Category: LBO

Infosec inflation: Slowing sales, rising prices

Stephanie Turner

by Brenon Daly

Even in a slump, it pays to be an information security (infosec) vendor. The latest company to realize the advantage of doing business in this red-hot market is Forescout Technologies, which is heading private in a $1.9bn deal with a pair of buyout shops. The network access control provider is set to exit Wall Street with a rather rich sendoff, given the mediocre numbers it has put up recently.

Despite a few brief slips, Forescout held itself together for most of last year. Through the first three quarters of 2019, shares soared some 45%. But all of those gains were wiped out overnight in early October as the company whiffed on its sales and losses widened.

According to S&P Capital IQ, revenue growth in 2019 was less than half the 30%+ rate it had been in recent years. Further, the tepid performance is expected to continue, with Capital IQ reporting that the consensus forecast calls for just 12% sales growth at Forescout in 2020.

Yet the vendor’s slowdown barely shows up in the valuation being paid by Advent International and Crosspoint Capital Partners. By our math, the buyout duo is paying 5.5x trailing sales for Forescout. That’s significantly richer than the average valuation of 3.8x trailing sales for all take-privates recorded over the past year in 451 Research‘s M&A KnowledgeBase. Our numbers show that Forescout is valued fully two turns higher than both LogMeIn and Cision in their recent leveraged buyouts (LBOs).

Even in the infosec market – where premium valuations are the prevailing prices – Forescout’s looks heady. For comparison, the 5.5x trailing sales multiple for Forescout exactly matches the multiple paid in the industry’s most recent significant take-private, Thoma Bravo‘s $3.8bn LBO of Sophos last October.

That’s the same valuation, even though Sophos has a much more attractive financial model, particularly to cash-flow-focused operators. Sophos put up roughly the same growth rate as Forescout heading into their LBOs, but brings in almost twice as much revenue. Probably more important for the new private equity owners, Sophos throws off several hundred million dollars of cash flow each year, while Forescout is still burning cash.

Paying up to restructure Instructure

Mark Fontecchio

by Brenon Daly

Dragged down by the uneven performance of its two main products, learning management software maker Instructure is headed toward a period of corporate rehabilitation behind closed doors. The company says it will be going private in a proposed $2bn LBO by Thoma Bravo, wrapping up a three-year stint on the NYSE. Under ownership of the buyout firm’s sharp-penciled operators, we expect Instructure’s portfolio to be thinned in short order.

Although the stock nearly tripled from its IPO price, the ed-tech vendor has been increasingly dogged by questions about its product lineup. For the first few years after its founding in 2008, Instructure had success in selling software to schools to manage their education programs. However, its effort to replicate the uptake that its Canvas offering had in schools with a product targeting learning in the workplace has foundered since its early-2015 launch.

The corporate learning management offering, Bridge, has been a bit of an albatross. Instructure acknowledged that in its recent quarterly report, adding that it had begun separating the underperforming Bridge division from the still-healthy Canvas unit. (Instructure doesn’t break out the respective financials of the two product lines.)

Based on early indications, that separation will likely be accelerated once the sale to Thoma Bravo closes, which is expected in Q1 2020. Consider this: In the release announcing the acquisition of the whole company, Thoma Bravo only references – and indeed, praises – Instructure’s Canvas offering. The Bridge product, which almost certainly burns cash, is conspicuously absent.

Since Instructure had publicly disclosed last month that it was reviewing ‘strategic alternatives’ for the company, the sale isn’t surprising. (Certainly, Wall Street had been betting that Instructure would get a deal done. Investors, including several activist hedge funds, had pushed Instructure shares to an all-time high in anticipation of a transaction. Turns out they got a bit ahead of themselves, as Thoma’s bid represents a slight ‘take under’ relative to the stock’s previous closing price.)

Still, this is not some bargain buyout. At roughly $2bn, Thoma Bravo is paying about 8x TTM sales of $245m at Instructure. According to 451 Research‘s M&A KnowledgeBase, that’s the highest multiple for any tech vendor erased from US stock exchanges in 10 months.

Corporates open doors for PE exits

Scott Denne

Contact: Scott Denne

After a dry spell in 2017, strategic acquirers have come pouring back into the tech M&A market, printing larger deals and paying higher prices. In doing so, they’re delivering a disproportionately high amount of exits for private equity (PE) investments.

According to 451 Research’s M&A KnowledgeBase, strategic acquirers have spent $19.6bn so far this year to buy tech assets out of PE portfolios. That’s up from $8bn through May of last year and more than the same period in any year since 2002. The volume of such deals has risen as well, yet soaring valuations play an outsized role.

Among the 10 largest sales of PE-backed companies to strategic acquirers this year, six have traded above 5x trailing revenue. At this point last year, only two such transactions surpassed that mark. Strategic buyers appear willing to pay more than in the past, both in terms of multiple and check size. Take Adobe’s purchase of Magento (a Permira Funds portfolio company) earlier this week. In that deal, the acquirer paid 11x trailing revenue – an organizational record and more than twice the median multiple for an Adobe purchase.

In other cases, infrequent buyers are making remarkable acquisitions. TransUnion, for example, has upped its deal-a-year pace with six purchases in the past 12 months, including the $1.4bn pickup of GTCR’s Callcredit in April – its biggest-ever acquisition. Likewise, healthcare software vendor Inovalon Holdings moved past printing the occasional tuck-in with the $1.2bn acquisition of ABILITY Network from Summit Partners in March.

The trend aligns with the predictions for the PE exit environment in the M&A Leaders’ Survey from 451 Research and Morrison & Foerster. In that April survey, respondents overwhelmingly predicted an increase in PE exits via strategic acquisitions, with eight times as many respondents predicting an increase as those anticipating a decrease. Indeed, more foresaw an uptick in strategic exits than any other avenue we asked about (secondary sales, IPOs, reverse mergers and bankruptcy).

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

Sensitive ‘barbarians’?

Brenon Daly

Contact: Brenon Daly

Although private equity (PE) is often portrayed as heartless and hardened dealmakers, it turns out the group is actually quite sensitive. We don’t necessarily mean emotionally sensitive but rather economically sensitive. This hyperactive group of acquirers is far more attuned to interest rates, credit availability and other economic factors than rival corporate buyers. What happens outside buyout firms goes a long way toward shaping what goes on inside.

We’re seeing that right now in the tech M&A market. The just-enacted sweeping overhaul to the US tax code has changed some of the key calculations that buyout shops have to make before they can put their unprecedented pile of cash to work in tech deals. Under the new tax regime, PE firms are facing higher costs and potentially longer holding periods – both of which would weigh on returns. (Buyout shops are getting hit with numerous changes, the most significant of which is that they are now only able to deduct a portion of the interest payments for the debt they use to acquire companies.)

The tax changes, which were negotiated and passed in the final few months of last year, knocked PE almost completely out of the market during that time. Through the first three quarters of 2017, buyout shops were clipping along at an average of about $10bn in spending each month, according to 451 Research’s M&A KnowledgeBase. However, spending plummeted to just $7bn for the entire fourth quarter. The aggregate value of deals in December – the month when the new tax code was approved – didn’t even reach a half-billion dollars, the lowest monthly total since early 2014.

Of course, this is only the most-recent case of macroeconomic conditions shaping PE activity. A far more vivid example of that came a decade ago, when the mortgage crisis effectively killed the first wave of tech buyouts. As we noted last summer on that unhappy anniversary, the last four crisis-shadowed months of 2007 accounted for just $7bn of the then-record $106bn in PE spending that year. The PE industry took until 2015 to reclaim the level of spending it put up in 2007, according to the M&A KnowledgeBase.

No one is suggesting the changes from the tax code will be anywhere as severe as the disappearance of credit, which is what we saw in the recession a decade ago. This time it’s more of a recalibration than a retreat.

What to look for in tech M&A in 2018

Brenon Daly

Contact: Brenon Daly

As we look back on 2017 and ahead to 2018, 451 Research has published its annual forecast for tech M&A, highlighting the trends that we expect to shape deal flow and the markets that we think will see much of the activity. The 2018 Tech M&A Outlook – Introduction serves as an overview of the broad M&A market, setting the stage for the upcoming publication of our comprehensive report that features analysis and predictions for eight specific IT markets on what deals are likely in 2018.

The full report, which we think of as an ‘M&A playbook’ for the enterprise IT market, has insightful forecasts for activity in application software, information security, mobility and other key sectors. The 80-plus-page 2018 Tech M&A Outlook report will be published at the end of January. It will be available at no additional cost for subscribers to 451 Research’s M&A KnowledgeBase Professional and Premium products, and will be available for purchase for 451 Research clients and others that don’t subscribe to our M&A KnowledgeBase products. (If you’re interested in purchasing the full 80-plus-page report, contact your account manager or click here.)

In the meantime, our introduction provides insights on some of the overall dealmaking trends that are also likely to shape activity and valuations in sector-specific transactions. Key highlights in our overview of the broader M&A market include:

  • After tech M&A spending in both 2015 and 2016 topped a half-trillion dollars, what happened that knocked the value of deals in 2017 down to just $325bn?
  • Many of the tech industry’s biggest buyers printed only half as many deals as they have in recent years. Is that the new pace of M&A at these serial acquirers, or will they rev up again in 2018?
  • The pending tax overhaul will likely add billions of dollars to the treasuries at major tech vendors. Why don’t we think that will necessarily lead to more M&A? If they don’t spend it on deals, what are tech companies going to do with the windfall?
  • Which tech markets are expected to see the biggest flow of M&A dollars in the coming year? Enterprise security tops the forecast once again, but what about emerging cross-sector themes such as machine learning and the Internet of Things?
  • How did private equity (PE) move from operating on the fringes of the tech industry to become the buyer of record? PE firms accounted for an unprecedented one out of every four tech transactions last year. Why do we think their share of the market will only increase?
  • VC portfolios are stuffed, as the number of exits in 2017 slumped to its lowest level since the recession. What challenges loom for startups and the broader entrepreneurial community without the return of billions of dollars from those investments?
  • For startups, will venture capital be flowing freely in 2018? Or will the polarized VC market (fewer rounds, but bigger rounds) continue this year?
  • Despite nearly ideal stock market conditions, why don’t we expect much acceleration in the tech IPO market in 2018? What needs to happen – to both supply and demand – for the number of new offerings to take off?

For answers to these questions – as well as other factors that will influence dealmaking in 2018 – see our just-published 2018 Tech M&A Outlook – Introduction.

Thoma Bravo goes fishing, lands a Barracuda

Brenon Daly

Contact: Brenon Daly

After four underwhelming years as a public company, Barracuda Networks will step off the NYSE in a $1.6bn take-private with Thoma Bravo. The all-cash transaction, which is expected to close within three months, is one of those rare deals that appears to fit both the buyer and the seller in equal measure. With $17bn sloshing around, private equity firm Thoma Bravo needs to put money to work and has made the information security market a favorite shopping ground, having previously taken four infosec vendors private.

For Barracuda, the proposed leveraged buyout (LBO) wraps a period of not truly finding a home on Wall Street. As a public company, Barracuda posted just one-third the return of the Nasdaq Composite over the same period. The $27.55 per share that Thoma Bravo is paying represents the highest price for Barracuda stock in two and a half years. At one point in 2015, shares of Barracuda changed hands above $40.

Part of the reason why Barracuda fell out of favor with investors is the company’s ongoing transition from an on-premises business to more of a cloud focus. The so-called ‘legacy’ revenue – much of which is tied to appliances – has been shrinking every quarter, but still represents roughly one-third of sales. Deemphasizing that business has boosted Barracuda’s operating margins, but has slowed overall revenue growth to the single digits. Going private to complete the transition to a higher-margin software business, while continuing to throw off $10-20m of free cash flow each quarter, makes sense for Barracuda.

On the other side, Thoma Bravo pays essentially a market multiple for a company that has figured out a way to turn a profit selling into the underserved SMB market. (The enterprise value of Thoma Bravo’s bid stands at $1.48bn, or 4x trailing 12-month sales at Barracuda. That roughly matches the 4.4x TTM sales/EV multiple that Thoma Bravo paid in its most recent infosec LBO, Imprivata.) Further, Thoma Bravo has some growth opportunities once it adds Barracuda to its portfolio, both in terms of products (for instance, the target’s managed security service) and markets (Barracuda still generates 70% of its revenue in the US).

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

Webinar: PE activity and outlook

Brenon Daly

Forget Oracle, IBM, or any of the other big-name, publicly traded acquirers that – until now – have always set the tone in the tech M&A market. If a tech deal printed in 2017, the buyer is more likely to be a private equity firm than any of the well-known serial acquirers on the US stock market. This is the first time in the history of the multibillion-dollar tech M&A market that financial acquirers have been busier than these strategic acquirers.

To understand how the ever-growing influence of buyout shops is reshaping both M&A and the tech industry, join 451 Research for an hour-long webinar on Thursday, September 7, 2017, starting at 1:00pm ET. Registration is available here: https://www.brighttalk.com/webcast/10363/274289.

Meet the new buyer of your tech company

Brenon Daly

Contact: Brenon Daly

For all the dramatic impact that private equity (PE) firms have had in snapping up huge chunks of the tech landscape, most of Silicon Valley actually knows very little about these buyout shops. (Not for nothing is the industry called private equity.) The little that is known about them probably dates back to Barbarians at the Gate, when the firms mostly operated with a strip-and-flip strategy. That’s not really the approach these new power brokers are bringing to their current tech investments.

In the rebooted strategy for hardware and software vendors, many of the buyout shops have swung their focus from costs to growth. Sure, PE firms still prize cash flow, but in many cases they will be looking as closely at the trend line for MRR as they do EBITDA generation. It’s an approach that has helped fuel five straight years of increasing tech deals by buyout shops, rising to the point now where financial acquirers are putting up more prints than the longtime leaders of the tech M&A market, strategic buyers.

Between direct acquisitions and deals done by portfolio companies, PE firms are on pace to purchase roughly 900 tech companies in 2017, which would work out to roughly one of every four tech transactions announced this year. That’s about twice the share of the tech M&A market that buyout shops have held even as recently as two years ago. More than any other buying group, PE firms are setting the tone in the market right now.

For a closer look at the stunning rise of PE buyers in the tech market, 451 Research is publishing a special two-part report on the trend, ‘Preeminent PE: The New Masters of the Tech Universe.’ The first part of the report takes a look at how financial acquirers sprinted ahead of strategic buyers, and how the current PE boom is different from the previous PE boom before the credit crisis. The second part turns to the strategy and valuations of tech deals done by buyout shops.

Although both of these reports will only be available to 451 Research subscribers, everyone is invited to join 451 Research for a webinar on the activity and outlook for PE firms in tech M&A on Thursday, September 7 at 1:00pm EST. Registration can be found here.

An unhappy anniversary for buyout shops

Brenon Daly

Contact: Brenon Daly

A decade ago, the financial world started its most recent journey toward ruin. Although the total collapse wouldn’t come for another year, the first tremors of the global financial crisis were felt in August 2007. At the time, few observers could have imagined that a bunch of bad bets made on shady mortgages could reduce some of the world’s biggest banks to heaps of rubble.

For some financial institutions, the destruction was self-inflicted. But others were simply collateral damage, counterparties to risky trades that they may not have fully understood but took on nonetheless. Whatever the cause, the result, which was just starting to be realized 10 years ago, was that everyone was in over their head.

As banks went into survival mode, the financial system dried up. Lenders, already worried about the bad debt on their books, stopped extending loans. It became a credit crisis, with whole chunks of the economy grinding to a halt. There was also a dramatic – if underappreciated – impact on the tech M&A market: the crisis effectively ended the first buyout boom.

Private equity (PE) firms were just hitting their stride when the crisis took away the currency that made their deals work: debt. Don’t forget that just months before August 2007, PE shops had announced mega-deals for First Data ($29bn) and Alltel ($27.5bn). Both of those acquisitions were $10bn bigger than any tech transaction ever announced by a financial acquirer up to that point.

Those deals turned out to be the high-water marks for PE at the time, with the water receding unexpectedly quickly. Of the 10 largest PE transactions listed in 451 Research’s M&A KnowledgeBase for 2007, only one of them came after August. More broadly, the last four crisis-shadowed months of 2007 accounted for just $7bn of the then-record $106bn in PE spending that year.

The late-2007 collapse in sponsor spending continued through 2008-09, as the recession broadened and deepened. The value of PE deals in both of those years dropped more than 80% compared with 2007, according to the M&A KnowledgeBase. The PE industry’s recovery from the credit crisis would take a long time, much longer than the relatively quick bounce-back in the equity markets, for instance. Overall spending by buyout firms wouldn’t hit 2007 levels again until 2015.

For more on the impact of PE activity in the tech market, be sure to join 451 Research for a special webinar on Thursday, September 7 at 1:00pm ET. Registration is free and available by clicking here.

In tech M&A, PE takes prominence

Brenon Daly

Contact: Brenon Daly

For the first time in tech M&A, financial acquirers are doing more deals than publicly traded strategic buyers. That’s a sharp reversal from years past, when private equity (PE) firms represented only bit players in the market, operating well outside the focus areas of US-listed acquirers. Even as recently as three years ago, US publicly traded companies were announcing more than twice as many transactions as PE shops.

So far in 2017, financial buyers (both through stand-alone purchases and deals done by their portfolio companies) have announced 511 tech transactions, slightly ahead of the 506 deals announced by tech vendors on the Nasdaq and NYSE, according to 451 Research’s M&A KnowledgeBase. Even more telling is the current trajectory of the two groups. PE firms, which have increased the number of acquisitions every single year for the past half-decade, are on pace to smash the full-year record of 680 PE transactions announced last year. Meanwhile, US-listed acquirers are almost certain to see a second consecutive decline in M&A activity, with the full-year 2017 number tracking to almost 20% below the totals of 2014 and 2015.

The dramatic shift in the tech industry’s buyers of record has been brought about by changes in both acquiring groups. PE shops have never held more capital than they currently hold, which means they need to find markets where they can put that to work. (The tech industry, which is aging but still growing, offers bountiful shopping opportunities.) Cash-rich buyout firms, which are built to transact, have simply taken the playbook they have used on their shopping trips through other markets such as manufacturing and retail, among others, and applied it to the technology industry.

In contrast to the ever-increasing number of PE shops and their ever-increasing buying power, the number of tech companies on the Nasdaq and NYSE has been dropping for years. (Indeed, the overall number of US traded companies has been declining for years, with some estimates putting the current count of listings at just half the number it was 20 years ago.) For instance, some 38 tech vendors have already been erased from the two US stock exchanges so far in 2017, according to the M&A KnowledgeBase.

Yet even those companies that still trade on the exchanges aren’t doing deals at the same rate they once did. In years past, some of the big-cap buyers — the ones that used to set the tone in the tech M&A market — would announce a deal every month or so. Now, public companies have slowed their pace, and PE firms have simply sprinted around them in the market.

Consider this tally, drawn from the M&A KnowledgeBase, of activity last month by the two respective groups. On the lengthy list of tech giants that didn’t put up a single print at all in July: Oracle, Microsoft, IBM, Hewlett Packard Enterprise, Salesforce and SAP. Meanwhile, financial acquirers went on a shopping spree. H.I.G. Capital, Francisco Partners, Clearlake Capital and Thoma Bravo (among other PE shops) all inked at least two prints last month.