The Avaya sale: Tech buyouts bear risks for customers, too

Private equity firms seek quick profits diminishing focus on products

The sale of Avaya is just the latest in an increasing number of private-equity buyouts of technology companies that might not be good things for customers.

The $8.2 billion deal announced today will take the company private and likely come with financial burdens that could sap the market-leading seller of corporate telecom gear of money needed to keep the company’s edge, experts say.

Equity firms like techSprint’s merger with Nextel will solidify the carrier’s position as the Recently, private equity firms have shown more interest in snapping up technology companies — traditionally a higher-risk business sector than these investors like to dabble in.
DateCompany boughtBuyerAmount
6/4/07AvayaTPG Capital and Silver Lake Partners$8.2 billion
5/30/07CDWMadison Dearborn Partners$7.3 billion
5/21/07AlltelGoldman Sachs and TPG Capital$27.5 billion
5/16/07AcxiomSilver Lake Partners and ValueAct Capital$3 billion
4/17/07Primax ElectronicsHong Chuan Investment$250 million
4/5/07First Data Corp.Kohlberg, Kravis, Roberts & Co.$29 billion

"When private equity shows up it's more about financial engineering, than it is about sort of products and synergies and those sorts of things,” says Samuel Wilson, an analyst with JMP Securities.

“Typically these deals load the company up with debt with significant restraints on operations and cash flow and demands for a better output,” says Francis McInerney, managing director of North River Ventures. “Technology development falls off because cash flow goes somewhere else.”

Over the past year, private equity firms seem to be buying up more technology companies, such as Avaya, Agilent Technologies, Alltel, First Data, CDW, Acxiom Corp. and Primax Electronics to name a few.

The good news is that if things do go awry, they usually happen slowly and they don’t send products or services into a tailspin. “It could be slow at first. It could be imperceptible,” McInerney says.

Technology companies are regarded as iffy investments because the products and the markets are so complex, experts say. But with an abundance of money to invest, the equity firms are willing to take more risks, he says. “It shows desperation on private equity’s part looking for deals, and at some point you run out of the deals private equity ideally looks for,” McInerney says.

That fact pushes the equity firms to take risks that more conservative investors would avoid. “It doesn't surprise me,” Wilson says. “In this market, with private equity, nothing that they do surprises me. They're sort of willing to do anything.”

Technology buys require specialized business talents, he says. “You’d better know what you’re doing, because these businesses can have enormous operational problems. It’s not like you’re buying something that pumps oil and there’s always going to be a market for oil.”

Once tech firms are taken private, the goal for investors is to make money on the deal quickly, McInerney says. “Have you seen the show ‘Flip This House”? It’s like that,” he says.

What equity firms do exactly can vary, and it’s more difficult to track because the company is now private and no longer subject to public stockholder scrutiny. “There are things they can do out of the public eye, which is true -- big public companies have a hard time doing,” Wilson says. “They can sort of clean it up, jazz it up, maybe do an acquisition or two, then maybe bring the company back public again.”

The problem with that is sometimes what the companies need to gain value falls into areas where equity firms are weak, McInerney says. “The problem with private equity guys as a rule is that very few of them have run businesses,” he says. “Most have never had profit and loss themselves, and there’s not a lot of operational expertise.”

In the case of Avaya, for example, McInerney believes the company needs to shorten the time it takes for customers to pay for gear once they’ve received it. That generally indicates that the vendor isn’t doing enough for its customers, but addressing the problem can take many forms.

For instance the problem might be with products, sales teams, and management of major accounts. Solving the problem requires nuts and bolts business analysis and reform. “I just don’t see how private equity could solve that,” he says.

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