Author: Mark Fontecchio

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

US-China: Gone and maybe not coming back

Mark Fontecchio

By Brenon Daly

As the trade war between China and the US continues to escalate, tech M&A between these two countries is suffering some pretty serious collateral damage from the battle. That makes sense since cross-border acquisitions are a form of trade, just as any other exchange of goods or services between two countries. But right now, relations between the two largest economies on the planet are making it pretty much impossible for them to get any tech deals done. What’s more, those deals may not even return when the current political hostilities have ended.

This year, which has already seen the two sides impose billions of dollars’ worth of tariffs on each other’s exports, is currently on pace for the fewest deals and lowest spending by Chinese companies on US-based tech businesses since China began shopping here in earnest a half-decade ago. According to 451 Research’s M&A KnowledgeBase, acquirers based in China have picked up only two US tech companies worth $137m so far in 2018. That puts this year on pace for just one-third the number of tech acquisitions announced by Chinese buyers in any of the previous four years.

While never a huge acquirer, China had emerged as a fledgling buyer of US technology vendors in recent years. For instance, Beijing-based IT giant Lenovo picked up significant hardware businesses cast off from IBM and Motorola Mobility in 2014, while more-recent activity saw China-based investment groups take out Lexmark and Ingram Micro, both in 2016. However, that mini-boom in M&A got snuffed almost overnight when China imposed severe restrictions on its currency in late 2016. That had the immediate effect of cutting Chinese spending on US tech providers by an incredible 95%, from a record $11bn in 2016 to just $500m in 2017.

Undeniably, the decline in 2017 was due to a change in internal Chinese policies. However, the further decline so far this year is more attributable to the ever-accelerating deterioration in US-Chinese relations. That’s likely to have implications for tech M&A between the two countries that last much longer than the current trade spat. Even assuming the two countries can resolve their trade difference (a large assumption given the tit-for-tat tariffs and a just-filed WTO complaint), China is unlikely to return to shopping for tech in the US, at least not like it did in the peak years.

Having seen how acquisitions in the US can potentially be ‘politicized’ and shot down, China is likely to focus its expansion in the technology industry via internal, rather than external, resources – building, rather than buying. It’s worth remembering that the country’s blueprint for upgrading its overall economy – and its technology industry, specifically – is called ‘Made in China 2025.’

Two great tastes that taste great together

Mark Fontecchio

By Brenon Daly

Chips and salsa? Sure. Chips and software? Not so much. Broadcom’s risky plan to pay $19bn for CA Technologies in an effort to become a software vendor left Wall Street puzzled, even mildly derisive. And when investors talk like that about a company, it’s almost invariably because they’re dumping it.

That’s certainly the case with shares of Broadcom, which plummeted 15% after the deal was announced. The decline slashed $15bn from Broadcom’s market value, almost equal to the amount of cash it is handing over for CA in the largest-ever purchase of a software provider. Weighing on the minds of investors is the tattered history of other hardware vendors that stumbled when they stepped into the enterprise software business.

The multibillion-dollar selloff is significant for two reasons – one that’s specific to acquiring a semiconductor firm and one that might have broader implications for large-scale tech M&A. For Broadcom, the reaction of Wall Street appears to be a penalty for it straying from a plan that had made it a favorite name among investors, who had doubled the value of the company since the start of 2016.

Much of that bullishness stemmed from the fact that Broadcom had been a disciplined financial operator, posting some of the healthiest margins in the semiconductor industry. (Recently, the company has been humming along with gross margins in the high-60% range and operating margins in the high-30% range.) It had a similarly disciplined approach to M&A, focusing on consolidating the mature semiconductor industry. That restrained strategy went out the window as it strayed into the unrelated field of enterprise software with CA.

More broadly, Wall Street’s stern reaction to Broadcom’s big bet reverses the support that investors have typically extended to acquirers in many of the tech industry’s largest transactions. In recent years, shares of buyers have largely been unmoved in the wake of blockbuster deal announcements, despite the dilution that can come with the acquisition as well as the possible integration difficulties.

But investors didn’t extend that confidence to Broadcom. In their view, the move from semiconductor giant to software provider is a step too far. 451 Research subscribers can view our full report on the massive transaction.

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

VC is looking easy this year

Mark Fontecchio

By Scott Denne

Halfway through the year, venture capitalists have already reaped a near-record amount of value from their portfolio companies. In any dissection of venture exits, a large deal or two can drive the annual total. This year is no exception, as the second-highest-priced VC exit since the dot-com days printed in May. Still, the rise in value isn’t limited to the high end of the market.

According to 451 Research’s M&A KnowledgeBase, VCs globally have sold $46.4bn worth of tech portfolio companies through the first half of the year. That’s already 45% higher than the amount from all of last year’s exits and just shy of the record for annual VC-backed sales – $50bn in 2014. Facebook’s $19bn reach for WhatsApp, the largest acquisition of a venture-funded company, led that year’s totals. Embedded in this year’s figure is the second-largest, Walmart’s $16bn purchase of Flipkart.

Still, this year’s record-setting pace isn’t propped up by a single transaction. Since 2002, only four VC portfolio companies have sold for more than $5bn – three of them came in the first half of this year. Even looking at the VC exit market without those rare $5bn-plus exits, this year’s first half generated more VC exit value than the first half in 15 of the past 16 years. In fact, more companies than ever are benefiting from higher prices. The running median value of a venture exit this year, at $123m, sits more than twice as high as last year’s median of $56m – a number that’s roughly in line with values between 2014 and 2016.

Many of the reasons for the surge are the same as those driving the broader tech M&A market toward another record, including increased activity among strategic acquirers buoyed by a tax windfall, a pageant of IPOs, the continued rise of private equity, and other trends that we’ll discuss in a webinar on Tuesday (more info here). Amplifying those trends, VCs benefit from a widespread fear of changes wrought by new technologies.

According to 451 Research’s Voice of the Enterprise: Digital Pulse, 46% of IT decision-makers predicted that digital technology would have a large impact on their companies’ markets over the next five years, compared with just 14% who forecast little or no impact. Those anticipated changes are playing out not just in the valuations, but in the type of deals getting done. Case in point: the $1.9bn pickup of oncology trial software developer Flatiron Health by Roche, a pharmaceutical firm that had never spent $100m on an information technology provider. Or Microsoft’s new tack in building software developer relationships via its $7.5bn acquisition of GitHub.

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

On track for a half-trillion

Mark Fontecchio

By Brenon Daly

Boosted by a record number of transactions valued at more than $1bn in the just-closed Q2, tech M&A spending across the globe surged to its highest quarterly level in a year and a half. The value of tech and telecom acquisitions announced around the globe from April to June more than doubled from the same period last year to $143bn, according to 451 Research’s M&A KnowledgeBase.

During Q2, private equity (PE) firms continued spending at an unprecedented rate, but it was the return of the so-called strategic acquirers that played a strategic role in driving the tech M&A market higher. Many of the tech industry’s biggest names shook off the timidity they have shown in recent years and started buying boldly once again.

Tech companies that have typically gone a long way in setting the tone in the overall M&A market accounted for 20 of the 30 tech deals announced last quarter, according to our M&A KnowledgeBase. And they paid up in the ‘three comma’ deals. Our calculations showed corporates paid an average of 6.8 times trailing sales, two full turns higher than the average 4.8x multiple paid by their financial rivals in their 10 billion-dollar-plus deals.

Undoubtedly, some of that corporate confidence to take on their financial rivals has come as their already stuffed treasuries received the windfall of this year’s tax law changes. Secure in their finances and, for the most part, posting solid growth, tech companies could afford to get adventurous in their acquisitions. To get a sense of this year’s acceleration in tech M&A, consider this: Spending so far in 2018 already exceeds the full-year totals from 2008-13, when tech companies were regaining their footing from the credit crisis.

More importantly, the trends that have pushed tech M&A to near-record levels should continue through the end of this year. At the midpoint of the year, 2018 is on track to see buyers shell out some $520bn for the tech companies they want to acquire. Assuming that pace holds in the second half of the year, 2018 would mark only the second time in our M&A KnowledgeBase that the value of announced transactions has topped a half-trillion dollars in a single year. 451 Research subscribers can look for our full report on Q2 M&A activity later today on our website.

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

Needs and wants

Mark Fontecchio

By Brenon Daly

Thinking big – and spending even bigger – has landed Josh James in a tough spot. That will become clear later this week, when the company that James heads, Domo, prices its IPO. But it’s even more clear when we compare the planned offering by the current company led by James with the mid-2006 offering by the previous company led by James, Omniture. Simply put, it’s the difference between a company going public because it wants to (Omniture) rather than because it needs to (Domo).

The IPO papers show that although the two companies have the same CEO, somewhere over the past dozen years, James lost fiscal rigor. The relatively parsimonious operations last decade at Omniture gave way to a lavish lifestyle at Domo, which has resulted in James having to tap Wall Street to keep the lights on. Consider this: in the final quarter before the offering, Domo is roughly twice the size of Omniture, but is losing 10 times more money, on both an operating and net basis.

Looking closer at the two prospectuses, it quickly becomes clear how Domo’s financials became so deeply stained in red compared with Omniture. Even in its early days, Omniture never really spent more than half of its revenue on sales and marketing. For the two years after its IPO, Omniture spent 44% of revenue on sales and marketing, a level that’s consistent with other hyper-growth SaaS vendors.

Domo, on the other hand, has spent more on sales and marketing than it has taken in for revenue on every single financial period it has reported. And, more to the point, the huge investment isn’t really paying off for Domo, certainly not the way it did for Omniture. Domo, which is reporting decelerating growth, posted just a 32% increase in revenue in its most recent quarter, while Omniture basically doubled revenue every year on its way to creating a $300m-revenue company just two years after its IPO.

Put it altogether, and Domo has piled up a mountainous $800m in accumulated deficit. In comparison, Omniture burned through just $35m on its way to Wall Street. In the current era of mega-fundings and ‘growth at all costs’ business plans, Omniture’s paltry deficit seems almost quaint. So, too, does the fact that just four banks took the company public, half the number listed for Domo and most other software IPOs these days.

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

AT&T ties data to content with AppNexus buy

Mark Fontecchio

By Scott Denne

Days after refashioning itself as a media company with the close of its Time Warner acquisition, AT&T has inked a deal to help connect its new business with its old. The telecom giant has purchased AppNexus, one of the largest independent ad-tech vendors, as it seeks to use its data-rich telecom networks to bolster ad prices for the richly funded content produced by Time Warner.

AT&T’s legacy business and its newly acquired content arm are menaced by the increasing reach of online video services and the consolidation of digital advertising among a handful of tech providers. As audiences flow online, AT&T’s wireless and satellite TV services face subscriber churn. Meanwhile, its Time Warner business must fend off Google and Facebook, which continue to syphon advertiser budgets through data-driven offerings. The acquisition of AppNexus could make AT&T competitive with those firms through ad sales tools that enable it to develop new, data-driven advertising products.

Although terms of the transaction weren’t disclosed, the target likely fetched north of $1bn. In addition to media reports of a $1.6bn price tag, AppNexus has raised venture capital above that level since 2014. And although ad-tech vendors haven’t been the most richly valued assets of late, AppNexus is a unique company in that the business is larger than most, if not all, independent ad-tech providers and it has a suite of tech products that cater to both advertisers and media companies.

As a wireless carrier and TV service provider, AT&T has an immense stock of data about media consumption habits, location and customer demographics, but few paths to monetize those assets. By owning AppNexus, AT&T can use its data to improve the value of the ads it sells via additional audience data, slice up its ad sales into more nuanced segments, and extend audience-based ad sales across AppNexus’ ad exchange.

We’ll have a more detailed report on this deal in tomorrow’s 451 Market Insight.

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

Managing an exit for Alert Logic?

Mark Fontecchio

By Brenon Daly, Scott Crawford

The field is tilted against companies trying to secure their information: they face an ever-growing number of attackers, but a shortage of defenders. To get around this imbalance, an increasing number of vendors are looking to hand off at least some of their security to other firms, which can manage headaches and heartaches that come with process. The offerings, which can range from single products all the way to broader portfolios from managed security service providers (MSSPs), have found buyers among thinly stretched CISOs. A recent survey of security professionals by 451 Research’s Voice of the Enterprise showed MSSPs ranking the second-highest increase in spending over the next year.

Against this backdrop of overall growth in the market, it’s worth noting that – unlike other areas of the information security (infosec) market – there haven’t been any significant prints recently, at least not among the pure MSSPs. According to 451 Research’s M&A KnowledgeBase, the most recent deal for a substantial MSSP came more than three years ago, when SingTel paid $810m for Trustwave. Since then, most of the M&A activity around hosted security has come from infosec vendors looking to acquire people and technology so they can offer their own product as a managed service. (For instance, earlier this month, CounterTack bought GoSecure, an 80-person startup that provides managed detection and response services.)

That could be changing. Long-rumored to be an acquisition candidate, Alert Logic would likely be the next blockbuster print in the spectrum of vendors that offer security as a service. This brings up a distinction not always clear in this space. Alert Logic is recognized by many as a provider of security SaaS, but the boundaries between that and managed security services keep getting blurrier, as traditional MSSPs move from one direction to reinforce managed services with hosted technologies, and from the other, security SaaS vendors augment their offerings with managed services. Alert Logic is among the poster children for the latter. (That approach also shows up in Alert Logic’s financials. According to our understanding, the company operates with gross margins of roughly 70%, much higher than a pure MSSP.)

Alert Logic has more than quadrupled revenue since it was recapitalized by private equity (PE) firm Welsh Carson Anderson & Stowe (WCAS) nearly five years ago. (Subscribers to the M&A KnowledgeBase can see our proprietary estimate of terms on that deal.) In addition to nearing the logical end of a holding period inside a PE portfolio, Alert Logic has also seen two top executives replaced this year. If it does trade, we estimate that Alert Logic’s price would be roughly double the amount WCAS paid, putting the transaction among the largest security services acquisitions.

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PE bags another elephant

Mark Fontecchio

By Brenon Daly

Extending this year’s record pace of private equity (PE) spending, Siris Capital plans to pay $2bn to take Web.com private. The transaction matches the largest deal Siris has made, according to 451 Research’s M&A KnowledgeBase. Debt-heavy Web.com, which has been public since 2005, has struggled with a declining number of subscribers in recent quarters.

The web hosting vendor has been slowly reorganizing its operations in recent quarters, and Siris’ offer reflects its transition. Terms call for the buyout shop to pay $25 for each share of Web.com, below the company’s share price last October. There’s a six-week ‘go shop’ included in the agreement, with the transaction expected to close in Q4.

Siris’ reach for Web.com marks the 10th deal announced by PE firms so far this year valued at $2bn or more. That nearly matches the total number of 11 similarly sized transactions announced in the first half of the two previous years combined, according to the M&A KnowledgeBase.

Of course, as active as the financial acquirers have been, they still have some distance to go to catch up to their corporate rivals, which had been largely unchallenged in the tech M&A market until just a few years ago. The M&A KnowledgeBase shows these strategic buyers have already announced 20 deals valued at $2bn or more this year. (451 Research subscribers can see more on the relentless rise of PE and the impact it is having on the tech landscape in our special two-part report: Part 1 and Part 2.)

Still, the dramatic increase in elephant hunting by PE firms is changing the top end of the tech M&A market. Of course, that is being driven by the unprecedented amount of capital buyout shops have to put to work. Estimates for the total amount of dry powder available to PE firms to go shopping in the tech industry is estimated in the hundreds of billions of dollars, with a handful of tech-focused shops raising single funds that top $10bn. Several other buyout firms have announced multibillion-dollar funds of their own. On top of that, the leverage available to PE shops multiplies their true purchasing power.

Buyout firms are putting that money to work at a record rate. Already this year, they have announced $71bn worth of transactions, according to the M&A KnowledgeBase. For perspective, that’s almost three times the average amount spent in the first half of the years since the start of this decade.

PayPal adds marketplace payments with $400m reach for Hyperwallet

Mark Fontecchio

By Jordan McKee

PayPal has shelled out $400m for Hyperwallet to improve its ability to serve the wide variety of marketplace businesses – from Expedia to Uber to Amazon – that have emerged in recent years. Marketplaces are growing rapidly and have more advanced payment needs than the average e-commerce business given their global nature and multiple stakeholders that are part of the transaction. PayPal has existing capabilities in marketplace payments, in part through its $800m acquisition of Braintree in 2013, but lacked a holistic platform and advanced capabilities. The gap it created allowed numerous marketplace payment specialists to emerge and scale, including Stripe, Adyen and YapStone.

Hyperwallet, which was founded in 2000 and has roughly 200 employees, has favorable margins on international payments with strong growth. Most importantly, the target brings PayPal a robust payout platform that can disburse funds in various ways to marketplace participants in upwards of 200 countries. Coupled with PayPal’s 218 million active consumer accounts, this should create the basis for a unique and highly efficient disbursement offering. Hyperwallet should complement PayPal’s Braintree business unit, with Hyperwallet CEO Brent Warrington reporting to Braintree head Juan Benitez when the deal closes, expected in Q4.

At its May investor day, PayPal’s CFO emphasized the importance of inorganic growth for the company’s long-term strategy, laying out plans to tap its strong balance sheet and spend $1-3bn annually on deals over the next few years. PayPal has a favorable position in the market but is facing mounting competitive pressure, especially on the merchant side of its business, which has been hit hardest by some of the above-mentioned entrants. In recent years, PayPal’s merchant capabilities have begun to lag market leaders, creating obvious gaps in its platform. With purchases in the past 30 days of iZettle for $2.2bn (SMB brick and mortar payments), Jetlore (commerce software) and now Hyperwallet (marketplace payouts), the company has wisely chosen to focus its M&A budget on merchants in an effort to deepen and diversify its value proposition.

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

MIPS takes Wave to the edge

Mark Fontecchio

By John Abbott, Scott Denne

Eyeing a move from training to endpoints, Wave Computing has acquired MIPS Tech, a pioneer in the development of RISC processors. The target, recently spun off of Imagination Technologies, provides the buyer, a designer of artificial intelligence (AI) semiconductors, the chance to sell its wares more broadly as organizations look to run AI algorithms directly on the endpoint.

Founded in 2010, Wave is one of multiple startups producing accelerators for AI workloads, and one of a smaller select group (along with Cambrian Systems, Cerebras Systems, Graphcore and Horizon Robotics) that have already raised over $100m in venture funding. Wave emerged from stealth in 2016 and made its compute appliance for training neural networks available to early-access customers in 2017. In March, Wave said it would be using the MIPS core as the integrated CPU within its next-generation Dataflow Processing Unit.

We noted in a previous report that MIPS would likely prove a valuable asset for AI applications. It’s been in business since the 1980s and has a significant embedded systems user base and a range of extensible cores. Once owned by SGI, MIPS ended up as part of UK-based GPU maker Imagination Technologies, but when Imagination was sold to China-based investor Canyon Bridge Capital Partners, US-based MIPS had to be divested separately to Tallwood Venture Capital for $65m. Tallwood is also an investor in Wave.

It’s likely that the power-efficient MIPS cores will be useful for the development of inference processors within edge devices, giving Wave an end-to-end story beyond its initial training focus, increasing its potential total addressable market significantly. MIPS will continue to be run as an independent unit, and will continue licensing its cores to third parties. 451 Research’s recent VotE: Internet of Things report shows that many companies are already making advanced calculations right on the endpoint – 40% of respondents claimed to run data analysis, cognitive computing or AI at the network edge or perimeter.

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