In HP’s earnings call, M&A talk expected to be muted

Contact: Thejeswi Venkatesh

Under the stewardship of its new CEO, Meg Whitman, who took the executive seat almost a year ago, Hewlett-Packard has been cautiously quiet when it comes to M&A. The usually acquisitive firm hasn’t announced a single deal this year, and likely won’t announce a large acquisition anytime soon, since many of its previous plays are widely regarded as blunders.

Following the purchase of Autonomy Corp, the largest software acquisition in seven years, and admitting failure in some of its previous transactions, most expect that HP won’t do another big deal in the near future.

The company is still reeling from some of its prior acquisitions. HP shuttered its Palm Inc business just one year after paying $1.4bn for the company. And HP recently announced that it would take an $8bn goodwill charge on its 2008 acquisition of Electronic Data Systems. Investors expect that write-downs in goodwill may continue because the value of HP’s goodwill ($45bn) exceeds its own market cap ($38bn).

Further reinforcing analysts’ expectations that HP will stay out of M&A is the fact that the company is struggling with its own operations. HP reports its fiscal third quarter after the closing bell today. The company has already indicated that it expects a loss of $4.31-4.49 per share. Over the past six months, HP’s shares have lost one-third of their value, while the Nasdaq has gained 5%.

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Stick with what you know

Contact: Ben Kolada, Thejeswi Venkatesh

Some moves just don’t pan out as planned, such as basketball legend Michael Jordan playing baseball or actor Joaquin Phoenix attempting to become a rapper. While those moves may have dented personal pride, when companies make failed moves, it hits their bottom line. Videoconferencing giant Polycom is experiencing that pain today. The company announced on Friday that it is divesting its enterprise wireless communications assets for just $110m to Sun Capital Partners, or about half the price that it paid for the business five years ago.

Polycom entered the wireless communications market in 2007 when it paid $220m for then publicly traded SpectraLink – it’s largest-ever acquisition (today’s divestiture also includes the assets of Kirk Telecom, which SpectraLink acquired for $61m in 2005). While we had doubts, Polycom argued that its rationale for the deal was sound. Polycom thought it would be able to boost revenue by leveraging the two companies’ complementary sales channels as well as by merging their server-side software products into a single platform.

Polycom, however, wasn’t able to generate the revenue that it expected from the acquired assets. The SpectraLink and Kirk Telecom assets dwindled within their newfound parent, falling from $144m in revenue in 2006 to about half that, $94m, in 2011.

Not to pick on Polycom, but its SpectraLink divestiture is just the most recent reminder of the risks involved in attempting game-changing acquisitions. Companies use M&A to enter new markets all the time, and often fail. HP shuttered its Palm Inc business just one year after paying $1.4bn for the company. And in 2010, Yahoo divested its Zimbra collaboration assets for $100m, or less than one-third of the $350m that it paid for the company in 2007. Cisco attempted to move into the consumer video segment when it paid $590m for Pure Digital Technologies, maker of the Flip video camera, but shut down that division two years later.

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

Deep-pocketed acquirers could bid up capacity-planning valuations

Contact: Ben Kolada

In a recent report, my colleague Rachel Chalmers discusses opportunities for some of the largest IT firms to fill holes in infrastructure management capacity planning through M&A. However, if bidding increases for the remaining startups in this sector, valuations could rise above the current estimated $100m record set by VMware’s Integrien acquisition.

Capacity planning is similar to performance monitoring. However, monitoring can only tell you what happened in the past, or at best, what’s happening now. Capacity planning requires you to have some idea of what will happen in the future. We’ve seen some dealmaking in this sector already, with each of the primary precedent transactions being valued well above the market average. However, many of the remaining potential acquirers have very deep pockets and intense bidding by this group for the decreasing pool of available targets could elevate valuations. Chalmers’ report cites Oracle, HP, IBM and Microsoft as still missing some capacity-planning capabilities – these four firms have a combined $100bn in cash and cash equivalents in their war chests. Click here for the full report, which includes current market valuations and details some of the most likely acquisition candidates.

What lies ahead for independent ESIM vendors?

Contact: Thejeswi Venkatesh, Ben Kolada

Hewlett-Packard recently announced the availability of ArcSight Express 3.0, an upgraded version of the product it acquired last year. In light of this release, we note that independent ESIM vendors aren’t resting on their laurels, either. They continue to develop, innovate and position themselves as potential IPO/acquisition candidates. Competition is already fierce among ESIM players, with each trying to expand their addressable markets, but with HP, Attachmate and Sophos adding ESIM offerings to their portfolios, rivals might look to add to their own to compete effectively.

In a recent report, my colleague Andrew Hay notes that there are several potential acquirers and targets. The list of takeout candidates continues to include Q1 Labs, although there have been M&A rumors around the company for a decade. Q1 Labs is also primping itself for an IPO, but we wouldn’t be surprised if it became the latest target in the growing line of dual-track acquisitions announced so far this year. Given its enviable revenue growth (Q1 Labs reported that its revenue grew 75% in 2010), we expect that Q1 Labs would catch a valuation similar to ArcSight. HP picked up that Cupertino, California-based security provider in September 2010 in a deal valued at nearly 8 times trailing sales. Beyond Q1 Labs, we could point to NitroSecurity, which was allegedly in talks with McAfee earlier this year. We’d also note that McAfee lost out on the ArcSight assets, and could look to NitroSecurity as an alternative.

Isilon and 3PAR: strikingly similar storage sales

Contact: Brenon Daly

EMC’s planned purchase of Isilon Systems comes as the second storage acquisition valued at more than $2bn in just three months. In fact, it lines up rather closely on a number of fronts with the other recent big-ticket storage deal, Hewlett-Packard’s pickup of 3PAR. For starters, the adviser. Qatalyst Partners got sole print for helping to sell 3PAR, and also had a hand in the process for Isilon. (Morgan Stanley and Qatalyst teamed up on the sell side.)

In terms of financial results, both Isilon and 3PAR are very similar. The two vendors were both generating about $200m in trailing revenue and only modest amounts of cash flow at the time of their acquisitions. (Both also had slightly more than $100m in cash on hand, thanks primarily to their recent IPOs.) That means both Isilon and 3PAR secured a valuation of more than 10 times trailing revenue in their sales to EMC and HP, respectively. If anything, Isilon is garnering an even richer valuation at 12.8x trailing 12-month sales and 8.7x projected 2011 sales.

And finally, both Isilon and 3PAR are being taken off the market at their highest-ever valuations, with acquisition offers of about $33 for each share. (That was the exact clearing bid for 3PAR, which came after two rounds of bumped bids, while Isilon shareholders are set to pocket $33.85 for each of their shares.) Given that Isilon and 3PAR were trading in the single digits just a few months before their acquisitions, shareholders in both storage vendors have reason to smile.

Is HP overcompensating?

Contact: Brenon Daly

Since when does an army without its top general go on the attack? That strategy would seem to go against convention, yet Hewlett-Packard has done just that since dumping Mark Hurd for his foibles. The tech giant has chased a pair of deals to valuations that are basically 2-3 times the prevailing market multiple. HP’s recent bidding war over 3PAR and the purchase of ArcSight shows a level of aggressiveness that indicates to us that the drivers for the acquisitions may have been emotional as well as financial, at least to a small degree.

If we step back and look at the setting for both deals, we can’t help but conclude that HP announced the transactions at a time when it looked vulnerable. Its star CEO had dramatically crashed back to earth, while its board (yet again) appeared to have bungled what looked like a fairly routine internal investigation. Statements by the company that it was ‘business as usual’ didn’t get much of a hearing on Wall Street. Shares that changed hands in the low $50s in April have been worth less than $40 for much of the past month. HP’s market cap lingers below $100bn, despite the company ringing up sales of about $120bn.

At the risk of drifting too far into psychology, we wonder if the deals weren’t a bit of overcompensation. (Certainly, paying 11x trailing sales for 3PAR might be considered overcompensation, or at the least, ‘heavy compensation,’ if you’ll forgive the pun.) If investors and others were going to view HP as weak or directionless while its corner office was empty, well, HP could use its vast resources to counter with a signal to remind everyone that it was formidable, with or without a fulltime CEO. Of course, we’re just playing armchair psychologist here. But something beyond just straight numbers seemed to be at work in HP’s recent moves.

A second exits gets ArcSight a 2x valuation

Contact: Brenon Daly

Hewlett-Packard’s pending purchase of ArcSight is the third IT security deal so far this year valued at more than $1bn, after not having a single security transaction valued in 10 digits in 2009. While the other two deals have gone off at basically market multiples, ArcSight is being valued at twice that level. The largest ESIM vendor agreed to sell itself to HP for $43.50 per share, valuing the security firm at more than four times the level it went public just two and a half years ago.

HP put the enterprise value of the transaction, which is slated to close by the end of the year, at $1.5bn. That means the tech giant is paying 7.5 times ArcSight’s trailing sales of $200m. (For the current fiscal year, ArcSight is expected to put up about $225m in sales, meaning HP is paying about 6.7x projected sales.) On a trailing basis, both McAfee and VeriSign’s identity and authentication business garnered 3.5x sales in their respective sales to Intel and Symantec. (Morgan Stanley advised both McAfee and ArcSight, while JP Morgan Securities advised VeriSign.)

The high-multiple deal represents a stunningly successful outcome for ArcSight. As we have mentioned in the past, both HP and McAfee approached ArcSight in the summer of 2007, ahead of the company’s IPO. We gather that both were bidders in the range of $600-750m. Unlike other dual-track candidates, ArcSight didn’t opt for the trade sale, but went ahead with its offering even as the equity market turned bearish. ArcSight spent virtually its entire first year as a public company trading in the single digits, including a fair amount of time below its offer price. (At one point when its shares were underwater, CA Technologies lobbed a low-ball bid at the firm, we understand.) If we had to guess at another suitor in the current process around ArcSight, we might tap EMC as an interested party.

Even as its stock took off over the past two years, ArcSight never did a secondary offering. (For a company with about $200m in sales, it has a very narrow base of shares, totaling only about 38 million.) In this case, the unwillingness to sell shares – either a small chunk or all of them – except at an eye-popping valuation has generated a return that seems reminiscent of the late 1990s. ArcSight raised only about $30m to build a business that got valued at 55 times that level on the exit.

Arms race M&A in application security

Contact: Brenon Daly

If IBM and Hewlett-Packard basically matched each other’s deal size in the first round of M&A for application security, HP has gone much bigger than Big Blue in the second round. In fact, we gather that the price tag for HP’s recent purchase of Fortify Software is more than 10 times larger than the amount IBM paid last summer for rival static code analysis vendor Ounce Labs. (When IBM announced the deal, we speculated that HP may well work out its own tit-for-tat deal, reaching for its partner Fortify.)

Terms weren’t revealed on either the Fortify or Ounce Lab transactions. However, we gather that IBM picked up Ounce Labs for about $25m and that HP likely paid about $275m (including an earnout) for Fortify. Our understanding is that Ounce Labs garnered roughly 3 times trailing sales, while Fortify went for about 4.6x trailing sales of about $60m.

Those deals, which were separated by roughly a year, came after both tech giants had made acquisitions of dynamic code analysis vendors within two weeks of one another. Back in mid-2007, IBM purchased Watchfire for an estimated $140m, roughly matching HP’s $135m acquisition of SPI Dynamics. Both transactions were done at more than 5x trailing sales, according to our understanding. For those keeping track of the arms race M&A by these two tech superpowers, the collective bill for their application security purchases now exceeds a half-billion dollars.

Select application security acquisitions

Date announced Acquirer Target Deal value Target trailing revenue
August 17, 2010 HP Fortify Software $275m* $60m*
July 28, 2009 IBM Ounce labs $25m* $8m*
June 19, 2007 HP SPI Dynamics $135m* $20m*
June 6, 2007 IBM Watchfire $140m* $30m*

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

And the Golden Tombstone goes to …

Contact: Brenon Daly

In addition to getting insight into what corporate development officials plan to buy in the coming year, our annual survey also asked which company they thought made the smartest acquisition during the previous year. (See our full report on the survey.) So which company gets the coveted Golden Tombstone for 2008? Hewlett-Packard, for its $13.9bn purchase of EDS in May.

However, in handing out this peer-voted accolade, we hope that HP doesn’t stumble after stepping up to the dais to accept it, as happened to last year’s winner. (Maybe this is a variation of the ‘Sports Illustrated cover jinx,’ which is a surprisingly accurate predictor of which team is about to hit an inexplicable – and intractable – slump.) Our 2007 Golden Tombstone went to Citrix for its $500m pickup of XenSource.

Although Citrix had promised big things for the virtualization startup, it is coming up short. When the ink had just dried on the acquisition, Citrix talked about $50m (or even higher, privately) of 2008 revenue from the startup, which had no sales to speak of when it sold. Now, it looks like XenDesktop and XenServer will actually contribute about $25m for the year. Granted, the startup XenSource and the 46-year-old EDS are at opposite ends of the corporate lifecycle, and the strategies that drove the deals are completely different. Still, we’re a superstitious bunch, particularly when we’ve already had so much bad luck on the market.

Take the next exit

In addition to clobbering existing stocks, the recent financial crisis has thinned the ranks of companies that we had expected to offer up stock in the coming months. In the past week alone, two companies that we had short-listed as IPO candidates (back when there was an IPO market) both got swallowed in trade sales.

On Wednesday, MessageLabs took a $695m offer from Symantec to help establish Big Yellow’s on-demand security offering. We understand MessageLabs had put together its underwriting ticket, and was planning to hit the market once the IPO window opened again. The IPO track was a distinct change from the path rumored for MessageLabs for more than two years. Several sources have indicated that MessageLabs had been shopped widely, with Trend Micro considered the most serious suitor at times.

And last week, we had to take LeftHand Networks out of the ‘shadow IPO pipeline’ when Hewlett-Packard came calling with a $360m offer. For more than a year we have noted that, pending the return of the market for new offerings, LeftHand appeared set to join the IPO parade of storage vendors (a half-dozen storage companies have gone public in the past two years). Instead, LeftHand sold, in a deal banked by Merrill Lynch. Incidentally, Merrill Lynch also banked the sale of another company that had its eye on the public market: Postini, a direct rival to MessageLabs, went to Google for $625m in July 2007.