Author: Mark Fontecchio

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

Busy with ‘things’

Mark Fontecchio

by Brenon Daly

Big things are forecast for the Internet of Things. IoT spending is expected to nearly quadruple over the next five years, topping a half-trillion dollars. To get a place in that massive market, acquirers have gone on an unprecedented shopping spree so far this year.

Already in 2019, tech titans including Microsoft, Intel and Facebook have picked up some ‘things.’ Altogether, 451 Research‘s M&A KnowledgeBase lists more IoT transactions in the first 10 months of this year than any other full year in history. Overall, our data shows 2019 deal volume in the sector will roughly double from 2014, while soaring tenfold from the start of the decade, when the IoT trend was first taking off.

To look deeper at the rapidly emerging IoT market, 451 Research will be hosting a special event next week focused on the technology and implementation trends that are spurring the record M&A activity. (Clients can register for our Cycle of Innovation Summit in Boston next Tuesday morning (11/5) on the event’s website.) During the Summit, we will be highlighting a number of key forecasts for the IoT market, including:

Right now, more than four of 10 IT professionals (43%) tell us they already have IoT technology deployed, according to a recent survey from 451 Research‘s Voice of the Enterprise: Internet of Things, Organizational Dynamics 2019. Further, almost as many survey respondents (39%) say they either have a proof of concept ongoing or will have something up and running within the next year.

As to what those future IoT deployments will be doing, the market for ‘things’ is going to tip heavily toward businesses in the coming years. The current IoT sector is evenly split between consumer and business, according to a recent 451 Research Market Monitor study. However, as more industries connect more of their business, our Market Monitor forecasts the B2B IoT segment will grow at twice the rate of the B2C IoT sector. By 2024, enterprise spending will account for 70% of the overall IoT market, with consumer spending just 30%.

Again, we look forward to seeing many of you – investors, IT professionals and entrepreneurs – at our Cycle of Innovation Summit in Boston next week, as we look at how companies are building value in the IoT market.

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Few ripples from Big Blue’s big deal

Mark Fontecchio

by Scott Denne

IBM’s $33.4bn acquisition of Red Hat – announced a year ago today – propelled an already heated market for IT infrastructure management targets to a stratospheric level. But that corner of the tech M&A sector has cooled precipitously since then, with this year tracking toward the lowest point in a decade as the most stalwart buyers back away from the space.

It wasn’t just Big Blue’s purchase that drove infrastructure management M&A in 2018 to a record $94.4bn – about 10x the amount we see in a typical year, according to 451 Research‘s M&A KnowledgeBase. Seven other strategic buyers spent $1bn or more on acquisitions in infrastructure management, although few of those are likely to continue to make big IT management deals. Salesforce’s $6.6bn pickup of MuleSoft was a one-off as that company typically buys other SaaS products. And Broadcom’s $18.9bn reach for CA, and subsequent moves to boost the target’s cash flow, took out one of the most active acquirers of infrastructure management.

The buyers that typically drive up the totals have been quiet this year and spending on the category sits at $5.9bn for 2019 – the lowest since 2009, our data shows. The IT infrastructure market is in the middle of a major transition driven by the continued expansion of cloud computing. According to 451 Research‘s Voice of the Enterprise: Digital Pulse, nine of 10 organizations are moving, rebuilding or updating their IT stack to run mission-critical workloads on more modern infrastructure.

But the move to cloud computing (public, private or hybrid) is well underway, leaving legacy vendors with a choice between making a massive bet to keep up (as IBM did by nabbing Red Hat and VMware is doing through a steady pace of hybrid and multi-cloud purchases) or shifting to ancillary areas. Cisco, for example, continues to actively acquire companies, although most of its recent transactions have been in support of its security and enterprise collaboration businesses. Or Citrix, whose last deal, the $200m acquisition of Sapho in 2018, expanded its Workspace line of products.

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Same transaction, very different valuation

Mark Fontecchio

by Brenon Daly

Two deals, both of them multibillion-dollar take-privates by buyout shops in the past week that, once completed, would return the targets to private equity (PE) portfolios after a brief stint as public companies. But that’s pretty much the end of the similarities between Cision and Sophos. There’s an ocean between the headquarters of the two vendors, and an ocean of difference between the two leveraged buyouts (LBOs).

Start with the headline valuation. Sophos is going private at 5.5x trailing sales, fully two turns higher than Cision’s 3.5x, which is more in line with prevailing LBO multiples. On a cash-flow basis, Sophos is garnering even more of a premium. (See more on Sophos‘ valuation in our report on the pending LBO.)

By our count, Thoma Bravo is paying 48x EBITDA for Sophos, almost three times richer than the 17x Platinum Equity Partners is paying for Cision, according to 451 Research‘s M&A KnowledgeBase. (We write that knowing that our EBITDA figures are far lower than the ‘adjusted’ figures that buyers and their bankers tend to use. For instance, we calculate Cision’s trailing EBITDA at $158m, while the company has guided for 2019 ‘adjusted EBITDA’ of about $270m. For most of the financial community, which tends to look through more costs than we do, Cision is a ’10x deal.’)

Whatever the exact numbers, it’s fair to say that Sophos is fetching an above-market valuation while Cision is more representative of what PE typically pays in LBOs. That’s fitting because, in many ways, Cision is generally thought of as the type of vendor that PE firms like to LBO. Broadly speaking, Cision – unlike Sophos – is a ‘value’ play that appears a bit out of place on growth-focused Wall Street.

In fact, Cision, which is a classic sponsor-backed rollup, only made it to the NYSE through a most unusual route: a so-called ‘blank check listing’ in mid-2017. Since then, the M&A KnowledgeBase shows it has spent $440m on four acquisitions. (For comparison, in that period, Sophos has only purchased three small startups.)

During its time on Wall Street, the rollup did little to distinguish itself. Platinum Equity is taking Cision off the Big Board at roughly the same price it came on. In contrast, Sophos gave public market investors more of what they wanted, roughly tripling its value on the LSE. Two very different companies, with two very different outcomes.

PE’s exit problem

Mark Fontecchio

by Scott Denne

Private equity (PE) exits are declining faster than at any time since the financial crisis. The change comes, in part, as PE firms, the most prominent source of exits for their peers, are slowing their purchases (a trend we covered recently). Yet it’s the disappearance of strategic acquirers that is most responsible for diminishing sales of PE portfolio companies.

After four consecutive years of growth, sales of tech vendors owned by PE shops are on pace to drop 24% from last year’s high. The rise in secondary deals (sales of companies from one sponsor to another) drove most of the previous year’s accelerating pace of exits (and now account for almost two of every three acquisitions of PE-backed vendors). But the vanishing strategic buyers are responsible for the largest decline in PE exit volume.

According to 451 Research‘s M&A KnowledgeBase, 2019 is likely to become the first year since 2014 when strategic acquirers purchase fewer than 100 companies from financial sponsors, doing 34% fewer pickups of PE portfolio vendors than last year. Yet this isn’t part of an overall falloff in strategic M&A – those buyers are printing overall tech transactions at roughly the same pace as last year, our data shows.

But the types of deals they’re doing have changed. Strategic acquirers appear to have lost much of their appetite for the high-multiple growth companies that have become a staple of PE tech M&A in the past couple of years. So far this year, we’ve only tracked 72 acquisitions where a strategic buyer paid 4x trailing revenue or more, roughly 20% fewer than they did at this time in 2018.

The shift away from the expensive end of the tech M&A market comes as the number of businesses missing their sales targets continues to expand throughout this year. According to 451 Research‘s Voice of the Enterprise: Macroeconomic Outlook, the number of respondents who say their organization’s revenue is ahead of their sales plan has dropped each quarter since September of last year. In the most recent edition of that survey, more respondents (24%) said sales were below plan than those that said sales were above plan (18%) for the first time since early 2017.

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Battered by Brexit

Mark Fontecchio

by Brenon Daly

Despite EU and UK leaders agreeing to terms on the country’s departure from the larger political and economic body, there’s still no actual Brexit. A weekend vote on the accord now looms large in the British Parliament, with early forecasts indicating the hard-won deal will likely struggle to get final approval. Parliament rejected a similar agreement earlier this year.

Regardless of whether the ‘ayes’ or the ‘nays’ carry the vote about the EU bloc, Brexit has already notably diminished the UK’s standing in another large marketplace: tech M&A. British buyers as well as British sellers in 2019 are on pace to announce their fewest tech deals in a half-decade, according to 451 Research‘s M&A KnowledgeBase. The slowdown there is being felt much more broadly, since our data shows the UK has perennially ranked as the second-busiest M&A market in the world.

Deal volume – both on the buy- and sell-side – is on track this year to drop about one-quarter from the recent highs they hit. Incidentally, our M&A KnowledgeBase indicates that tech M&A in the UK peaked in 2015 – the year before the Brexit vote. Since the contentious vote in mid-2016 and the still-unresolved results, the number of British tech prints has dropped every year.

Somewhat unexpectedly, however, recent M&A spending has clipped along at exceptional levels. Based on annualized totals for year-to-date activity from our M&A KnowledgeBase, British buyers will spend a record amount on tech acquisitions in 2019, while spending on acquired UK-based tech companies is on pace for its second-highest annual level.

For dealmakers, Brexit has essentially meant fewer bets but much bigger bets. As an example, consider this week’s take-private of British endpoint security vendor Sophos. To erase Sophos from its home on the London Stock Exchange, Thoma Bravo is paying $3.8bn. To put that price into context, the Sophos take-private is more than the combined price of the buyout firm’s two next-largest information security LBOs.

As the sale of Sophos also shows, deals can still be struck in times of uncertainty, but extra work is required. More than three years since the original decision, Brexit has left open vexingly large questions for businesses, such as taxation rates, employee permits and supply chains. All of those have a direct impact on a company’s valuation, which is the key consideration in all acquisitions. Fittingly enough for the contentious three-year Brexit process, the British Parliament’s vote this weekend may only add to the volatility.

A change of seasons in tech M&A

Mark Fontecchio

Rising global uncertainty coupled with slowing economic growth combined to knock Q3 spending on tech acquisitions to the lowest quarterly level in nearly two years. Buyers around the world announced tech purchases valued at just $96bn from July to September, according to 451 Research‘s M&A KnowledgeBase. (451 Research subscribers can look for our full report on Q3 M&A activity on our site later today.)

The late-summer slowdown, where Q3 spending declined 25% from this year’s two previous quarters, has effectively removed 2019 from the top rank of tech M&A. Our data indicates that full-year 2019 is now on track to fall more than $100bn lower than recent strong spending years. That drops this year from an exceptional one to merely above-average.

To put some numbers on that, the third-quarter slump snapped the unexpectedly strong start to 2019 and, more symbolically, it likely ended this year’s march to top a half-trillion dollars of acquisition spending. Dealmakers had been very much on track for that significant $500bn+ threshold through the first half of this year. But now, with the change of seasons, it looks increasingly out of reach. Again, we’ll have a full report on Q3 M&A activity – including the quarter’s top prints, recent trends in private equity dealmaking and how the broader macroeconomic economy is shaping tech acquisitions – on our site later today.

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Run this search in the M&A KnowledgeBase to see more detail.

Venture’s Vista

Mark Fontecchio

With Vista Equity Partners’ acquisition of a majority stake in Acquia, private equity (PE) firms are now on pace to deliver as many exits to VC funds as the previous record year. It’s appropriate (although maybe not surprising) to see a deal by Vista pushing PE purchases of startups toward a record streak – it has bought more of them than any of its peers.

According to 451 Research‘s M&A KnowledgeBase, Acquia marks Vista’s 55th acquisition of a venture-funded company since the start of this decade. Only Cisco, Google and Microsoft have picked up more startups during the same time. And this year, Vista has been far more prolific, having printed nine such transactions, compared with six each from 2019’s next-most-prolific buyers of startups (Microsoft and VMware).

Last year, PE firms purchased 147 startups, 53% more than any other year, our data shows. With today’s announcement, sponsors are on pace to match that total, having bought 108 so far. In the overall tech M&A market, buyout shops are on pace to print 5% fewer deals than they did last year. The decline itself is hardly noteworthy – even if the year ended today, PE firms would have acquired more tech vendors in 2019 than they did in all but two other years.

But the growing ratio of VC-backed companies does show that the PE playbook continues to swing toward buying growth companies and adding value to them through bolt-on acquisitions. There’s every indication that Vista will run that playbook on Acquia. It’s a common strategy for Vista – of its 55 purchases of startups, 36 have been acquisitions done by its portfolio companies. Also Acquia, an open source content management software developer (subscribers to the M&A KnowledgeBase can see our estimate of Acquia‘s revenue here), has recently become an acquirer in its own right, having inked two transactions since May.

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A suddenly healthy market for healthcare machine learning

Mark Fontecchio

by Michael Hill

Faster medical research, improved diagnosis and efficient patient monitoring were early and oft-touted examples of the changes that machine learning could bring. Despite that, there’s been little demand for acquisitions of machine learning vendors in the healthcare vertical. Or at least that was the case. This year, healthcare machine learning deals have suddenly accelerated as strategic buyers have begun seeking bolt-on acquisitions to keep up with customer demand.

According to 451 Research‘s M&A KnowledgeBase, nearly half of all machine learning purchases in the healthcare market have printed since the start of 2019. This year has seen 15 acquisitions of machine learning companies where the acquirer or target (often both) are selling into the healthcare vertical. Prior to this year, there hadn’t been more than six such deals in a single year.

Healthcare machine learning transactions in 2019 have largely been characterized by a mix of veteran and first-time strategic buyers reaching for emerging tech targets to complement their existing offerings in line with their customers’ needs. For example, Royal Philips added Medumo’s machine learning patient monitoring software to its healthcare IT suite as a survey by 451 Research’s Voice of the Enterprise finds that ‘patient monitoring’ ranked at the top of multiple healthcare applications of machine learning, with 46% of healthcare respondents citing it as a use case for machine learning.

Nearly one of three survey respondents cited ‘clinical trials’ as an application of machine learning, which aligns with the rationales behind five of this year’s deals. And while the applications of machine learning in healthcare are coalescing, adoption remains nascent. Fewer than one of five healthcare providers claims to be using machine learning today.

Figure 1: Healthcare industry-specific machine learning use cases deployed today

Monetary policy and its discontents

Mark Fontecchio

by Brenon Daly

What if the US Federal Reserve cut interest rates and nobody noticed? Or, worse, what if the central bankers cut twice, and still no one noticed? That appears to be the case as the Fed trimmed its benchmark rate last week for the second time in two months. Following the latest easing, markets gyrated a bit but basically shrugged off the move.

The collective shrug comes, at least in part, because the central bankers are looking to solve a problem that doesn’t really exist. At least it’s not a problem that’s weighing heavily on US businesses. In a summer survey of roughly 1,100 North American business employees by 451 Research concerning a host of business considerations as well as overall macroeconomic outlook, interest rates and the related concern of credit availability barely merited a mention.

Specifically, respondents to our Voice of the Enterprise: Macroeconomic Outlook survey didn’t even rank interest rate worries among the top five threats to sales at their companies. Instead, labor shortages and trade wars were overwhelmingly cited as the main headwind to business right now. Three times as many survey respondents indicated that those two separate concerns are weighing more on sales right now than interest rates.

Most of the pressing problems that businesses articulated in our survey fall a bit outside the realm of domestic monetary policy. Even an area where the Fed does have influence, our survey respondents don’t necessarily see a problem there: credit is flowing freely, according to their view from summer. Just one in 20 respondents (6%) said it was harder for their company to borrow money now than it was three months ago.

Get rich or die trying

Mark Fontecchio

by Brenon Daly

As we saw in this week’s offering from Ping Identity, there’s virtually no middle ground for IPOs from the information security (infosec) market. More than any other tech segment, infosec prices its chosen few at astronomical heights, while relegating the rest to a far more earthbound valuation.

Broadly speaking, on a price-to-trailing-sales multiple, infosec IPOs inevitably come to market at either a high-single-digit valuation or at greater than 20x. Nothing in between. None of those deals that price at twice the low end, but half the high end. As a result, when we survey the IPO valuation landscape, we see a very unusual distribution: cybersecurity tends to stack up in two camel-like humps rather than a conventional bell shape.

According to our analysis, Ping is the ninth debutant from the infosec market on US exchanges in the past two years. (See our full preview on Ping‘s offering.) The identity and access management vendor created some $1.6bn in (undiluted) market value in its IPO. That works out to about 7.5x its trailing sales of $215m through midyear.

Ping’s price-to-sales valuation slots right next to the current trading multiples of other recent infosec IPOs such as Tufin Software Technologies (6x), Tenable (7x) and SailPoint Technologies (7x). (SailPoint, like Ping, came public from a private equity portfolio, after being acquired for a fraction of its current valuation.) Similarly, Carbon Black, which came public last year, is being erased from the Nasdaq by VMware in a deal that gives the endpoint security provider a terminal value of 9x trailing sales.

Further out on the histogram of trading multiples, there are the vertiginous valuations of Okta (25x), which came public in 2017, as well as last year’s entrant Zscaler (20x). Both of those are bargains compared with CrowdStrike, which listed three months ago and currently trades at twice the multiple of either of the other highfliers.

Of course, valuation is always relative. Even as some of infosec’s recent debutants look longingly up at the market caps and multiples of others in the industry, there are whole sectors of IT that would gladly take the valuation of a ‘left behind’ infosec vendor like Ping. For a great number of tech startups, even the lowliest infosec valuation would be a trade up.

Figure 1: Infosec IPO valuations