The Urge to Merge

IntraLinks plans to go public by March. But the 3-year-old online financial services company does not plan use its IPO proceeds to support operations or buttress its already healthy sales. It wants the money to buy other companies. "We've completed one acquisition to date and we're actively looking at others," says Mark Adams, chief executive at New York-based IntraLinks. "It could be expanding into new markets or new areas, or acquiring a new technology that's instrumental in improving a product or service for our customers."

Not long ago the urge to merge at a firm like IntraLinks would have been seen as precocious at best, and downright foolhardy at worst. A young company that needed new technology or new customers would develop them itself, not go shopping for a startup.

That's sure to change this year. The first weeks of the year saw several mergers among e-commerce companies, capped off by last week's megamerger between America Online and Time Warner. Barring a major shift in the financial markets, expect dozens of other e-commerce firms to follow the lead of heavyhitters like Amazon.com, eBay and Ariba, all of which boosted their business in 1999 by aggressively making acquisitions.

The obvious motivation is money. A record number of Internet companies - more than 200 - went public last year and now have stacks of stock market cash to spend. "As spring follows winter, M&A activity follows IPOs," says Bradford C.

Koenig, a managing director at Goldman Sachs and codirector of its global technology group.

But there's more to the story. In the aftermath of the holiday season, online retail's stronger performers will likely see their stocks rise, while those of their weaker rivals will fall. In such an environment, the big companies will naturally turn a hungry eye to the smaller ones - and the smaller ones will think quickly about joining together to survive.

In the first week of January, Proflowers.com acquired Flowerfarm.com; luxury-goods retailer Ashford.com snapped up Jasmin.com, a perfume site; and shopping services company Brodia merged with gift registry WishConnect. On the business-to-business front, Commerce One acquired Mergent Systems. Concurrent with the merger trend is the continued drive among the largest Net companies to expand their reach into new sectors. Last year eBay moved into car sales and Amazon invested in everything from drugs to groceries. Both are expected to make strides this year.

But, as IntraLinks demonstrates, the desire to acquire is not an impulse felt only by established players. Looking ahead to 2000, investment bankers and e-commerce experts are buzzing about the number of companies that have gone public early and still need to add a range of products and services. Their choice is either to develop them internally or to buy them. Many are opting for the latter.

These mergers "are virtuous, they're offensive in nature and they're synergistic," Koenig says. "These are all about strategic positioning to be able to compete better."

For many companies, they're also about primping for Wall Street. By raising sales through acquisitions, firms reassure those investors who value Net stocks by revenue growth rather than profits.

"Wall Street expects growth and M&As are a piece of that," says Todd Carter, director of investment banking at Robertson Stephens.

Of course, mergers and acquisitions have not always been considered a good thing. Critics attacked them in the past as little more than financial engineering to inflate a company's value and to pad revenue growth. But Net deals appear to be passing muster among investors.

Net companies that announced large acquisitions in the past two years have seen their stock prices rise that day an average of nearly 3 percent more than the Standard & Poor's 500 Index, according to Ken Sawyer, managing director at Prudential Volpe Technology Group. In contrast, back at the start of the 1990s such news from tech companies was greeted by an average increase of under 1 percent.

"Historically an acquirer's stock price has declined on announcement of a merger transaction, but that's not so in the Internet space," Sawyer says.

"It's a Wild West land grab, and M&As are a key part of the dynamic."

THE ROARING 2000S

Investment bankers and analysts are forecasting an M&A feeding frenzy in the year ahead. For the Net in general they expect continued buying sprees by Yahoo and AOL, which will look to spread into new sectors and expand globally. In online retail they foresee fewer players in crowded areas like pet food and consumer electronics, predicting that megastores will move in and make acquisitions.

In the business-to-business e-commerce sector, big information-services providers like Oracle, the Netscape-Sun Alliance and IBM are also likely to be chasing deals, as are the new pure-play b-to-b giants, Ariba and Commerce One.

This wave of merger activity actually began as 1999 ended. A lot of bankers were already toiling long hours in late December. At Robertson Stephens, an adviser on many of 1999's biggest Net M&As, Carter says he was working on six deals, two of which involved mergers between major e-commerce companies.

Robertson Stephens is now looking to add more bankers to its M&A team, although the current number - over 100 - is five times what Robertson had a few years ago.

The pace is also accelerating at Deutsche Banc Alex. Brown. On Sept. 22, Broadbase Software, which creates software to help Web sites track customer information, went public. Just days later, Broadbase executives approached their bankers at Deutsche Banc about possible acquisition strategies, says Jeff Liu, a Deutsche Banc VP responsible for business-to-business solutions. By early December, Broadbase had a $330 million deal to buy Rubric, a privately held maker of software that helps businesses conduct Internet marketing campaigns.

"To compress all of that into a couple of months would have been unheard of a few years ago," says Karl Will, a Deutsche Banc managing director in charge of technology M&As. "It's now taking one to two weeks for a deal to happen instead of one to two months."

SITES ON SALE

Perhaps no area of the Internet Economy is more ripe for M&A activity than online retailing.

One faltering retailer is already a prime candidate for acquisition. Just before the new year, Value America warned that sales would fall below expectations and said it would cut its workforce in half. The company announced it would evaluate "strategic refinement," a euphemism often used by firms seeking a buyout.

Some analysts think M&A activity in the retail sector will be slowed by struggling retailers with few assets worth consolidating. But others say such companies could be good buys for land-based retailers that seek entry to e-commerce. In 1999, for instance, retail chain KB Toys teamed with BrainPlay.com to form KBkids.com.

Mergers in online retailing undoubtedly will take various forms. Some struggling online companies will seek to reshape themselves, others will try to buy their way into new niches. Some categories, such as apparel, should be big enough to sustain multiple players if each appeals to a specific segment of the market. On the other hand, categories in which products are commodities, such as consumer electronics, pet supplies or gift certificates, are likely to be less forgiving of second-tier companies.

"There should be consolidation but I don't believe all categories will be represented by single brands," says Tod Francis, a general partner at Trinity Ventures, a VC firm in Menlo Park, Calif., that has backed such online retailers as 800.com, iMotors.com, Della.com and Internet Diamonds (recently renamed BlueNile.com). Anthony Noto, an e-commerce analyst at Goldman Sachs, thinks most commerce categories will end up sustaining three or four major players. "In a particular sector you may see players who are No. 5 and 6 combining to become a viable No. 3," he says.

Noto expects online retailers in narrow market sectors to reach into adjacent categories to attract customers and revenues. An online grocery store, for instance, might consider acquiring a pet-supply provider or even a Web-based pharmacy.

MyPoints and Netcentives, two companies that offer one piece of Internet marketing, will likely be targeted by larger online advertising and marketing firms that want to broaden their platforms, expects one venture capitalist, who spoke on condition of anonymity.

Analysts do not anticipate that the heavyweights will rest on their laurels in the year to come. Amazon and eBay are expected to invest in companies to spread their franchise into new categories, technologies and regions.

That was the strategy behind a number of Amazon's big buys last year, most notably a string of three deals involving $645 million in stock that was announced in April. Primarily a seller of books and music at the time, Amazon gobbled up Exchange.com to expand into rare books; it also acquired Alexa Internet and Accept.com to get tools for improving navigation on its site. The company also made sizable investments in online retailers that complement its core business, including Della.com, Drugstore.com and HomeGrocer.com.

EBay, meanwhile, has bought its way into businesses that fit its emphasis on online auctions: international operations in Germany, Butterfield & Butterfield for high-end auctions and Kruse International for auto auctions. Recently eBay absorbed Blackthorne Software, a company that makes it easier for active sellers to manage their auctions. Some analysts have suggested that eBay might now move into the business-to-business space; indeed it already has made an equity investment in Tradeout.com, a site for surplus corporate materials.

The business-to-business side of e-commerce is expected to see heavy M&A activity in the future, though the sector is generally thought to be a year or so behind online retailing in that department. Only a few b-to-b companies have made their public debut but dozens more are expected to list their shares in the coming months - and then pursue the same M&A strategy followed by firms that went public in the past couple of years.

Want a glimpse of what's to come? Consider the skyrocketing valuation of Tradex Technologies, a Houston-based company that sells infrastructure software for set- ting up Internet exchanges. Tradex, which Ariba plans to acquire, saw its value jump from $100 million earlier in the year to nearly $2 billion in December, when the deal was announced.

"Some [investors] think they left some money on the table, because [Tradex] could have been a $4 billion to $5 billion IPO," says Daniel Aegerter, Tradex's chief executive. "We were ready, locked and loaded to take this out."

So why didn't he? Aegerter says that route would have brought the company money, but also would have isolated it from the large networks that are emerging in the b-to-b marketplace. Aegerter calls Ariba one of the "gorillas" in that market, and he thinks it's better to be on Ariba's good side, even if that means a little less cash.

Tradex wasn't the only acquisition by Ariba, which went public in 1999 and quickly reached a stock market valuation greater than $10 billion. In November it scooped up Trading Dynamics, an auction-based marketplace for suppliers, for more than $400 million in stock. Meanwhile, Ariba rival Commerce One swapped cash and shares worth about $230 million to acquire CommerceBid.com.

Now other b-to-b procurement companies are looking to take similar steps. Firms like Intelisys Electronic Commerce, a second-tier provider of infrastructure for online marketplaces, know that if they want to compete with Ariba and Commerce One they'll need auction services. Intelisys board member Ray Fattell says his company "absolutely" will have auction capability and will consider making acquisitions to meet that need.

A possible target for Intelisys - and for other companies seeking to develop b-to-b exhanges - is Moai Technologies, which makes auction software for just such exchanges. (Ann Perlman, Moai's chief executive, said in an interview in December that the company was raising another round of venture funding and was not involved in any merger talks.) The motor behind all this merger movement is the trend toward b-to-b trading exchanges. While there are about 200 such marketplaces in various niches - from office supplies to truck parts - only a few are gaining critical mass.

Kenneth Fox, managing director of Internet Capital Group, a holding company with stakes in 28 online marketplaces, predicts leading b-to-b companies will consolidate their hold on their marketplace niches, then seek to expand. A plastics company, for example, might look to move into chemicals. "There are going to be consolidation opportunities across process industries," Fox says.

"These [online marketplaces] tend to be winner-take-all," he adds. "You're going to see No. 1 buy No. 2 and 3."

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