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[Editor’s note: We asked Gerald Hwasta to make sense of all the buyout activity going on]

We’re seeing a lot of action suddenly in the area of technology buyouts, and it’s impacting Silicon Valley.

These transactions are driven by private equity firms searching for businesses with reliable cash flows. The firms, including mine, want to acquire these businesses, often with borrowed money (debt), and then try to increase the cash flows even more, in order to sell these businesses for a profit in the future.

As the WSJ reports today (Friday), private equity investors are focused on companies whose market value doesn’t reflect the cash their operations generate. Cypress Semiconductor Corp., Atmel Corp., both of Silicon Valley, and STMicroelectronics NV are just the latest potential targets. This follows lots of other recent action, including targets Freescale Semiconductor, Philips Semiconductors (NXP), Agilent Technologies (Avago) and some of Intel’s units.

Historically businesses acquired in buyouts have been steady cash flow entities, which gave lenders comfort. Why have these lenders and the buyout firms moved into technology, a segment of the economy that traditionally had erratic financial results, far from the steady cash flow businesses that attracted buyout investors?

The answer is that many sectors of technology are established, i.e. “mature.” Whether operating as strong cash flow businesses or still needing operating transformation to achieve profitability, companies in the technology field are increasingly attractive to buyout firms.

At a time when Sevin Rosen has declared that the VC model is broken, buyout firms are raising record sums of capital. Dow Jones reported that buyout funds raised $172.2 billion in the first three quarters of 2006. This fund-raising pace is on target for 2006 to be an all-time record for capital raised.

In 2005, 71% of the number of technology deals was between $10 million and $500 million in value, indicating that over 80% of the deals were less that $500 million in value.

It is in this “mid-market” segment of the market where my firm, Shah Capital Partners is focusing its efforts on technology buyouts. Even the large buyout firms are now going to raise dedicated funds to compete in this highly attractive segment of the market.

Venture capital still performs a very significant role in business formation and driving technology innovation, but like all industries, many technology companies are maturing, and with that maturation comes the need for a different approach to investing. Mid-market technology buyouts have come of age.


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