By Alice Hohler
Financial News, 22 January 2001
Once the TMT shake-out is over, quality will begin to shine through
This time last year the headlines were full of dot-coms going public and making paper millionaires, even billionaires, out of their founders. A year on the picture could hardly be more different. Now the news is overflowing with stories of the latest technology, media and telecoms (TMT) corporate collapse and technology companies being forced to pull their IPOs.
'It's about getting rid of the people who weren't invited to the party'
Paul Lufkin, ARC Associates
The public equity markets across Europe have effectively been closed to TMT issuers since November and the situation is similar in the US. The Neuer Markt has lost 75% of its peak value and Nasdaq has seen 42 IPOs pulled since December, with a combined value of $3.54bn (€3.75bn). Debt capital is just as hard to get hold of. The high-yield bond markets, which have hitherto offered another option for TMT funding, remain in bad shape. The debt market has slightly improved from the last weeks of 2000. Already in 2001, four telecoms companies - Charter Communications, Macleod, NTL and KPNQWest - have issued bonds. But these are the best-quality and best-known credits. For most others, bond markets will not be a capital-raising option for at least the first quarter, and probably longer.
This trend is creating real problems for companies who have come to rely on access to the public markets for new capital or secondary funding. Many of those who took advantage of the technology gold-rush that peaked in March 1999 are running out of money. But they are finding investors much more wary, determined not to throw good money after bad. The inevitable consequence is a massive purging process across the TMT sector, one that those in the industry predict will lead to more corporate collapses and consolidation.
The Neuer Markt has been particularly hard hit, partly because its exponential growth meant it had further to fall, and partly because its members are typically illiquid, leading to high volatility. In addition, it is now feeling the consequences of what many see as insufficiently stringent admission procedures.
Michael Donovan, a German technology analyst at Jefferies International, a specialist investment boutique, says: 'The Neuer Markt served last year as a market taking on a lot of companies that should never have gone public. We're only part-way through a purging process and the equity markets are closed even for reasonably high-quality IPOs.'
Paul Lufkin, a director at ARC Associates, a London-based investment banking and advisory firm specialising in the TMT sector, sums up the current situation in more colourful terms: 'What we're experiencing is a shake-out, a hangover after a huge party. It's about getting rid of the people who weren't invited.' But the current purge is not only about identifying and punishing gatecrashers; many of the legitimate guests also got carried away and are nursing sore heads. 'We're going through a dip that is shaking out all the exuberance that was ill-founded in the first place,' he says.
Even those who did not over-indulge are suffering. Chris Robson, chief executive of Syzygy, a profitable e-consultancy that is listed on the Neuer Markt, points out that good companies are seeing their share prices plummet alongside the bad. He says: 'It's very frustrating. There's not a lot we can do. Even good news won't help us at the moment.'
Syzygy, however, is one of the relatively fortunate TMT companies. Not only is it a profitable business - and therefore self-sustaining - but it got its IPO away towards the end of October, just as the market started its current descent and before it effectively closed. It also managed to price its shares at the top of estimates, even though the firm has since lost more than two-thirds of its value.
Ubis, a German software company, has been less lucky. The 13-year old business became the Neuer Markt's first new issue casualty of 2001 when it cancelled its planned flotation last week. Ubis was not desperate for the capital, and decided not to proceed because it was worried about lack of investor interest and low valuations. However, most other companies which have been forced to abandon their listing aspirations are in a far weaker position, short of capital reserves and not yet cash-generative. Not surprisingly, their views on the outlook for the capital markets are not forthcoming.
Fraser Park, finance director of Nettec, an e-consultancy that is confident it has enough capital to tide it through to profitability, says: 'If you were to talk to any finance director, they would agree that the market has over-reacted. There is an extreme lack of clarity in the financial marketplace and uncertainty about valuations. No one is making any big moves at the moment.'
Lack of discrimination is typical of the early stages of a market shake-out, according to Greg Lockwood, a director at UBS Capital, UBS's private equity operation. 'In the first phase of a technical correction, a lot of companies suffer. Many good companies have been penalised.' From a private equity perspective, however, the current conditions have a silver lining. 'In some ways, for us, it has improved the situation because price expectations from entrepreneurs have declined,' he says. Also, now that IPOs are no longer an option for many companies, venture capitalists are seeing more opportunities for later-stage financing. Still, exits are becoming harder and cannot be postponed indefinitely.
Most people expect the first quarter of 2001, and probably the first half of the year, to remain very quiet in terms of new equity issuance in Europe. Tim Linacre, from West LB Panmure's technology team, believes that the imminent reporting season is creating a wait-and-see environment. 'The shake-out process has some way to go. People are expecting more bad news, and until they know, they're not going to get their cheque books out. If there is more bad news, the bounce in the market will be even further off,' he says.
However, the news is not entirely bad. Those in both the private and public equity markets agree that quality will still shine through, especially once the current initial stage of shake-out is over. Most believe that this will take around six months. West LB Panmure's Linacre says that liquidity will be a key success factor in attracting investors: 'Most investors are looking for safe havens and, in general, for large stocks with good liquidity.' He cites Vodafone as an example. 'It's a grown-up, proper business - and you can buy it on Monday and sell it on Wednesday,' he says.
Size, however, will not count for everything; nor will having a well-recognised name. Many investors' concerns are focused on the high debt levels of the telecoms companies, several of which are the largest and most high-profile members of the TMT sector. Much of the debt they have accumulated, particularly to fund third-generation licence auctions, was financed on fairly short-term arrangements in the hope of refinancing via an IPO (such as Orange) or, as now looks more likely, in the bond markets. 'There's very little appetite at the moment for refinancings like this,' says ARC's Lufkin.
Jefferies' Donovan is also concerned about the possible impact of telecoms indebtedness: 'Telecoms debt could drag the market down in a very serious way. All we need is one more telecoms company - on the service or equipment side - to go down and then we really will have a collapse on our hands.'
Size, therefore, cannot necessarily be equated with safety. From now on, all companies can expect to be far more closely scrutinised by investors. Linacre says: 'Investors will not throw good money after bad. Selectivity will be key as we will see a return to the old realities; quality management, a strong business model and profitability. If you're after gambling money, you're going to find the casino closed.'
David Reynolds, an e-business software analyst at JP Morgan H&Q, says that the current situation is complex, but not necessarily that bleak. Investor sentiment has changed, but there is still demand. 'Clearly, we're in emotional - as opposed to logical - times. But the capital markets in Europe aren't closed for good companies,' he says.
He believes that the European tech sector is in a far stronger position than its US counterpart, signalling perhaps the long-awaited dislocation of European capital markets from Nasdaq. Whereas technology capital spend growth in the US seems to be slowing down, in Europe it continues to accelerate. Surveys suggest growth in 2001 of 14% in Europe, but only 5% to 7% in the US. 'Things are better here than there, capital raising being one aspect,' he says.
Corporate capital spend has shifted as people see the importance of technology as a way of streamlining suppliers, partners and customers rather than in straight business-to-customer applications.
This shift favours different types of companies, such as those offering e-security and customer relationship management software.
Still, although Reynolds believes that good companies can still raise capital in Europe, he does not expect to see reasonable IPO activity for another six months.
It is clear that the TMT sector's day is far from over. The commercial imperative behind the communications boom is still there, even if its focus has changed and investor expectations scaled back. The current shake-out does not necessarily mean that the old economy has returned to favour. As West LB Panmure's Linacre says: 'Investors are looking for growth, and it's hard to believe that the technology sector doesn't offer great opportunities for such growth.'
Those TMT companies that are strong enough to survive the current market can probably look forward to a bright future. The billion-dollar question is just how long and how hard their mettle will be tested.
Reproduced from Financial News
http://www.financialnews.co.uk