Author: Mark Fontecchio

I am a research manager for 451 Research's M&A KnowledgeBase.

A blockbuster year for blockbuster deals

Mark Fontecchio

by Brenon Daly

Flush with cash and filled with confidence, tech acquirers have put up more billion-dollar deals so far this year than any other year. 451 Research’s M&A KnowledgeBase lists 100 acquisitions valued at more than $1bn already in 2018. For those who don’t have a calendar handy, the pace works out to the head-spinning rate of more than two announced transactions every week since January. Back in the recent recession, tech buyers were taking about a month to do the same number of $1bn+ deals.

The unprecedented activity at the top end of the tech M&A market is being driven by record levels of big-ticket purchases by both of the main buying groups: tech companies and buyout firms. Corporate acquirers, which account for two-thirds of the billion-dollar prints, have seen many of the market mainstays start buying again. And buying big.

For instance, IBM hadn’t paid more than a billion dollars for any company in two and a half years before announcing the $33.4bn purchase of Red Hat last month. That’s the largest-ever software acquisition. For the first half of this decade, Big Blue averaged roughly a billion-dollar deal every year. Elsewhere, German giant SAP had been missing from the list of blockbuster buyers since 2014, until it put together a $10bn double-dip this year. It paid $2.4bn for Callidus Software in January, and followed that up last week with the $8bn pickup of IPO-bound startup Qualtrics.

The recent growth in deals by strategic acquirers, however, has been outpaced by financial buyers. An ever-increasing number of private equity (PE) firms have found an ever-increasing number of ways to shop big in tech. At the start of the current decade they were averaging about a dozen billion-dollar transactions each year. This year, they are on pace to do three times that number.

Fittingly, buyout shops are using their full M&A playbook to get to a record number of $1bn+ deals. They have done large take-privates (Vista Equity-Apptio, Thoma Bravo-Imperva); they have done carve-outs (The Blackstone Group’s $17bn purchase of Thomson Reuters’ financial markets business); and, especially, they have done secondaries (Rocket Software, Eagleview Technologies and BMC Software have all traded one set of PE owners for another). Further, all of that activity comes at a time of relatively high valuations across the tech landscape for these notoriously price-sensitive buyers.

Overall, the activity at the top is important to the broader tech M&A market because the deals are the main contributor to this year’s surge in acquisition spending, which is nearing an all-time annual record. This year’s billion-dollar transactions account for all but $100bn of the total $545bn we tally for all of tech M&A so far in 2018.

But the importance of blockbuster deals goes well beyond their dollars. Big buyers inking big transactions tends to embolden other companies and their boards to pursue their own ambitious acquisitions. That’s how the number of $1bn tech deals in a single year gets pushed into the triple digits for the first time ever.

For more real-time information on tech M&A, follow us on Twitter @451TechMnA.

Mixed buyers harvest security targets

Mark Fontecchio

by Scott Denne

In making its latest security purchase, BlackBerry joins a pageant of infosec acquirers chasing after ballooning budgets. With BlackBerry’s $1.4bn pickup of Cylance, there have now been 15 acquisitions of infosec vendors valued above $250m this year, according to 451 Research’s M&A KnowledgeBase. Only three of those were printed by buyers who make infosec their primary business.

To be sure, BlackBerry isn’t new to the security market. Since its mobile device business began its decline earlier this decade, it has focused on mobile device management software and expanded on its reputation for secure communications since the purchase of encryption specialist Secusmart in 2014. Still, this deal marks its most significant dive into cybersecurity. (In fact, it’s the company’s most significant acquisition in any category as it’s three times the size of its previous organizational high – the $425m pickup of Good Technology in 2015.)

Many of this year’s acquirers resemble BlackBerry in being on the edges of infosec and looking to go deeper. Splunk, for instance, printed its $350m reach for Phantom Cyber just as its security revenue was expanding to 50% of its topline. Others had little presence in cybersecurity: TransUnion and Reed Elsevier, both already in the risk business, got deeper into digital risk by nabbing antifraud firms. Also, AT&T moved into the market with the acquisition of AlienVault. And, of course, reflecting the broader trend in tech M&A, private equity (PE) firms are the largest category of infosec acquirer.

Whether from telecom or PE, expanding budgets are the draw for most buyers. Across all of our surveys, security budgets have risen steadily and dramatically. Among respondents to 451 Research’s VoCUL: Corporate IT Spending survey, at least 18% have indicated rising security budgets in each of the past five quarters. In that same time, no other single software segment garnered higher than 12%. And in our security-focused panel, the responses have been more dramatic. In 451 Research’s Voice of the Enterprise: Information Security report, 80% anticipate rising budgets in 2018, compared with just 6% forecasting a decline.

VC exits soar for some

Mark Fontecchio

by Scott Denne

With its $8bn purchase of Qualtrics earlier this week, SAP helped push venture exits into the nosebleeds. About seven weeks remain in the year and the total value of acquired startups has already smashed the previous post-dot-com record. Yet the spoils aren’t evenly distributed. Those startups getting sold are often commanding a premium, although most aren’t getting sold at all.

According to 451 Research’s M&A KnowledgeBase, venture funds have sold a collective $75bn worth of tech vendors, 50% more than the previous record of $50bn. Rising prices, rather than deal volume, are driving that total. Since the dot-com days, VCs have sold five private companies for more than $5bn. Four of them have traded this year. Moreover, 11 have sold at $1bn-plus, more than the previous two years combined.

The trend isn’t limited to the big-ticket transactions. Overall, the businesses that are getting sold are selling for more. The median price tag for a venture-funded vendor stands at $123m this year, well above the typical $55-65m for the most recent years. Demand from acquirers isn’t the only reason for rising startup prices. Venture-backed companies are also raising more and bigger rounds, staying private longer and, therefore, fetching more when they do sell. Still, the number of venture-backed vendors to find a buyer this year – 520 so far – is on pace to be the lowest since 2009.

The perception that there’s a major tech-driven transformation afoot has sparked many of this year’s exits. Indeed, the largely untried idea of combining ERP, CRM and HR data with customer and employee sentiment drove SAP’s Qualtrics purchase. According to 451 Research’s Voice of the Enterprise: Digital Pulse report, 46% of respondents told us that they expect digital technology to highly impact their organization’s industry over the next five years. Whether acquirers view the looming transition as an opportunity or a challenge, it’s pushing them toward the perceived winners in each category and creating a willingness to pay up. There doesn’t appear to be much of a prize for second place.

Fear and uncertainty

Mark Fontecchio

by Brenon Daly

When investors flipped their calendars from October to November, they were also hoping to turn the page on the worries that knocked US stocks last month to their worst monthly performance in six years. They looked through last week’s political instability – the divisive midterm elections in the US, which, appropriately enough, produced a divided Congress – in favor of market stability. Calm had descended on Wall Street once again.

And then came this week. Stability eroded and confidence evaporated, prompting investors to dump stocks in early-afternoon trading today and, even more so, on Monday. Stock market indexes that had hung close to the level where they opened the month in the first week of November suddenly plummeted into the red. Instead of a rebound from October, trading in November has turned into more of the same from last month.

Most market participants track uncertainty through the CBOE’s Volatility Index, which is known as the VIX. (Fast-talking traders shorthand everything.) Without going too deeply into the makeup and implications of the VIX, the index measures investors’ expectations about the direction of stocks. The index tends to move higher when stocks move lower.

We certainly saw that in last month’s bear market, when the VIX surged to roughly twice the level it held in the summer months. And while the so-called ‘fear gauge’ did ease significantly in early November as US equity markets recovered, this week’s rout has spurred it higher. The VIX is one-third higher now than it was last week, and is approaching last month’s levels.

As a mechanical measure of human emotion, however, the VIX has its shortcomings. Its utility is also limited because it is, necessarily, tied to every single tick of the market. That makes it difficult to base long-term strategy – whether a significant investment or a meaningful acquisition – on an index that fluctuates every second.

At 451 Research, we have our own version of the VIX. As part of a monthly survey, our Voice of the Connected User Landscape (VoCUL) asks over 1,400 respondents how they feel about the stock market. Specifically, we ask about the all-important sentiment of confidence in the market right now compared with three months earlier. Both the timing and the structure of our question is designed to draw out a more durable forecast than the more-reactive VIX.

So what does our survey say? Given the uncertainty that ripped through Wall Street in October, it’s probably no surprise that investor sentiment deteriorated notably in the latest VoCUL survey. Just one in eight respondents indicated that they had more confidence in Wall Street now than in August, when the stock market was roughly 10% higher. The most recent outlook – with the bearish views outnumbering the bulls almost three to one – is among the dourest outlooks of the past three years.

Waving goodbye to Wall Street

Mark Fontecchio

by Brenon Daly

For software providers, Wall Street used to be a desirable location to set up shop. But now, an ever-increasing number of companies are waving goodbye to the neighborhood of public entities. Either the vendors bypass the fabled destination as they head to newer places with more privacy or, once public, they do a deal that’s the corporate equivalent of moving to the suburbs: consolidate with a larger software firm.

Already this year, the two major US stock exchanges have lost almost twice as many software companies as they have gained. According to 451 Research’s M&A KnowledgeBase, 15 publicly traded (or soon-to-be publicly traded) software providers have been acquired, compared with just eight new software listings.

Just today, the Nasdaq saw both medical software supplier athenahealth and cloud expense management specialist Apptio announce take-privates by buyout shops. And Qualtrics got picked off by SAP even before it had a chance to matriculate to the Nasdaq. (451 Research subscribers can look for our full report on SAP-Qualtrics on our site later today.)

The net reduction in publicly traded companies has erased tens of billions of dollars of market value from what had once been viewed as the place for software vendors to be, from both a marketing and financial point of view. For generations, software entrepreneurs founded and funded their businesses with a singular goal: IPO. Ringing the opening bell on the Nasdaq or NYSE was seen as a rite of passage for a company that aspired to grow out of its status as a ‘startup.’

Of course, tech vendors in general have been eschewing IPOs ever since the dot-com bust, in part due to regulatory changes on Wall Street. But the trend has accelerated in just the past half-decade as gigantic pools of private capital have, to some degree, replaced public market investors. For instance, Qualtrics managed to raise $400m from investors without an IPO. Domo raised almost twice that amount as a private company before its offering last spring.

All of that private-market capital has allowed software providers the luxury of operating behind closed doors for much longer, perhaps indefinitely. Institutional investors have accepted that new reality. Several deep-pocketed firms started putting money into the private market, which is a bit of a stretch for investors accustomed to the liquidity and transparency that comes with a public listing. But if software vendors won’t come to Wall Street, then Wall Street investors have to go to them.

For more real-time information on tech M&A, follow us on Twitter @451TechMnA.

PE goes gray

Mark Fontecchio

by Scott Denne

As it celebrates its 25th year in business, ConvergeOne is falling again into the hands of a private equity (PE) shop. With CVC Capital Partners’ $1.8bn acquisition of the communications integration services firm, ConvergeOne joins an expanding list of tech companies landing in PE portfolios when they’re well into adulthood. As buyout firms vary their strategies to incorporate growing businesses and venture-funded startups, there’s a sense that they’re making room for younger companies. But in reality, PE tech targets keep getting older.

According to 451 Research’s M&A KnowledgeBase, the median age of a PE acquisition has risen steadily through this decade. In 2010, the typical technology vendor was 12 years old upon joining a PE portfolio – four years younger than the typical 2018 purchase. (The analysis doesn’t include corporate spinoffs, whose founding dates are difficult to pin down.) Although PE firms are buying more young companies on an absolute basis, those targets make up a smaller share of PE deals. So far this year, they’ve bought 158 businesses – one out of five PE transactions – with less than a decade of operations, while in 2010, nearly one-third were below that age.

The graying of PE portfolio companies reflects a dramatic shift in the source of deals for PE shops. Acquisitions of vendors that have already been through at least one cycle of PE ownership are accelerating at the expense of all other sources of deal flow, including take-privates, buyouts of venture-backed businesses and corporate spinoffs. Excluding bolt-on transactions, such secondary acquisitions account for more than one out of every four tech purchases by PE firms this year.

In its latest move, CVC Capital becomes the third buyout shop to own ConvergeOne. Several companies are passing from one sponsor to another for the second or third time this year. In January, Marketron was bought by its fourth financial sponsor as the radio broadcasting software business approaches its 50th anniversary. And in one of the largest PE deals of the year, Carlyle Group spent $6.7bn to become the third PE owner of Sedgwick, a 47-year-old claims management outsourcer.

PE’s expanding footprint in tech M&A naturally results in a rise in secondary transactions as more of the available targets are PE-owned. By our count, PE firms and their portfolio companies have inked almost one out of every three tech deals this year. Yet the rising age of PE-owned companies suggests that those firms aren’t replenishing their stock of potential targets as fast as they are recycling it.

For more real-time information on tech M&A, follow us on Twitter @451TechMnA.

Buying a lot, selling a little

Mark Fontecchio

by Brenon Daly

Less than two months ago, we speculated that Broadcom would be cleaning out the closet at CA Technologies once it owned the enterprise software company. On cue, the semiconductor giant announced Monday that it had closed its $19bn purchase of CA and, in virtually the same breath, said it had divested one of the just-acquired businesses. The unwinding of Veracode almost certainly won’t be the last pruning of the CA portfolio done by the financial hawks at Broadcom.

But first, on the announced deal: Thoma Bravo said it will spend $950m to carve application security provider Veracode out of the now-Broadcom-owned CA. The transaction effectively unwinds CA’s pickup of Veracode two and a half years ago. In a reversal from most of these moves, CA’s exit price is significantly richer – nearly 50% higher – than its entry price. (451 Research subscribers can look for our full report on the deal on our website tomorrow.)

While not unexpected, Broadcom’s divestiture nonetheless comes at a time when corporate castoffs are running at a multiyear low. According to 451 Research’s M&A KnowledgeBase, publicly traded tech companies like Broadcom are on pace in 2018 to print the second-fewest divestitures of any year since the recent recession. Further, our database indicates that this year will see listed tech vendors shed roughly one-quarter fewer business than the average year over the past decade.

Broadly speaking, the surge in earnings this year at tech giants and, until recently, their record-high equity prices has blunted the need for most companies to radically overhaul their businesses. Growth masks a lot of flaws. In any downturn, we would expect the pace of divestitures to pick up.

In the case of Broadcom, however, its move wasn’t so much macro-driven as it was just a case of hitting an internal target. Specifically, the chipmaker, which runs a tight ship, laid out the goal of ‘long-term adjusted EBITDA margins’ above 55% once it fully integrated CA.

There’s a fair amount of wiggle room in both the timing and financial measure of that target. But it suggests that more divestitures are coming. Most of CA’s enterprise software business doesn’t run anywhere close to the margins Broadcom has modeled. In contrast, CA’s mainframe business, which is roughly half of total revenue, throws off a ton of cash.

If we had to guess at another acquired business that Broadcom is likely taking a hard look at right now, we wonder if CA’s mid-2015 acquisition of Rally Software Development might also get unwound. (The business is now known as Agile Central.) The Agile software development shop relied on a fair amount of professional services (mid-teens percent of total revenue), which pressured margins and kept the business running in the red. Unless CA has dramatically improved the business, Rally may not make the cut.

M&A unspooked by blood-red October

Mark Fontecchio

by Brenon Daly

The largest software acquisition in history helped push overall tech M&A spending in October to the second-highest monthly total in the past two years. Acquirers around the world spent $72bn on 319 tech deals, according to 451 Research’s M&A KnowledgeBase. About half of the spending came from IBM’s blockbuster purchase of Red Hat just before the end of the month.

As the most significant transaction in October – and, indeed, of 2018 so far – Big Blue’s big bet on the open source software pioneer is noteworthy both in terms of scale and strategy. For starters, the $33.4bn price is as large as the second- and third-largest software deals combined, according to the M&A KnowledgeBase.

For 107-year-old IBM, its make-or-break pickup of Red Hat marks the first time the company has splashed out more than $1bn on a single acquisition in two and a half years. In that same time, however, the tech veteran has spent tens of billions of dollars on dividends and stock repurchases as it struggled to find revenue growth. For its part, Red Hat has reported 65 consecutive quarters of revenue growth.

IBM’s risky bet on the open source software provider stands out even more when we view it against the tumultuous month of October in the overall economy and, especially, the equity markets. Once-bankable investments in many of the tech industry’s main names turned blood red last month. For instance, Amazon, which secured a market value of $1 trillion in September, saw its shares plummet 20% in October alone. More broadly, the tech-heavy Nasdaq Index ended the month down roughly 9%.

Economic uncertainty and Wall Street volatility can complicate pricing for acquisitions, as well as prolong negotiations as parties sometimes revise their assumptions or recalculate their models if the outlook for the future becomes particularly cloudy. Those potential snags tend not to show up in transactions by corporate acquirers until some months later. In contrast, the impact tends to be more immediate for financial buyers, who rely more than their strategic rivals on the economically sensitive debt market to finance their deals.

Although October could very well be a blip in an otherwise record run by private equity (PE) acquirers this year in the tech industry, we would nonetheless note that buyout activity slumped notably last month. According to the M&A KnowledgeBase, PE firms in October spent just half of the monthly average of the preceding nine months of 2018.

For more real-time information on tech M&A, follow us on Twitter @451TechMnA.

Private equity’s upbeat healthcare prognosis

Mark Fontecchio

by Michael Hill

Financial sponsors are poised to set a new high in the number of healthcare IT deals, and have already invested a record amount of money. The increasing spend comes as most healthcare businesses overhaul their digital strategies, providing a temporary opening for private equity portfolio companies to land new healthcare clients.

According to 451 Research’s M&A KnowledgeBase, private equity firms have bought 77 healthcare IT companies, on pace to best 2017’s 82. In the process, they’ve spent $8.5bn in a category that has only stretched above $4bn in one other year. The striking surge in healthcare comes amid a steady cadence of increasing PE investments in vertically specific technologies, where PE acquisitions have grown every year since 2012.

Particularly in healthcare, much of the year’s surge comes from a single deal – Veritas Capital’s $4.3bn reach for Cotiviti in June. That deal valued the target, a patient-billing services provider, at 6.6x trailing revenue and a rich 20x trailing EBITDA. Those multiples are well above the broader healthcare tech market, where the median revenue multiple stands at 2.3x across all deals in the last 24 months. Still, Cotiviti isn’t alone in fetching a premium valuation from a PE firm. In April, Vista Equity Partners paid similar multiples in its purchase of healthcare BI specialist Allocate Software (M&A KnowledgeBase subscribers can see our estimate of that deal here.)

The dramatic rise in PE spend comes as healthcare companies reassess their digital investments. According to 451 Research’s Voice of the Enterprise Digital Pulse report earlier this month, nearly half (42%) of responding healthcare companies reported that they are planning and researching a digital transformation strategy. The abundance of healthcare customers in that pre-buying phase offers vendors a chance to develop new relationships that could pay out for years. However, as planning moves to execution, that opportunity will flatline.

For more real-time information on tech M&A, follow us on Twitter @451TechMnA.

A bullish bet in a bearish market

Mark Fontecchio

by Brenon Daly

The recent rout of technology stocks didn’t actually provide much of a discount in Big Blue’s big bet on Red Hat. In the largest-ever software acquisition, IBM is valuing the open source software provider at its highest price since its dot-com-era IPO. Essentially, Big Blue had to make up Red Hat’s recent stock decline with a very generous premium. (Subscribers to 451 Research can look for our full analysis of the transaction and its implications on our website later today.)

Ahead of the announcement, shares of Red Hat had shed about one-quarter of their value just since mid-September. The stock bottomed out last week at about $117, its lowest level in a year. Under terms, IBM is paying $190 for each Red Hat share, which works out to a premium of more than 60% from the prior close. That’s about twice as rich as the typical premium in a significant software acquisition.

However, looking at the terminal value of a company relative to the market value of a company doesn’t make too much sense unless we also factor in the state of the overall market. Stock prices change every day, particularly for high-beta stocks like Red Hat. It just so happens that in recent sessions on Wall Street, virtually all of the changes have been marked in red.

In the case of Red Hat, it was riding high last summer, with shares peaking at about $177. At that level, IBM is paying a scant 7% premium on Red Hat’s market value. (That fact hasn’t been lost on plaintiff lawyers, who have already revved up their strike-suit machine to target this deal.)

Rather than comparing how IBM is valuing the company to how public market investors value the company, it’s more useful to look at how IBM is valuing Red Hat’s actual business. And by that measure, this is a pricey pairing.

IBM, which trades at less than 2x trailing sales, is valuing Red Hat at more than 10x trailing sales. That’s substantially higher than the average multiple of 6.6x trailing sales for the 10 largest software acquisitions recorded in 451 Research’s M&A KnowledgeBase.