Author: Brenon Daly

The market and Meru

Brenon Daly

Contact: Brenon Daly

Having watched at least three of its rivals get acquired in recent years, Meru Networks is now aiming for the other exit: a public offering. The WLAN equipment maker filed its IPO paperwork on Friday for an $86m offering to be led by Bank of America Merrill Lynch, with co-managers Robert W. Baird & Co, Cowen & Co, JMP Securities and ThinkEquity. Meru plans to trade on the NYSE under the ticker MERU. (Incidentally, the company was one we put on our list of IPO candidates for 2010 in our recently published 2010 M&A Outlook – Security and networks.)

If Meru does manage to make it onto the public market, it will reverse the flow of deals in the sector. In recent years, a large publicly traded rival (Symbol Technologies) and two other competing startups (Colubris Networks and Trapeze Networks) have all been acquired. Those trade sales have valued the WLAN equipment vendors at a range of 2.1-3x trailing 12-month (TTM) sales.

We noted a year and a half ago that all of the transactions probably meant that Meru would have trouble finding a buyer, except among public market investors. Not that Meru hasn’t kicked around a possible sale in the past. Rumors have tied it to both Juniper Networks and Foundry. The Foundry relationship seems to have died off since Foundry sold to Brocade Communications. According to Meru’s S-1, Foundry/Brocade accounted for a full 35% of its revenue in 2007, but that level has fallen to less than 10% now.

With Meru aiming to hit the market in 2010, we suspect that it will be hoping to have a stronger offering than publicly traded rival Aruba Networks, which initially priced its shares in its March 2007 offering at $11 each. Although Aruba traded above the offer price for almost a year, it broke issue in February 2008 and has not traded above the initial price since then. That said, the stock is nearing that level, changing hands at about $10.65 in midday trading Tuesday. It has more than quadrupled in 2009. The dramatic rebound in Aruba shares has pushed the firm’s valuation to 4.6x TTM sales. Applying that same multiple to Meru’s $67m TTM sales gives the company a valuation of about $310m.

Tech bankers: Business is back

Brenon Daly

Contact: Brenon Daly

Every year, we survey our investment banking contacts to get a sense of what they anticipate for both their business and the overall technology M&A market in the coming year. The results this year seem to fully indicate that the recession that flattened business – and entire institutions – in 2009 will give way to a busier and more vibrant dealmaking market in 2010. Bankers projected that activity will pick up across virtually every part of the business, including the IPOs and private equity buyouts that had all but disappeared this year.

Altogether, the results show a stunning turnaround from our previous survey. (See our report on last year’s survey.) Of course, 2008’s survey went out when the Nasdaq was trading around 1,550 amid the historic upheaval and blood-letting on Wall Street caused by the credit crisis. As devastating as the crisis seemed at the time, it has actually turned out to be a boon for most. More than half of the bankers responded that those unprecedented changes actually boosted their firm’s opportunities – and they expect to be hiring to handle the additional work they see coming in 2010.

The main reason why the banks see the need to hire is that business has recovered dramatically. When we asked bankers to gauge their current pipeline compared to where it was at this time last year, the recovery was striking. Two-thirds said the dollar value of mandates on the deals they are currently working on is higher than it was in late 2008. In the 2008 survey, half of the bankers said their pipeline was drier. Look for our full report on the survey in tonight’s 451 Group MIS sendout.

Change in number of formal tech mandates

Pipeline volume 2006 2007 2008 2009
Increase 84% 70% 39% 67%
Increase 25% or more 58% 31% 9% 39%
Decrease 4% 13% 34% 19%

Source: Annual 451 Tech Banking Outlook Survey

Kana: bidding while the cash burns

Brenon Daly

Contact: Brenon Daly

The progression from spurned bidder to shareholder activist isn’t all that unusual. But it is unusual when the party smarting is a publicly traded company, and decides to express its agitation through press releases. Yet, that’s exactly how Chordiant Software is venting its frustration over not landing Kana Software, with Chordiant telling the world earlier this week that it plans to vote its shares (amounting to 4% of the total equity outstanding) against the proposed sale of Kana’s operating business to midmarket buyout firm Accel-KKR. Chordiant followed that up on Thursday evening with a new cash-and-stock offer that values Kana higher than the buyout bid.

All of this comes just days before shareholders are slated to vote on Accel-KKR’s offer (the vote is scheduled for Wednesday). Kana’s board continues to recommend that shareholders back the planned transaction, which would effectively carve the business out of Kana and leave only a shell company in its place. We have noted that it’s an imperfect structure, but one that probably serves the fundamentally flawed firm reasonably well. Of course, some shareholders (including Chordiant) don’t agree, and should vote however they want. We would only note that while the two sides argue, Kana continues to burn cash. At the end of its most-recent quarter (ending September 30), the company was down to just $1.8m (it started the year with $7m). While the cash burn is nothing new for Kana, which has lost $4.3bn since its inception, it could become pressing: Kana noted in its proxy that it has a $5.4m debt payment coming due in 2010.

Sailing around the market with Cisco

Brenon Daly

Contact: Brenon Daly

There are a lot of ways to chart the pickup in M&A activity over the course of 2009. In our recently published M&A Outlook, we cover a lot of the empirical indications, including the fact that spending on deals in the second half of 2009 is tracking 50% higher than in the first half of the year, as well as that the median valuation for fourth-quarter transactions is the highest we’ve seen in the year since the credit crisis erupted.

But our favorite way to encapsulate the changes between the climate a year ago and right now isn’t through data but through anecdote. (Of course, there are those who joke that ‘data’ is just the plural of ‘anecdote.’) Last year, we recall Cisco Systems’ CEO John Chambers ominously remarking that the economy was in ‘uncharted waters.’ Cisco is often considered a bellwether for the broader tech industry, and the company has been a particularly active shopper. Over the past five years, Cisco has spent more than $20bn to buy its way into new markets.

Not that Cisco – or any other company, for that matter – was doing much of that in early 2009. Since then, however, the waters have gotten more navigable. That certainty has helped Cisco step back in the market, with a pair of $3bn transactions as well as its $183m pickup of on-demand security firm ScanSafe. We suspect that signals like that may well encourage other corporate buyers to perhaps at least revisit some of the deals that were put on pause earlier this year. Merely working through that backlog could get M&A off to a strong start in 2010.

Microsoft (officially) pals up with Opalis

Brenon Daly

Contact: Brenon Daly

Two months after we first indicated that Microsoft was interested in Opalis Software, the software giant has indeed acquired the runbook automation (RBA) vendor. No terms were disclosed, but when we talked with sources in mid-October, the price being kicked around was $60m. Opalis was thought to be running at about $10m in revenue. We understand that Cowen Group banked Toronto-based Opalis.

The deal, now that it is official, comes after other fellow RBA startups were snapped up. In March 2007, Opsware (now part of Hewlett-Packard) spent $54m in cash and stock for iConclude, and four months later, BMC paid $53m for RealOps. As that wave of consolidation swept through the RBA market, Opalis positioned itself as an independent alternative to the offerings from the system management giants. That said, the vendor had been drawing closer to Microsoft. In late April, the two companies announced a joint technology agreement that saw, among other things, Opalis integrated into Microsoft’s System Center Operations Manager 2007 and System Center Virtual Machine Manager 2008 consoles.

More businesses on the block at LexisNexis?

Brenon Daly

Contact: Brenon Daly

When LexisNexis announced last month that it was selling off its HotDocs business, it got us thinking about other divestitures that the information provider may be contemplating. More specifically, we wonder if LexisNexis is considering reheating its effort to shed Applied Discovery. Not too long ago, we heard rumors that LexisNexis had hired a bank to help it unwind its $95m purchase of the Seattle-based e-discovery startup. LexisNexis picked up Applied Discovery in mid-2003.

According to one source, LexisNexis came close to selling Applied Discovery to the Silicon Valley-based buyout shop for about $70m, but talks collapsed during due diligence. Shortly after that, LexisNexis cut its asking price for Applied Discovery to basically half of the $95m that it originally paid for the company, but a second source indicated that the unit still didn’t generate much interest. The reason? Many would-be financial buyers are put off by the lumpy business in the e-discovery sector. Sales are typically driven by investigations or lawsuits, which can make it difficult to predict. Meanwhile, among the strategic buyers, many of the large information management vendors – including Autonomy Corp, Iron Mountain, Seagate and EMC, among others – have already announced acquisitions of e-discovery players.

The wisdom of the crowds

Brenon Daly

Contact: Brenon Daly

As pretty much the only buyers at the table right now, corporate development executives’ views go a long way toward shaping the overall outlook for tech M&A. So it seems a fitting time to survey these shoppers in order to get their expectations for deal flow in 2010. The views of the corporate buyers are crucial to understanding deal flow because, collectively, strategic acquirers account for some 85% of the total M&A spending so far this year. (Note: If you are a corporate development officer and would like to take part in our survey, just email me and I’ll send you the link for the survey, which should only take about five minutes to complete.)

Over the past few years, the survey responses have correlated very closely with how deal flow has actually developed. For instance, when we asked corporate development executives last year what they expected to pay for startups in the coming year, nine out of 10 said private company valuations would come down in 2009. (That has certainly been the case this year.) And in our summer survey, we noted a significant increase in M&A appetite among the strategic buyers. That has certainly been the case, too. Spending on deals in the second half of 2009 is running 50% higher than the amount spent in the first two quarters of the year. Again, if any corporate development officers would like to take part in this survey, contact me and I’ll get you the form.

What a pair of startup sales tells us about the recession

Brenon Daly

Contact: Brenon Daly

If there was any doubt that the M&A climate has warmed since the beginning of this year, consider the relative exits for a pair of database-monitoring startups. Back in February, when venture funding was hard to come by and wind-down sales were plentiful, Tizor Systems sold to Netezza for just $3m. Fast-forward nine months, and Guardium sells to IBM for an estimated $230m. Viewed another way, Tizor returned just one-tenth the amount of venture funding it raised, while Guardium returned more than 10 times the funding it raised.

Granted, the relative returns of Guardium and Tizor probably have more to do with the business performance of the two rivals than what was going on in the economy. After all, Tizor was limping along with just $2m in sales, while Guardium was sprinting along at around $40m. (Both companies were founded in 2002.) That said, we’re pretty confident that the fact that the US is no longer (officially) in a recession certainly didn’t hurt the valuation of Guardium, a company we have thought has been in play for some time.

Indeed, as we look down our list of recent IT security deals, we can’t help but notice that the three largest transactions – all of which saw marquee tech companies paying above-market multiples – have come in the past four months. In addition to the sale of Guardium to IBM at an estimated 6x trailing sales, we’ve also seen Cisco Systems pay the same multiple for ScanSafe and McAfee pick up MX Logic for an estimated 4x trailing sales. A few more of these types of deals and we may start to believe that we are indeed out of the recession.

The mysterious case of Investment Bank A

Brenon Daly

Contact: Brenon Daly

In proxy statements, we’re used to seeing unidentified parties that figure into transactions referred to as ‘Company A,’ ‘Company B’ and so on. Sometimes, the identity of these would-be buyers is widely known, like the not-so-mysterious ‘Company A’ that was bidding for Sun Microsystems earlier this year before Oracle landed the faded tech star. But in most cases, the other parties are typically more lookers than buyers, perhaps trying to gather a bit of competitive intelligence on the company or the auction process itself.

So there’s nothing unusual about putting the cloak of anonymity over buyers that fall by the wayside. But, for the first time that we can recall, we recently saw the cloak extended to an adviser that had fallen by the wayside, too. In the SEC paperwork that Kana filed for its ‘fittingly imperfect’ wind-down sale, the vendor noted that from mid-2008 to mid-2009 it was advised by ‘Investment Bank A.’ When the banker left this unnamed firm, Kana vetted other banks before selecting Pagemill Partners.

We have our suspicions about the identity of ‘Investment Bank A,’ but we’re actually more intrigued to think about whether this situation is a sign of the times. Before all of the upheaval in the investment banking business, we would have found it hard to imagine a bank effectively writing off a year of work that one of its erstwhile bankers had sunk into a potential transaction. We all know that the unprecedented mayhem on Wall Street forced some changes on the investment banks that would have been unimaginable at any time since The Glass-Steagall Act was repealed a decade ago. But we were under the impression that investment banking was still a fee-based business, even if those fees are scarce across the board.

freenet: getting paid to sell

Brenon Daly

Contact: Brenon Daly

In a time when nearly all divestitures are done on the cheap, freenet’s recent sale of its mass-market hosting business Strato generated an unexpectedly rich return for the German telco. In fact, freenet more than doubled its money in the five years that it owned Strato. Back in December 2004, freenet handed over $177m ($107m in cash, $70m in equity) to German network equipment provider Teles for Strato. When freenet shed Strato to Deutsche Telekom (DT) two weeks ago, it pocketed $410m. (Arma Partners advised freenet on the divestiture.)

On top of that return, of course, freenet will hold on to the cash that Strato generated while owned by freenet. That’s not an insubstantial consideration, given that Strato ran at an Ebitda margin in the mid-30% range. We understand that Strato was tracking to about $50m in Ebitda for 2009, up slightly from about $46m last year. Revenue at Strato was also expected to show a mid-single-digit percentage increase in 2009, despite the tough economic conditions in freenet’s home market of Germany. DT’s bid values Strato at roughly 3x trailing sales and nearly 9x trailing Ebitda. That’s a solid valuation for corporate castoffs, which typically garner about 1x trailing sales and maybe 4-5x Ebitda.

Freenet’s divestiture of the Strato hosting business to DT comes a half-year after it sold its DSL business to United Internet, a sale that was also banked by Arma. The company has been looking to shed businesses as a way to pay down the debt that it took on for its $2.57bn acquisition of debitel in April 2008. Since that landmark deal, freenet has focused its operations on mobile communications, and had been reporting the DSL and Strato businesses separately. We understand that there may be additional divestitures by freenet, but they will be smaller transactions for more ‘ancillary’ businesses.