Category: M&A

Snapping up smarts

Mark Fontecchio

by Brenon Daly

Having gotten a little richer in its mid-March IPO, Zscaler is now looking to get a little smarter with some M&A. In its first-ever acquisition, the cloud security vendor has reached for TrustPath, a startup that Zscaler plans to use to help speed and sharpen its analysis of the billions of transactions that flow over its platform each day. Not much is known about TrustPath, which is still operating in stealth mode.

Zscaler’s inaugural print continues the trend of information security (infosec) providers emerging as some of the busiest buyers of machine learning (ML) startups, a market that itself is pretty busy. In fact, for the past two years, tech investment bankers we have surveyed have forecast ML to be the single biggest driver for M&A in each of the coming years, ahead of other notable themes such as the Internet of Things and cloud computing.

More importantly, that sentiment is coming through in the actual deal flow. According to 451 Research’s M&A KnowledgeBase, the number of overall ML transactions is on pace to top 120 deals in 2018, three times the number announced just in 2015. Infosec is playing a key role in the record number of ML transactions, with Zscaler joining Amazon Web Services, Splunk and even PayPal in the parade of recent security-focused ML acquirers.

Collectively, infosec buyers are punching well above their weight in the emerging field of ML M&A. Look at it this way: Infosec accounts for roughly 15% of total ML deals in the M&A KnowledgeBase, despite security acquisitions making up less than 5% of all tech transactions we record in any given year.

The main reason for infosec’s outsized role in the ML market is that there’s actually business to be done there. In fact, in a recent survey by 451 Research’s Voice of the Enterprise: AI & Machine Learning, Adoption, Drivers and Stakeholders 2018, infosec emerged as the second-highest rated use case for ML, trailing only ‘business analytics.’ Importantly, the rankings in our survey came from folks who actually have ML technology up and running or are nearly there. With that kind of demand from customers, it’s no wonder infosec suppliers are leading the charge in snapping up smarts.

Cloud migration acceleration

Mark Fontecchio
by Mark Fontecchio

Businesses providing migration, integration and other IT services for the three most popular IaaS players – Amazon, Microsoft and Google – are being bought at a record pace. Enterprises are migrating IT workloads off-premises at an increasing pace, and cloud migration and integration service providers must keep up. In addition to expanding internally, some cloud vendors are leaning on inorganic growth to add expertise and fill customer needs.

According to 451 Research’s M&A KnowledgeBase, purchases of service providers around those three IaaS players are being inked at a record pace, with nine already this year. That equals the volume for all of 2017 and surpasses the full annual total for any year before that. Notable deals this year include Cloudreach’s acquisition of Relus Cloud last week and Hitachi’s pickup of AWS integrator REAN Cloud, which itself bought AWS integrator 47Lining last year. For Cloudreach, acquiring Relus Cloud added expertise from a company that got its start in 2013 as a consulting services firm focused solely on AWS adoption and migration. Relus Cloud subsequently garnered a reputation as an expert in cloud data analysis products such as Amazon’s Hadoop-based Elastic MapReduce and Redshift data warehouse.

Considering the rate at which companies are migrating off-premises, we expect these types of transactions to continue. Businesses’ primary IT environments are on the move. According to a Voice of the Enterprise survey, the share of organizations employing off-premises IT infrastructure as their primary environment is set to jump to 66% by 2020 from 48% this year. And that shift is most pronounced among the largest companies. Among enterprises with at least 10,000 employees, just 11% use IaaS or PaaS as their primary environment, although 28% expect to move their environment to the cloud in two years.

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

M&A makes for strange bedfellows

Mark Fontecchio

by Brenon Daly

Talk about strange bedfellows. Serta, a private equity-backed mattress maker that depends on retail sales to stay in business, has picked up Tuft & Needle (T&N), a startup that not only bypasses traditional retail but has spent heavily on advertising to deliberately antagonize those outlets. (T&N is probably best known for running in-your-face billboards across the country that starkly state: ‘Mattress stores are greedy.’)

Of course, this pairing of an octogenarian veteran with a ‘digital disruptor’ of a more-recent vintage isn’t the first example of established companies leaning on M&A in an attempt to stay relevant in the shifting retail landscape. Two years ago, for instance, Unilever paid $1bn for Dollar Shave Club, an e-commerce razor site that, like T&N, sold its wares directly to consumers.

The ‘unicorn’ price was built in part on the assumption that Unilever could use Dollar Shave Club’s existing business to expand its online sales for all sorts of additional grooming products made by the Anglo-Dutch giant. That hasn’t happened. (For more on why that is, see our recent report on the uneasy combination of new and old.)

The muted returns from Unilever-Dollar Shave Club and other similar offline-online transactions underscore just how difficult it is to reconcile separate – and, indeed, incompatible – business models. In this case, Serta generates an order of magnitude more revenue than T&N by relying mostly on retailers to move its mattresses.

However, that reliance can become a hindrance when one of the industry’s largest retailers hits the skids, which is what’s playing out in the mattress industry right now. (Earlier this year, it was the toy industry, which got choked up when retailer Toys R Us went bankrupt.)

So the urge to merge is certainly understandable when seen as a way for a company to have more control over the sale of its own product. (Serta already sells its mattresses on its own website.) And while the direct-to-consumer model has taken off, it hasn’t replaced brick and mortar by any means. In fact, the lines are increasingly blurring.

Rival online ‘bed in a box’ startup Casper, which has raised a whopping $240m in venture backing, counts retail giant Target among its investors. Further, the trendy website announced earlier this month that it plans to open 200 of its own retail outlets in the coming years. Presumably, Casper’s stores won’t be among the ‘greedy’ ones T&N was talking about.

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

Strategic shopping

Mark Fontecchio

by Brenon Daly

The tech M&A market just hit a watershed moment, with dealmakers handing out more money already this year than they did in all of 2017. 451 Research’s M&A KnowledgeBase shows spending on tech and telecom transactions around the globe since January has totaled $334bn, slightly eclipsing the full-year total of 2017. For the most part, this year’s surge has been led by corporate acquirers returning to the market after cooling it on the sidelines last year.

Of the one-third of a trillion dollars in M&A value we have tracked so far this year, so-called strategic buyers account for three-quarters of the total amount, or $247bn. That’s $100bn more than corporate acquirers had spent at this point last year, according to the M&A KnowledgeBase. More broadly, overall spending by strategic buyers is running at the second-highest level for any comparable period since the credit crisis a decade ago.

More importantly than the dollars, however, is who is spending them. In 2018, the acquirers that, historically, have set much of the tone in the overall market are doing that once again. Tech bellwethers such as Microsoft, SAP, Salesforce and Adobe have all announced acquisitions valued at more than $1bn in 2018. Last year, not a single one of the quartet did that.

Of course, those companies – and, indeed, most US companies across the entire economy – are much richer now than they were last year, by a variety of measures. The tax overhaul that was enacted at the start of 2018 has pushed cash balances for most businesses to record levels. Meanwhile, the bull market continues to run along, driving valuations ever higher. (For reference, the stocks of the four tech giants that have announced a $1bn+ deal so far in 2018 are up an average of 46% over just the past 12 months.) With high-flying valuations and more cash than they have ever held, it’s no wonder tech vendors are back buying big.

Dabbling in digital deals

Mark Fontecchio

by Brenon Daly

Consultant-speak to the contrary, not every company is a tech company. The idea that old-world companies could magically boost their status – and accompanying valuation – by reaching for a shiny new startup might have played well in the boardroom, but it tended to break down in the real world. A company rarely becomes something by buying something.

Nonetheless, the allure is understandable: Take a plodding business and make it light on its feet by adding in a bit of acquired technology. That M&A drive is sharpened by the numerous cases of upstart startups siphoning off tremendous valuations from the otherwise fairly staid industries. (Think of Airbnb valued in the private market at more than $30bn, higher than virtually any online travel agency or major hotel operator. Or just ask taxi drivers in any major city what their medallions are worth since Uber came along.)

Deals born of envy, however, lead mostly poisoned lives. Returns inevitably dwindle as the culture and operations of the acquired company get ignored or diluted by the larger acquiring company. The whole reason for the deal gets snuffed under the weight of unrealistic expectations of miraculous transformation. (For more on lessons learned in that area, see my colleague Scott Denne’s analysis of Best Buy’s purchase yesterday of GreatCall, a transaction closer in purpose for the electronics retailer than its earlier M&A forays into the larger IT market. Most of those earlier, more ambitious deals have been unwound.)

And yet, the desire to ‘digitally transform’ what are essentially analog businesses continues to push M&A activity ever higher. Brick-and-mortar retailers, industrial equipment makers, pharma giants and others are all shopping for tech. This strategy has meant more spending by non-tech vendors on tech startups so far this year than any other recent year, according to 451 Research’s M&A KnowledgeBase. In the first half of 2018, non-tech acquirers handed over $18.8bn for VC-backed startups, more than they spent in the previous half-decade combined.

Of course, this year’s spending is skewed by Walmart’s blockbuster $16bn purchase of a majority stake of Flipkart, a transaction that not only seeks to combine two irreconcilable business models but also has the added complication of geography. (The difficulty of successfully shopping internationally shouldn’t be underestimated. A look at the expand-then-retreat M&A programs of Groupon and eBay show how difficult it is to get returns on deals outside a company’s home market.)

More broadly, we would suggest that the current trend of adventurous acquisitions by non-tech companies will be the first casualty when the nine-year-old bull market finally dies of old age. It’s one thing for a cash-rich, old-line company to go shopping when business is booming like it is now. (Earnings at the average S&P 500 company were up an astounding 24% in Q2, with double-digit revenue advances.) But when times get tougher, old-world companies won’t be dabbling in digital deals. Downturns mean playing defense, not offense.

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

Best Buy nabs elderly mobility vendor: earlier deals haven’t aged well

Mark Fontecchio

by Scott Denne

Best Buy has ended a prolonged dry spell with the $800m purchase of GreatCall, a maker of phones and wearables for the elderly. Like all brick-and-mortar retailers, the buyer is contending with a shifting channel as much of the path to purchase moves online. With this deal, and more broadly, Best Buy is responding by playing up its strength in customer services, which it expects to be valuable as a raft of new consumer technologies (smart home, virtual reality, etc.) come to market. Today’s transaction fits into that strategy and shows that Best Buy has learned from its past failed tech acquisitions.

The purchase marks a new high for the electronics retailer. According to 451 Research’s M&A KnowledgeBase, it had never spent more than $167m on a tech acquisition and had never valued any of its targets above 2x trailing revenue – this deal values GreatCall at roughly 2.5x. Aside from the financial metrics, the acquisition differs from Best Buy’s past tech M&A in another respect – it’s not looking to jump into an unfamiliar market.

Its previous purchases have extended the retailer into web hosting (Speakeasy) and digital music (Napster). In 2011 and 2012, around the time it was divesting Napster in a pair of sales to Rhapsody, it entered the IT managed services market with the pickup of mindSHIFT and another tuck-in to support that asset. That deal was unwound two years later in a sale to Ricoh.

This time, Best Buy isn’t stretching as far. Although it hadn’t previously bought a device maker, it’s been offering its own private-label electronics (Insignia) for over a decade. Moreover, GreatCall offers a subscription service for help with its devices, emergency dispatch and the like. Although the purpose differs, the business model resembles the subscription technical support that Best Buy is rolling out today.

While there’s probably some synergy between consumer technical support and GreatCall’s elderly audience, and the acquisition furthers Best Buy’s customer-service story, it’s not clear that the device business will do much to drive traffic to Best Buy’s stores. According to 451 Research’s VoCUL: Smartphone Leading Indicator Survey, July 2018, more than half of those purchasing a new smartphone this quarter plan to buy from the wireless provider or manufacturer – fewer than 5% plan to go to an electronics store or big-box retailer.

Best Buy nabs elderly mobility vendor: earlier deals haven’t aged well

Scott Denne

Best Buy has ended a prolonged dry spell with the $800m purchase of GreatCall, a maker of phones and wearables for the elderly. Like all brick-and-mortar retailers, the buyer is contending with a shifting channel as much of the path to purchase moves online. With this deal, and more broadly, Best Buy is responding by playing up its strength in customer services, which it expects to be valuable as a raft of new consumer technologies (smart home, virtual reality, etc.) come to market. Today’s transaction fits into that strategy and shows that Best Buy has learned from its past failed tech acquisitions.

The purchase marks a new high for the electronics retailer. According to 451 Research’s M&A KnowledgeBase, it had never spent more than $167m on a tech acquisition and had never valued any of its targets above 2x trailing revenue – this deal values GreatCall at roughly 2.5x. Aside from the financial metrics, the acquisition differs from Best Buy’s past tech M&A in another respect – it’s not looking to jump into an unfamiliar market.

Its previous purchases have extended the retailer into web hosting (Speakeasy) and digital music (Napster). In 2011 and 2012, around the time it was divesting Napster in a pair of sales to Rhapsody, it entered the IT managed services market with the pickup of mindSHIFT and another tuck-in to support that asset. That deal was unwound two years later in a sale to Ricoh.

This time, Best Buy isn’t stretching as far. Although it hadn’t previously bought a device maker, it’s been offering its own private-label electronics (Insignia) for over a decade. Moreover, GreatCall offers a subscription service for help with its devices, emergency dispatch and the like. Although the purpose differs, the business model resembles the subscription technical support that Best Buy is rolling out today.

While there’s probably some synergy between consumer technical support and GreatCall’s elderly audience, and the acquisition furthers Best Buy’s customer-service story, it’s not clear that the device business will do much to drive traffic to Best Buy’s stores. According to 451 Research’s VoCUL: Smartphone Leading Indicator Survey, July 2018, more than half of those purchasing a new smartphone this quarter plan to buy from the wireless provider or manufacturer – fewer than 5% plan to go to an electronics store or big-box retailer.

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Source: 451 Research, LLC

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

A safe bet to get rich

Mark Fontecchio

by Brenon Daly

Playing defense can be a lucrative strategy. Along with the record deal volume in the information security (infosec) market this year, valuations across the fast-growing sector have surged to their highest level. Already in 2018, 451 Research’s M&A KnowledgeBase lists eight transactions that have gone off at price-to-sales multiples of more than 10x, based on disclosed or estimated terms.

These double-digit valuations have helped to push the multiple across the entire infosec market to new heights, twice as rich as virtually all other major IT sectors. According to the M&A KnowledgeBase, acquirers have been paying 8.1x trailing sales for the infosec companies they have picked up so far this year.

For comparison, the next-richest segment (infrastructure software) checks in at 6.6x trailing sales. One sign of how inflated that market has become is the surprisingly rich valuation of infrastructure software titan CA Technologies. Broadcom is paying the highest price for CA shares since the internet bubble collapsed. The deal values CA at 4.5x sales, roughly a turn higher than other large software vendors that aren’t really growing. Additionally, Salesforce paid more than 20x trailing sales for MuleSoft in March.

More broadly, valuations in the 10 other IT sectors we track in the M&A KnowledgeBase are all less than half the median valuation in infosec. For instance, application software transactions this year are going off at 3.4x trailing sales, which is roughly consistent with the two previous years.

Of course, as in any small market, a few richly valued deals can skew the overall valuation for the sector. (The number of infosec prints each year is only about one-tenth the number of application software transactions in any given year.) And the infosec market has seen an unusually large number of big prices paid for very early-stage startups. Deals such as Palo Alto Networks-Evident.io and Splunk-Phantom Cyber are certainly pushing the median multiple higher. But even outside those outliers, acquirers are having to reach deeper than ever before to secure the security providers they want to buy.

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

Broadcom can’t get there from here

Mark Fontecchio

by Brenon Daly

CA Technologies just reported what’s likely to be its next-to-last financial results as a public company, and the numbers don’t add up. We’re not referring to anything about the specific bookkeeping at CA, which has long since distanced itself from the time when the ‘CA’ was said to stand for ‘Creative Accounting,’ with ’35-day months’ and the like.

Instead, our assessment of CA’s financial performance is based on the targets that its soon-to-be owner Broadcom has set for the combined company once the largest-ever software transaction closes later this year. In fact, it looks increasingly inescapable that the only way they get there from here is to shed a bunch of CA’s businesses.

Recall that the chip giant (rather inexplicably) turned its consolidation machine to the software industry, paying $19bn for CA in mid-July. As part of that blockbuster purchase, Broadcom laid out the goal of ‘long-term adjusted EBITDA margins’ above 55% for the combined company. Of course, the phrasing gives Broadcom plenty of wiggle room. ‘Long-term’ can mean a wide range of time, while ‘adjusted EBITDA’ is basically a fictitious financial measure that excludes many of the true costs of doing business.

But even setting aside our unfashionable quibbles around accounting, Broadcom’s margin goal looks like a stretch for CA, at least in its current form. On Monday, the company reported its overall financial performance for its just-completed quarter, and it’s pretty clear there are businesses inside of CA that will appeal to Broadcom and those that may not make the cut. CA’s financial results highlight the vast financial differences between its mature, cash-rich mainframe business and the other lines of more growth-oriented software that it has picked up over the course of a roughly 30-year M&A career.

CA’s two main businesses are nearly the same size, but the mainframe division runs at a 67% operating margin – more than 4x the operating margin posted by its enterprise software division. For the company’s full fiscal year, which ended in March, the enterprise software unit put up $1.7bn in revenue but only $151m in operating income. The tiny margin in CA’s enterprise software business, which contrasts with its richly profitable mainframe division, won’t help Broadcom hit its projected EBITDA targets, no matter how many ‘adjustments’ are made. In fact, the division stands in the way.

That reality won’t be lost on Broadcom, which had collected a bullish following on Wall Street for its reputation as a sharp financial operator. Nor will the fact that most other hardware vendors (including HPE, Dell and fellow chipmaker Intel) that have acquired their way into the software industry have eventually unwound many of their purchases. CA’s enterprise software division sells software in numerous markets, including identity and access management, application development, and security and IT operations management. For Broadcom to reestablish credibility among skeptical investors and hit the targets for the combined company, it is almost certain to divest some of those CA units.

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

Location, location, location (data)

Mark Fontecchio

by Scott Denne

Marketers are experimenting with a variety of applications for consumer location data, which is expanding the supply of potential acquirers for a set of startups that was once relegated to a niche corner of the mobile ad sector. The abundance of early-stage startups in this space will likely keep exit sizes modest for now, benefiting companies that need an early exit. Yet vendors that are able to successfully transition from ad-tech suppliers to core elements of the marketing stack could see large exits in another year or two.

Location data was initially gathered in two ways – through beacon deployments at retail locations and via data shared in advertising exchanges. As we detailed in an earlier report, the methods for gathering and managing this data have since expanded and the applications have moved beyond showing mobile ads based on device proximity. That has led to a growing interest among marketers to employ location data for multiple applications, such as behavioral targeting, ad attribution, loyalty programs and competitive intelligence. In a survey from 451 Research’s Voice of the Connected User Landscape, more than half of respondents said this data was ‘very important’ to gaining insight into customer experience.

While the uses of location data are largely experimental today, more marketers are faced with a mandate to meld their physical and digital operations. Location data helps bridge those two by linking digital identity with physical movements. As location data becomes a pervasive part of customer analytics, marketing measurement and campaigns, businesses that can build relationships with brands that encompass multiple parts of the advertising stack will be well-positioned for a bigger payday.

While the exits have been few, they have come at enviable multiples. The most notable of late are Snap’s acquisition of Placed – a supplier of location-based attribution services – and Ericsson’s purchase of Placecast, a developer of white-label advertising software that provides telcos and others with consumer location data to monetize those signals. We estimate that both sold for north of 5x trailing revenue. Each of these deals hits on a theme that we expect to drive future M&A in this market.

Although initially divided between beacon management and mobile advertising firms, we now see five distinct product segments emerging in this market. For a discussion of those segments, along with potential targets in each, read our full sector IQ report on the topic.