M&A industry veteran Paul Deninger, a vice chairman at Jefferies & Co., has made a living advising companies on mergers, acquisitions, IPOs and the like. But even he acknowledges that too much industry consolidation isn't a good thing for technology innovation. Deninger talks about the state of the M&A market and what's likely ahead.
How would you characterise 2008's network industry M&A activity?
The market in technology in 2008 has been OK, not great. The volume of transactions feels like it's been off by about a third and value has come down as well, so maybe in aggregate it's been a little under half of what it was in '07. But unlike the debt and equity markets where virtually nothing is happening, there is M&A activity going on, even in the fourth quarter.
So what of the deals that did take place, like those involving big carriers such as AT&T and Verizon Wireless?
In a tough market environment the character of the M&A transactions that will take place shifts from companies looking for growth to more consolidation. That's because your own business is not growing as fast as you would hope, so the only way to grow earnings is to cut costs and the easiest way to do that is in the context of a consolidation. We saw a lot of consolidation M&A in 2008 and I think you're going to see more of it in 2009. You could even argue that the HP-EDS transaction is a consolidation even though it greatly expanded HP's reach in services and made them even bigger than IBM in that market.
One of the things that has happened in this decade is a dramatic reduction in the number of IPOs per year. Such that we are in the eighth straight year of a decline in the number of public technology companies. You would have to go back to 1988-1989 to find a period where you had a decline in the number of public technology companies for two straight years. That's not quite a generation, but it's pretty damn close. What does that mean? The effect is that the number of buyers is shrinking and consolidation among those buyers means that those that are buying are bigger. There's been a hollowing out of the middle market and by that I mean companies with US$2 billion-$10 billion in market cap. If you go back in time you would have been able to name dozens of companies that had $1.5-$2.5 billion of market cap and were aspiring to be the next Cisco or SAP or Oracle. That is very rare and almost no longer the case today because of the paucity of IPOs and the consolidation of the market.
What does the nature of this M&A activity mean to CIOs and other high-level network executives?
What I would say to CIOs is: Be careful what you ask for, you might get it. I believe that your readers and the companies they serve have benefited dramatically from the innovation cycle that we have come through. It has been driven by young entrepreneurial companies. I remember the early 1980s when IBM's innovation was dead. IBM had so much account control that they could basically say yeah, we don't need to bring this innovation to market, sort of like the automakers. Customers will buy what we tell them to buy. But technology innovation shook that status quo and it was good because enormous productivity came out of it. Massively changed business processes and improved global competitiveness came out of it. Incredible ways to access new customers in new ways to drive revenue came out of it. CIOs are more aggressively now than ever saying we don't want to buy from small companies, we want to buy from large companies, so find yourself a partner. And I just would throw a little caution to say in an environment like we're going into where the natural economic activity is going to be to drive consolidation be careful what you ask for, you might get it. If it becomes increasingly hard to sell to the customer base, if it becomes increasingly hard to get the revenue traction to go public, then the innovation engine on which you rely will die. And how far away from Cisco is IBM in 1984? The challenge and question I would put in front of your readers is that.
It almost seems like some VCs have given up on enterprise networking.
I do believe that the talk about innovation being over in network-based computing is silly. I would just throw out two very big-picture points to suggest it just can't possibly be true. One is mobility. There are something like 3.3 billion mobile devices in the world right now. That's more mobile devices than PCs, automobiles and credit cards combined. Think about how big an impact credit cards have on commerce, how big an impact on personal transportation automobiles have had and think about how big an impact the PC has had on the enterprise. There are more mobile devices than those three things combined in the world. There is no way that doesn't result in massive change in network computing. We're only at the beginning of that happening
The second change that is far less obvious but that might be more revolutionary and therefore more unknowable is the following. The millennials are coming. They're coming as knowledge workers. Most of your readers are guys like you and me who have been doing this for 20 years and we were the revolutionaries. We were the ones who broke down the glass house and changed computing forever. When we started in business there was no such thing as e-mail, voice mail, video. Think of all the things that didn't exist that are central to today's computing environment. But we look at our kids and the level of transparency they are comfortable with, the virtuality of the world in which they live and affiliations they maintain, the democratic access to information they depend upon and we look at that as somewhat foreign. I think we look at them somewhat like the generation before us looked at us. We say what do you mean virtualized organizations and everybody has access to everything? What do you mean no privacy? I have no idea how this plays out but we will not make this change, they will and they are within a decade of having the power to do so. It will be really interesting to see how corporate computing, network access and information flows change because of how the millennials live their lives and seek to do business.
More immediately, where do you see things going this year on the M&A front?
One of the things that we're going to see in '09 is these big companies, EMC, HP, Oracle, the large telcos, they're going to flex their muscles and buy aggressively and I don't just mean dozens of deals. I mean they will be aggressive on value and going after the best companies that don't have another alternative and that might otherwise have done an IPO. So they're going to seek to strengthen their already strong position ...put distance between them and their nearest competitors.
Would you include Cisco in that group?
Yes. There's a lot of rationalization going on at Cisco, particularly around video. They are so dominant in the enterprise now it is hard to think of what else they need to do. In video, there are two things that caused them not to move as aggressively this year as they otherwise would have. They're still sorting through their strategy around the Scientific-Atlanta acquisition and how they're going to organize and manage themselves to capitalize on that market. No. 2, the videoconference modernization process hasn't matured as some people thought it would.
Going back to 2008, what deals surprised you, had you scratching your head or didn't happen that you thought might?
The big deal everyone was talking about of course was Microsoft-Yahoo and whether it should or shouldn't happen. As an M&A professional I don't want that deal to happen because I want more buyers in the marketplace. If you're a venture capitalist, if you're building next-generation technology companies you don't want to see consolidation among your big players like Microsoft and Yahoo. The second angle is if you're a Microsoft shareholder, and I think this angle was relatively underreported, I'm not sure why you want that deal to happen. If I'm a public shareholder I can go buy Yahoo stock. I have to believe that Microsoft and Yahoo together are better than Yahoo alone and I personally don't think Microsoft made a very compelling case as to why that was true.
Another deal that didn't happen is Facebook. It seems very inclined to focus on building itself as a significant, powerful and independent company. I'm delighted they were not acquired by one of the obvious players. It takes a lot of courage to turn down that much money.
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