Author: Brenon Daly

Is Kana buying time before it gets bought?

Brenon Daly

by Brenon Daly, China Martens

The showdown that has been brewing around Kana Software for months was supposed to come to a head today. Hedge fund KVO Capital Management had been planning to put forward a director for election at the company’s annual meeting, which was originally scheduled for July 15. Instead, Kana pushed the meeting back. Not by a week or two, or even a month, but until December 1. KVO is the largest shareholder in Kana, with some 3.4 million shares, or 8% of the company.

Although Kana has postponed its annual meeting, we can’t help but wonder if the customer service software vendor is merely buying time until it can get bought. That’s certainly what some shareholders have speculated about the company, which trades at just 0.5x revenue. (And we’ve been saying that for nearly three years.) On its own, there’s little to be bullish about at Kana, a money-burning shop that has been relegated to the Bulletin Board since December 2006. But it does have at least one valuable piece to its business: a deep, long-term relationship with IBM. We suspect Big Blue would be the first call Kana would make if it continues to get pushed for a sale.

Of course, IBM has repeatedly said that it doesn’t want to be an application software vendor. (Saying and doing are two different things, however. Several of its largest acquisitions were for straight application vendors, such as Cognos and FileNet.) In any case, the two firms have had an OEM arrangement for the past seven years, and we understand from a source inside Kana that IBM-related sales have exceeded their quota in recent years. Kana has also baked a fair amount of Big Blue software (notably DB2) into its offerings. So integrating the technology wouldn’t be a challenge in this hypothetical pairing. And financially, IBM has plenty of resources to share with Kana, which would be a nice change of pace for the struggling microcap company. Kana has largely lived off equity and debt offerings over the past 12 years, having run up an astounding $4.3bn in accumulated deficit since its founding.

What’s the value of advice on the Entrust LBO?

Brenon Daly

Contact: Brenon Daly

The ‘go-shop’ period at Entrust came and went a month ago, but on Friday the security vendor nonetheless got a richer offer in its three-month-old leveraged buyout. The bidder? Thoma Bravo, the same buyout shop that has had an agreement in place since April to acquire Entrust. Originally, Thoma Bravo offered $114m, or $1.85 per Entrust share, but as the company’s shareholders were set last Friday to vote on it, Thoma Bravo bumped up its bid to $124m, or $2 for each Entrust share. The buyout shop says that is its best and final offer for Entrust.

Thoma Bravo topped itself despite having Entrust’s board unanimously back the initial $1.85-per-share bid. The raise also came despite both of the main proxy advising outfits backing the original offer, which valued Entrust at less than 1x sales, on the basis of enterprise value. If shareholders had actually listened to both Glass, Lewis & Co and Proxy Governance Inc, they would have shortchanged themselves $10m. (And shareholders have already suffered enough by holding Entrust, which has basically traded down over the past four years, with only brief interruptions.)

Undoubtedly, the proxy firms will (once again) throw their support behind the new and improved buyout bid ahead of the shareholder vote, which is slated for July 28. But any endorsement sort of strains credibility given that they already backed one deal that the would-be buyer has acknowledged was too cheap.

Broadcom-Emulex: Failure rewarded?

Brenon Daly

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?

Is Riverbed the next Data Domain?

Brenon Daly

Contact: Brenon Daly

With Data Domain off the market, we did a bit of blue-sky thinking about which company might find itself snapped up in a similar scenario. Our pick? Riverbed Technology. We’re not suggesting that the vendor is in play by any means, but hear us out on this one.

For starters, both Data Domain and Riverbed are fast-growing, single-product companies in markets that are dominated by mature technology vendors that have deep pockets and are hungry for growth. In the case of Data Domain it’s the storage market, while for Riverbed it’s the networking market. (To put some numbers around the differences, consider that Data Domain more than doubled its revenue in 2008, while its acquirer, EMC, saw storage revenue inch up just 10% last year.)

The obvious buyer of Riverbed would be Cisco. That’s so obvious, in fact, that we heard Cisco made at least two overtures to Riverbed before the company went public in September 2006. (However, one source characterized Cisco’s interest more as ‘industrial espionage’ than acquisition negotiations.) So we don’t see Riverbed going to Cisco. Instead, we like Hewlett-Packard as the acquirer of Riverbed.

The two companies have been friendly for years. HP originally had an OEM deal with Riverbed, and later resold the Riverbed product. HP has also integrated the Riverbed Optimization Software into its ProCurve infrastructure. To be clear, we’re not suggesting that there’s anything more than technology talks between the two sides right now. But if HP wanted to bolster ProCurve, picking up Riverbed would do that. Plus, such a deal could help HP stick it to Cisco, which took a swipe at HP earlier this year by jumping into the server market. Maybe HP is interested in countering with a big buy into one of the fastest-growing segments of the networking market.

Halfway through a rough year

Brenon Daly

Contact: Brenon Daly

Since we’re at the midpoint of 2009, we thought we’d tally what we’ve already seen in M&A this year and project what we’re likely to see for the remainder of the year. First, the look back at the first two quarters of 2009: The $58bn in announced and estimated deal spending so far this year is the lowest level of January–June tech shopping in a half-decade. More dramatically, spending on deals in the first two quarters of 2009 is only about one-quarter the amount spent during the comparable period in any of the past three years. June was a particularly slow month, after there were a flurry of deals in April and May.

As to what the rest of 2009 will look like, we suspect it will closely resemble the second half of last year. For the record, the announced spending from July–December 2008 hit just $72bn. Obviously, it’s difficult to predict a lumpy business like M&A. But the way the economy is dragging along right now, we’re inclined to think that big buyers will look to take small bites for the rest of the year. That’s what they did in the second half of 2008. Indeed, it wasn’t that the traditionally busiest buyers in tech took themselves out of the market altogether. Rather, they just scaled back their purchases, despite holding tens of billions of dollars in cash. For instance, the largest transactions inked in the back half of last year by tech giants such as McAfee, Oracle, IBM, Google and Microsoft – among many other companies – were all less than a half-billion dollars.

Q1-Q2 tech spending

Year Deal volume Deal value
2009 1,400 $58bn
2008 1,557 $228bn
2007 2,005 $294bn
2006 2,019 $268bn
2005 1,388 $162bn
2004 999 $111bn

Source: The 451 M&A KnowledgeBase

Data Domain: Battle at Centre Court

Brenon Daly

Contact: Brenon Daly

A long, drawn-out battle – with back-and-forth volleying – to claim a coveted prize. We could be talking about the amazing men’s final at Wimbledon over the weekend, but since we’re back in the office, we’re actually referring to the ongoing fight over Data Domain. On Monday, EMC served up what it hopes will be an ace. It raised its existing all-cash offer for the data de-duplication specialist to $33.50 per share.

EMC’s latest bid values Data Domain at roughly $2.3bn, richer than its previous offer as well as the one from original suitor NetApp. Recall that NetApp served first, offering $1.75bn in cash and stock for Data Domain on May 20. EMC returned that with a $2.1bn bid of its own a week and a half later. And now, EMC has knocked a shot that, honestly, we feel NetApp will have trouble stretching to get. Our view: Advantage EMC.

A ‘paper’ windfall in LogMeIn IPO

Brenon Daly

Contact: Brenon Daly

One of the investment banks that profited the most from Wednesday’s strong debut of LogMeIn wasn’t even on the prospectus. Instead, it was in the prospectus. McNamee Lawrence, an advisory shop with no underwriting business, realized a tidy little $2m windfall from the IPO.

Heading into the offering, McNamee Lawrence held some 99,000 shares in LogMeIn that it picked up in late 2004 for helping to place the startup’s series A funding round, as well as other advisory work. McNamee Lawrence took a small amount of money off the table, selling some 21,000 shares at the $16 initial pricing of LogMeIn. That netted the bank about $336,000. It still holds some 78,000 shares, which had a paper value of about $1.6m, based on the price of LogMeIn shares on Thursday afternoon.

Granted, the holdings of McNamee Lawrence are only a tiny slice of the overall 21.4 million LogMeIn shares outstanding. And the firm’s stake is a fraction of the major owners of LogMeIn, Prism Venture Partners and Polaris Venture Partners. Prism holds shares worth about $80m, while Polaris, which sold $7.4m worth of shares in the offering, still owns a chunk valued at about $59m.

Still, the shares represent a nice windfall for McNamee Lawrence. (In addition, some of the firm’s partners put money individually into LogMeIn in the company’s seed round in early 2004.) Of course, the practice of taking paper as payment was pretty common across all kinds of service providers back in the Bubble Era, when startups routinely handed out options and warrants to cover bills from banks, lawyers and even landlords. After so many people got burned by taking worthless options and warrants in the early 2000s, however, cash returned as the currency of choice.

Q2 ends with a whimper

Brenon Daly

Contact: Brenon Daly

The second quarter is in the books, and we would suggest that the M&A tally is a bit deceptive. Yes, both the number of tech deals and the announced deal values hit their highest levels in a year. But lurking behind that rebound is the fact that M&A tailed off dramatically in June. In fact, the final month of the quarter accounted for just 16% of the total M&A spending in the period. The breakdown of the overall $48.4bn in the second quarter: April-May spending hit $40.7bn, while June spending was a scant $7.7bn.

We noted recently how June saw the return of gun-to-the-head sales of many tech companies, both large and small. That is reflected in the dramatic change in average deal size over the course of the quarter. (Granted, average deal size is a crude measure, but it is illustrative nonetheless.) In the April-May period, the 517 deals had an announced deal value of $40.7bn, yielding an average purchase price of $78m. In June, the average sale was less than half that level: 233 deals with an aggregate spend of $7.7bn, for an average of $33m. That’s a worry trend as we head into the second half of the year.

Overall tech M&A

Period Deal volume Deal value
Q2 2009 750 $48bn
Q1 2009 646 $9bn
Q4 2008 723 $40bn
Q3 2008 737 $32bn
Q2 2008 721 $173bn

Source: The 451 M&A KnowledgeBase

Imaging an alternative exit for LogMeIn

Brenon Daly

Contact: Brenon Daly

With LogMeIn set to price its IPO later today, the next ‘buyer’ of the company will be public market investors. The on-demand vendor will sell 6.7 million shares in an offering that’s being led by JPMorgan Chase and Barclays Capital. LogMeIn set an initial range of $14-16 per share, implying a market capitalization of $300m-340m. It will likely price above that range, and we expect strong demand for LogMeIn shares once they start trading under the ticker ‘LOGM’ on the Nasdaq.

As the company gets set to realize that exit (after more than 17 months on file with the US Securities and Exchange Commission), we thought about where it might have looked had it opted for the other possible exit, a trade sale. We’re not suggesting that LogMeIn was dual-tracking by any means. In fact, although it kept its S-1 alive while so many other tech companies pulled their IPO paperwork, that move wasn’t driven by desperation. LogMeIn doesn’t actually need the proceeds. It is heading into the offering with no debt and $27m in cash on its books, having generated cash for the past nine quarters. Even on a GAAP basis, the firm has been profitable for the past three quarters.

Thus, LogMeIn doesn’t need the offering any more than it needs a trade sale. And to be clear, we hadn’t heard that the company was pursuing anything other than an IPO. Nonetheless, as we did some blue-sky thinking, we quickly came up with two deep-pocketed companies that would have been very smart to nab LogMeIn before it went public. Keep in mind, too, that the two primary rivals to LogMeIn are GoToMyPC and WebEx Communications, firms that have been snapped up by tech giants Citrix and Cisco, respectively.

So here’s our hypothetical short list of possible buyers for LogMeIn. Symantec already has several products that compete with LogMeIn (notably, PC Anywhere), but it is a key partner for LogMeIn. And Big Yellow has shown that it is ready to go shopping to bolster its software-as-a-service business. It paid $695m, or almost 5x trailing 12-month sales, for MessageLabs last October, its largest deal in more than a year and a half. Alternatively, Dell knows all about picking up companies just before they go public. It paid a double-digit multiple for its push into storage with the $1.4bn EqualLogic purchase in November 2007. However, Dell has also done a quartet of deals to build out its services offerings, some of which are offered by LogMeIn and others that are complementary. In addition, the customer profiles of the two vendors would synch pretty well, since LogMeIn gets roughly 80% of its revenue from the SMB market.

June gloom

Brenon Daly

Contact: Brenon Daly

Whether or not the rebound got ahead of itself, the market has certainly tightened up this month. And no, we’re not talking about the equity market. (Although the sentiment is applicable there, as well, with the Nasdaq recently dipping to its lowest point in a month.) Instead, we’re talking about the M&A market. After a furious start to the second quarter, dealmaking has slipped back to the sluggish pace we saw in the first few months of 2009.

A quick glimpse at the numbers: In both April and May, we saw some 250 deals worth about $20bn in each month. So far this month, we’ve had about 205 deals worth a scant $8bn. With just three business days to go in June, we’re looking at spending being down about 60% from what it was in each of the first two months of the quarter.

We’ve also noticed the recent return of a trend that we saw more often in the opening months of 2009: the involuntary sale. In both large and small transactions, sellers have increasingly found themselves forced to take any offer that comes in. We noted that this week in the startup world, as LucidEra was turned over to a workout firm to sell its carcass. And on a larger scale, bankrupt Nortel Networks gave up on ever emerging as a viable company and began the painful process of liquidation sales. The first deal gives some sign of the resignation: Nortel sold its most valuable unit for what is likely to be less than 1x cash flow.

Second-quarter deal flow

Period Deal volume Deal value
April 2009 263 $21bn
May 2009 242 $19bn
June 2009 205 $8bn

Source: The 451 M&A KnowledgeBase