Venture capitalists shop for bargains

With stocks sagging, they're buying more mature companies

April 04, 2003|By Julie Bell | Julie Bell,SUN STAFF

Venture capital firms, known for investing in young private companies, are buying into more mature and even publicly traded ones amid a depressed stock market that has made stakes in established companies more affordable.

The trend is particularly noticeable in the health care industry. Last week, for example, Baltimore-based Elder Health said it had raised $16 million in additional venture capital to geographically expand health insurance plans already operating in Maryland and Pennsylvania.

Last month, Baltimore-based New Enterprise Associates added $5 million to its investment in publicly traded Aradigm Corp., a Hayward, Calif., maker of medicine inhalers. And in January, Iomai Corp., a Gaithersburg company whose skin-patch technology for delivering vaccines is nearing final-stage clinical trials, raised $54 million in venture capital rather than trying to do an initial public offering of shares in a recalcitrant stock market.

"Currently, there is no market for an IPO," said Iomai Chief Executive Officer Stanley C. Erck. The market is far different than it was "three years ago, [when] companies went public without products in clinical trials."

The amount of venture capital invested has steadily declined nationally from a peak of $106.6 billion in 2000 to $21.2 billion last year, according to the latest MoneyTree Survey by PricewaterhouseCoopers, Venture Economics and the National Venture Capital Association. But the recent deals demonstrate that venture firms aren't just adjusting to the market downturn by slowing the pace at which they invest. They're also bargain-hunting.

For some firms, that means grabbing cheap stock in mature companies they hope they can quickly sell for a profit when the market comes back. For others, it means concentrating on deals in sectors that are out of favor but expected to rebound.

"In the height of the bubble, when technology stocks were soaring, we were selling our technology businesses and investing in traditional businesses," said Frank A. Adams, managing general partner of Timonium-based Grotech Capital Group. "Now it's the other way around: We're selling our traditional businesses and buying technology businesses."

Grotech, for example, purchased the Long John Silver and A&W restaurant chains for a total of about $30 million during the technology boom in 1999 and sold them last year for about $300 million. It also plowed $60 million into four young companies in the depressed telecommunications sector last year with the expectation it will bounce back.

Tom Salemi, editor of Venture Capital Analyst/Health Care, said venture firm investment in public companies is "getting more common," though venture funds traditionally promise they won't invest more than 20 percent of their funds in publicly traded stocks.

"V.C.s are wondering, why invest in a private company for $2 a share when I can get a public company for $2 a share?" he said, noting that the firms can more easily sell shares that are already public.

But with the public markets impossible to tap for initial public offerings, young companies are forced to take venture capitalists' terms or go without. The private financiers calculate the price of a private company based on the market capitalization of similar publicly traded ones -- which are currently depressed.

Erck of Iomai declined to discuss terms of his company's deal. But he acknowledged that he had to accept less per share than he would have several years ago -- presuming the company had been at an identical stage of development -- in order to raise the same amount of money.

The low price encouraged Rockville venture firm Emerging Technology Partners, which raised its $40 million fund in 2003, said general partner Wei-Wu He. "There are probably later-stage deals for our size fund we would not have touched," he said. Now, he said, "our little amount of money can make an impact."

Venture capitalists valued Elder Health at more than $50 million when it raised money three years ago, CEO Michael R. Steele acknowledged. Now, he said the profitable company is considered to be worth $26 million, even though it just expanded into Pennsylvania.

"It's hard to raise money," Steele said, adding that the company went ahead because it needed to meet regulatory requirements for cash reserves after its expansion into Pennsylvania and wanted additional cash to expand further. But he said the deal terms, which he didn't disclose, gave the company "money from smart, sophisticated investors with the ability to help us grow the company."

Nashville, Tenn., venture firms Coleman Swenson Booth Inc. and Salix Ventures both had previously invested in Elder Health when it was an earlier stage company, along with New Enterprise Associates.

Its latest fund-raising included $4.25 million from Conning Capital Partners of Hartford, Conn., which was attracted to the deal in part because it could get a significant chunk of the company for less, according to Conning partner Michael Aspinwall, an Elder Health board member.

"For us, it's a little bit later-stage investment," Aspinwall said, adding that he expects Conning to be able to get back money invested in Elder Health plus a profit in about four years.

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