility in that, but my guess is that there's a fair amount of anger going around Fed these days.  Anger that none of the politicians listened to them, anger that Fannie and Freddie consistently thumbed their noses at them, and anger above all else that they are currently stuck cleaning up a mess they warned everyone who would listen would one day come their way.

So how might the Fed translate this anger into policy now that it has officially been given, at least partial, control of Fannie and Freddie's regulatory leash?  To get some insight into that one need only to read a speech about Fannie and Freddie from Chairman Bernanke just over a year ago.  Indeed, the final paragraph gives good sense of what the future has in store for Fannie and Freddie:

Legislation to strengthen the regulation and supervision of GSEs is highly desirable, both to ensure that these companies pose fewer risks to the financial system and to direct them toward activities that provide important social benefits.  Financial safety and soundness can be enhanced by giving the GSE regulator capital powers comparable to those of bank supervisors and by creating a clear and credible receivership process that leads debt holders to recognize that they would suffer financial losses should a GSE fail.  Finally, the Federal Reserve Board believes that the GSEs’ investment portfolios should be firmly anchored to a measurable public purpose, such as the promotion of affordable housing.  I believe that this approach provides a reasonable balance of social costs and benefits for the GSE portfolios. In particular, this approach would re-focus the GSEs on the affordable housing objectives given to them by the Congress.

Before you react to this, consider that this speech was made over a year ago when Fannie Mae's stock price was 5 times higher and its powerful political coalitions were still fully intact making any attempt at criticism a rare, brave, and largely futile endeavor.  Once one gets past the obligatory genuflections to "affordable housing", the Fed's prescription in this speech is clear:  they want to kill Fannie and Freddie Golden Gooses, i.e. they want to dramatically reduce their $1.5TR mortgage portfolios to a small fraction of their current size and return both companies to their original mission as a conduit and guarantor with maybe a few "investment" dollars thrown in to grease the skids of the only the most politically sacrosanct areas of the mortgage market.  In short, the Fed intends to replace Fannie and Freddie's regulatory leash with choke chain and then proceed to pull it ... very hard.

Say Goodbye To The Golden Years
For taxpayers, this is largely good news as it will likely result in far smaller balance sheets at Fannie Mae and Freddie Mac with far lower potential for a (another) costly bail-out.  For consumers this is probably slightly negative news as the absence of the agency's "risk free" buying binges will probably lead to slightly higher mortgage rates. For Fannie and Freddie shareholders, beyond Monday's likely relief rally, this is long term bad news because it means that the government is killing off the agencies golden gooses and therefore the companies are never likely to return to the halcyon days when their biggest concern was making too much money.

All that said, given Fannie and Freddie's prior political and economic comebacks it's entirely conceivable that they will be able to weather the storm and then refashion a political consensus that allows them to get back to the good old days (up until Friday they were doing pretty well).  But even politicians are once bitten are twice shy, so it may be awhile before Washington DC forgets enough of today's pain to let the GSE's take another free-ride on the government guarantee express, and if the Fed has its way, that train will never leave the station again.

I currently have no investment position, long or short, in Fannie Mae or Freddie Mac.  This is not investment advice. Please see my disclaimer at the bottom of this page for further details.

July 13, 2008 in Wall Street | Permalink


Fannie Mae's Golden Goose: A Lesson In Moral Hazard


The World’s Biggest Mortgage Bank

I don’t know exactly what the future holds for Fannie Mae, but I think I can shed some light on how it got in this position in the first place.    The seeds of Fannie Mae’s current crisis were actually sown in the recovery from its last crisis.  In the mid-1980s Fannie Mae almost went out of business thanks in large part to some very poor and rather unsophisticated asset and liability management practices.   What basically happened is that the aggregate cost of Fannie Mae’s debt exceeded the income it was deriving from its (then relatively modest) mortgage portfolio.  This never should have happened given the instruments and strategies available to Fannie Mae’s finance team, but they had become somewhat complacent and had failed to keep up with the state of the art in portfolio and treasury management.

Creating the Golden Goose
A new team of people took over the finance side of Fannie Mae and implemented a series a relatively sophisticated and ultimately incredibly profitable Asset and Liability Management (ALM) strategies.  One of the key innovations was issuing debt instruments, specifically callable debt instruments, that enabled Fannie Mae to much more closely match both the duration and pre-payment characteristics of its Assets (primary residential mortgage securities) with its debt (primarily Fannie Mae corporate debt).  Normally, callable debt is quite expensive (much more expensive than residential mortgage debt), because bond holders want to be compensated for selling the call option to the issuer, but thanks to Fannie Mae’s quasi-government status it was able to issue this callable debt at yields that were only marginally above straight treasury yields.  This debt combined with a more sophisticated overall ALM approach, not only reduced Fannie Mae’s borrowing costs significantly, but enabled it to very quickly adjust its portfolio in the event of rapid changes in pre-payments.

With this strategy in hand, not only could Fannie Mae buy mortgage securities for less than the cost of its debt (and thus earn a nice spread), but it could almost entirely contain pre-payment risk effectively making the purchase of mortgage securities “risk free” except for credit risk, which itself was very low thanks to Fannie Mae’s strong underwriting guidelines.  Fannie Mae had discovered the equivalent of a financial golden goose.

Let’s Get This Party Started
With its golden goose in hand, Fannie Mae almost immediately began buying a lot more mortgage securities.  Who did it buy these securities from?  Why none other than Fannie Mae itself.  You see Fannie Mae’s original role was to buy mortgages from individual banks, package them up into securities, guarantee those securities against loss, and then sell them to other financial institutions.  However once Fannie Mae realized that the “golden goose” allowed them to buy those same securities for its own portfolio and lock-in “risk free” profits, Fannie became a major buyer of its own securities.  Fannie Mae was thus in the rather bizarre position of guaranteeing an ever increasing portion of its own assets against default. 

By the time I showed up in the mid-1990’s, Fannie Mae had become one of the largest buyers of its own securities.  Its stock was up over 40X from it’s 1980s nadir and it seemed as though the single biggest problem it had was deciding on how much money it wanted to make.  This was a bigger problem than you might imagine because as a quasi-government agency, and a constant political football, Fannie Mae realized it couldn’t be seen to be abusing its market position.  So rather than go crazy and buy every mortgage security in sight, Fannie Mae just settled on charting a nice predictable upward growth in earnings fueled largely by buying an ever increasing share of its own securities.



Moral Hazard vs. Mo’ Money



A Victim of Its Own Success
Fast forward to the mid-2000’s and Fannie Mae’s financial and political strategy was largely a resounding success.   Fannie was now offering a wide range of mortgages that required less than a 20% down payment including even some that required no down payment at all! These products had dramatically increased the addressable size of the mortgage market.  The increased size of the mortgage market enabled Fannie to purchase a massive amount of its own mortgage securities.  In fact by this point Fannie Mae had become the single largest purchaser of its own securities.  These newly purchased assets in turn enabled Fannie to continue to grow earnings which in turn supported a stock price that continued to trend nicely upward (though at a much more modest rate).



The Goose Is Not Dead Yet
Despite all of this, I personally don’t expect either company to go out of business.  If recent comments from a slew of politicians are any indication, they are indeed “too big to fail”.

What I find most ironic in all of the current commotion is that rather than trying to address the root causes of Fannie Mae’s precarious state: dramatically lower underwriting standards and a massively levered balance sheet taking a free ride on the government’s back, politicians are doing the exact opposite:  they are dramatically increasing the size of the mortgages that Fannie and Freddie can buy and pressuring them to maintain and even further lower their already un-sustainably low underwriting standards.  I don’t know where this ends, but reinforcing the bad behavior that led to the crisis in the first place can’t end well

UPDATE: See my latest post if you are interested in my take on the Fed/Treasury's recently announced strategies for helping Fannie/Freddie.



July 11, 2008 in Wall Street | Permalink


Infospace and the Great Shareholder Robbery of 2007

Wow.  Infospace reported earnings today and the stock was off 14%.  But that's not what's making me say "wow".  What's making me say "wow" is that I took this opportunity to take a look at Infospace's 2007 "earnings" report and I have to say I am impressed because it has to go down as one of the great shareholder robberies of all time.  Infospace, as you may recall, was a once high flying internet content company that assembled a motley menagerie of web and mobile based content businesses via 30+ acquisitions over the last 10 years.  They bought everything from Authorize.Net, to Go2Net, to Switchboard.  While there was supposedly a grand strategy driving to all these purchases, arguably what they were left with after 10 years and $1.7BN in paid in capital was just over $1BN in retained losses and a motley collection of business that looked like they were going no where fast.

Anyway, the company's mobile business was held out as the potential savior for a long time but as that too began to implode in 2006 and early 2007 the management team basically threw in the towel and embarked on a process of selling off the company's assets piece meal to the highest bidder.  No doubt a somber occasion given that the sales represented the culmination of a failed strategy that had cost shareholder's a cool $1BN, but at least you have to give the management team and the board credit for doing the honorable thing by admitting they failed and doing their best to salvage something for the shareholders.  Or do you...

On Closer Inspection
Before you give the management team and board any credit for doing the right thing, you might want to know a little something about the a deal they struck for themselves that nicely coincided with their fire sale.  The plan was to sell off the assets and dividend out the cash proceeds to the company's long suffering shareholders, which sounds fair enough.  However, the management team was able to convince the board that they should get paid a "bonus" equivalent to the dollar value of the dividends that would theoretically accrue to any vested or unvested stock options they might have.   So if the company did a $5 dividend of sale proceeds and the stock dropped $5 (which it inevitably would), the management team would get a $5/share bonus for each vested and unvested stock option they owned.

Now on one level that sounds fair enough.  I mean after all, why should the management team and the employees have their options go further underwater simply because they are doing the right thing and trying to get shareholders back some cash.  However the net effect of such a scheme is to basically give the management team a gross cut of whatever they sell an asset for without regard to whether or not the sale was even profitable.   The cynic/economist/anyone with common sense would say that under such a incentive structure management would race out and sell everything and the kitchen sink for whatever price they could get because it was money in their pocket no matter what.

Care to guess what happened?

Everything Must Go!
That's right, Infospace's management team ran out and sold everything they could for whatever price they could get.  The directory business, painstakingly built up over a period of 10 years: sold for $225M to a private equity firm.  The mobile business, which they been acquiring new businesses for less than a year earlier: sold for $135M to a private competitor (who reportedly now mightily regrets the purchase).

And what did they do with all that cash (as well some cash from settling a lawsuit with a former founder who defrauded the company's investors)? Why surprise, surprise, they dividended out all that cash out to their shareholders in two special dividends totaling $15.30/share or over $500M in cold hard cash.

And what, pray tell, what did the management team get for the arduous task of lifting up the phone and calling their bankers?  A cool $90M in special cash bonuses and stock compensation in 2007.  If you are on that management team, the thought that likely came to mind as you cashed your 2007 bonus check was "God Bless America!"

Defending the Indefensible
But wait, defenders of the management team's "golden dividend" might point out that the asset sales generated a combined $149M "gain" and surely the team should at least be entitled to share some of that gain.  But that logic fails to account for that fact that prior to 2007, Infospace had already taken $240M in impairment charges since 2000 which means that the actual "gain" on sale of those assets was likely far lower and might even have been a net loss of over $90M on an original cost basis. (I'd guarantee its a loss, but it's impossible to figure out what impaired assets were sold given how many deals they did.)

One final point of defense might be the stock price.  Defenders might point out that at the beginning of 2007, before management embarked on the asset sale strategy, Infospace's stock price was $20.51, and even though it closed at $10.38 today, when you add back the $15.30 in dividends, you get an adjusted price of $25.68 or about $5.17 higher, so one could argue that despite all the management payouts they still created value.  There are only two problems with that logic:  1.  With 33 million shares outstanding, $5.17/share translates into only $170M in increased "shareholder value" vs. $90M in management comp which equates to a 35% cut for the management team.  M&A bankers would sell their mothers to get a 3% cut of a sale so I shudder think what they'd do for a 35% cut.  2.  If you go back just 3 years, the stock price was at a whopping $47.55 meaning that shareholders have suffered a 46% loss in the last 3 years, but the management team and the board thinks that's an occasion for them to give themselves a windfall payday the size of which would make even an investment banker blush.

Don't Look Now But You've Been Robbed
Let me be clear: I've never owned or shorted (unfortunately) Infospace stock, so I don't really have a dog in this fight.  I am just flabbergasted that none of their shareholders stood up to such a blatant scheme and called it for what it is: highway robbery.  I don't have a problem at all with paying management teams well for creating value,  I just have a huge problem with handing out huge bonuses (i.e. more than 10X the already egregious fees charged by bankers) to people who sell assets for little if any gain when their shareholders are already sitting on $1BN an losses and a 46% stock depreciation since 2005.  Call me crazy, but I have a problem with that even if, inexplicably, Infospace's shareholders don't.  You may also ask why didn't the board, who supposedly represents the shareholders, have problem with that: simple, they cut the same deal for themselves.

As for shareholders, they are now left with a business whose only significant asset is a website called Dog Pile.  If you're like me, the image that pops into your mind when you hear the term "Dog Pile" isn't exactly a pile of money, which at least strikes me as poetic justice if nothing else.

I currently have no investment position, long or short, in Infospace.  This is not investment advice, it is an incredulous rant.  Please see my disclaimer at the bottom of this page for further details.

May 1, 2008 in Internet, Wall Street | Permalink


SkyGrid and the Emergence of Flow-Based Search



Old Search: Crawl/Index/Query



SkyGrid Search: Flow/Filter/Analyze




Google Roadkill?


