Category: VC

Tech M&A stumbles out of summer

Brenon Daly

Contact: Brenon Daly

This summer’s momentum in the tech M&A market petered out as autumn arrived. Spending in the just-completed month of October slumped to its second-lowest monthly total of the year. Across the globe, acquirers announced just $17bn worth of tech and telco purchases in October, equaling only slightly more than half the average monthly deal value in the nine previous months, according to 451 Research’s M&A KnowledgeBase.

October’s spending represents a sharp decline from September and, more broadly, the entire third quarter. (See our full Q3 report.) Spending on tech deals in September, which featured this year’s two largest acquisitions, came in more than three times higher than October. The September surge helped boost overall Q3 deal value to a quarterly level more in-line with the boom years of 2015 and 2016. (The two previous years stand out as banner years for tech M&A. At this point in the year, deal makers had spent 85% more in 2015 and 50% more in 2016 than they have so far in 2017.)

However, deal makers abruptly hit the brakes in October, particularly when shopping for big-ticket targets. Our M&A KnowledgeBase records just three transactions last month valued at $1bn or more, down from a monthly average of five 10-digit deals so far in 2017. Without a continuation of those billion-dollar deals, the start of Q4 is tracking much more closely to the first two quarters of this year, rather than the breakout Q3. Overall, with 10 months now in the books, 2017 is on pace for about $340bn in full-year M&A spending, which would represent the lowest annual total in four years.

VCs aren’t buying what VCs are selling

Brenon Daly

Contact: Brenon Daly

VCs aren’t buying what other VCs are selling, slamming shut a once-reliable exit door for startups. The recent shift in M&A has left the number of VC-to-VC acquisitions down about 40% so far this year compared with the previous three years, according to 451 Research’s M&A KnowledgeBase. The current weekly pace of two sales of VC-backed companies to other VC-backed companies would put this year’s total at about 105, representing the lowest full-year number of exits since the start of the decade.

There are several reasons for the decline in intra-industry deals, depending on the stature of the acquiring startup. In the rarified land of unicorns, there is a prevailing focus for VC portfolio companies on operational improvements, rather than inorganic expansion. Unlimited spending – whether it’s on KIND bars or Y Combinator graduates – has fallen out of fashion.

For instance, the M&A KnowledgeBase lists 24 acquisitions for Dropbox, which has raised more than $2bn in debt and equity. However, not one of those purchases has come in the past two years. It’s a bit different for Uber, which has its own ‘operational improvements’ to make. That besieged startup hasn’t done any deals in 2017, after doing two in each of the two previous years, according to the M&A KnowledgeBase.

Beneath that top tier of once-active, big-name startups is a fatter slice of VC-backed companies that have also cut their shopping, but for a different reason. In many cases, the startups simply don’t have the money for M&A because they haven’t been able to raise any new funding. This year is on pace to feature the fewest number of startups receiving venture investment since 2012, according to trade group National Venture Capital Association.

MongoDB maintains in its IPO

Brenon Daly

Contact: Brenon Daly

Despite a well-received IPO, MongoDB’s valuation basically flatlined from the private market to the public market. The open source NoSQL database provider priced shares at $24 each and jumped in mid-Thursday trading to about $30. The 25% pop on the Nasdaq basically brought MongoDB shares back to the price where the company sold them to crossover investors in late 2014.

MongoDB has slightly more than 50 million shares outstanding, on an undiluted basis. With investors paying about $30 for shares in the company’s public debut, that gives MongoDB a market cap of more than $1.5bn. It raised $192m in the public offering, on top of the $300m it raised as a private company.

That means Wall Street is valuing MongoDB, which will put up about $150m in the current fiscal year, at 10x current revenue. That’s a rather rich premium compared with the most-recent big-data IPO, Cloudera. The Hadoop pioneer, which went public six months ago, currently trades at about 6x current revenue. For more on MongoDB’s IPO, 451 Research subscribers can see our full report, including our sizing of the NoSQL database market, as well as an in-depth look at the evolution of the 10-year-old company’s technology and its competitors.

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

Startups stuck in a billion-dollar backlog

Brenon Daly

Contact: Brenon Daly

Startups are increasingly stuck. The well-worn path to riches – selling to an established tech giant – isn’t providing nearly as many exits as it once did. In fact, based on 451 Research calculations, 2017 will see roughly 100 fewer exits for VC-backed companies than any year over the past half-decade. This current crimp in startup deal flow, which is costing billions of dollars in VC distributions, could have implications well beyond Silicon Valley.

First, the numbers. So far this year, 451 Research’s M&A KnowledgeBase reports just 439 VC-backed companies have been acquired, putting full-year 2017 on pace for roughly 570 exits. That’s 16% fewer deals than the average number of VC exits realized from 2012-16, and the lowest number of prints since the recession year of 2009, when startups were mostly focused on survival rather than a sale.

The reason for the current slowdown in the prototypical startup-sells-to-brand-name-buyer transaction that has generated hundreds of billions of dollars in investment returns over the years is that the buyers aren’t buying. (We would note that’s only the case for the bellwether tech vendors, the so-called strategic acquirers. Rival financial buyers – both through direct investment and acquisitions made by their portfolio companies – have never purchased more VC-backed firms in history than they have in 2017, even as the overall number of venture exits declines. Private equity now accounts for 17% of all VC-backed exits, twice the percentage the buying group held at the start of the decade, according to the M&A KnowledgeBase.)

Parked in VC portfolios, startups can, of course, build their businesses, along with the accompanying value. What they can’t do as long as they are still owned by venture investors is realize that value, at least not tangibly or completely. That takes either a sale of the company outright or an IPO. (Wall Street hasn’t provided many exits at all for VC-backed companies since 2000, and isn’t ever likely to be a primary destination for startups.)

And although we’re talking about small companies, there’s already been a pretty big impact. Even if we take a conservative average exit price of $50m for startups, multiplying that across the 100 exits that won’t happen this year means a staggering $5bn won’t get distributed in 2017 that would have in previous years. Without capital once again flowing from corporate acquirers back to startups and VCs, the entire ecosystem runs the risk of stagnation.

Survey: Steady as she goes for tech M&A

Brenon Daly

Contact: Brenon Daly

Undeterred by the recent slowdown in M&A activity, tech acquirers have largely left their bullish forecast for dealmaking unchanged. For the third consecutive time, essentially half of the respondents to the semiannual M&A Leaders’ Survey from 451 Research and Morrison & Foerster indicated that they expected an acceleration in acquisition activity.

The 51% that forecast a pickup over the next year in M&A in our most-recent edition is more than twice the 19% that projected a decline. The results lined up very closely with the sentiment from both the year-ago survey as well as our previous survey in April.

More broadly, the outlook from the three recent surveys reflects an unusual bit of stability in what is an inherently lumpy business. A bit of history: Over the previous half-dozen years of the M&A Leaders’ Survey from 451 Research and Morrison & Foerster, swings of 10 or even 20 percentage points from one edition to the next haven’t been uncommon.

451 Research subscribers can click here for the full report on the views from 150 top dealmakers, including their forecasts on M&A valuations, their thoughts on where startups should be looking to exit, and how they see the pitched fight with cash-rich private equity buyers playing out.

Barely a ripple in the pool of tech M&A buyers

Brenon Daly

Contact: Brenon Daly

New companies are constantly wading into the tech buying pool. As welcome as those new entrants are, however, their arrival has barely caused a ripple in the overall tech M&A market. Unconventional buyers – including retailers looking to jumpstart online sales and consumer product vendors looking to digitally connect their wares – have come up far short in offsetting the dealmaking absence of the mainstay tech acquirers. The resulting void of several hundred transactions has left 2017 on track for the lowest overall tech M&A volume in four years, according to 451 Research’s M&A KnowledgeBase.

Already this year, the M&A KnowledgeBase lists several first tech deals from well-known names from outside the tech industry such as IKEA, Albertsons, Signet Jewelers and Whirlpool. These debutants join other non-tech giants that have recently reached for startups, including Bed Bath & Beyond, Hudsons Bay Company, Unilever and Deere & Company.

Given that digital deals by analog companies tend to be viewed as ancillary to their businesses, they will likely never have the same M&A pace of tech vendors themselves. For instance, we noted in our recent Q3 report on tech M&A that heavy machinery manufacturer Deere & Company, which bought a tiny machine-learning startup in early September, had gone about three years since its previous tech transaction. In the interim, other acquirers inked more than 11,000 tech deals, according to the M&A KnowledgeBase.

As these non-tech buyers dabble in deals, the bellwether acquirers have dramatically slowed their pace. Consider the recent activity of some of the companies that have traditionally set the tone in the tech M&A market. Salesforce has put up just one print so far this year. Serial acquirer Oracle hasn’t announced an acquisition in six months. IBM is averaging a deal every other month in 2017, just half the rate it acquired companies in both 2016 and 2015.

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

ForeScout looks ahead to Wall Street

Brenon Daly

Contact: Brenon Daly

For all the ‘next generation’ hype throughout much of the information security (infosec) market, 17-year-old ForeScout represents a bit of a throwback. For instance, ForeScout has been around twice as long as the other infosec company to make it public this year, Okta. Further, its business is primarily tied to old-line boxes, while Okta and other startups of a more-recent vintage have pushed their businesses to the cloud.

That comes through in the numbers. At ForeScout, sales of products (physical appliances, mostly) still accounts for about half of the company’s revenue. The remaining half comes from maintenance fees, with just a sliver of professional services revenue. There’s no mention in ForeScout’s IPO paperwork of ‘bookings’ or ‘billings’ or any other business metric favored by companies delivering their offering through a newer subscription model

While not flashy, ForeScout’s business model works. (There aren’t too many startups that are generating a quarter-billion dollars of revenue and increasing that by one-third every year.) ForeScout posted $167m in sales in 2016, and $91m in the first half of 2017. (Growth over that period has been consistent at roughly 33%.) Assuming that pace holds through the end of 2017, ForeScout would put up about $220m in revenue, or roughly triple the amount of sales it generated in 2014.

However, in our view, much of that performance has been more than priced into the company, which secured a $1bn valuation in the private market. That said, we also don’t imagine that ForeScout will be one of those unicorns that stumbles when it steps onto Wall Street. (Post-IPO valuations for recent offerings from Snap, Blue Apron, Cloudera and Tintri are all lingering below the level they secured from VCs.)

ForeScout likely won’t enjoy anywhere near the platinum valuation that Okta commands. (The cloud-based identity vendor currently trades at a market valuation of $2.7bn, or 11x this year’s forecast revenue of $245m.) Instead, to value ForeScout, Wall Street might look to another product-based infosec provider, Fortinet.

The two companies don’t exactly line up, either in terms of strategic focus or scale. (Fortinet generates far more revenue each quarter than ForeScout will all year, while ForeScout is growing about twice as fast as Fortinet.) Nonetheless, Wall Street currently values Fortinet at roughly 4.3x current year’s revenue. Slapping that valuation on ForeScout would get the company to a $1bn valuation, but not much higher.

451 Research subscribers can look for a full report on ForeScout’s filing later today.

A pause in Big Software’s ‘SaaS grab’

Brenon Daly

Contact: Brenon Daly

After years of trying to leap directly to the cloud through blockbuster acquisitions, major software vendors have been taking a more step-by-step approach lately. That’s shown up clearly in the M&A bills for two of the biggest shops from the previous era trying to make the transition to Software 2.0: Oracle and SAP.

Since the start of the current decade, the duo has done 11 SaaS purchases valued at more than $1bn, according to 451 Research’s M&A KnowledgeBase. However, not one of those deals has come in the past 14 months, as the two companies have largely focused on the implications of their earlier ‘SaaS grab.’

During their previous shopping spree for subscription-based software providers, Oracle and SAP collectively bought their way into virtually every significant market for enterprise applications: ERP, expense management, marketing automation, HR management, CRM, supply chain management and elsewhere. All of the transactions appeared designed to simply get the middle-aged companies bulk in cloud revenue, with Oracle and SAP paying up for the privilege. In almost half of their SaaS acquisitions, Oracle and SAP paid double-digit multiples, handing out valuations for subscription-based firms that were twice as rich as their own.

In addition to the comparatively high upfront cost of the SaaS targets, old-line software companies face particular challenges on integrating SaaS vendors as part of a larger, multiyear shift to subscription delivery models. Like a transplanted organ in the human body, the changes caused by an acquired company inside the host company tend to show up throughout the organization, with software engineers re-platforming some of the previously stand-alone technology and sales reps having their compensation plans completely overhauled.

The disruption inherent in bringing together two fundamentally incompatible software business models shows up even though the acquired SaaS providers typically measure their sales in the hundreds of millions of dollars, while SAP and Oracle both measure their sales in the tens of billions of dollars.

For instance, SAP is currently posting declining margins, an unusual position for a mature software vendor that would typically look to run more – not less – financially efficient. But, as the 45-year-old software giant has clearly communicated, the temporary margin compression is a short-term cost the company has to absorb as it transitions from a provider of on-premises software to the cloud.

Of course, the transition by software suppliers such as Oracle and SAP – painful and expensive though it may be – simply reflects the increasing appetite for SaaS among software buyers. In a series of surveys of several hundred IT decision-makers, 451 Research’s Voice of the Enterprise found that 15% of application workloads are running as SaaS right now. More importantly, the respondents forecast that level will top 21% of workloads by 2019, with all of the growth coming at the expense of legacy non-cloud environments. That’s a shift that will likely swing tens of billions of dollars of software spending in the coming years, and could very well have a similar impact on the market capitalization of the software vendors themselves.

Another ‘down round’ IPO?

Brenon Daly

Contact: Brenon Daly

Another unicorn is set to gallop onto Wall Street, as MongoDB has put in its IPO paperwork. The open source NoSQL database provider plans to raise $100m in the offering, on top of the $311m it drew in from private-market investors over the past decade. As has been the case in other recent tech offerings, however, some of those later investors in MongoDB may well find that the IPO represents a ‘down round’ of funding.

Any discount for MongoDB likely won’t be as steep as the discount Wall Street put on the previous data platform provider to come public, Cloudera. Investors currently value the Hadoop pioneer at $2.2bn, slightly more than half its peak valuation as a private company. For its part, MongoDB, which last sold stock at $16.72, has more than 100 million shares outstanding, giving it a valuation of roughly $1.7bn.

While not directly comparable, Cloudera and MongoDB do share some traits that lend themselves to comparison. Both companies have their roots in open source software, and wrap some services around their licenses. (That said, MongoDB has gross margins more in line with a true software vendor than Cloudera. So far this year, it has been running at 71% gross margins, compared with just 46% for Cloudera.) Further, both companies are growing at about 50%, even though Cloudera is more than twice the size of MongoDB.

Assuming Wall Street looks at Cloudera for some direction on valuing MongoDB, shares of the NoSQL database provider appear set to hit the public market marked down from the private market. Cloudera is valued at slightly more than six times its projected revenue of $360m for the current fiscal year. Putting that multiple on the projected revenue of roughly $150m for MongoDB in its current fiscal year would pencil out to a market cap of about $920m. Given its cleaner business model and less red ink, MongoDB probably deserves a premium to Cloudera. While MongoDB certainly may top the $1bn valuation on its debut, reclaiming the previous peak price seems a bit out of reach.

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.