Category: technology stocks

A longshot for Leo?

Brenon Daly

Contact: Brenon Daly

Hewlett-Packard is now, officially, Leo Apotheker’s company. Since his somewhat surprising appointment as HP’s chief executive last fall, Apotheker has been taking small steps while also dropping big hints that he would be recasting the tech giant. But few observers could have imagined the almost unprecedented scope of the transition that Apotheker laid out late Thursday: HP will be integrating the largest acquisition in the software industry in seven years while simultaneously looking into selling off its hardware business.

Wall Street appears to be skeptical that HP can pull that off, as shares in the company on Friday sank to their lowest level since mid-2006. (Incidentally, that’s just before Apotheker’s predecessor, Mark Hurd, took over the company.) On their own, either one of HP’s dramatic moves (working through the top-dollar acquisition of Autonomy Corp and possibly selling the world’s largest PC maker) would be enough to keep any company busy. Taken together, the combination appears doubly difficult. And that’s even more the case for HP, which, to be candid, has a spotty record on M&A.

Consider this: Autonomy will be slotted into HP’s software unit, which has been built primarily via M&A. But that division runs at a paltry 19% operating margin, less than half the rate of many large software companies, including Autonomy itself. And then there’s the $13.9bn HP spent in mid-2008 for EDS in an effort to become a services giant. So far this year, however, that business hasn’t put up any growth. And perhaps most damning is the fact that HP now doesn’t really know what it will do with its hardware business – a unit that largely comes from the multibillion-dollar purchases of Compaq Computer and Palm Inc.

Microsemi opens the hostilities

Brenon Daly

Contact: Brenon Daly

In a bear-hug letter last month, Microsemi warned fellow chipmaker Zarlink Semiconductor that it was ready to ‘take all necessary actions’ to consolidate the Canadian company. On Wednesday, that came to pass: Microsemi said it would bypass Zarlink’s board, which shot down the unsolicited offer, and take its $549m all-cash bid directly to shareholders. Incidentally, the opening of this hostile offer in the semiconductor industry came on the same day that SABMiller launched its $10bn hostile bid for Australian brewer Foster’s Group.

Going hostile in deals is relatively rare, as the drawn-out procedure can be expensive and disruptive to business on both sides. Further, in the tech industry, the conventional wisdom has always been that hostile approaches would cause an exodus of employees at the target company, undermining the very reason for the acquisition. (Given our realpolitik view of the world, we’ve always been a little bit skeptical about that bromide. We just can’t help but think back a few years ago to how PeopleSoft, with its culture of hugs and Hawaiian shirts, stood up to the relentless push by Oracle.)

Whatever the theoretical concerns, Microsemi must have certainly factored them in before launching the offer. The company says it has the financing in place, and will have its bid open through September 22. (Morgan Stanley and Stifel Nicolaus Weisel are advising Microsemi, while Ottawa-based Zarlink is relying on RBC Capital Markets.) It’s hard to know exactly which way Zarlink shareholders will go on this one, but we can’t help but note that shares on the Toronto Stock Exchange have already traded through the bid since Microsemi floated its offer.

A little something for your trouble

Brenon Daly

Contact: Brenon Daly

Breaking up is hard to do. And it can be expensive, too. But as a pair of deals this week shows, the costs aren’t necessarily borne equally by the two sides in a planned transaction. In the higher-profile case, the market is buzzing that Google may be on the hook for a $2.5bn payment to Motorola Mobility if that deal unravels. If that’s the case, the payment (known as a reverse breakup fee) would be 6-7 times larger than the payment Google would stand to pocket if Motorola Mobility walks away from the transaction.

That gap is much wider than is seen in deals that feature reverse breakup fees, where a would-be buyer might face a fee that would be closer to twice the amount the seller might pay. That’s how it is, for instance, in Permira’s planned $440m buyout of education software maker Renaissance Learning. According to terms of Tuesday’s leveraged buyout (LBO), if Permira walks away from the transaction, it will have to come up with $26m, or nearly 6% of the equity value of the proposed deal. On the other side, if Renaissance Learning backs away, it will have to hand over just $13m, or about 3% of the equity value.

Reverse breakup fees have long been an accepted way for a would-be seller to receive compensation for any risks in getting a transaction closed. (The rationale is that the disruption in business due to an acquisition is much greater to the target company than the acquirer, so the greater potential risk is offset by a greater potential reward.) Of course, these fees are far more common in LBOs than when the deal is struck between two companies, like Google buying Motorola Mobility. But then again, the search giant – going back to its Dutch auction IPO and continuing to today’s practice of not giving quarterly financial guidance – has never been a company that really follows Wall Street convention.

Google gets discounted Droids

Brenon Daly

Contact: Brenon Daly

Google didn’t have to reach too deeply to fatten its patent portfolio as it also becomes one of the few vertically integrated smartphone and tablet makers. Sure, it will have to hand over $12.5bn in cash for Motorola Mobility to cover its planned purchase of the hardware manufacturer. But it will immediately get back some $3bn in cash from Motorola Mobility, as well as an undisclosed amount of tax advantages that can be used to lower the amount of taxes that the wildly profitable search giant will face in the future. Even setting aside the very real tax breaks, Google is on the hook for just $9.5bn for Motorola Mobility.

The enterprise value of $9.5bn works out to just 0.75 times the $12.7bn of revenue that Motorola Mobility has generated over the past four quarters. That’s less than half the median valuation (1.8x trailing sales) of all tech transactions announced so far this year, according to our calculations. Further, it’s just one-third the multiple of 2.2x trailing sales that we calculated for the 50 largest deals (by equity value) so far this year.

More relevantly, it’s half a turn less than Hewlett-Packard paid in 2010 to bolster its integrated mobile strategy. Last April, HP paid $1.4bn for Palm Inc in a transaction that valued the struggling company at some 1.1x sales. (And we could certainly make the case that Motorola Mobility is in better financial shape than Palm, which was burning cash amid a dramatic sales slowdown.) Another way to look at it: Google’s bid values Motorola Mobility only slightly above the current market multiple for fellow mobile device vendor Research In Motion. But then, we should add that shares in the Blackberry maker are currently changing hands at their lowest level in a half-decade.

A ‘patently’ big deal for Google

Brenon Daly

Contact: Brenon Daly

Google said Monday that it plans to hand over $12.5bn in cash for Motorola Mobility, spending more for the mobile company than it has, collectively, on the more than 100 acquisitions it has done in its history. The deal makes it more likely that Google, which will continue to offer its Android OS free to other handset manufactures, will be able to more deeply integrate the hardware and software on future devices. Additionally, Google will be gaining substantial heft in its patent portfolio, with the Motorola division counting some 17,000 issued patents and another 7,500 pending. That’s a key concern for Google, which has found itself at the center of several IP-related lawsuits.

Under terms, Google will pay $40 for each share of Motorola Mobility, for an equity value of some $12.5bn. While the bid represents a premium of 65% over the previous closing price of Motorola Mobility, it is only slightly above the price the shares fetched on their own in the days following their debut back in January. (Under pressure from activist investors including Carl Icahn, 80-year-old Motorola split itself into two companies at the start of 2011. The remaining company, Motorola Solutions, sells primarily networking and communications technology and is unaffected by Google’s proposed acquisition of the smaller but faster-growing mobile division.)

In looking at the price, however, we should note that Google will enjoy a substantial ‘rebate’ when the deal closes because Motorola Mobility basically carried no debt but held nearly $3bn in cash. So Google’s net cost is closer to $9.5bn, which works out to just 0.75x the $12.7bn of revenue that Motorola Mobility has generated over the past four quarters. Google shares, which have underperformed the Nasdaq for nearly all of 2011, were down slightly Monday on an otherwise up day on Wall Street. We’ll have a full report on the transaction in tonight’s Daily 451.

Summing up the IPO calculus

Brenon Daly

Contact: Brenon Daly

At the risk of oversimplifying the market for new offerings this week, we might nonetheless formulate an equation like this: AAA to AA+ = RW. Spelled out, that means: The historic downgrade in the credit worthiness of the US contributed to some of the bloodiest days Wall Street has seen, which in turn contributed to many IPO candidates deciding to scrap their planned offering. (Companies formally do this by filing what’s known as an RW form, for ‘Registration Withdrawal,’ with the SEC.)

Amid the choppy trading this week, both WageWorks and Trustwave shelved their proposed IPOs, which were originally expected to raise, collectively, about $200m for the companies. Instead, they’ll be heading home empty-handed from their aborted push to the public market. (The sole tech firm that made it to market, online backup vendor Carbonite, did so only after trimming its offering, which meant raising one-third less money than planned.)

While WageWorks and Trustwave – both of which have been active acquirers, even as private companies – will undoubtedly miss that windfall from their planned IPOs, the decision to scrap the offerings this week was inevitable. For a bit of context, consider this: When the two companies originally filed their paperwork to go public back in April, the Nasdaq was roughly 10% higher and the overall market volatility (as measured by the CBOE Volatility Index, or VIX) was less than half the level it is now.

Will a stabilized Cisco step back into the market?

Brenon Daly

Contact: Brenon Daly

After back-to-back quarters that roughed up the networking giant, Cisco reported on Wednesday a reasonably strong close to it fiscal year. Fourth-quarter revenue and earnings at the company topped Wall Street’s expectations, and included a rebound in Cisco’s core switch business. The company also projected that its overall growth would continue in the current fiscal first quarter, although the rate would be just 1-4%.

Chief executive John Chambers stopped short of using one of the metaphoric expressions like ‘air pockets’ or ‘uncharted waters’ that he has used in the past to describe economic uncertainty, but he said repeatedly on the conference call discussing results that the economy is facing numerous ‘challenges.’ From our perspective, we wonder if Cisco will get its M&A machine humming again if it continues to stabilize its business.

The company announced a deal in each of the first three months of 2011, but has been notably absent since then. In other words, Cisco has been out of the market since it first let on that business was getting tougher. Will that change now that business appears to be picking up again?

Are Internet infrastructure exits interconnected?

Ben Kolada

Contact: Ben Kolada

Providing further proof that it’s a tough time to be on the market, much less come to market, GI Partners has opted to sell its Telx investment rather than battle through an IPO. The company’s sale to ABRY Partners and Berkshire Partners closes the books (at least for now) on a proposed public offering that Telx initially filed back in March 2010. And we wouldn’t be surprised if Telx’s sale caused other IPO candidates in the industry to rethink their entry onto the public stage as well.

Terms weren’t disclosed, but we understand that Telx caught a fairly high valuation that would have provided a more immediate – and lucrative – return than an IPO. Although the Internet infrastructure industry showed resilience throughout the recession, consistently growing revenue, that hasn’t always been the case when it comes to the public markets. Chinese datacenter operator 21Vianet Group, for example, closed its first trading day on the Nasdaq with a market cap of $1bn. However, since then its shares have lost 40% of their value. (We note, however, that the success of 21Vianet’s IPO was due in part to success from other Chinese IPOs, as well as buyout speculation in the industry.)

Just as the Internet infrastructure market focuses on interconnection, we suspect that its participants’ exits are also interconnected. We feel that Telx’s recent sale to ABRY Partners and Berkshire Partners could cause the industry’s other IPO candidates to pause before hitting the public markets. Our colleagues at Tier1 Research maintain a list of the Internet infrastructure industry’s potential IPO candidates. Although speculation surrounds such fast-growing firms as SoftLayer Technologies, Peak 10, Zimory and Next Generation Data, an IPO for these players may be pushed to the back burner, at least for the foreseeable future.

‘Bear-ing’ down on the IPO market

Brenon Daly

Contact: Brenon Daly

This time last week, the Dow Jones Industrial Average was just above 12,000. Even with today’s relief rally, the benchmark index is 1,000 points lower, and is at its lowest level since last October. More broadly, both the S&P 500 and the Nasdaq have dropped 15% over the past month – declines that cut more than $1 trillion of market value from indexes. Amid all of this value being erased from the market, it’s no wonder that companies are struggling to create new market value, in the form of an IPO.

At least three tech vendors are hoping to debut this week, including online backup provider Carbonite, compliance security specialist Trustwave and WageWorks, which provides services around employee benefits. But those offerings by unknown and unproven companies appear to be a tough sell when the shares of well-known firms with a proven track record are getting mauled by the current bear market.

We’re already seeing signs of the fallout from the rout. WageWorks had to substantially trim the price range in its expected IPO last week. And on Monday, Cornerstone OnDemand, which went public in March, shelved a planned secondary offering.

Even if the equity market does stabilize in the coming days, there’s still a fair amount of uncertainty lingering from recent events such as the debt ceiling debate and the downgrade of the US credit rating, a move that would have been almost unimaginable in earlier decades. Reflecting that skittishness, the CBOE Volatility Index, or VIX, closed at 48 on Monday. That’s the highest reading since the recession days of early 2009 and twice the level from earlier this summer. Altogether, it’s a tough time to be on the market, much less come to market.

Fusion-io’s ‘flash-y’ and jumpy M&A currency

Brenon Daly

Contact: Brenon Daly

In the same breath that it announced quarterly results for the first time, Fusion-io also announced its first-ever acquisition. The flash storage specialist reached for IO Turbine, a caching software startup that had only emerged from stealth mode earlier this summer. Our storage analyst, Henry Baltazar, points out that although IO Turbine was only just getting started, its software had been bundled with Fusion-io’s PCIe flash cards. Fusion-io says the pairing boosts performance, and should open up new markets in virtualized environments.

Fusion-io will use both cash and stock to cover the $95m price of its inaugural purchase. The exact makeup of the consideration wasn’t released, but it’s basically one-third cash and two-thirds equity. That breakdown is noteworthy, given that Fusion-io – with some $220m in cash, thanks to its IPO two months ago – could have easily just used greenbacks to pay for IO Turbine.

Instead, the startup felt comfortable enough to take the majority of its payment in Fusion-io shares, which have been noticeably volatile since their June debut. Consider this: During last Thursday’s rough ride for the overall market, Fusion-io was particularly jumpy ahead of its earnings announcement. Shares opened at $28 each, dropped as much as 14% in the first hour of trading, actually popped above the opening trading price at midway through the session, and then slid almost uninterruptedly to close at the low of the day.

Granted, the trading last Thursday for individual equities was overshadowed by the historic 500-point drop in the Dow Jones Industrial Average that day. But we would note that the Dow was in the red from the opening bell, while Fusion-io actually rallied into the green at one point before sliding. Given those sorts of swings, it might not be a bad idea for the new holders of Fusion-io shares to look into a hedging plan for their holdings.