Category: investment banking

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.

Navigating a decent exit

Brenon Daly

Contact: Brenon Daly

When we last checked in with Networks In Motion (NiM) two weeks ago, we noted that the turn-by-turn navigation vendor had just been stepped on by the not-so-gentle giant, Google. As it turns out, NiM’s valuation got stepped on a bit, too. The Aliso Viejo, California-based company sold itself Tuesday to TeleCommunication Systems for $170m. Terms call for TeleCommunication to hand over $110m in cash and $20m in shares, along with a $40m note. Raymond James & Associates advised TeleCommunication Systems while Jefferies & Co advised NiM on the transaction, which is expected to close by the end of the month.

The offer values NiM at 2.3 times 2009 revenue and 1.7x the company’s projected sales for next year, according to our understanding. NiM’s expectation of $100m in sales in 2010, representing 33% growth, strikes us as a bit aggressive. The reason? Google has started giving away a turn-by-turn navigation product for select Android devices that run on Verizon Wireless, the only network on which NiM currently offers its service. Although the threat of Google completely wiping away NiM’s business is grossly overblown, we suspect that it did put some pressure on the price of the company. NiM’s early focus on feature phones gave competitors such as TeleNav an early lead on smartphones such as BlackBerry and Windows Mobile. According to one rumor, T-Mobile and NiM had been close to a deal earlier this year. Without the ‘Google overhang,’ we could imagine that NiM would be selling for quite a bit more than the $170m that TeleCommunication Systems is slated to pay.

That said, it’s actually a decent exit for seven-year-old NiM. Although it’s getting an admittedly so-so multiple for its business, the company is providing a solid return for its backers, largely because it didn’t raise much money. It drew in a total of less than $20m, with Mission Ventures and Redpoint Ventures as early NiM backers and Sutter Hill Ventures joining in the third – and last – round of NiM funding in March 2006. (There was also some money from unnamed strategic investors.) Unlike rival TeleNav, NiM was unlikely to go public because of concerns about competition from Google. (TeleNav, which put in its IPO paperwork a month ago, isn’t immediately threatened by Google because the latter’s service isn’t yet available on TeleNav’s networks, AT&T and Sprint.) A solid (if not spectacular) trade sale of NiM in the face of growing competition from Google isn’t a bad bit of navigation for the startup at all.

A quiet end to the year

Brenon Daly

Contact: Brenon Daly

As we flip the calendar to the final month of 2009, it’s worth noting that December is almost always a quiet month for M&A. That was particularly true last December, which saw just $6bn of spending on tech acquisitions. The spending level represented a scant 2% of the total $301bn of spending on deals in 2008. (If the month had recorded its representative one-twelfth (8%) of the annual total, spending would have come in at roughly $25bn.)

Of course, last December was a pretty bleak time, with investment banks reeling and companies ratcheting back their financial projections for the coming quarters. But even in times of more robust dealmaking, December has been a below-average contributor to annual M&A spending. For instance, deals in the final month of 2007 and 2006 represented just 6% of the totals in both years.

So what does all that mean for M&A in the final month of this year? Assuming we return to a more normalized level of activity in which December accounts for about 6% of total annual spending, we’ll be looking at about $9bn worth of deals between now and year-end. Overall, that would put total spending for 2009 at just $151bn – exactly half the amount that we saw in 2008.

A month off

Year Total spending in December December spending as % of annual total
2008 $6bn 2%
2007 $26bn 6%
2006 $29bn 6%
2005 $38bn 10%

Source: The 451 M&A KnowledgeBase

Cyber Monday’s here

-Contact Thomas Rasmussen, Brenon Daly

Even though the receipts from Black Friday, the traditional retailers’ launch of the holiday shopping season, weren’t much bigger than they were last year, online retailers on Cyber Monday appeared to be ringing up a pretty good business this year. Amid all of the cyber-shopping, we couldn’t help but notice that there has also been a fair amount of buying of the shopping sites themselves. For instance, Amazon recently wrapped up its $847m all-stock acquisition of online apparel retailer Zappos. This stands as Amazon’s largest purchase, nearly three times larger than its second-largest buy. (We should also note that when the deal closed earlier this month, the equity was worth a whopping $1.2bn thanks to the recent surge in Amazon shares. The stock, which hit an all-time high on Monday, has risen some 62% over the past three months.) While overall M&A spending this year appears likely to be half the amount of 2008, online retail dealmaking is still going strong. We expect spending on Internet commerce acquisitions to come in roughly where it did in previous years, at some $2.3bn worth of transactions in the sector.

Meanwhile, another e-commerce vendor continues its push for a different exit. Newegg.com filed to go public in late September, and appears to be on track for a debut early next year. The online electronics retailer, which was founded in 2001, has more than doubled sales over the past four years while also posting a profit in each of those years. Although growth has slowed so far this year, Newegg still raked in $2.2bn in revenue and $70m in EBITDA for the four quarters that ended last June.

Given the recent trend in dual-track offerings, we wonder if Newegg might not get snapped up before it hits the Nasdaq under the ticker ‘EGGZ.’ Granted, this is pure speculation, but there are a fair number of parallels between Newegg and Zappos, which could mean that Amazon will reach for it. (Both Newegg and Zappos have developed profitable, growing businesses by specializing in a slice of the market that Amazon has tried – but failed – to dominate.) Additionally, electronics retailers such as Best Buy could well be interested in bolstering their online sales units with Newegg. Although Newegg and its underwriters haven’t set an initial valuation, we suspect that any buyer would have to be ready to hand over slightly more than $2bn to add Newegg to its shopping cart.

Online retail M&A

Period Number of deals Total deal value
2005 30 $1.27bn
2006 53 $3.78bn
2007 36 $2.62bn
2008 45 $1.36bn (excluding the sale of Getty Images)
2009 YTD 55 $2.34bn

Source: The 451 M&A KnowledgeBase

Corel: ‘What a turkey’

Brenon Daly

Contact: Brenon Daly

As many of us get ready to sit down with friends and family for our annual Thanksgiving dinner on Thursday, our thoughts inescapably turn to poultry. When we look around at some of the deals out there right now, our thoughts also turn to poultry. For instance, whenever Corel comes up, we can’t help but think to ourselves, ‘What a turkey.’

By ‘turkey,’ we don’t just mean that Corel has been a second-rate software company and an even worse investment. (Although both are certainly true. Corel shares have never traded above the price at which they were spun off in mid-2006, and currently change hands at just one-quarter of that level.) But we also mean that since the grab-bag software vendor went private in mid-2003 with Vector Capital, Corel equity has been carved up like a Thanksgiving turkey. And now there’s a fight brewing over one of the drumsticks.

As we’ve chronicled in the past, Vector has been angling to repurchase the chunk of Corel that it spun to the public three-and-a-half years ago. Vector recently offered to repurchase the one-third of Corel shares that it doesn’t own at $4 each. While that was a bit higher than it initially offered in late October, the bid is substantially below its offer of $11 per share back in March 2008.

Vector’s effort received a new urgency this week when Corel warned that it runs the risk of falling below certain covenants and defaulting on its loans unless the sale to Vector goes through. The deadline for being in line with the covenants is November 30. The buyout shop contends, among other things, that the costs of Corel being a public company get in the way of making the necessary investments to keep the 24-year-old firm competitive. Corel’s investors aren’t necessarily buying that, at least not at the price offered by Vector. Corel shares have traded above the $4 bid for the past two weeks.

Bets on casual games are paying off

-Contact: Thomas Rasmussen, Brenon Daly

Fittingly enough, on the one-year anniversary of our piece predicting continued consolidation of the social and casual gaming space, Electronic Arts announced the industry’s largest acquisition. The Redwood City, California-based videogame giant acquired Playfish on November 9 for $275m, although an earnout could mean that EA will pay as much as $400m over the next two years for the company. We estimate that Playfish, which will be slotted into the EA Interactive division, generated about $50m in trailing sales. Overall M&A continues to be strong in the still-niche gaming sector, with deal volume up about 25% from last year with about 35 transactions inked so far in 2009.

With the gaming industry seemingly in recovery mode after not-so-horrible earnings announcements from industry bellwethers EA and Activision Blizzard, we’re confident that more videogame and media companies will look to add social networking games. (After all, the big gaming players have used M&A as a way to buy a piece of a fast-growing, emerging market. For instance, EA spent $680m in cash four years ago for Jamdat Mobile to get into wireless gaming.) With Playfish off the board, which other social gaming startups might find themselves targeted by one of the big gaming vendors?

While there are literally hundreds of promising startups, most are too small to be important enough for a big buyer. Nevertheless, there are a few firms that have grown – both organically and inorganically – enough to make them attractive acquisition targets. For instance, Playdom, which develops games primarily for MySpace and Facebook, recently reached for a pair of smaller gaming startups. The company also recently raised $43m. Similarly, Zynga recently raised a funding round ($15m) and has also picked up two small startups this year. Two other names to watch in the emerging social gaming market are Digital Chocolate and Social Gaming Network Inc.

NetApp: Single and lovin’ it

Brenon Daly

Contact: Brenon Daly

Jilted earlier this summer, NetApp is nonetheless doing just fine on its own, thank you very much. Shares of the storage giant are now changing hands at their highest level in more than two years, giving the company a market capitalization of a cool $10bn. (The stock tacked on 4% on Thursday after NetApp topped Wall Street expectations for its fiscal second-quarter results and indicated that its current quarter is shaping up stronger than investors initially projected. Shares closed up $1.21 at $30.83 Thursday in an otherwise down day for the market.)

Thursday’s move higher continues a recent bull run for NetApp shares since the firm got elbowed aside by EMC in the fight over Data Domain. In the six months since NetApp unveiled its unsuccessful bid for the data de-duplication specialist, shares of NetApp have soared 70%. (In comparison, the winner in the bidding war, EMC, has returned ‘only’ 40% over that period.) We mention the relative performance of the shares of the two vendors because originally, NetApp planned to use its equity to cover slightly more than half the cost of Data Domain. (With its deeper pockets, EMC always planned to pay all cash for Data Domain, as it did when it wrapped up the acquisition in late July.)

So, from the outset, we agree that our back-of-the-envelope calculation is a bit academic, given that the Data Domain deal has been done and dusted for nearly four months. (And we’ll acknowledge that it’s a bit inexact because NetApp never formally announced the precise amount of stock, or even the specific conversion price, that it planned to use.) Nonetheless, it’s pretty clear that Data Domain owners would have done pretty well if they had taken NetApp equity. (Of course, shareholders did just fine with the $33.50 in cash from EMC, which, at 7.4 times trailing sales, was the highest multiple paid for a US-listed public company since March 2008.)

With all of those disclaimers, here’s our math: When NetApp first announced the bid on May 20, its shares traded at about $17.30 each. Although it didn’t reveal the exact breakdown of cash and stock in its offer, which had an equity value of $1.75bn, we understand that NetApp was planning to hand over about $800m in cash and cover the remaining $950m in equity. Assuming that’s roughly the breakdown, that same chunk of NetApp stock would now be worth about $1.8bn – more than the full value of its initial cash-and-stock offer. Add the $800m in cash into the mix, and the total consideration for Data Domain (based on NetApp’s current share price) hits $2.6bn. That’s roughly $300m more than EMC ended up paying for Data Domain.