American Electronics Association
Mid Cap Conference
We have attended both the AEA Mid Cap conference and AEA Micro Cap conference in the last twelve months. These conferences have given us a good insight into the current mood among analysts and company management. Following the credit squeeze in July we were interested to hear what analysts and management of small companies were saying and doing and so attended the Technology Capital Conference, which specifically targets US technology small caps looking to raise capital.
The experience proved worthwhile. Most fascinating was the insight into the level of innovation shown by new companies. We were also pleasantly surprised by the appetite among these companies for a public listing given the numerous alternatives which have been made available to them in recent years.
Over the last fourteen years, we have witnessed the rise and fall of technology companies and marked changes in the attitudes of analysts and company management from exultation to disillusionment. At the previous two conferences, the over-riding theme was that management seemed resigned to, but felt disheartened by, life as a listed company. Having survived the technology bubble and undertaken radical and deep rooted restructuring programmes, the share prices of their companies were still languishing and the hostility from analysts remained intact.
At this most recent conference it was therefore pleasing to see enthusiastic company management full of optimism for the future. The only complaint was the difficulty in hiring enough good marketing people. There was a real sense that this was going to be the ’new beginning’.
The evening before the conference began there was a drinks reception and an opportunity to talk to a number of industry professionals including analysts, company management, venture capitalists and private equity representatives. We enjoyed many discussions about specific companies and the sector in general.
Among the highlights of the pre conference session was a conversation with an Account Executive at Trinet Solutions - the nineteenth fastest growing company in Orange County no less! He included some impressive anecdotes in his presentation among which was the fact that his own business is growing strongly and he is signing off $500,000 to $700,000 deals for back-ends of new websites which are fully financed and ready to go ... with lots of web fulfilment ideas I haven't heard of before".
A senior member of Thembid.com, a company which arranges online reverse auctions for consumers to apply for builders and plumbers "to have a go at your DIY job," spoke about his unbridled enthusiasm for the application, which is genuinely novel. He has no idea how distribution will work, whether it be through Google (who have a payments system and so may be attracted by the idea of rivalling EBAY with Paypal albeit coming at it from the opposite method!), through Home Depot or through the house builders direct. We also had a private discussion about his enhanced Global Positioning System business which sounds fascinating. He is a post graduate from Berkeley and spoke about the scientific possibilities of "producing far better results than Google Earth". Again, he is unsure what to do with the science and is looking for partners and financing but, "not on the terms I have seen from all the recognised names so far".
This conversation revealed the first example of what was to become a running feature of the conference, namely a genuine disillusionment with Venture Capital (VCs) companies and their requirements for investing. How different from a year ago. One example was a request from VCs for companies to move offshore. Not only does this make it more difficult for the companies to keep abreast of the daily changes in technology, ’everything changes from day to day in Open Source’ but more importantly ’VCs fail to grasp the importance of working in the US time zone which is a clear bonus - and our chief developer will not leave the country".
The representative from Silicon Valley Bank continued on the same theme. The bank has enjoyed a recent boon providing working capital and mezzanine finance for small start ups but he explained how, recently, clients had become disillusioned with VCs. This is because, when they invest, they use a set template to run their investments and one size doesn’t fit all: "everyone is trying to bootstrap their development. ’VCs have put off a lot of people." The gentleman we spoke to is based in Orange County "so we're vmy colleagues in Santa Monica next to Los Angeles are the ones seeing the next MySpace or Facebook come through the door each day - the media guys are on fire!" The same gentleman took us aside at the start of the conference and gave us a key piece of advice: "go to the education sessions where the start ups wanting junior mezzanine will be. That's really interesting. Everybody is starving themselves these days. They do not want to go to VCs at all. They want to do it all themselves."
Nine companies presented on the main day of the conference. This was followed by a number of short presentations from various industry professionals. All the industry participants and speakers addressed the issue of "the market for growth capital". An interesting theme for all those present.
The key note speaker was Mr Grady from the Carlyle Group who laid out the reasons behind their wish to invest in small companies. Grady was unashamedly optimistic albeit that he did point out how difficult his job had become now that over $140 trillion worth of investable capital was now present in the world, "up from $2 trillion in 1969 and over $40 trillion more than in 2000...all this growth in just one generation!"
It was then explained that since 1990 25% of all US Initial Public Offerings (IPOs) had founders who were foreign nationals and how in the area of technology, this figure rose to 40%. The combined market capitalisation of these companies exceeds $500 billion and the public environment has clearly "attracted the best talent".
Yet in Grady’s view, stock markets in developed economies have recently created a "liquidity gap" for smaller emerging companies where additional cash resources have been hard to come by. In the case of the US he attributed these to "accidental mishaps which have determined things, decimalisation of stock quotes which have wiped out profits for market makers, Regulation Full Disclosure, the Global Research Settlement formed after the scandals of the last decade and Sarbanes Oxley." In the case of Sarbanes Oxley, numerous examples were cited to prove just how costly extra protection for investors has proven to be in terms of hits to earnings and hence hits to valuation multiples.
"The little guy is clearly worse off," was Mr Grady’s core theme. He pointed out that 60% of companies listed on NASDAQ now have only one analyst covering them and 40% have no coverage at all. The net result has been to "make research proprietary for hedge funds and no one else - a vacuum has been created."
The consequence of all the recent changes has been to make going public harder for companies than at any time in recent history. A prospective market capitalisation of $400 million is now deemed the appropriate size to make a public listing economic according to Carlyle: "in the last two years, companies looking to IPO have had revenues of $100 million but they still cannot attract a following."
Carlyle made some strong arguments for companies to come to them and other private equity and venture capital businesses for funding. Carlyle recently raised additional cash for a fund in the technology arena but we weren’t entirely convinced that this was the best route available for many of the companies present.
The perception that equity markets "are broken for smaller companies’ was a theme elaborated on by the lunch time speaker from a local private equity firm. The speaker explained that, among the many options now available to private company CEOs who wish to extract value from their firms, "companies capitalised at $600 to $700 million are the right size for IPOs." However it was also extremely interesting to hear the speaker state that "the best returns from the private equity firms’ investments come from companies where we have made non controlled investments rather than one where we have 51%." A startling comment but one which opened a new area of debate for many delegates.
However glacial the realisation that private equity and venture capital firms may not be the best option for emerging companies, it is a marked change in opinion. From a financing point of view rather than an operational point of view it was explained at one of the Industry roundtables how, "since late June the syndicated loan market has closed down - we have seen a switch in the cost of finance for private equity firms from Libor plus 0.25% and light covenants to big banks charging Libor plus 0.5% with very tough covenants and the bonds being sold at 95 cents in the dollar." Pricing has clearly gone up and it is estimated that the ability of firms to leverage their investments as a multiple of cash flow has been reduced by a quarter to a fifth.
Some smaller banks are still seen as being keen to lend and many participants agreed that the credit crunch problem lies with the big City banks which have "left the private equity firms feeling over banked - it is a very frothy environment for them." However, it is also telling that yet again this session produced a host of negative comments about the "new" finance providers: "with VCs it’s all about win, win - the deal is off, it’s on, it’s off again, it’s on, you never know where you stand. we’re not going to work with them again."
In the afternoon sessions it was also interesting to hear specific comments of how the credit crunch or "in certain areas a credit pinch" has led to a collapse in numerous private equity deals. It was mentioned by a number of panel speakers that private companies are at last seeing an alternative to selling their businesses to private equity. One of the more interesting quotes was, "IPOs stand at a two year high, tech is only 16% of this pipeline but growing and its worth bearing in mind that a lot of companies haven’t reached profitability yet. "going public is now a viable threat when talking to companies posing as potential investors."
The trend away from the VCs and private equity firms extended into other panel discussions where it was striking just how far many of the companies have come on such small resources from "reliable partners such as friends, family and business angel consortiums." The recurring joke during the presentations was how the CEOs "wanted a little bit of cash, a strategic partner, some consulting advice but more importantly a hug and a high five."
The attached table provides a financial summary of the companies present and their achievements. The financials were provided by the companies and included in the conference guide. Not all details were disclosed.
Incuity was the first firm to present. A genuinely interesting business manned by a team of expert industry professionals: "we’re entering a growth phase." The company supplies software to manufacturing companies which allows them to ensure that "at long last their entire legacy systems can talk to each other "everyone is fixated on the top end or the bottom end of this market, we supply the middle segment of the market."
In conversations afterwards we spoke to the company and commented how we had seen the CEO of Filenet, a document management company, explain in 2001 that he foresaw that "one day there would be 10 companies capitalised at $1.5 billion, each supplying the software to manage General Electric’s supply chain." Clearly this market has failed to materialise and in the views of Incuity it has been due solely to the technology not existing: "we address this problem and our software works."
We were pleased to hear that of the $8 to $10 million that Incuity is looking to raise, almost all of this will be used for marketing purposes. "We need to increase our sales activity because we are in a market place seeking help with product variants, launch cycles and global competition."
Zango is a supplier of free content for online users, and again, in a welcome return to the last decade admitted that their business is solely funded by advertising. They "give" their content to users - games, video clips and screen savers - with the added fashionable appeal of a large proportion of their content being home made. Management spoke vividly about their belief in the "content economy." Their content will hopefully allow them to gather information about their users which can be realised by advertisers and which can then allow adverts to "be delivered to the right user at the right time." The more general message was that this was a company which had a fast growth rate and deserved better than the terms being offered by those providing an alternative option to listing on the public stock markets.
Corticon Technology also unveiled software which they feel is doing something genuinely new, this time in the area of Rules Based software. Their software allows companies involved in the handling of claims or applications, principally finance and health related areas, to process claims more efficiently. "How should they price orders? Should they accept the order? What type of claim is it? Is it valid?"
They spoke of their contracts with Shell, Citi, Lloyds, Barclays and ING and how this "infant market" would see more and more decisions being automated. Their last fund raising for $2 million was in 2003 and they wish to raise another $10 million with the aim of adding marketing people to their quickly growing company.
Innovate Tech was one of the hardware companies present. They have patented a circuit on a semi-conductor chip which can be embedded into engines "which will save billions of dollars of gas every year." A bold statement. They feel their probe will generate greater efficiency and lower emissions for auto suppliers, auto manufacturers, as well as truck and van suppliers.
Global Touch Telecom is a supplier of Video & Voice over Internet Protocal (VOIP) software which allows firms to ’own brand’ their service as a new product offering. Their white label software could prove to be a key marketing differentiator. The management made the claim that "this could be the most revolutionary telephone service ever delivered." They have an aggressive plan for the roll out of their product to retailers, broadcasters and telephone providers, "mainly tier 2 and tier 3 suppliers who aren’t able to produce the service themselves."
They said they were self-financed with family, angel and mezzanine debt, "definitely no VC cash." The management team seem determined to keep the upside in the valuation for themselves.
Datallegro supplies software which runs alongside storage hardware to create, in their opinion, bigger and better data warehousing as well as access to that data. They caught the attention of a lot of the delegates. The manner in which they stressed the additional cost and speed benefits of their software compared with running existing storage systems was interesting. They are tapping into an area of growing interest for investors.
Semi-South ’manufactures a genuine advance in power electronics with silicon carbide.’ The CEO was interesting and hospitable and explained how their semi-conductor increases the efficiency of existing hardware systems and offers the chance for new systems such as clean power processes to develop. In areas such as data centres, "an incredibly harsh environment "we offer the prospect of lower power loss, the ability to withstand higher temperatures and lower conductor losses."
As the need for greater data capability grows, Semi-South offers an interesting proposition. One of the keynote speakers mentioned how the world is "moving towards a data centre model. ’in 1998 only 2% of the worlds top 500 super computers ran on X86 chips, now 60% of the top 500 run on X86 chips.’ Other headline catching developments in this area included the fact that Microsoft is building a new data centre with 1 million servers and that Google is finding that it is spending more on the power to run the centres than the cost of the hardware they are installing in the centres.
It is therefore not surprising that Semi-South could talk about pushing power protection deals out to Q1 and Q2 2008 due to "demand constraint. "we can't build extensions to the fab quickly enough."
The final company to present was Day Software, a provider of software which allows companies to manage their data and content more effectively. Many companies and industry experts talked about data management and the requirement for companies to be more efficient so this is perhaps an interesting area to look at.
Conclusion
There was a great deal of information to absorb in one day. The interest the conference attracted is sure to mean that it is extended to two days in the future. That is, unless the venture capitalists and private equity professionals can prevent it. The wave of disillusionment with capital raising in the manner was greater than we anticipated and, while listing on the public exchanges is an alternative option, in order to make this a sufficiently attractive proposition investors must try and undertake the necessary research to make sure companies trade on a fair valuation.
