Category: LBO

Will Earthlink acquire AOL’s ISP business?

In April we speculated that AOL (TWC) might be close to shedding its legacy ISP access business. We pegged the most likely acquirer as Earthlink (ELNK). In an earnings conference call this week, Earthlink CEO Rolla Huff echoed that sentiment, stating that he was bullish about combining its business with the AOL division.

Of course, interest from one party does not a deal make. But, given AOL’s burning desire to shed this dinosaur and completely rid itself of its ancient and tumultuous past, it is safe to assume that if the two parties can agree on terms, a deal might just materialize. The real question is how struggling Earthlink can come up with the estimated $1.5bn-$2.5bn it would take to acquire the AOL unit and its roughly nine million subscribers. Since Earthlink is one of few companies able and willing to make that acquisition, AOL does not exactly hold a lot of bargaining power. We think Earthlink might just get this at a bargain basement valuation closer to $1.5bn, just two times AOL’s cash flow from its ISP division.

The Art of hosting

Art Zeile is at it again. The private equity arm of Wachovia recently bought privately held HostMySite for an estimated $60m. Wachovia Capital Partners has tapped Zeile and his management team to lead the company, and intends to aggressively grow the venture through further acquisitions. Despite an unfavorable market for M&As, both Wachovia and Zeile are very bullish about going on a shopping spree. And they have a pile of cash – to the tune upwards of $150m – to do so. We hear that talks are already under way. But while awaiting official word of forthcoming deals, we take a stab at identifying some potential candidates.

Although it’s in a unique position as one of the leaders in the niche managed dedicated hosting space, HostMySite is currently not a heavyweight by any means. It is running about $20-25m in revenue at the moment. Nonetheless, it is the future prospects and track record of the new management that have Wachovia and a few other undisclosed investors so willingly parting with their money. Zeile and his team founded Inflow Inc in 1997, successfully navigated it through the bubble era, and with a few strategic acquisitions turned it into a $70m company. Inflow was sold to SunGard Data Systems in early 2005 for almost $200m.

The managed dedicated hosting sector has seen a lot of consolidation over the past few years. One of the main reasons for this is the prevalence of on-demand and outsourced hosting. The dominant players in the space are looking to build up scale and expand geographically to better meet their customers’ increasing needs.

According to insiders, HostMySite is looking at buying up small to medium-sized companies with revenue greater than $10m, largely focused on managed dedicated hosting. It has a preference for companies based in the West and Midwest, for geographical diversity. The market is littered with hosting providers, but few that fit those parameters, especially ones focused mostly on managed dedicated hosting. We did manage to come up with a few potential targets: LiquidWeb, ServePath, and INetU. All three are making names for themselves in the managed dedicated hosting space – but with revenue between $10-20m, they’re still small enough for a potential acquisition.

Frankly we would be surprised if at least one of these companies wasn’t acquired in the near future, either by HostMySite or another company. In fact, given the revenue multiples typically applied to acquisitions in this space (between 2.5 to 3.5 times trailing 12-month revenue), all three could conceivably be bought for about $100m – leaving ample cash for future endeavors.

Recent select managed hosting acquisitions

Date Acquirer Target Deal value TTM revenue
April 2008 ABRY Partners Hosted Solutions $140m $39m*
December 2006 Fujitsu Services TDS AG $132m NA
June 2008 International Game Technology Cyberview Technology $76m $53m
February 2006 VeriSign 3united Mobile Solutions $65m NA
April 2008 Layered Technologies FastServers.Net $13.5m* $9.5m*

Source: The 451 M&A KnowledgeBase * official 451 Group estimate

Should Ask prepare to get Answers?

Ask.com – a subsidiary of IAC/InterActiveCorp – closed its acquisition of Lexico Publishing Group last week. The 16-person company, which includes Dictionary.com, Reference.com and Thesaurus.com, reportedly went for $100m in cash, representing a multiple that we estimate at 10 times its trailing twelve-months revenue, or more than $6 per monthly unique visitor. This acquisition comes after a tumultuous ride for the profitable Lexico. The company was almost acquired by Answers Corp (Answers.com) in 2007, but after Answers failed to drum up proper financing, the deal turned sour. It was officially terminated in February, presenting an opening for Ask.com to swoop in. Besides being a happy ending for Lexico, which has been chasing an exit for a while, this fits well with Ask.com’s restructuring strategy of returning to its roots as an answer facilitator after its short but decidedly failed attempt to out-Google Google in the search engine department. Ask.com has openly said that more acquisitions are forthcoming. So who might the company buy next?

Among others, we see Answers.com itself as a potential acquisition target. Despite a growing base of about 20 million loyal users, the provider has had a tough time monetizing its page views and has been bleeding cash for more than a year now. Incorporating Answers.com’s user base and content could solidify Ask.com as the leader in the answer-search business. And with Amazon and Yahoo moving in on Ask.com’s turf, it is necessary for the company to continue to grow its market share. Indeed, we’ve heard industry rumors that Ask.com had made overtures to its rival well before the failed Lexico deal. And interestingly, Redpoint Ventures recently pumped $6m (with an option for another $7m) into Answers.com. That is the same Redpoint Ventures that helped fund Ask.com during its early days and that still has a stake in the IAC division. Ask.com’s former CEO Jim Lanzone also happens to be an entrepreneur-in-residence at Redpoint.

Surely the struggling company could be had for much less than the revenue multiple accorded to Lexico, which reported a healthy EBITDA of about $3m for calendar 2006, the last data made public. While the revenue multiple and price-per-user metrics of the Lexico deal would suggest a $100m-plus valuation for Answers, the company, which reported an operating loss of about $3.7m in the first quarter of this year, is clearly going to be valued at a steep discount. It’s currently trading at a 52-week low, with a market cap of just above $23m, or just a bit more than two times trailing revenue and a little over a dollar per user. With more than three times the number of employees as Lexico, Answers clearly has a much more labor-intensive model than its peer. That may change, though. Answers.com’s fast-growing new WikiAnswers.com service offers a lower-cost community-based answer site and is expected to exceed the more labor-intensive Answers.com service in revenue by the second half of 2008.

At a minimum, we estimate that Ask.com would have to shell out somewhere in the neighborhood of $30m, or roughly $3.80 per share, for the company – a 30% premium to the current price. It’s certainly not a question of whether IAC can afford the deal – it currently has a little more than $1.2bn in cash and a market cap of $4.7bn – but how much it could leverage the deal by cutting costs, monetizing the user base and expanding the WikiAnswers business. Indeed, for Answers.com, an acquisition by Ask.com may be just what the company and its desperate shareholders have been looking for.

On a final note, Ask.com’s new strategy of no longer trying to beat Google at its own game is in stark contrast to that of Microsoft, whose recent investments and acquisitions put it on a head-on collision course with Google. However, Microsoft’s recent acquisition of Powerset at least gives it technology that is capable (within Wikipedia, at least – it is yet to be tested publicly on a large corpus) of providing answers to both questions and keyword queries and could end up being a major challenge to the Q&A format Ask.com favors. That is, of course, if it doesn’t get lost in the mix if Microsoft should buy Yahoo’s search business.

M&A goes MIA in Q2

Brenon Daly1 Comment

With the second quarter wrapped up, we’ve been busy tallying the deal flow from the period. As you might guess, M&A levels for the past three months mirror the dour economic climate. The quick numbers: Overall tech M&A fell 40% in the second quarter, year-over-year, dragged down by private equity players that have been knocked out of the market by the credit market turmoil. The total shopping bill of $148bn is a sharp decline from the $241bn in the same period last year, putting it only slightly above the $122bn recorded in the second quarter of 2006.

A number of trends shaped M&A in the quarter, including the continued use of bear hugs to pressure reluctant sellers, the frozen IPO market and the rise of consolidation deals. Of course, the single largest crimp on deal-making in the second quarter was the utter disappearance of tech buyouts. The value of tech LBOs in the second quarter fell more than 90% compared to the same period last year, when credit was flowing freely. In the just-completed quarter, we recorded some $7bn worth of tech buyouts, down from $85bn in the year-ago period. Looked at another way, LBOs accounted for just 5% of all tech M&A spending in the second quarter, after representing a full one-third of total spending in the same period last year.

Deal flow breakdown

Quarter PE deal value Corp. deal value Total deal value
Q2 2006 $13bn $109bn $122bn
Q2 2007 $85bn $156bn $241bn
Q2 2008 $7bn $141bn $148bn

Source: The 451 M&A KnowledgeBase

Bear market mauls debutants

Brenon Daly

The talking heads at the Nasdaq and the New York Stock Exchange generally define a bear market as a 20% decline from the index’s highs. And, as anyone who picked up a weekend newspaper knows, the markets have officially slumped into bear territory since peaking last fall.

Of course, an index is made up of individual stocks, with some getting more roughed up than others. Oracle has basically traded flat since the Nasdaq meltdown began last October; Microsoft has matched the index’s decline; and VMware has been hammered, plunging nearly three times the Nasdaq decline over the same period. (Another way to look at the meltdown in shares of VMware: At its peak, VMware stock was worth roughly the same amount as a barrel of oil at current prices. Now, you’d have to pony up nearly three shares of VMware to trade for that same barrel of oil.)

With investors not willing to take a chance on shares of existing companies, what chance do the shares of largely unknown and entirely untested IPO candidates have? The short answer is ‘zilch.’ Actually, it’s somewhat of an academic question as there hasn’t been a VC-backed IPO since ArcSight floated on the Nasdaq four months ago. (As we’ve written in the past, we wouldn’t be surprised to see ArcSight get gobbled up, with Hewlett-Packard a logical buyer, in our view.)

With the IPO window closed, corporate acquirers have even more leverage in negotiations. (In other words, don’t expect transactions going off at a double-digit price-to-sales multiple, like IPO candidate EqualLogic got from Dell last November.) We’ve already seen Initiate Systems scrap its proposed offering and go hat-in-hand to a gaggle of investors. Meanwhile, a handful of other S-1s from other companies are gathering dust at the SEC. And we hardly expect any movement during the third quarter. Given the parched IPO market and corporate acquirers in the doldrums, it’s going to be a long, hot summer for a few of these IPO candidates.

Buyout blues

Brenon Daly

Three years ago, the buyout barons shook up the technology M&A market with the $11.3bn LBO of services giant SunGard. At the time it was the largest tech buyout, equaling basically half the money spent on all LBOs in the previous year. Even as financial acquirers became more active – increasingly their spending sevenfold from 2004-07 – the SunGard buyout stood as the third-largest tech LBO.

SunGard’s brozen-medal placing seemed unlikely to hold at this time last year. There seemed to be a new multibillion-dollar LBO every week, with the targets getting bigger in every transaction. (Remember the half-serious speculation that Microsoft could be taken private?) All that changed in late summer, when debt became more expensive, sending the LBO market into a funk from which it hasn’t recovered. So far this year, LBO firms have announced 49 deals worth $10.3bn, down from 59 deals worth $97bn in the same period last year, according to The 451 Group’s M&A KnowledgeBase.

The change in climate isn’t lost on the financial deal-makers. Underscoring the difficulties in the current credit market, SilverLake’s Alan Austin said at the recent IBF VC Investing Conference in San Francisco that his firm couldn’t pull off a deal like SunGard right now. The buyout firm put in $3bn of equity and borrowed the remaining $8bn. ‘We could never do something like that today – never mind the terms (of the debt)’, Austin said at the conference.

PE deal flow

Period Deal volume Deal value
Jan. – June 2008 51 $11bn
Jan. – June 2007 59 $97bn
Jan. – June 2006  35  $17bn
Jan. – June 2005 25 $24bn

Source: The 451 M&A KnowledgeBase

How do you say ‘Tumbleweed’ in French?

Brenon Daly

About a year and a half ago, we heard Tumbleweed Communications was being shopped hard by private equity firms. The intervening credit crises – which bumped up the price of debt and trimmed the returns on LBOs – quite likely tabled any buyout. The email security vendor has struggled since then. It came up short of Wall Street estimates in every quarter in 2007. Shares that changed hands above $3 each in early 2007 dropped in a straight line to just above $1 this March.

Rather than a PE shop, however, it turns out Tumbleweed’s buyer will be the Sopra Group, a French IT consulting firm. Sopra will make the acquisition through its Axway subsidiary, paying $2.70 in cash for each share. With about 51 million shares outstanding, Tumbleweed gets a an equity value of about $138m, only slightly more than twice the sales it is expected to record this year. Sopra also got a discount from its currency: the Euro has climbed about 18% in value since we reported on Tumbleweed in February 2007. See full report.

Barracuda bares its teeth

Brenon Daly

Never known as a shy or retiring competitor, Barracuda Networks has lobbed an unsolicited bid to acquire Sourcefire for $7.50 per share in cash. (Full report.) That works out to a slight 13% premium on Sourcefire’s closing price ahead of the bid, and essentially where the shares began 2008.

We look at Barracuda’s bid as setting a ‘floor price’ for Sourcefire. It is certainly an opportunistic offer, as Sourcefire has been burned on Wall Street. (The company didn’t help itself when it came up short of investors’ expectations in its first quarter as a public company a year ago.) To get this deal closed, however, we suspect Barracuda will have to raise its bid. Investors have already pushed Sourcefire shares above the offer price.

To push this deal along, Barracuda can draw on the experience of one of its two outside backers, Francisco Partners. The buyout shop took IT security appliance vendor WatchGuard Technologies private in July 2006 after a protracted and bitter campaign.

An Oak accord

Brenon Daly

Oak Investment Partners has finally helped broker a marriage for portfolio company Talisma – a full half-decade after the startup stumbled on its way down the aisle. In both cases, however, it isn’t exactly clear whether the investment firm should be sitting on the bride’s side or the groom’s side at the wedding. In fact, Oak would have a seat on both sides of the aisle.

In this go-round for Talisma, Oak’s late-March investment of $50m in nGenera helped the SaaS rollup add Talisma to its portfolio. If the strategy sounds familiar, it’s because Oak, which owns a majority of Talisma, had a nearly identical plan for the CRM vendor in late 2003. In that case, Oak wanted to stitch together Talisma with fellow portfolio company Pivotal Corp, in a deal that valued publicly traded Pivotal at $48m. Just as that deal was heading toward a vote, however, two other companies outbid Oak for Pivotal. (First, it was Onyx Software, then it was CDC Software. Of course, those companies would go at it again three years later when CDC tried to spoil the purchase of Onyx by Consona, which was then known as M2M Holdings.)

What exactly Oak plans to do with its newly enlarged portfolio company, nGenera, is anyone’s guess. However, it could do a lot worse than follow the strategy of Consona, which was taken private by Battery Ventures. Since the LBO, we understand Battery has pulled out something like six times its money from the CRM rollup, which is still rolling along. Maybe nGenera will serve as Oak’s enterprise SaaS rollup. The company has already done six deals – and counting. 

nGenera’s (fka BSG Alliance) acquisitive history

Announced Target Deal value Target description
May 21, 2008 Talisma Not disclosed SaaS customer service automation
March 5, 2008 Iconixx Not disclosed On-demand talent management HR software
Oct. 3, 2007 Industrial Science Not disclosed Business simulation software
Nov. 29, 2007 New Paradigm Not disclosed Research company
Sept. 13, 2007 Kalivo Not disclosed On-demand collaboration provider
May 7, 2007 The Concours Group Not disclosed Research and executive education firm

Big Yellow’s purple elephant

Brenon Daly

Asked not too long ago to explain the slump in Symantec’s stock since acquiring Veritas three years ago, CEO John Thompson memorably called the combined company ‘a purple elephant.’ The allegorical description was a bit of a departure for the straight-laced, straight-talking ex-Big Blue executive, who went on to add that since Wall Street had never seen such a large security-storage company, it didn’t know how to value it. (Generally speaking, however, investors have known how to value it: lower. Since announcing the $13.5bn acquisition in December 2004, Symantec shares have shed about 22% of their value, compared to a 15% gain in the Nasdaq over that same time.)

The purple elephant has turned into a bit of a sacred cow, with Thompson defending the combination at every turn and forcefully knocking down any suggestion that Symantec should shed some of the Veritas assets. (Of course, Symantec already ditched Precise – an application performance management product that it inherited from Veritas – back in January.) Talk of possible divestitures surfaced last week following a research note from Cowen and Co analyst Walter Pritchard, who speculated that NetBackup and Data Center Foundation, a storage and server management product, may find their way onto the auction block. Not so, countered Thompson on Symantec’s first-quarter earnings call last Wednesday. The company has ‘no plans to divest anything – none.’ A senior corporate development guy at a company named as one of the possible buyers of the Foundation business told us recently that he hasn’t even been informally approached to gauge the company’s possible interest in Foundation, much less seen a book on the possible asset sale.

Of course, M&A is cyclical, to some degree tracking the overall economy. And we know this about dealmaking in a recession: When times get tight, ties get thin. We’ve already seen that most dramatically in the private equity world, whether it’s former buyout buddies taking each other to court or banks looking to get out of their lending agreements they’ve already signed. That same thinking (‘maybe we shouldn’t have done…’) is now hitting the C-suite. Consider the ongoing sell-a-thon at Time Warner, with the company planning to split off its cable services business, and, we speculate, finally putting AOL’s core US access business on the block. Or, there’s eBay entertaining the idea of jettisoning Skype Technologies, after writing down basically half of the $2.6bn purchase price. Or, if current reports are to be believed, Sprint Nextel may unwind the $39bn acquisition that has soured into a money-burning debacle. Although Thompson says Symantec isn’t a seller, this is clearly the climate in which companies are being pushed to reexamine their acquisitions. That could very well mean taking the knife to the purple elephant again.

Reversing deal flow

Company Assets Comment
Symantec NetBackup, Data Center Foundation, according to rumors Symantec says it’s not looking to sell.
Time Warner Cable services business, and (we speculate) AOL’s US access unit AOL has already shed ISP businesses overseas.
eBay Skype Technologies New CEO says next few quarters will determine if company keeps its overpriced acquisition.
Sprint Nextel Nextel WSJ reports this week that Sprint may unwind Nextel deal, and look to sell itself.
VeriSign Numerous units picked up in 20-company shopping spree VeriSign has already divested three businesses this year.