Author: Mark Fontecchio

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

Dealmakers immune to ‘World Cup flu’

Mark Fontecchio

By Brenon Daly

With the World Cup kicking off today, economists are once again totting up the billions of dollars in worker productivity they estimate gets lost to viewing the quadrennial soccer tournament. We’ll leave the broader macroeconomic calculations, which have increasingly come into question in recent years, to those with bigger spreadsheets than us. How they come up with the precise cost of watching Messi and Ronaldo do their thing on the field would appear to be driven more by spongy anecdote than hard data.

As a counter to the forecasts of distraction and idleness during the World Cup, we would note that in our world of tech M&A, it turns out people can actually strike deals while watching players strike a soccer ball. In fact, our numbers for the previous event indicate that tech acquisition activity actually accelerated a little during the month-long period where employees supposedly tuned out their work and tuned into the largest sporting event. Dealmakers appear to be immune to the ‘World Cup flu.’ Looking back to the previous World Cup, which ran from mid-June 2014 to mid-July 2014, acquirers announced 340 tech transactions valued at $36bn, according to 451 Research’s M&A KnowledgeBase. That four-week total was slightly ahead of the average monthly level during 2014 of 332 deals worth $33bn. Nor did deal flow dry up immediately after that year’s World Cup. The M&A KnowledgeBase shows an unusual level of consistency of monthly activity from June to September of 2014, with monthly spending ranging within a tight band of $31-37bn.

Looking further back to the 2010 event hosted by South Africa, the World Cup didn’t have any discernable impact on tech M&A, despite the annoying sounds of the vuvuzela echoing around the globe. The June and July monthly totals almost exactly matched both the average number of tech deals and spending during that year, according to the M&A KnowledgeBase. The following month of August registered the highest monthly acquisition spending level of the entire year. So if any dealmakers are among the estimated 3.4 billion people who plan to cast at least one eye on the World Cup over the next few weeks, they can know that in years past, it’s been business as usual while the games go on.

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Growth’s rich rewards

Mark Fontecchio

By Brenon Daly

With public market investors handing out sky-high valuations for software vendors that are coming public, the debutants are under a fair amount of pressure to start strong on Wall Street. So far in their inaugural reports as public companies, the class of 2018 has delivered. All four enterprise software providers – which are growing, on average, nearly 50% – have kept their businesses humming along as they have stepped onto the NYSE and Nasdaq.

In other words, the newly public software companies (Dropbox, Zuora, Smartsheet and DocuSign) are keeping their end of the bargain they struck with investors during their IPO to post growth that’s well above the market average. In return, Wall Street is continuing to value them at a level that’s well above the market average. Valuations for the quartet range from roughly 10-22 times trailing sales, averaging almost 18x. That’s a richer valuation than virtually any of the existing SaaS kingpins, and three or four times the public market valuations for conventional software vendors.

That run of outsized rewards for above-market growth for enterprise software IPOs appears all but certain to end when Domo comes public in a few weeks. The reason? Domo is decelerating. In its most-recent quarter (ending in April), the BI startup reported 32% growth, down from the high-40% range for both the year-ago quarter as well as the full fiscal year. The slowdown at Domo means the company is now growing at only about half the rate of the two other similarly sized enterprise software providers that have come public in 2018, Smartsheet and Zuora.

Of course, Domo faces a more existential concern than how much revenue it adds each quarter. As we noted in our full report on the planned IPO, the company has spent itself into a hole and needs the money from the offering to get out of it. At current rates, Domo has only enough cash in the bank to keep the business going for two quarters. Wall Street knows that and will price it into offering. Unlike this year’s other software debutants, Domo – with its slowing growth and dwindling treasury – will get discounted when it comes to market.

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The healthy state of healthcare IT M&A

Mark Fontecchio

Contact: Mark Fontecchio

Healthcare IT M&A has passed its recent quarterly checkup with flying colors. Massive high-multiple acquisitions by strategic buyers resulted in a record quarter of M&A value in the sector. The consolidation comes as healthcare enterprises are pulling back spending.

Purchases of healthcare IT targets totaled $6.1bn in the first quarter, significantly above any previous quarter in 451 Research’s M&A KnowledgeBase. The deals also occurred at higher multiples. Inovalon’s $1.2bn pickup of ABILITY Network – one of four $1bn+ transactions last quarter – valued the target at 8.6x trailing revenue. That’s the highest multiple on any healthcare IT acquisition in the M&A KnowledgeBase, and several turns higher than the 3.9x median for the previous five years.

At the same time, 28% of healthcare enterprises expect IT spending to decrease this year. That’s more than any other vertical, according to 451 Research’s Voice of the Enterprise: Digital Pulse, Budgets and Outlook survey. Strategic acquirers accounted for more than 60% of healthcare IT M&A spending in Q1, upping activity through the first quarter as they seek to expand their portfolios in search of cross-selling opportunities and battle for every available dollar.

Case in point: Inovalon’s purchase of ABILITY Network brings the buyer healthcare data analytics, as well as 44,000 provider customers. Also, the $100m acquisition of Practice Fusion and its 30,000 customers should help Allscripts extend its electronic health records software into smaller medical practices.

The indications are already there that M&A spending on healthcare IT will continue this year. Two days into the second quarter, Veritas Capital agreed to pay $1.1bn for healthcare IT assets from GE Healthcare. The private equity firm has a history of buying healthcare IT firms and then selling them off after a couple of bolt-on acquisitions.

Hosted services M&A sees another $15bn+ year

Mark Fontecchio

Contact: Mark Fontecchio

Hosted services M&A in 2017 had a second consecutive year of $15bn+ in spending, an unprecedented streak in the sector. While overall tech M&A spending dropped steeply, it was essentially flat in hosted services. Meanwhile, the median deal value rose as smaller and medium-sized players decided on sale or scale to survive, and as targets grew scarce, acquirers paid higher multiples.

An indicative transaction of these sector trends was also the largest of 2017 – Digital Realty Trust’s $6bn purchase of DuPont Fabros. The past three years have been rich with big-ticket deals in hosted services, but this acquisition stands out because of its outsized multiples – 14x trailing revenue and 23x EBITDA. Those are the highest-ever multiples in $1bn-plus hosted services transactions in 451 Research’s M&A KnowledgeBase, which dates back to 2002.

Digital Realty’s reach for DuPont Fabros was not an isolated incident, either. Three of the four highest value-to-revenue multiples in $100m+ hosted services deals happened in 2017, according to the M&A KnowledgeBase. Overall, the sector’s median EBITDA multiple of 16.1x was the highest since 2012. Three consecutive years of more than $10bn in deal value has consolidated more than 10 million square feet of operational space, according to 451 Research’s Datacenter KnowledgeBase. That has removed many big players from the market, making larger targets scarcer, and thus more valuable in 2017.

In 2018, we expect hosted services M&A to continue to be robust to account for enterprises increasingly pushing workloads to the cloud. According to a 451 Voice of the Enterprise survey last year, the percentage of IT workload spending in the cloud is expected to jump from 27% in 2016 to 46% in 2018. Managed hosting and colocation providers must scale vertically – offering more services – and geographically to suit enterprise needs for functionality and availability, respectively. Large public hosted service providers that are still on the market could fetch a premium, while thousands of smaller players could sell or merge with one another to become competitive.

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Crown Castle pays big for small cells

Mark Fontecchio

Contact: Mark Fontecchio

Crown Castle International shells out $7.1bn for fellow cell tower company Lightower Fiber Networks in the latest and largest of a flurry of acquisitions by the buyer to expand its small-cell coverage in the US. The purchases, made at above-market multiples, come as Crown Castle builds out infrastructure to support mobile operators dealing with surging data traffic.

With Lightower, Crown Castle obtains a larger network of cell towers, small-cell nodes and fiber deployments concentrated in the Northeast. Crown Castle has now spent $10.7bn on M&A in three years to build its small-cell network in the Northeast, southern California, Florida and Texas through acquisitions such as FiberNet ($1.5bn) and Sunesys ($1bn).

In the process, Crown Castle has spent more on M&A since 2014 than it had in the entire preceding decade and paid rich multiples along the way. According to 451 Research’s M&A KnowledgeBase, purchases of tower and fiber targets since 2014 carried a median valuation of 3x trailing revenue. Today’s pickup of Lightower values the target at about 9x, in the same neighborhood as Crown Castle’s other small-cell deals.

Why the premium? As we discussed in a December report, mobile networks face escalating demand as consumers increase video consumption and enterprises deploy mobile cloud apps. To keep up with that data demand, operators are increasingly turning to small-cell deployments.

Morgan Stanley advised Crown Castle on the transaction, while Citigroup Global Markets and Evercore Partners banked the seller.

No more caution flags with autonomous vehicle M&A

Mark Fontecchio

Contact: Mark Fontecchio, mark.fontecchio@451research.com

Autonomous vehicle (AV) targets are in the driver’s seat again, this time with Ford Motor’s majority acquisition of software firm Argo AI through a five-year, $1bn investment. The finish line for Ford is 2021, when it aims to roll out a fully autonomous vehicle. To get there, Ford plans to combine its existing self-driving tech with Argo’s artificial intelligence (AI) and robotics software.

Before 2016, Ford had only made one tech purchase in the previous decade, for software to connect smartphones with in-car entertainment. Then last year – a year when tech vendors including Google and Uber were already testing self-driving cars on the roads of Pittsburgh and elsewhere – Ford awoke, buying computer vision and machine-learning software firm SAIPS. That deal followed similar moves by its peers in 2016, as Toyota nabbed Jaybridge Robotics and General Motors paid $581m for self-driving navigation systems provider Cruise Automation.

Auto manufacturers are far from the only companies – or even the only non-tech companies – inking transactions in this space. We are also seeing activity from automotive parts suppliers like Continental AG and Delphi, both of which made an AV acquisition in the past two years, as well as tech vendors such as Google, Uber, Intel, HARMAN and TomTom, the last of which purchased a company in the sector called Autonomos just last month. According to 451 Research’s M&A KnowledgeBase, there have been 20 acquisitions of AV tech since the start of last year, compared with just six in the four years before that.

We highlight AI and machine learning in our 2017 Tech M&A Outlook for application software, as we predict that companies will buy technology and expertise in this area. Subscribers to 451 Research’s Market Insight Service can also access our report on M&A trends and predictions in AI and machine learning.

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

CenturyLink connects with Level 3 in 2016’s largest telecom deal

Mark Fontecchio

Contact: Mark Fontecchio

CenturyLink makes a move to the other side of the deal table, shelling out $24bn for Level 3 Communications in an attempt to expand its portfolio of business services as the datacenter market awaits an announcement on the fate of the company’s colocation business. Today’s transaction marks a big bump in telco M&A spending for the year. The acquisition is 2016’s largest telecom consolidation play by a factor of 10, although it would be less than half the biggest in either 2015 or 2014.

The purchase is uncharacteristically sizable for CenturyLink, which had a market cap of about $16bn before the announcement. The company had only paid beyond $10bn once before, when it bought Qwest Communications in 2010. Its next-largest purchase, the $5.8bn reach for EMBARQ in 2008, was a similar pickup of a consumer-focused telco. Most of CenturyLink’s recent investments have aimed to bolster its business services. Yet the only time it’s spent more than $1bn on such an effort was the $2.5bn acquisition of Savvis in 2011, some of which could be undone when it finishes exploring ‘strategic alternatives’ for its shrinking colocation unit – a process that it says will still wrap up this quarter.

CenturyLink will pay 60% of the cost of Level 3 in stock and the rest in cash. That dilution helped push the company’s stock price down 12% following the deal announcement. Including debt, the purchase values the target at $34bn, or 4.1x trailing revenue. That’s the second-highest multiple among the nine $10bn+ telco deals in the past half-decade, according to 451 Research’s M&A KnowledgeBase. The healthy valuation is certainly not due to recent growth, as Level 3’s revenue is flat.

What CenturyLink does obtain is an international footprint (20% of Level 3’s revenue is generated outside the US), an extensive fiber network and expanded revenue from businesses. Inclusion of Level 3’s revenue bumps CenturyLink’s enterprise sales to 75% from 64%. This acquisition is being driven as much by financial considerations as strategic ones. CenturyLink will inherit $10bn of net operating losses and gain an estimated $975m in cost reductions when the transaction closes, which is expected in the second half of next year.

The deal is the third-largest telco consolidation play in the past eight years, behind Charter Communications buying Time Warner Cable and AT&T nabbing DIRECTV. It significantly expands what had previously been a lean year for telecom M&A, with this single transaction nearly doubling the total amount that telcos have spent on acquisitions in 2016, to about $50bn. Compare that with 2014 and 2015, during which telcos spent an average of $150bn on purchases, according to the M&A KnowledgeBase.

Bank of America Merrill Lynch and Morgan Stanley advised and Evercore Partners provided a fairness opinion to CenturyLink on the deal, while Citigroup Global Markets advised and Lazard provided a fairness opinion to Level 3.

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Qualcomm buys NXP in biggest chip deal ever

Mark Fontecchio

Contact: Mark Fontecchio, John Abbott

All the chips get pushed to the middle as Qualcomm agrees to acquire NXP Semiconductors for $39.2bn. The massive deal is the largest ever in semiconductors, and the second-biggest non-telco tech transaction in the past decade, according to 451 Research’s M&A KnowledgeBase. It is also magnitudes larger than Qualcomm’s previous high-water mark, the $3.6bn purchase of Atheros in 2011.

Qualcomm and NXP’s combined portfolio looks unusually synergistic. The buyer is dominant in smartphones and wireless networking, while the target has leading positions in automotive (self-driving cars and in-car entertainment) and the Internet of Things (including mobile payments, security and sensors). Those are two major market segments where Qualcomm can apply its long-standing mobile expertise. A side benefit is that the addition of NXP will increase the number of components Qualcomm can sell to its existing smartphone customers. The recently introduced Snapdragon Neural Processing Engine and Zeroth Machine Intelligence Platform may also help extend NXP’s existing autonomous car activities. NXP has its own manufacturing fabs, while Qualcomm is mostly fabless, but there’s plenty of room for flexibility between the two models due to the range of devices in the catalog.

Today’s deal marks the fifth $15bn+ chip purchase since the start of 2015. NXP is valued at 5.5x trailing revenue. That’s well past the 2.5x median multiple on billion-dollar chip transactions in the past five years and right in the middle of the pack of the recent $15bn+ deals (see chart below).

According to the KnowledgeBase, semiconductor M&A since 2015 has seen four quarters of relatively modest activity ($28bn total) bookended by four quarters – two at the start of 2015, and two at the end of this year – of massive value totaling more than $165bn. The scale of recent consolidation in the semiconductor industry has been astounding. The nearly $90bn in M&A spending we saw last year was more than the previous four years combined. And now, remarkably, value in 2016 has already crested $100bn with two months to go.

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Motorola motors toward public-sector software and services

Mark Fontecchio

Contact: Scott Denne, Mark Fontecchio

Motorola continues to look to software and services to rescue its hardware business. The acquisition of Spillman Technologies is the latest in a string of such deals by the radio communications company, which has spent the past five years getting back to its legacy business in public safety through a spinoff and several divestitures. Those moves brought it relief from several price-sensitive commodity markets but left it in one with little growth – there aren’t a lot of new fire departments and police stations that have yet to invest in a radio system.

Acquiring Spillman Technologies, a developer of dispatch and records management software for police and fire agencies, gives Motorola a software offering to push into a sector where it’s entrenched. That’s similar to the rationale behind its two other recent software purchases: PublicEngines and Emergency CallWorks.

In addition to market maturity, weakness in foreign sales has also pushed down revenue for Motorola’s hardware products, yet its managed services business has grown. Its $1.2bn acquisition of Airwave Solutions in February drove 26% year-over-year growth in its services segment last quarter (organically, that unit grew in the low-single digits). While services still makes up less than half of its roughly $6bn topline, the combination of Motorola’s hardware and existing network management services along with Airwave’s network management business provides it a channel through which it can push new offerings and grab share in a market it already dominates. Motorola’s public-safety business is 10 times the size of Harris, its nearest competitor.

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A dimming Active Power looks to sell

Mark Fontecchio

Contact: Mark Fontecchio

Active Power, which produces flywheel-based uninterruptible power systems (UPS) for datacenters, is seeking a buyer. In conjunction with a dismal Q2 earnings release, Active Power announced that its board is reviewing “strategic and financial alternatives” that could include new investors, pivoting to a different business or selling the company. However, based on its own financial performance as well as previous transactions in this niche market, any deal would be a tough sell for Active Power. It currently sports a market cap of just $9.5m, having lost about two-thirds of its value so far this year.

The stock’s slump has mirrored the company’s declining financial performance. In the first half of 2016, Active Power’s revenue has plummeted 45% year over year to just $16.4m. More alarmingly, losses more than tripled to $5.7m, leaving it with only about half as much cash as it had two years ago. While large orders for backup power systems can significantly affect short-term results, the company’s financial performance over the past year shows uninterrupted red ink and a dipping top line.

Active Power says deferred deliveries and delayed orders were cause for the decline. This is just the latest indication that flywheel-based UPS are not yet widely accepted. Despite their smaller footprint and longer lifetime, there is a combination of resistance ‎to change in the datacenter industry, a fear of shorter ride-through times compared with batteries, lower availability in the channel, and the fact that financial prudence is still rather new to datacenter operations. Further, the smaller flywheel-based UPS vendors have been at a competitive disadvantage as they have gone against giant battery UPS sellers such as Schneider Electric and Emerson Network Power.

The difficulties around selling flywheel UPS have already pushed two small companies into what appear to be distressed deals. Pentadyne’s disintegrating sales led the company to divest its manufacturing business in 2010 to Phillips Service Industries, a government contractor that was one of its customers. It was rebranded and now sells as POWERTHRU. Meanwhile, in 2014 Vycon sold to and is now a subsidiary of Calnetix, which makes generators and other power systems in and out of the datacenter.

As for who might acquire Active Power, we struggle to come up with many buyers. Private equity firms might view the company’s offering as ‘tried and failed’ and it could also be suffering from pitch fatigue as it’s been in the market for about 20 years without a breakthrough. Major industry players such as Schneider Electric’s IT division, Emerson Network Power and Eaton might have even less appetite, as Active Power’s flywheel competes head-on with battery UPS. We see two potential avenues for Active Power to pursue beyond datacenters: generator manufacturers and vendors with a focus on micro-grids.

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