Whither Tech Investment Banking? Peter Blackwood Talks about Deal Flow and What’s Hot

Peter A. Blackwood is a Managing Director, and heads the Technology & Media investment banking group at Philadelphia-based Janney Montgomery Scott LLC, a bank whose roots go back to 1832, and probably the most prominent mid-Atlantic regional full-service investment bank, broker-dealer and asset manager (with more than $55 billion in assets under management).   Prior to joining Janney in 2009, Peter was a Principal and Head of the Internet & Digital Media Group at Merriman Curhan Ford & Co.  He joined Merriman from SoundView Technology Group, and began his career at E*OFFERING, a startup investment bank later acquired by SoundView.  He went to school at Ohio Wesleyan University.  pabmugshot

I met Peter at Merriman not quite 10 years ago when we were working with a digital media company headquartered in London, which was at length acquired by a larger digital media company that Peter had worked with.  We had a chance to talk on April 16 about the current state of the technology industry vis-à-vis investment banking, and what he foresees for 2013 in terms of deal flow, what he sees as “hot” in technology these days, and what kinds of public and private deal structures are most common in this market.

JA:  How is 2013 compared to 2012 in terms of deal flow?

PB:  The first few months of 2013 have been busy for us.  A number of transactions we were working on last year were delayed as people worried about the negotiations in Congress over the sequester, and moved into this year.  In the first quarter our team was quite busy executing and completing these transactions, as well as evaluating and pitching new business opportunities.  With regard to Q2 and the balance of the year, we are witnessing a marked increase in activity with regard to public offerings, both with companies selecting underwriters and working through the registration process.

JA:  Interesting that you mention IPOs first.  What is the situation these days with regard to IPOs vs PIPEs?

PB:  Over the past 2 years, PIPEs, or Private Investments in Public Equities, have fallen somewhat out of favor.  Today traditional unregistered PIPEs from the mid-2000s are few and far between.  We are seeing a preference for Registered Direct (RD) offerings, and even more for CMPOs or Confidentially Marketed Public Offerings, a variant of RD offering.  Both the CMPO and Registered Direct offerings are based on shelf registrations, but the Registered Direct is an agented offering and the CMPO is an underwritten offering.

Many issuers now prefer a CMPO structure because it opens up the number of institutions that can participate due to the underwritten vs. agented format.  Some institutional investors have charters that restrict their ability to buy agented offerings vs. underwritten offerings – which means they are excluded from Registered Direct offerings, because they are not underwritten, even though they are fully registered and tradable.  The difference is that the CMPO provides a publicly-filed prospectus supplement prior to pricing, even though it is marketed to a limited number of institutional investors, so the fact of the offering is public knowledge, and it can be underwritten by the investment bank.  As a result, CMPOs have been quite popular over the last few years.

With that said, this year we are beginning to see a bit of resurgence in structured deals, or PIPEs.  We are learning that buyers are more risk-friendly now than they have been for a few years, and are looking to invest in structured deals, which are most commonly PIPEs with common stock and warrants, with registration being filed only after the deal is completed.

JA:  How about size of deals?  Are you seeing small-caps back in the public offering market?

PB:  At our firm, and particularly in technology, the size of companies we deal with is quite broad.  For example, we recently closed a sell-side advisory deal for under $20 million, and are actively working on several deals over $200 million today.  For us, deal size is not the primary motivational factor for new business, but is rather driven by our ability to add value to help a client achieve their goals.  So, if we see an emerging technology that has potentially great demand, we will look to be involved regardless of the size of the company.

On the financing front, today we are primarily oriented toward working on financings for public companies, either IPOs or Follow-Ons.  When it comes to M&A transactions we will seek to work with both private and public companies.  At the moment, we are seeing venture capital at an unfavorable inflection point these days, and we’re not looking at VC deals as a result.

JA: What’s hot in terms of tech sectors?  What can we expect to see industrywide in terms of new issues?

PB:  Many companies across the technology and media landscape today are positioning their solutions as SaaS (Software as a Service) or a Cloud-based solution – for the obvious reasons pertaining to valuation.  So I would say those are two of the hottest sectors.  There are so many companies claiming to be SaaS or Cloud-based that it is creating some confusion, as a matter of fact.

Broadly speaking in software land, perpetual software licensing business is being transitioned to term-based licensing.  Companies with traditional software licensing strategies are in the midst of trying to convert these perpetual relationships to hosted and recurring-revenue models.  So we are seeing, for instance, a business that might have been 65% perpetual licenses, 20% maintenance, and 15% term licenses actively converting or sunsetting these perpetual licenses to either term licensing or recurring, seat-based licensing..  As the value proposition goes, it is more cost-efficient on the client to pay for what they are using.

JA:  What other sectors are you seeing more of?

PB:  Another emerging area that we are quite excited about is where e-commerce and technology intersect, and the emergence of next-generation e-commerce platforms, many of which are SaaS-based.

To give you a case study for the growing need for these eCommerce platforms, let me run through a brief example.  Ten years ago, if you were a company such as Best Buy, as a traditional retailer also seeking to sell goods online with the growth of the Internet.  With the rapid growth in web-based business opportunity, an entire department was created to focus on your web presence, from website creation to product description, pricing, and IT/server management. Today, much of these eCommerce initiatives are being contracted to a third-party provider due to the increased complexity with so many new customer interaction ‘channels’ being used, which is broadly referred to as Omni-Channel.

A few examples of leading brands that have outsourced their eCommerce solutions include UnderArmour and Crocs.

In pre-Internet days, maybe you would have received a catalog from someone like Best Buy, for instance.  You would flip through it and then call in your order on the telephone.  Today, with the rise of these Omni-Channels, you may still get that catalog, or you may get it digitally.  But if you get the catalog  you throw it in your briefcase and look at it on the train or bus while you are going to work.  You use your smartphone or tablet or Kindle and have a look at the items you are interested in.  You get to the office, go on your desktop and have a look at the website to see a bigger image.  You scroll down and look at the reviews.  Maybe on your way home you actually stop by a Best Buy store to look at the laptop or television that caught your eye, but then you go on home.  They maybe you make the actual purchase on the desktop at home.  So you had a catalog or a digital catalog, a smartphone platform, a visit to the store, a visit to the website from a desktop, and a purchase made from a different desktop at home.  All of these consumer touch points have to be tracked and managed seamlessly; order execution has to be flawless, and the branding has to be identical across all platforms.  The retailer, in my example, Best Buy, is now collecting information about your various visits to understand what is attracting you about the product, what you like.  Typically they do not have all that expertise in-house and have no intention of building an inside empire to address it.

Another area we are focused on is within the marketing & advertising space, and also where this content meets technology platforms.  Whether it’s the growth of video-based advertising over traditional display, or the emerging channels of mobile and social, we expect to see this ecosystem to be fertile ground for both new equity issuance and M&A activity for several years to come.

JA:  Are retail investors back in the market, or are all these deals institutional?

PB:  From our perspective, the retail investor is very much back in the market.  Janney has completed 23 public equity offerings so far this year, and retail participation from our platform has been significant across the board.  We find that the retail investor has gotten much more active on IPOs and follow-on offerings than for several years past.  For quite a while now, the retail investor has focused on yield – dividends, interest, and other forms of income.  What we’re seeing this year is retail beginning to be more open to risk by way of more traditional equity, and pursuing capital appreciation over traditional yield.

Retail investors have traditionally been more interested in large caps, but we are seeing them reach into the mid-caps now as well.  We have more than 95 retail offices at Janney, and 10 institutional offices, so we are clearly weighted toward serving the retail constituency by those numbers.

JA:  What are a couple of the deals that the tech group at Janney has participated in recently?

PB:  Over the past year, we worked with Angie’s List (ANGI) on their IPO and follow-on offering, CaféPress on their IPO, and on a secondary offering for WNS Holdings (WNS), which is a business outsourcing company.  We also recently worked on the acquisition by Lexmark (LXK) of Twistage, a unique cloud-based media management platform, and expect to continue to be active in M&A through the balance of the year.

JA:  Is Janney likely to stay regional or will it follow some of the other middle-market banks and go national or international?

PB:  Founded in  Philadelphia in 1832, I would say it is a safe assumption that Janney is and always will be a mid-Atlantic firm.  We have offices in most major metropolitan areas of the United States, but our strongest coverage in terms of sales and trading is geographically centered in the mid-Atlantic.  I am in San Francisco with a part of the technology team, and Janney has had both sales & trading and equity research here for a while but we only added investment banking here in mid 2012 – I was in Philadelphia before that.

Janney’s capital markets presence has seen significant growth over the last few years, across our sales & trading, research and investment banking divisions. Today, we are not seeing many new investment banks being formed.  There are some boutiques out there who are working on specialized deals, mostly in M&A.  The consolidation of Wall Street as a whole after 2007-2008 has been an opportunity for us to pick up key talent as people have been displaced from other banks.  So in many respects, the last few years have been a time of opportunity for Janney.

JA:  Thanks, Peter.

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David Fondrie from Heartland Advisors: A Glass-Half-Full Guy Looks at the Sequester and Economic Growth

David Fondrie is a Senior Vice President and Portfolio Manager for the Select Value Fund at Heartland Advisors in Milwaukee (www.heartlandfunds.com).   He joined Heartland in 1994 and subsequently served as Heartland’s Director of Equity Research for ten years from 2001 to 2011.  He also held the position of CEO of Heartland Funds from 2006 to 2012.  He’s a Badger from the University of Wisconsin and served with the armed forces in Korea.  He started his career with Price Waterhouse and is a CPA.  Our paths have crossed repeatedly over the years since we had interests in some of the same companies.  Like many Midwesterners, he is a plain-spoken man.

Dave Fondrie, Heartland Advisors Inc

Dave Fondrie, Heartland Advisors Inc

We had an opportunity to chat on March 1, the day the much-discussed government spending sequester went into effect, and I asked him what he thought would happen as a result.

DF:  The headline effect is likely to be worse than the real effect.  It’s not going to be as devastating as the articles in the press would have us believe.  There will no doubt be some pain inflicted on defense stocks, for instance.  But for the most part people have been expecting this to happen, so it is not a surprise, and it is built into the market.  There are too many green shoots in the economy now for something like the sequester to knock them all down.

JA:  Are you seeing it more like a speed bump than a brick wall?

DF: Yes, exactly.  I think Congress will get around to the budget and the cuts, adjusting them to what makes more sense.  If you look around at the United States economy right now, what is striking is what is going on in the oil and gas field.  Suddenly we are one of the lowest-cost energy producers and consumers in the world.  Not only does that have a direct effect on business, it is creating a new industry that is building out the infrastructure that will allow us to provide low-cost natural gas energy to industrial America.  This has put us in quite a positive situation.

We are paying $3.50 for natural gas, where Europe is paying $12.00 and Japan is paying  $16.00.  So to me that means that companies that rely on energy for their operations are much better off here than in other major developed economies around the world.  A steel forge, for instance or a company like Precision Castparts Corp (PCP), which use enormous amounts of energy in making parts, are a lot better off here than anywhere else.  Fertilizer plants.  The renaissance in chemicals here is extraordinary.  There are 12 new ammonia plants on the drawing boards, and they all will have a reliable and lowcost stream of natural gas as both energy and raw material.  We can use that ammonia domestically and stop importing it from other economies.

LNG.  There are a number of proposals for LNG plants.  These days we are talking about exporting LNG, where we never thought about anything but importing it in years gone by.  I think this low-cost energy source is underappreciated.  In fact it will spur the continued development of oil and gas, infrastructure, chemical plants, and other types of industrial expansion.   All of that is good for the economy.  Add to that some continued improvement in employment and housing, with home prices increasing, and we foresee stronger consumer confidence, especially as a result of higher home prices.  Already 401(k) values have been improving, and it is undeniable that we are in a low interest-rate environment as well.

All this headline talk about the sequester risk is overblown.  There is no doubt that federal spending and the size of the national debt have to be brought under control.  Entitlement plans have to be rationalized.  But add to the overall situation the fact that China is clearly recovering.  Chinese electrical usage is up, their industrial consumption of materials and energy is up, and as China grows, their growth is good for the other economies that feed her growth.  Europe is not likely to get any worse.

We’re looking for 2.5% to 3% GDP growth in 2013.  The stock markets continue to be reasonably valued.  Corporate balance sheets are good; earnings are good and continuing to improve modestly.  The S&P 500 is trading at 14 times earnings, where in the past it has traded at an average of 16 times earnings.

The wild card is what happens with interest rates.  People have not yet abandoned bonds, but the inflows have receded after several years.  There have been outflows from the equity markets for five years.  Now we are seeing a trickle-back return to the equity markets.  Sadly there is a pattern that is repeating itself, with many buyers entering at the midpoint of an equity run, not at the beginning.  But this is the way cycles go.  We are in the 4th or 5th inning if you take a long view of this bull market over the last three years.

JA:  So are you buying energy companies?

DF:  Not particularly.  Low energy prices are not particularly favorable for exploration and production companies.  But we are looking closely and buying companies that supply goods and services to the energy patch.  For the last two or three years, for instance, it has been apparent that there will have to continue to be huge investments in the energy patch.  If you are drilling in North Dakota, you may have no infrastructure to bring the liquids you are pumping to the refineries, which all tend to be downriver by quite a distance.  We have huge backups in Oklahoma because there is not enough pipeline to carry all the energy.  One company we have owned for 2 to 3 years is Mas Tec Inc (MTZ).  We bought it in the 12s and it closed Friday at $30.78.  Part of their business is in pipelines, and they have also done well at the gathering systems in areas where energy is being produced at the wellhead.  Those are both high-growth areas; the stock was trading cheap two years ago, and it has given us a reward.  Quanta Services Inc (PWR) is very much the same story – we used to own that stock as well, but we sold it when its valuation reached what we thought was a sensible level; in their case they are exposed to pipeline development and new high-voltage lines.

JA:  How about life sciences companies?

DF:  The FDA has been problematic as they have increased their oversight of the industry resulting in complex regulations and inspection observations (commonly called 483 observations).   We own Hospira Inc (HSP), which was a spinout a few years back from Abbott Laboratories  (ABT).  They have run awry of the FDA at a manufacturing facility in Rocky Mount, North Carolina.  In Hospira’s case, addressing the 483 observations and revising processes and procedures has resulted in over $300 million in costs and reduced output of drugs that are already in short supply.  We are all concerned with safety; however those concerns should be balanced with a sensible and timely regulatory process.

JA: Does that put a caution flag out?

DF:  I can’t speculate on what kinds of furloughs the FDA will have to put into effect.   I doubt that we will have chickens rotting on processing lines waiting for FDA inspectors as the press and certain congressional members have suggested, but the big issues around drug approvals will continue to be important, and is likely to be slowed down even further with the automatic budget cuts.  Hopefully they will prioritize their cutbacks and the expense reductions will have less impact than we might expect.  But government does not always work very efficiently.  We hope they will be smart and furlough the poor performers instead of just following  a LIFO pattern.

JA:  How do you feel about ObamaCare and stocks?

DF:  I do sense that there is a bit more thought being given to the impact of ObamaCare.  We just reviewed the 2014 Medicare Advantage benchmark payment rates by the Centers for Medicare and Medicaid Services (CMS), and the cuts were more draconian than expected.  But the government was clear that they are not trying to cripple the HMOs because they are a vital part of the new program.  I am a glass-half-full guy most of the time, and I think if people sit down and talk they can get to some reasonable results; let’s hope that happens.  There is always give-and-take with reimbursement rates, and they end up meeting someplace in the middle.  US businesses are resilient; once they know where the boundaries are, what the rules are, they adjust.  What happens is what you expect in a capitalist system: change comes quickly.  Capitalism works pretty well.

JA:  Where do you think people ought to be looking in the equity markets this year?

DF:  I am in the camp that says we will continue to have a modest economic recovery.  In that kind of environment you have to look at cyclical companies.  We are overweight in industrials and information technology companies.  Everyone is going to look at productivity, and technology is important there.  People will continue to invest in technology to improve productivity.  We are going to be hooking up all kinds of machines at home and in factories to the Internet.  We think tech plays work.  We might stay away from actual PCs, but mobility will continue to expand, and downloads will continue to grow, keeping  Internet growth robust.  Probably financials are good, due in large part to a stronger housing market.  We are a little more cautious on that because the interest rate environment does not allow much net interest rate gain to banks.  But housing will drive loan growth, and the banks have plenty of capital to lend.  With business loans at 3.5%, it is hard for banks to make money.  If we got an uptick of half a percent, it would do wonders.

In tech companies, we like Cisco Systems Inc (CSCO).  We see Cisco as a chief enabler of the infrastructure of the Internet.  Cloud computing is driving a lot of internet traffic.  Cisco is cheap at 12 times earnings, and there is that nice dividend yield of 3% too.  The balance sheet is pristine; altogether it is a very attractive risk-reward proposition.  I run a value-oriented multicap fund.  Cisco is seen as a growth stock, but right now it is also a value stock.  They have gotten their act together after some unwise acquisitions a few years back; we think the downside is minimal.

JA:  What about social media?

DF:  Social media doesn’t really fit our style.  Even Google is not in an area where we play.  Thematically I like agricultural plays like Archer Daniels Midland Company (ADM).  It is trading a bit above book value, and the dividend yield is 2.4%.  If we have a big corn crop, ADM is going to benefit from processing all that corn.  I believe we will have a big corn crop this year, and we need one.  ADM’s PE is under the S&P 500.  I can’t predict the weather, but we are getting moisture that we badly need in the Midwest, so the water table can support strong crops this year.  We’re looking at fertilizer companies, seed companies, and farm equipment (especially on a dip).  Railroads are a bit expensive right now, but it is worth noting that the number of rail cars carrying oil is growing at 25%, which makes those cars part of the infrastructure for moving energy.  Oil companies and refiners are buying those cars and the rails are moving them.  We’ll buy rails on dips too.

One final area that is more in the later innings is deepwater offshore.  We are particularly interested in drilling off the east and west coasts of Africa.  We like the companies that build out those platforms and subsea infrastructure to bring that oil to market.  We like the boat companies that service those rigs.  These are long-cycle investments; the big international oil companies don’t start-and-stop those projects.

JA:  What about shipping companies?

DF:  There may be too much capacity there.  OSG went bankrupt.  What has happened in the US is that we are importing less oil than we were five years ago, and the amount we are producing here has increased.  Our demand for oil from overseas has decreased.  So tanker ship demand has decreased as well.  If China starts to really boom again, that could absorb some of the excess capacity, but I don’t see that as near-term.

JA:  How about the greenback?

DF: The euro is at risk, but the dollar should hold its own.  If the Chinese let their currency float more that might affect the dollar, but for now the dollar is fine.

JA:  Is there an upside to the 2.5% to 3% GDP growth you mentioned?

DF:  Maybe in the back half.  If we resolve our government problems, that might restore more confidence.

JA:  Thanks, Dave.

Allen & Caron owns none of the stocks mentioned in this interview, and Joe Allen owns none of the stocks mentioned in his personal accounts.  Please do your own research.  JA