Leveraged Buyouts' Strange Return

SAN FRANCISCO (01/04/2000) - In the increasingly crowded field of billion-dollar Silicon Valley investment funds, Silver Lake Partners has managed to stand out by staking claim to a territory where few financiers have dared to tread.

Silver Lake's plan: Take a tactic made popular in the 1980s - the leveraged buyout - and blend it with the tech-savvy of the venture capital crowd on Sand Hill Road. Although LBOs haven't often been applied to technology companies, and have been even more rarely used with Internet businesses, Silver Lake obviously struck a chord with its wealthy clients, raising $2.3 billion.

In December, Silver Lake unveiled its first deal: Along with the Barksdale Group, the fund invested $75 million in SubmitOrder.com, a privately held warehouse and fulfillment company.

At first glance, it's hard to tell how the investment is different from a traditional venture deal, but Roger McNamee, a Silver Lake partner and cofounder, disagrees. "This isn't a venture deal," he insists. "This is just a down payment on the thing."

Silver Lake has entered the LBO arena at a time when traditional buyout firms have begun to look for ways to invest in Net companies. Over the last year, LBO specialists like Kohlberg Kravis Roberts and the Carlyle Group have turned their attentions to tech companies. The reason: Returns from Net venture deals lately have dwarfed those from LBOs.

In the '80s, LBOs were often synonymous with hostile takeovers. The buyer - often a Drexel Burnham-backed corporate raider - would put up a small amount of cash and borrow the rest, sometimes in bank loans, often in the form of junk bonds. To help pay down the debt, the buyer would later sell off parts of the company and slash staffing.

The approach has only rarely been applied to tech firms. It's a reflection of the fact that the most appealing LBOs are those which are earnings poor but asset rich - mismanaged companies with hidden assets and little growth, often public companies trading at valuations below book value. Tech stocks rarely fit the bill.

Silver Lake, trying to adapt the LBO to new times, brings an impressive pedigree to the task. McNamee is a partner in Integral Capital Partners, a Menlo Park, Calif., investment firm with close ties to Kleiner Perkins Caufield & Byers. (Integral shares office space with Kleiner; Kleiner is also an investor in Silver Lake's fund.) Other founders include Glenn Hutchins, formerly senior managing director at the Blackstone Group; David Roux, once executive VP for equity investment and M&A at Oracle; and James Davidson, previously managing director at Hambrecht & Quist.

Among the fund's investors: Oracle Chairman Larry Ellison, the Rothschilds, Bill Gates, Michael Dell, Calpers, Stanford and the World Bank.

Silver Lake looks for solid but undervalued tech businesses with the potential to generate solid earnings growth - and to provide investors a fat return. For instance, McNamee believes that SubmitOrder.com has the potential to be a $1 billion business - he says the company chose to sell a majority stake to add muscle to scale up the company. "Assume that we will be putting in a lot of money," McNamee says. Future steps could involve acquisitions, debt-financing or even a public offering.

Silver Lake has competition. Both Sandy Robertson, founder of investment bank Robertson Stephens, and David Stanton, formerly of the buyout firm Texas Pacific Group, are reportedly planing tech buyout funds. Meanwhile, Texas Pacific partner Justin Chang says his firm will be announcing several new deals this month - and he reports that Texas Pacific has just closed a new $4 billion buyout fund, half of which will be devoted to technology investments.

Still, its not clear the new buyout funds are doing anything much different than the growing population of VC funds. Chang says the distinction is useless.

"Buyout and venture are converging," he says. "I don't really think of myself as a buyout guy or a venture guy - I'm an investor in technology."

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