Category: VC

Changing channels

Brenon Daly6 Comments

In the hyper-competitive storage market, it seems that one vendor’s pain is another vendor’s gain. We’ve heard from three market sources recently that Dell’s largest-ever acquisition — its $1.4bn purchase of EqualLogic — has hit some difficulties around defections and uncertainties from the SAN vendor’s existing channel partners. Resellers who pushed EqualLogic’s offering in the past are worried about being crushed by Dell’s powerful direct-sales machine, as has happened to some of Dell’s ‘partners’ in the past.

Based on the recent numbers posted by rival SAN vendor Compellent Technologies, there may be something to those concerns. Compellent, which recently signed up its 1,000th customer, said second-quarter sales surged 74% to $21m — which is about what they were for the first two quarters of 2007 combined. (The performance, along with the forecast for profitability for the rest of the year, helped spark a 20% rally in the company’s shares over the past month.) At a recent investment banking technology conference, Compellent CEO Phil Soran told us he’s looking to poach EqualLogic’s channel partners. We’ve heard similar plans coming from rival storage player Lefthand Networks.

How well Dell is able to balance the sales channels for EqualLogic will go a long way toward determining how much of a boost the acquisition will give to its emerging push into storage. Already, the return on EqualLogic is made more challenging by the fact that Dell bought it literally at the top of the market. The day that Dell announced the acquisition, the Nasdaq hit a level it hadn’t seen since early 2001. (The index is currently off 14% since then, after having dropped as much as 23% from its early-November highs.) To make its high-priced acquisition of EqualLogic pay off, Dell is going to have to work hard to keep its new SAN rivals from siphoning off channel sales.

Try, try again — then liquidate

Brenon Daly

Born from the ashes of a burned-out company, agami Systems may well have landed back in an ash heap. Several reports have indicated the NAS storage specialist wound down operations recently. (We were unable to raise anyone in several calls to their Sunnyvale, California, headquarters.) Just before agami emerged from stealth three years ago, we noted that the company’s core IP – along with a pair of primary VCs and handful of employees – came from NAS startup Zambeel. That company flamed out in 2003, after burning through some $72m in funding. (For its part, agami incinerated about $85m, which included $45m raised earlier this year.)

If indeed agami has gone the way of Zambeel, we highly doubt the sale of agami assets (if that comes) will go the way of Zambeel’s assets. Having lost now on both go-rounds with this technology, Kleiner Perkins Caufield & Byers and New Enterprise Associates probably aren’t interested in stepping in for a third time.

Still, there’s undoubtedly some interesting technology at agami, particularly for block-level vendors that have ambitions for their own NAS products. For instance, Dell, which recently made a significant push into storage, might want to look at agami’s IP. The same is probably true for Compellent Technologies, which has a heap of money from its IPO last year, and for fast-growing LeftHand Networks, a privately held company with some 3,300 customers.

Meanwhile, NetApp, which agami sought to undercut on price, might want to do a ‘buy & bury’ to knock out any future threat. (Keep in mind that NetApp has done graveside deals for NAS technology in the past, buying the patent portfolio of Auspex five years ago during a bankruptcy auction.) In any case, whoever picks up the bits of agami that come up for sale is likely to get a bargain. In fact, we’d be surprised if agami garnered even one-tenth of the $85m that went into it over the past three years.

Selected NAS deals

Date Acquirer Target Price
Sept. 2007 Sun Microsystems Cluster File Systems undisclosed
August 2007 F5 Networks Acopia $210m
Nov. 2003 NetApp Spinnaker $300m
June 2003 NetApp Auspex (patents) $9m

Source: The 451 M&A KnowledgeBase

‘Cuil-ing’ off Google

In the lucrative world of search, not much has changed in recent years. Google is still running away with market share, handling an estimated two-thirds of all queries, followed – at a distance – by Yahoo and Microsoft. However, some changes may be coming, with a host of new search startups coming out of beta. The latest: Cuil. The highly touted and heavily funded startup created by some high-ranking former Google search employees hopes to dethrone Google. Do we believe it can accomplish that? Of course not; in fact, due to a less-than-stellar launch, it may have already lost.

Still, there is a small opening for Cuil and the other startups. Google has been mired in controversy for the past year over privacy concerns and regulatory hurdles, not to mention its ambitions to become a software application vendor. Those distractions at Google have encouraged venture capitalists, particular the more adventurous angels, to once again put money into search. Cuil has collected about $30m, while Blekko has received $6m. (The funding at Blekko comes despite the fact that the company, as it stands now, is nothing more than a promising idea from industry veterans and an empty webpage.)

Of course, the reason this new generation of search companies is getting VC attention is that there are natural acquirers for this technology. One example: Microsoft’s purchase of Powerset earlier this month for an estimated $100m. While that valuation may seem a bit low for Powerset, which was once as hotly hyped as Cuil, keep in mind that the price was essentially twice its post-money valuation in its latest round. Not great, but not bad in this market.

We suspect other search startups will ultimately sell for much the same reason that Powerset sold: scaling up these startups to deal with millions of users, and competing with multimillion-dollar R&D budgets of the ‘Big Search’ companies is not an easy or cheap task. With a proven willingness and desire of Yahoo, Microsoft and Google to make defensive or technology acquisitions in search, we believe the end game for Cuil, Mahalo, Blekko and the like will all be the same: acquisition. The bigger picture in the Cuil saga is that there is a batch of ex-Googlers up for grabs – Googlers who helped define the core technology of early Google search technology. Though Google is rumored to already be in engaged in talks with the company, how could Microsoft and Yahoo possibly resist swooping in for the coup?

Startup search engines

Company Year founded Funding
Cuil 2007 $30m
Mahalo 2007 $20m
Blekko 2006 $6m
ChaCha 2006 $16m
Hakia 2004 $21m

Source: Company reports

Netezza’s bogeyman

Brenon Daly

When Microsoft gets into a new market, the impact on the existing vendors tends to be in line with the software giant’s gargantuan size. After all, fears among startups over getting ‘Netscape-d’ have often been realized. That’s particularly true in the days before the convicted monopolist started putting on a softer face on its business. Gone are the days when Microsoft would threaten ‘to cut off the air supply’ of other companies, as it famously did to the Internet browser pioneer. Maybe it’s middle-aged softness at the 33-year-old company, but Microsoft’s bite often seems a little toothless these days. (Does anyone really think Microsoft – with or without spending $45bn on Yahoo – will be able to narrow the gap to Google in search advertising?)

Still, there was a moment last week when it appeared the Redmond, Wash.-based behemoth once again looked like it had the power to scare the bejesus out of a company (and its investors) by buying its way into a market. Last Thursday, as it was holding its annual meeting with Wall Street, Microsoft said it was purchasing Datallegro, a data-warehousing startup that we estimate was running at about $35m in sales. A market source indicated that rumors of the deal started percolating late Wednesday, a day before official word of the acquisition. Almost immediately, shares of data-warehousing vendor Netezza came under pressure. After hitting an intra-day high of $13.36 on Wednesday, Netezza stock slumped as much as 8% and closed basically at the low of the day. It opened even lower Thursday and sunk the entire day, finishing the session at $11.48. From its peak to its trough in those two sessions, Netezza lost 14%, with trading on Thursday about 50% busier than average.

However, as easy as it may be to point to Microsoft’s competitive move as the reason for Netezza’s decline, the two events are linked only by coincidence rather than causality. According to two market sources, Netezza actually distributed shares back to its VCs, meaning the stock’s slump can be attributed to the supply side, rather than demand side. (There have been no SEC filings about the move, and calls to the company to verify the information weren’t immediately returned.) Maybe Microsoft isn’t the big, bad company we all thought it was?

Star-crossed companies?

Brenon Daly

Having already made a pair of profitable on-demand investments, venture firm StarVest Partners has decided to take a larger bite in its most recent software-as-a-service (SaaS) deal. The New York City-based firm recently led the majority acquisition of Iron Solutions, which provides online information about used farm and industrial machinery. (Want to buy a John Deere tractor? There are nearly 2,900 of them for sale on the Iron Solutions site.) StarVest put up $8.5m of the $15m for 90% of Iron Solutions, with the remaining money coming from Dublin Capital Partners, Spring Mountain Capital and GVIC Communications.

The deal caught our eye because StarVest was also an early investor in NetSuite, owning 5% of the company according to the S-1 filed ahead of NetSuite’s IPO in 2007. (StarVest’s other SaaS exit came when Dell paid $155m in cash for portfolio company MessageOne, an on-demand email archiving company run by Michael Dell’s brother.)

StarVest’s interest in NetSuite dates back to May 2000, when it led a Series C investment in the SaaS applications suite vendor together with Oracle head honcho Larry Ellison. (Ellison, of course, is the co-founder and majority owner of NetSuite.) Iron Solutions and NetSuite teamed up in October 2007 to provide industry-specific applications for agricultural equipment dealerships, and the on-demand player often uses that example to illustrate how its software can be tailored to a specific industry.

Does StarVest’s simplification of the capital structure at Iron Solutions make a sale more likely, perhaps making the firm a broker in a deal between a pair of portfolio companies? (We would note that Oak Investment Partners recently played matchmaker in an inter-portfolio marriage of two SaaS companies.)

Speculation about a possible purchase of Iron Solutions by NetSuite may be a bit of a stretch. However, it’s worth noting that NetSuite’s only acquisition so far has been a vertical deal: the $31m purchase of OpenAir, which helped boost NetSuite’s services industry expertise.

Perhaps NetSuite could broaden the focus of Iron Solutions’ online marketplace, appraisal and valuation services to a much wider market. The applications vendor has already begun to offer applications tailored for light manufacturing and has voiced a desire to add in heavy manufacturing in the future. If it’s serious about those moves, NetSuite may well find that Iron Solutions’ equipment marketplace and other know-how come in handy. The two sides, and their backers, certainly know each other well enough.

Selected StarVest exits

Company Event
MessageOne Sale to Dell for $155m
NetSuite IPO in December 2007

Assembling the deliverable

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Comcast’s digital content delivery software subsidiary ThePlatform made its first acquisition this week, picking up tiny social networking startup Chirp Interactive. Founded just one year ago, the San Francisco-based company has developed an interactive screen saver that collects updates from websites like Facebook and Flickr. Structured as an asset acquisition, ThePlatform will use the VC-backed company’s technology and select employees to build similar social features into its own content distribution and management system.

Comcast bought ThePlatform in 2006, early in its efforts to build a viable online video distribution business, and operates the business as an independent entity. Since 2006, it’s been reported that the cable giant has shelled out nearly half a billion dollars on five online deals since the beginning of 2006, including its purchases of movie review and ticketing website Fandango in April 2007 and social networking site Plaxo in May 2008. Comcast’s VC arm, Comcast Interactive Capital, has also been banking heavily on online startup. One recipient of Comcast’s capital is tiny video and advertising distribution company Revver, which incidentally was picked up by LiveUniverse in February.

Going forward, we ask where Comcast and its VC arm will be setting their sights. Well, mobile content distribution, of course. In fact, Comcast participated in a $12.6m seed-round funding of Boston-based mobile WiMax startup Cartiza earlier this month. It also joined Google, Time Warner and other industry behemoths in a $3.2bn round in WiMax company Clearwire in April. After building up a healthy reserve of content, a video and advertising distribution platform and increasing social networking capabilities, the need to converge these platforms on mobile devices is clear, and Comcast is making the moves to do just this.

Selected Comcast acquisitions

Date announced Target Target description Deal value
May 14, 2008 Plaxo Online address book synchronization $160m*
April 11, 2007 Fandango Online movie tickets & reviews $192m*
June 28, 2006 ThePlatform Digital media publishing & delivery $90m*

Source: The 451 M&A KnowledgeBase *Reported values

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.

Location-based stalking?

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Nokia has been going navi-crazy lately. Last week, the Finnish conglomerate bought location-based social networking company Plazes for an estimated $30m. This comes as the company is wrapping up the largest acquisition in its history – the $8.1bn purchase of Navteq. We believe this is just the beginning for Nokia and others in the excessively hyped mobile location-based services (LBS) space. The question arising from this acquisition, as well as Vodafone’s $48.7m acquisition of Zyb in May, is what these acquisitions mean for the rest of the market. One implication is already clear: GPS technology has been commodified. (Just ask shareholders of Garmin, who have seen the stock skid to a two-year low.) With this technology popping up on dozens of devices, we expect hardware vendors to be even more active in snapping up LBS startups.

Nokia plans to roll Plazes into its Nokia Maps division, which itself was formed from the acquisition of gate5 in late 2006. It is part of Nokia’s overall strategy to have GPS technology play a large role in expanding beyond just being a mobile hardware company. Nokia claims it will sell upward of 37 million GPS-enabled handsets this year alone. The approaching worldwide release of the GPS iPhone, as well as Research in Motion’s push to include the technology in most of its BlackBerry devices, make it clear why high-profile backers such as KPCB and Sequoia Capital are so excited about LBS applications.

Beyond being a simple technology purchase, however, Plazes and other future deals will likely bring another important component to the apps: users. Despite their hype and position as leaders in the space, services such as Palego’s Whrrl, Loopt and Brightkite have fewer than a million users combined. Compare that to the hundreds of millions of users that ‘traditional’ social-networking sites such as Facebook and MySpace command, and one wonders what the hype is all about. By pairing up with larger companies, however, the services get instant access to millions of users. It is the technology and expertise that rumored suitors such as Facebook, Microsoft, Google and now the mobile carriers and hardware manufacturers are interested in. With continued consolidation, the fear of being left behind in a potentially important market will drive many to acquire first and ask questions later. Nokia might have just lit the fire in the M&A race to dominate the LBS market.

Seven signs of a consolidating LBS industry

Announced Acquirer Target Deal value
June 2008 Nokia Plazes $30m*
June 2008 Polaris Hughes Telematics $700m
May 2008 Vodafone Zyb $48.7m
October 2007 Nokia Navteq $8.1bn
July 2007 TomTom Tele Atlas $2.8bn
July 2007 Springbank Resources Location Based Technologies (fka PocketFinder) $50m
August 2006 Nokia gate5 $250m*

*estimated, Source: The 451 M&A KnowledgeBase