Emulex goes from defense to offense

Contact: Brenon Daly

This time a year ago, Emulex was stiff-arming an unwelcome suitor. Now, it is warmly embracing another company. Emulex said Monday that it will acquire ServerEngines for $159m in cash and stock.

It will hand over about $78m in cash and eight million shares, which were valued at $81m based on Emulex’s closing price ahead of the announcement. The deal, which is expected to close in July, also has a possible earnout of four million shares that would be paid over the next two years. (While the terms are fairly straightforward, it does have one surprising agreement: a $10m breakup fee, representing a fairly steep 6% of the deal value.)

Emulex’s purchase of its partner comes a year after the vendor fended off an unsolicited bid from larger rival Broadcom. The fight between the two Southern California companies turned particularly nasty during the two-and-half-month process, which ended last July after Emulex’s board shot down Broadcom’s offer for a second time. (For the record, shares of Emulex trade at roughly the level of Broadcom’s first offer but 14% below its topping bid.) The two companies are still battling it out in the courtroom over alleged patent infringement.

As a final thought, we would note that Emulex’s contentious relationship with Broadcom is probably not an unknown feeling at the firm that it just acquired, ServerEngines. A decade ago, the CEO of SeverEngines, Raju Vegesna, sold his previous company ServerWorks to Broadcom for $1.8bn. He left two years later after a fallout with Broadcom leadership over the strategic direction of the business.

Broadcom-Emulex: Failure rewarded?

Contact: Brenon Daly

Is this a case of the market rewarding failure? Since Broadcom unveiled its now-aborted bid for Emulex, shares of both companies have outperformed the Nasdaq. That bull run stands in sharp contrast to the performance of firms that have been involved in other unsolicited efforts, as we noted when Broadcom first started squeezing Emulex. Broadcom took its unsolicited offer public for its fellow southern California-based vendor on April 21. Initially, Broadcom was set to hand over $9.25 in cash for each share of Emulex, although last week it bumped the bid up to $11 per share. That’s not a bad premium for Emulex, which had spent much of the year trading at around $6.

Of course, it’s not surprising that Emulex shares would be trading higher, given the ‘floor’ valuation that Broadcom put on the company. (On Friday morning, Emulex stock was changing hands at around $9, just slightly below Broadcom’s opening bid.) On the other side, Broadcom stock has slightly outperformed the broader market over the two and a half months that it has been trying to land Emulex. On Thursday, Broadcom gave up its effort. In a brief release explaining the abandoned bid, Broadcom CEO Scott McGregor said the company would now look at other ‘value-creating alternatives.’ Like, say, an unsolicited run at another company?

Going it alone can be expensive

Contact: Brenon Daly, Henry Baltazar

Wall Street hasn’t been particularly supportive of tech companies that turn down unsolicited offers and opt to go it alone. Shares in a number of the targeted firms are currently changing hands at less than half the level that the would-be suitors were willing to pay for them. To wit: Microsoft was reportedly set to pay in the mid-$30s for each share of Yahoo, which is now trading in the mid-teens. And having spurned a $16-per-share unsolicited bid from Cadence Design Systems last summer, Mentor Graphics stock is now trading at about $7.

We mention that bit of cautionary history because there’s another showdown brewing. Broadcom, advised by Banc of America Securities, recently offered $9.25 for each share of Emulex, giving the unsolicited bid a total equity value of $764m. (As it often does, Goldman Sachs is advising the target.)

Broadcom’s bid values Emulex where it was trading last October. On an enterprise value basis, the proposed transaction values the maker of storage networking gear at just 1.2x its trailing 12-month (TTM) sales and 5.5x TTM EBITDA. Emulex investors want a richer valuation and have pushed the stock above $10 since the offer was unveiled. Broadcom has vowed to take the unsolicited bid directly to shareholders if the Emulex board rebuffs it. On its conference call Monday discussing fiscal third-quarter results, Emulex said only that it was ‘thoroughly’ reviewing Broadcom’s offer.

From Broadcom’s point of view, it’s understandable why it would want its fellow southern California-based company. If the deal goes through, Broadcom would get a foothold in a few interesting storage markets such as host bus adapters (for both standard servers and blade servers) and embedded storage processors for disk arrays. Broadcom sells Gigabit Ethernet and 10-Gigabit Ethernet products, but is not a player in the SAN market. With network convergence growing in popularity, Broadcom would also benefit from Emulex’s fiber channel technology and its new Fiber Channel over Ethernet adapters.

Of ‘corrections’ and ‘recalibrations’

Since the beginning of September, a new euphemism has found its way into Wall Street parlance: ‘recalibration.’ It is a close cousin to the original euphemism, ‘correction.’ In fact, the pair of linguistically neutral terms are often popping up in the same sentence, such as ‘Given the market’s correction, we have recalibrated the deal.’ We gather that’s a lot more sensitive than saying, ‘Look, stocks have gone to hell, so we slashed the deal.’

Whatever the language, we saw two cases of this on Wednesday. Not unexpectedly, Brocade ‘amended’ its offer to buy Foundry, originally inked in late July. (‘Did we say $3bn? We meant $2.6bn.’) And Broadcom took a pair of scissors to its agreement to buy AMD’s digital television unit, cutting 25% from the price.

At least the deals will get done (probably). The same can’t be said for a transaction a banker described for us yesterday over coffee. Working on the sell-side, the banker and his client hammered out an agreement with a strategic acquirer over the summer. Terms called for the buyer to pay about $30m, about $25m of that in cash, the rest in equity. As shares in the would-be buyer ‘corrected,’ the company ‘recalibrated’ the price down to about $20m. The final kicker: the company planned to pay in stock. The would-be target is ‘recalibrating’ its interest in the offer.

Net effect from Intel’s buy

-by Thomas Rasmussen

It’s a somber 10-year anniversary for 10-Gigabit Ethernet vendor NetEffect. The company was picked up by Intel in a bankruptcy asset sale last week for a bargain $8m. Its technology, along with 30 of its engineers, will be rolled into Intel’s LAN Access Division. NetEffect has burned through some $50m in funding since recapitalizing in 2004. The company, which we once heralded as an innovator and potential leader in 10GigE technology, simply ran out of cash.

One reason for NetEffect’s scrap sale might be the increased competition. Big players like Intel, with its own organic offerings and its tuck-in of NetEffect, and Broadcom, with its $77m acquisition of Siliquent Technologies in 2005, have been crowding an already teeming market. This, coupled with scarce funding and lack of widespread adoption of the technology, makes us wonder what will happen to NetEffect’s surviving former rival startups still trying to stay afloat.

Venture capitalists have thrown hundreds of millions of dollars at 10GigE companies, with little to no payoff. We suspect the wind-down of NetEffect is an indication that VCs have had enough. Tehuti Networks, iVivity, Myricom, Neterion Technologies and Alacritech are some of the many startups in this sector that could potentially feel the net effect from this. In fact, iVivity seems to have quietly hit the switch already; its website is down and its phones are off the hook. Firms that will benefit from this include IBM, Hewlett-Packard, Dell and Hitachi, which are likely to follow Intel’s lead and peruse the bargain bin.

Known funding of select 10GigE players

Company Total funding Last round Status
Chelsio Communications $100m $25m series E (2008) Active
iVivity $60m $10m series D (2006) Missing in action
NetEffect $47m $25m series B (2006) Acquired by Intel for $8m
Siliquent Technologies $40m $21m (2004) Acquired by Broadcom in 2005 for $77m
Silverback Systems $51m $16m series D (2006) Acquired by Brocade Communications in 2007 for less than $10m*
Tehuti Networks Unknown Series B (2008) Active

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