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After Strong End To 2010, M&A And IPOs Show Lackluster First Quarter

After a strong end to last year, venture firms’ exit opportunities suffered a setback in the first quarter as corporations pulled back on spending and initial public offerings remained stagnant.

Acquirers spent $8.95 billion in the first quarter on 91 deals, compared to $10.77 billion on 128 deals in the fourth quarter of 2010, according to Dow Jones VentureSource. The latest deal total was the lowest for a three-month period since the third quarter of 2009, when there were 87 deals. The first-quarter amount, however, topped the year-ago total of $7.43 billion.

While the consumer services sector produced some big deals—such as AOL Inc.‘s (AOL) $315 million buy of news and opinion site HuffingtonPost.com Inc. and Nordstrom Inc.‘s (JWN) $180 million acquisition of online fashion shopping site HauteLook Inc.—a decline in health-care and information technology deals couldn’t make up the difference.

“It feels contrary to the environment—the stock markets are at big highs and moving, the economy’s doing better, but when you dig into the [tech M&A] numbers, it’s pretty negative,” said Ben Howe, chief executive of America’s Growth Capital, a technology focused investment bank.

The IPO market, meanwhile, didn’t show signs of improvement in the first quarter, as 11 venture-backed companies went public, down from 14 in the previous quarter, but slightly better than the eight offerings in the year-ago period. The underwriters of many of these IPOs cut prices ahead of the offerings, and only one IPO—biofuel company Gevo Inc. (GEVO)—produced more than $100 million.

The IPO pipeline remains strong, however, with 45 companies, and many of them may be waiting for their 2010 financial results to be audited before trying to price the offerings.

Meanwhile, a number of big publicly traded companies, such as Cisco Systems Inc. (CSCO), Google Inc. (GOOG) and Microsoft Corp. (MSFT), are still sitting on huge cash piles and have signaled they’re hunting for deals.

“I think the logic points to a pretty good year,” said Todd Hixon, a managing partner at New Atlantic Ventures, adding that corporations that retrenched during the financial crisis now want to figure out how to get more growth.

Howe, of America’s Growth Capital, noted the first-quarter M&A drop-off was likely a natural effect of the late rush for deals at the end of the year, but said that rising valuations were also likely a factor in the slowdown.

“There’s a little pullback because [large tech companies] already made a lot of purchases and need time to digest them, and valuations have come up and they’re getting more disciplined,” Howe said, adding that portfolio companies are “doing better, growing faster, so there’s more conviction” on price.

Some executives at big corporations scouting start-ups have expressed restraint, concerned about the rising valuations. At the recent America’s Growth Conference in San Francisco, Ken Gonzalez, a senior vice president of corporate development at McAfee, now owned by Intel Corp. (INTC), said the run-up in acquisition prices has put a damper on transactions. Added fellow panelist Monty Gray, director of mergers and acquisition at SAP AG (SAP, SAP.XE): “Transaction multiples are really getting way up there.”

Indeed, the median acquisition size of venture-backed companies soared to $95 million in the fourth quarter, the highest three-month total since the fourth quarter of 2009 and the second highest since the second quarter of 2000, according to VentureSource. That brought the 2010 median total up to $46 million, the highest since 2007.

In the first quarter, the median post-value at liquidity was $55 million in the first quarter, far above the $21 million in the year-ago quarter.

Technology M&A deals declined to $2.08 billion on 34 deals, from $3.16 billion and 67 deals in the year-ago period. The consumer services sector went a long way toward making up those declines, however, with 22 deals generating $3.22 billion in the first quarter, more than four times the year ago total on five fewer deals.

The health-care space saw the two largest M&A deals in the quarter: Medtronic Inc. (MDT) paid $800 million for catheter developer Ardian Inc., while Amgen Inc. (AMGN) bought cancer therapy company BioVex Group Inc. for $425 million plus potentially $575 million in milestones. Overall, health-care M&A brought in $2.25 billion on 15 deals, comparable to the first three quarters of 2010, but down from $3.65 billion on 29 deals in the fourth quarter.

Jay Lichter, managing director at life sciences firm Avalon Ventures, said companies with late-stage products and companies that target “orphan diseases” are still ripe targets for acquirers, he said.

As an example, he cited the recent sale of Calistoga Pharmaceuticals Inc., whose lead drug shows potential to treat certain blood cancers that resist existing treatments, to Gilead Pharmaceuticals Inc. for up to $600 million in cash and milestones. “Mid-size biotech is very aggressive,” he said of the deal, which hasn’t yet closed and thus was not included in the first quarter numbers.

At least in the first quarter, though, acquirers seemed to target companies earlier in their development, with the median amount raised to liquidity falling to $13.3 million from $19.78 million in the fourth quarter deals. The $13.3 million was the lowest total since the second quarter of 2002. The 4.58 years to liquidity was also the lowest total since the second quarter of 2009.

Google Inc. was the top acquirer of venture-backed companies in the quarter with two deals: web-video development start-up Next New Networks Inc. and voice messaging start-up SayNow Corp.

—With reporting by Scott Denne, Russell Garland and Timothy Hay

-By Zoran Basich, Dow Jones VentureWire, 415-439-6684; zoran.basich@dowjones.com