PE firms play small ball

Contact: Brenon Daly

After years of writing multibillion-dollar checks in some of the largest tech transactions, private equity (PE) shops dramatically scaled back their purchases in 2011. The single biggest deal last year (The Blackstone Group’s $3bn take-private of healthcare technology vendor Emdeon) only ranked 15th among the largest transactions in 2011.

It was the first time PE firms haven’t have a hand in at least one of the year’s 10 largest deals since 2008. Even in the recession-wracked year of 2009, one buyout slotted into the top 10. And in 2010, when the economy appeared to be solidly recovering and the credit markets were more welcoming, PE firms accounted for fully three of the 10 largest transactions of that year. But last year, the buyout barons were overwhelmed by their corporate rivals, who are flush with cash.

Recent Blue Coat shareholders no longer in the red

Contact: Brenon Daly

Anyone who bought shares of Blue Coat Systems over the past half-year breathed a sigh of relief after the recent buyout of the old-line security vendor. Thoma Bravo’s bid of $25.81 for each share means that buyers since May are all above water. (The offer represents a 48% premium over the previous close and is almost twice the price that Blue Coat stock fetched on its own back in August.)

But there’s another longtime shareholder that’s probably plenty relieved as well: Francisco Partners. Recall that the buyout firm, which had previously invested in the company, also loaned Blue Coat $80m to help it pay for its purchase of Packeteer in 2008. Francisco took convertible notes, which came at an exercise price of $20.76. Although that was roughly where the stock was trading in the spring of 2008, it finished out the year in the single digits as the recession deepened.

More recently, Blue Coat had been trading below the exercise price for the past four months, hurt by three consecutive revenue shortfalls and turnover in the chief executive office. But with Thoma Bravo’s take-private, which is slated to close in the first quarter of 2012, Francisco Partners will pocket a tidy return. On paper, the firm will book a $19m profit on the convertible notes, equaling a roughly 25% gain. That’s certainly not the biggest gain Francisco Partners has ever put up, but given that the firm spent a fair amount of time underwater on its holding, it’s not a bad outcome at all. And it certainly beats the return from just plunking the money into the broad market, which declined about 10% over the period.

Renaissance plays politics

Contact: Brenon Daly

It must be election season. That’s what struck us when we saw earlier this week that Renaissance Learning went ahead and accepted a buyout offer that valued the online education vendor at about 10% less than an unsolicited bid. To our ear, some of the material in the proxies filed in connection with the $455m leveraged buyout could very well have come from a campaigning politician. The deal closed earlier this week.

Consider the language that the company used in laying out why shareholders should follow the lead of the company’s cofounders, who controlled some 69% of the equity, and back the initial offer from buyout firm Permira: The deal would be ‘more favorable’ to the employees and the broader community than the unsolicited bid from rival company PLATO Learning. (In addition, Renaissance said PLATO’s offer would take longer and be less likely to close, in their view.)

The concern, presumably, is that there would be far more overlapping employees if the two companies were merged, resulting in more job cuts than if Renaissance were taken private and largely left to run as it had been running. Who knows, maybe if PLATO took the company over, the combined company would start with cuts in the executive ranks. If that were the case, the cofounders of Renaissance would go from majority owners to unemployed.

Don’t get us wrong. We’re all for not contributing to the already intractably high unemployment rate in the US. But as a public company, Renaissance has a fiduciary responsibility to all its shareholders, not just the ones in its hometown. It’s worth noting that Renaissance is incorporated in its home state of Wisconsin, rather than the typical location for incorporation, Delaware. (Roughly half of US companies, including PLATO, are incorporated in Delaware.) So that may go some distance toward explaining why the company made ‘jobs and community’ a part of its pitch.

Ness gets a scant sendoff

Contact: Brenon Daly

Three-quarters of Ness Technologies shareholders have backed the planned $307m take-private of the IT services vendor, clearing the way for the sale to Citi Venture Capital International (CVCI) to close by the end of the month. CVCI acquired nearly 10% of Ness in early 2008 and first offered to pick up the whole company in July 2010, according to the proxy filed in connection with the proposed deal.

Last summer, CVCI indicated that it would be looking to pay $5.50-5.75 for each Ness share it didn’t already own. Three financial buyers who also got involved in the bidding last fall indicated that they would be prepared to top that by about a dollar a share. In the end, CVCI agreed to pay $7.75 for each share, roughly one-third more than the opening bid from the buyout shop .

And yet, despite the topping bid, Ness is exiting the public market at what would appear to be a rather paltry valuation. The company recently reported that it was tracking to about $600m in sales for 2011, and yet is selling for just $307m. (Including Ness’ small net debt position, the enterprise value of the deal is $342m.) That works out to a scant 0.6 times trailing sales – just one-third the median price-to-sales valuation for US publicly traded companies so far this year, according to our calculations.

Some of that can be attributed to the fact that IT services vendors typically trade at a substantial discount to other technology firms. And yet, even within recent IT services deals, 0.6x trailing sales is the low end of the range for most acquisitions. (For instance, EDS went for that multiple in its sale to Hewlett-Packard in mid-2008, while Perot Systems got more than twice that (1.4x) in its purchase by Dell in September 2009.) In fact, Ness is selling to CVCI for a lower price than it fetched on the open market more than three years ago when the buyout shop first took its stake.

A little something for your trouble

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.

Big deals for single PE firms

Contact: Brenon Daly

In 2010, it was The Carlyle Group. So far in 2011, it’s Providence Equity Partners. These two private equity (PE) firms have the two largest non-club tech leveraged buyouts in each of the past two years. Recall that last October – on successive days, no less – Carlyle erased both CommScope and Syniverse Technologies from the public market in a pair of deals that cost the buyout shop $6.5bn. (Understandably, Carlyle has been fairly quiet since then, announcing only a pair of small transactions.)

Now, Providence has its own double-barrel deals that are on top of the standings. Somewhat unusually, both of the firm’s acquisitions came on the first day of a new quarter: On April 1, it announced the planned take-private of SRA International for $1.9bn, and then followed that up Friday with the $1.6bn buyout of Blackboard to start the third quarter.

PE activity since the Great Recession

Period Deal volume Deal value
Q3-Q4, 2009 62 $12.1bn
Q1-Q2, 2010 57 $10.7bn
Q3-Q4, 2010 76 $15.6bn
Q1-Q2, 2011 78 $11.9bn

Source: The 451 M&A KnowledgeBase

Flips and flops for PE shops

Contact: Brenon Daly

There are flips that fly, and flips that flop. Consider the two recent exits by private-equity (PE)-owned companies Skype Technologies and Freescale Semiconductor. One deal basically quadrupled the price of the portfolio company, while the other company is still lingering at a value of less than half its original purchase price. Granted, that ‘headline’ calculation misses some of the nuances of the holdings and their returns to the PE shops, but it’s nonetheless a solid reminder that deals need to be done with a focus on the ‘demand’ side of the exit.

For Skype’s PE ownership of Silver Lake Partners, Index Ventures and Andreessen Horowitz, the $8.5bn all-cash sale to Microsoft came less than two years after the consortium carved the VoIP provider out of eBay for just $2bn. The deal stands as the largest ever purchase by Microsoft, and the double-digit price-to-sales valuation suggests Redmond had to reach deep to take Skype off the board. Skype had filed to go public, but was also rumored to have attracted interest from Google as a possible buyer.

On the other hand, there wasn’t much demand for Freescale, which was coming public after undergoing the largest tech LBO in history. Freescale priced its recent IPO some 20% below the bottom end of its expected range. That had to be a painful concession for the PE owners of the company: Blackstone Group, Carlyle Group, Permira Funds and Texas Pacific Group. The club paid $17.6bn in mid-2006 for the semiconductor maker, loading up the company with billions in debt just as the market tanked. Freescale, which still carts around about $7.5bn in debt, has lower sales now than when it was taken private four years ago.

Heading in and out at Vector

Contact: Brenon Daly

Some eight months after the opening bid for RAE Systems was announced, it looks like Vector Capital continues to have the inside track in taking private the maker of gas detection monitors. The San Francisco-based buyout firm earlier this week raised its offer for RAE Systems to $2 per share, or roughly $120m. That marks the third time that Vector has bumped its bid in its competition with original bidder Battery Ventures.

Vector’s current offer adds some $25m to Battery’s initial price, and is more than twice the level where RAE Systems shares traded over the year leading up to the first announcement last September. Perhaps most crucially, RAE Systems executives, who own roughly 31% of outstanding shares, have thrown their support behind Vector by giving up shares for no consideration as well as rolling over a large portion of their equity holdings.

While Vector works to add RAE Systems to its portfolio, we understand that it may be looking to free up a spot there as well. Several market sources have indicated that Vector has retained Jefferies & Company to advise it on a possible sale of Corel. Running at more than $200m in sales, Corel has a number of products for graphics design, as well as WordPerfect and WinDVD, among other titles.

Vector has owned Corel since 2003, though it did sell a bit of the software company to the public in 2006 before buying back that chunk three years later. Given that Corel is a fairly large portfolio of mostly mature businesses, we suspect that the most likely buyer would be a fellow PE shop. However, the process is still in its early days, according to a source.

TI-NatSemi: Large and analog

Contact: Brenon Daly

The fragmented market for makers of analog integrated circuits looks a whole less scattered now that Texas Instruments has reached for National Semiconductor. Already the largest analog vendor, TI will have some 17% of the market provided its $6.5bn all-cash offer for NatSemi closes later this year. (If it can’t close the deal, for whatever reason, TI faces a $350m reverse breakup fee, while NatSemi would have to pay a $200m termination fee.)

As it stands, the pending purchase of NatSemi would be the third-largest semiconductor deal, but the single largest by a non-financial buyer. Recall that in the pre-Credit Crisis days of 2006, buyout consortiums took Freescale Semiconductor private in a $17.6bn buyout while another private equity (PE) club carved the semiconductor business out of Royal Philips Electronics. Given the travails that the Freescale LBO has faced over the past half-decade, we suspect that PE shops won’t be looking to do any buyouts that big anytime soon.

PE firms back at the table

Contact: Brenon Daly

The buyout barons might not be as powerful as they were before the Credit Crisis, but that doesn’t mean the financial buyers can’t elbow aside their rivals from the corporate world. Earlier this week, Golden Gate Capital topped an existing agreement that Conexant Systems had with fellow chipmaker Standard Microsystems. While it wasn’t unusual for private equity (PE) firms to take auctions when credit was flowing cheap and easy, it’s been relatively rare in the past two years.

Terms call for Golden Gate to hand over $2.40 for each share of Conexant, giving the deal an equity value of roughly $180m. (Additionally, the company carries $86m of net debt.) The buyout firm’s all-cash offer topped a cash-and-stock bid of $2.25 per share from Standard Microsystems. The new agreement has a ‘no shop’ clause and is not conditional on financing. It also carries a $7.7m breakup fee, exactly the same amount that Standard Microsystems is pocketing for its trouble.

A 7% bump in acquisition price may not seem like much, but it could be an early signal that PE firms are getting much more aggressive in deals. That’s actually what corporate development executives told us they expected in 2011 from their PE rivals. In our annual survey, nearly four out of 10 (38%) corporate buyers said they expected more competition from buyout shops, compared to just 13% who said the opposite.