June 2005  
For background information about methodology and definitions, please click here.

Market Overview


Equity markets have faced a continued tough stretch since the beginning of June, due to digestion of last month’s rally and uncertainty over the Fed’s direction after the June 30th meeting.  The Dow Jones and Nasdaq indices are both moderately lower for June and the S&P 500 is flat for the month.

 

Short term interest rates are expected to increase at the Fed’s June 30th meeting but recent economic performance has tempered inflation fears and raised hopes for a pause in the measured increases seen over the last twelve months. The producer price index fell 0.6% percent in the month of May, compared to a 0.6% increase in April and 0.7% increase in March.  The decrease in the PPI was larger than industry estimates of 0.2%, mostly due to a decrease in energy prices of 3.5%, the sharpest drop in oil prices since April 2003.  Sales figures also showed a larger than expected drop for the month of May, representing the first decline in nine months.  The 0.5% decrease in overall sales, coming after a revised 1.5% increase in the month of April, was attributed to declining auto sales and lower prices for gasoline.

 

Long term interest rates continue to fall despite the Fed’s tripling of rates over the last 12 months.  The federal funds rate has risen from 1% to 3% after eight quarter percentage point increases since last June while the yield on the 10-year Treasury note has fallen from 4.8% to around 4% over the same period of time.  Based on past policy tightening trends the 10-year yield should have increased to the 5 to 6% range.  The low long term interest rates continue to fuel a red hot housing market, as current mortgage rates are lower than last summer when the Fed began raising short term rates.  April existing home sales rose 4.5 percent to hit a record annual rate of 7.2 million and new home sales for the month hit a record high with 1.32 million.

 

Merger Activity

 

The availability of capital continues to drive an active M&A market.  This year through April 225 public companies in the US have agreed to be bought out at a combined cost of $246 billion.  An additional 339 companies started programs to buy back shares that if completed will lead to $132 billion of equity taken out of circulation. 

 

Merger activity in Europe has also kicked into high gear, with the value of European mergers completed this year higher than in the US.  According to a study by KPMG Corporate Finance, $232 billion of deals have closed in Europe compared to $222 billion in the US.  However, the number of announced deals shows US activity has picked up recently and is likely to surpass Europe as more than $422 billion of M&A has been announced in the US through June 3, compared to $309 billion in Europe.

 

The stock trading industry has seen active consolidation recently with both the NYSE and Nasdaq making high profile acquisitions.  The NYSE’s purchase of Archipelago Holdings, Inc. provides them with an electronic platform to trade Nasdaq stocks and expand into other products such as options. Nasdaq’s acquisition of Instinet Group, owner of stock trading network Inet, allows it to become an even bigger destination in the trading of its own stocks as well as establishes a larger footprint in trading NYSE listed stocks.

 

The deals have led to concern among the trading community that the two already dominant stock-trading markets will form a duopoly, gaining even more clout in the markets and possibly instituting higher prices for trading stocks.  That concern is tempered by Regulation NMS, a reform package recently approved by the Securities and Exchange Commission that goes into effect next year.  The regulation works in favor of competing markets and holds that trades will generally be expected to get the best prices available even if that means going to another market.  Alternatives to the big two exchanges have also continued to draw interest.  In February Liquidnet, a system designed to help institutional investors find matches among each other for their large orders to buy and sell stock, sold a minority stake for $250 million to two private-equity firms, Summit Partners and Technology Crossover Ventures.


The above exhibit provides an illustration of the exit environment for venture backed firms by geography. The first two metrics for each region are fairly straight forward: the total number of documented exits over the last twelve months and the percentage of the exits achieved through IPOs. The last two "return" metrics (based on sample medians) require further explanation and various caveats.

 

The M&A "return" is calculated by dividing the exit deal value by the total amount invested in the company. It aims to provide a sense for how many times the investors made their money back. Important caveats include the fact that the time-value of money is ignored and the implicit assumption that venture investors are the main source of financing for the company (since we use venture investments as a proxy for total investment in the calculations).

 

The IPO "return" is calculated as the value of the equity of the company at the time of the IPO less the amount of capital issued *, divided by the total amount invested. This ratio aims to provide a sense of the investment return for the original investors. The caveats for this metric include the two caveats mentioned for the M&A return, as well as the fact that the IPO value does not equate to the eventual exit value for the original investors and various other distortions that may arise as a result of the exact structure of the IPO.


Despite the various flaws inherent in the presented metrics, Mirus believes they do provide a directional sense for the current venture-backed exit environment. Clearly, the West Coast is still the most active region, though the combined East Coast (North-East and Southern East-Coast) also have robust exit activity levels. Clearly, IPOs typically represent a higher return scenario for investors than an M&A exit (the Southern East-Coast represents and exception for this period, driven by various highly successful M&A transactions such as the sales of Seisint, Lynk Systems and Upstate Biotechnology).

 

The high proportion of IPOs on the West coasts suggest a healthy venture environment, which is not surprising given the region’s strong technology and venture capital focus. Perhaps more surprising are the robust IPO activity levels and strong overall returns in the Mid-West. Various successful IPOs of Mid-West based companies include LHC Group, QC Holdings, Kanbay and Build-a-Bear Workshop – smaller offerings that represented strong returns for investors.

 

* The logic/assumption for netting out the issued amount is that typically in IPOs the venture firm will retain most of its equity (due to the potential signal sent by materially "cashing out", among other factors), so that the amount raised corresponds to equity issued to new investors (the public). By netting out the amount raised, we obtain an estimate of the value attributable to the original investors.







For any questions about the Middle Market Monitor or Mirus Capital Advisors, please contact Mirus Capital Advisors at 781-418-5900 or visit www.merger.com.  You can also contact our partners directly at:

Sources: Thomson Financial (SDC), OneSource and Mirus analysis. Copyright 2005, Mirus Capital Advisors, Inc.  All rights reserved. Mirus Capital Advisors does not assume any liability for errors or omissions.


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