Mergers & Acquisitions
Jan, 2000

Internet Deals in a Down Market.

An unsteady stock market does not have to be a deal deterrent for Internet acquirers intending to use their attractively priced shares as acquisition currency. With a bit of creative deal structuring, acquirers can pull off a stock deal, even in a volatile market.

While a sagging market can hinder stock deals of any type, the m&a plans of Internet companies especially are vulnerable to stock market gyrations, since those companies may have few, or no, alternatives for financing their acquisitions. Yet, even cash-poor acquirers can get deals done if they, and their targets, are willing to be flexible on deal structuring options, experts say.

In many cases, if a downturn in the market lowers an acquirer's share price, chances are that the target's stock price will decline as well, and the value of the deal will fluctuate little, if at all. If for some reason the value of the deal changes dramatically, both parties may have to re-evaluate their goals and determine whether the deal is still worth pursuing. If they agree that it is, there are conventional, and some less conventional, ways for them to salvage the deal.

David B. Boris, executive vice president and director of investment banking at Ladenburg, Thalmann & Co., notes that Internet dealmaking essentially is traditional m&a, but with a twist, given the volatility of Internet stocks. Many of the devices in Internet deal structuring, such as floors and collars, come straight out of the traditional m&a play book, he points out. Although they are protective devices for both parties to a deal, not all Internet deals include them. "Some of these companies are going naked and doing these deals without collars or floors. From what I understand, in Ask Jeeves' acquisition of Net Effect Systems, there is no collar in that deal," Boris says.

Boris points Out that one thing he hasn't seen yet in Internet deals is perceived valuation gaps, in which an acquirer and target differ greatly on the value of the deal. "M&a practitioners have created tools like contingent value rights, which we saw a lot of in the 1980s and a bit of in the 1990s, for doing deals where the parties had a dispute on the price. We really haven't seen those used in Internet transactions yet, but I think we will see more creative structuring coming into play in those deals," he notes.

There may be different issues to consider, depending on whether the deal is an acquisition of full or partial interest, remarks Jeff Anderson, principal at Bond & Pecaro Inc., Washington, D.C.-based consulting firm specializing in the communications, media, and new-technology industries. In a full acquisition, he says, in which there is an agreement to sell a certain number of shares at a set price, the acquirer could offer more of its shares to maintain the value of the deal, in the event that its share price declines before deal closing. However, he notes, offering more stock would raise a host of questions regarding the capital cost structure of the company, a potential increase in the cost of the acquisition, and possible dilution of the stock, which in turn would raise ownership and control issues.

In a more traditional solution, the buyer could offer warrants to the target, which would give it the opportunity to buy additional shares of the acquirer in the future, he adds. That could provide a good upside opportunity for the seller in return for accepting a lower initial price, he notes. "There may be an added benefit from the target management's perspective that might be attractive. If the acquirer seeks to retain key target personnel by offering stock options, the stock option exercise price may be lower, given a drop in the acquirer's stock price."

In an acquisition of partial interest, Anderson notes, the seller might be willing to accept forms of investment other than stock or cash. He points out that in the media industry, there are companies that are willing to exchange advertising or promotion for en equity stake in a company. CBS has been aggressive in that area, he says. The company acquired a partial interest in SportsLine USA essentially by exchanging advertising and promotion for an equity stake.

Centers of Attraction For Acquirers

Intellectual properties, such as proprietary technology, patents, copyrights, software, know-how, customer relations, and similar resources, often represent the most valuable assets of high-technology companies, and acquirers should have a firm idea of their economic value. Many companies have intangible assets that can be valuable to other companies. Even the acquirer's marketing or sales force might be attractive to a target, Anderson adds.

Most of the value of Internet companies is in their intangible assets. The difference between the fair market value of these companies and their fixed assets is huge, and their intangible assets make up the balance, says Anderson. "Internet companies may have affiliate agreement programs, distribution agreements, technology, personnel, customer relationships, perhaps even a very strong brand name, like Amazon. All of those assets could be of tremendous use to a related company," he says.

While these modes of deal payment are less conventional than cash or stock, companies bent on doing deals with stock may need to be open-minded in devising out-of-the-box solutions for completing deals when market conditions are bearish and financing options are few.