Tech Companies Struggling to SurviveBy Reuters | Posted 2008-11-10 Email Print
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Technology vendors and solution providers laden with debt could be the next targets for industry consolidation. Several companies have already filed for bankruptcy protection. Selling out could be the next step.
By Caroline Humer and Anupreeta Das - Analysis
NEW YORK/SAN FRANCISCO (Reuters) - Technology companies may be the next group swept up in a restructuring wave that began on Wall Street.
Purchases of computer hardware, software and services have already been affected by the global credit crisis that has slowed lending, and a broad recession that has taken hold of the economy as consumers struggle with unemployment and mortgage payments.
But the economic downturn promises to be particularly severe for technology companies, many of which are laden with debt brought on during the credit boom of recent years.
Some of that debt came as banks became more comfortable lending to tech companies, which had typically tapped the equity markets for capital.
But most came as the companies were bought by private equity firms, which, when faced with pricey mergers and acquisitions, turned to their typical method of increasing returns -- heaping on leverage or debt.
Many leveraged buyouts were done at debt-to-EBITDA (or earnings before interest, taxes, depreciation and amortization) multiples of up to 8, far higher than the rule-of-thumb multiple of 3, said Peter Falvey, co-founder and managing director of the technology-focused investment banking firm Revolution Partners.
"You're going to get a triple whammy" of highly-levered balance sheets, an overall economic slowdown and shrinking IT budgets at major clients such as financial services firms, Falvey said.
Both the broader economic recession and tight financing are weighing on companies, according to Andrew Hinkelman, a Senior Managing Director in FTI's Corporate Finance practice in San Francisco.
"There are some companies that are completely overleveraged and then there are those cases where the debt is coming due and the banks are not willing or able to refinance since the credit markets have dried up," Hinkelman said. "You are stuck at that point."
"Companies are going to be forced to use bankruptcy as a vehicle to right-size the balance sheet," he said.
Experts said much of the damage will begin to play out next year, but some companies are already at risk. They pointed to software companies and semiconductor companies as some with high debt loads.
And companies that need to raise money now are not having any easy time, experts said.
"These days the capital that is available to be invested, which is quite a bit, is at least temporarily sitting on the sidelines. Those people who need fresh capital to grow their businesses, irrespective of whether it's debt or equity, are going to have a hard time finding it," said Leo Crowley, an insolvency and restructuring lawyer at Pillsbury Winthrop Shaw Pittman LLP in New York.
The bankruptcies have already begun. On Friday, a small personal computer vendor, MPC Corp (MPCC.PK: Quote, Profile, Research, Stock Buzz), filed for bankruptcy, blaming its professional business unit.
Earlier this week, a small privately-held software company called Solution Technology that provides financial information to insurers and reinsurers filed for Chapter 11 bankruptcy protection.
Meanwhile, shares in smartphone maker Palm Inc (PALM.O: Quote, Profile, Research, Stock Buzz) fell on Wednesday after an analyst downgraded the stock and questioned in a research report its need for additional capital. The Morgan Keegan report said Palm may be able to turn to private equity firm Elevation Partners, which owns 25 percent of the company.
Turning to their deep-pocketed investors may be a solution for other companies, too. Private equity firms may step in to provide cash infusions to debt-ridden tech companies, using the capital that they had earmarked for new deals -- the new deals that are not happening now because of the credit crunch, Falvey said.
"All the capital that was earmarked for levered deals (by buyout shops) is just going unused. So there's a great pool of capital that they've got to put to work," he said.
But another technology banker who declined to be named said it might be hard for private equity firms to justify such investments. "If you're investing in equity, it's hard to determine you're buying at the right time," the banker said.
The banker said more technology companies have come in recently, worried about the possibility of a prolonged recession and the need to shore up liquidity in order to avoid the specter of debt defaults.
But the opportunities to restructure balance sheets are pretty limited right now, the banker said. "We're definitely talking to people about it, but it's not right to say a massive amount of this stuff will happen because the market just isn't there," the banker said.
"It's not like you can access the high-yield markets or the leveraged loan markets. ... The government's backstopping even the commercial paper market."
(Editing by Brian Moss)