Category: investment banking

Q1 M&A: Recession hits deal-making

Brenon Daly

Contact: Brenon Daly

We’ve just finished tallying the first-quarter tech M&A numbers, and the picture is pretty bleak. In the first three months of the year, there were just 625 tech and telecom transactions, with total spending in the quarter hitting a mere $8bn. Compared to the first quarter of 2008, the number of deals dropped by about one-quarter, while spending plummeted 85%.

The main reason for the sharp decline in spending is the disappearance of big deals. In fact, for the first time in the seven years we’ve kept records on tech M&A, buyers didn’t announce a single transaction worth more than $1bn during the quarter. During 2006 and 2007, we saw an average of about 18 deals announced each quarter that were valued at more than $1bn. Even last year, when the current recession began to be felt, we still saw an average of some nine billion-dollar-plus deals each quarter. (However, on Wednesday, which is the first day of the second quarter, Fidelity National Information Services said it would acquire Metavante for almost $3bn in an all-stock deal.) The largest single transaction in the first quarter was Autonomy Corp’s $775m purchase of Interwoven.

Projecting annual totals from a single quarter is hardly an accurate way to predict deal flow, particularly in a lumpy business like M&A. (The Fidelity National-Metavante transaction underscores that.) Nonetheless, we would note that right now, 2009 is on track to post the lowest deal spending totals since the Internet bubble burst. The current low-water mark was hit in 2003, when spending totaled just $61bn. Since then, tech M&A has boomed, with spending in each of the past four years topping $300bn. But the way it looks now, 2009 is shaping up as a year when we could very well measure annual tech M&A spending in the tens of billions of dollars, rather than hundreds of billions of dollars. We’ll have a full report on first-quarter M&A on Thursday.

Quarter-by-quarter M&A totals

Period Deal volume Deal value
Q1 2009 625 $8bn
Q4 2008 721 $40.7bn
Q3 2008 733 $32.2bn
Q2 2008 716 $173.2bn
Q1 2008 835 $55.2bn

Source: The 451 M&A KnowledgeBase

Will mobile payment startups pay off?

-Contact Thomas Rasmussen, Chris Hazelton

In 2006 and 2007, mobile payment startups were a favorite among venture capitalists. The promise of dethroning the credit card companies by bypassing them had VCs and strategic investors throwing hundreds of millions of dollars after such startups. During this time, a few lucky vendors managed to secure lucrative exits. Among other deals, Firethorn, a company backed with just $14m, sold to Qualcomm for $210m and 3united Mobile Solutions was rolled up for $70m as part of VeriSign’s acquisition spree. Recent prices, however, haven’t been anywhere near as rich. Consider this: VeriSign unwound its 3united purchase last month, pocketing what we understand was about $5m. Similarly, Sybase picked up PayBox Solution for just $11.4m, while Kushcash and other promising mobile payment startups have quietly closed their doors.

Last week, Belgian phone company Belgacom took a 40% stake in mobile payment provider Tunz. Tunz has taken in a relatively small $4m in funding since launching in 2007, but with VCs sidelined, we believe this investment was a strategic cash infusion to keep alive the company behind Belgacom’s mobile payment strategy. It may well be a prelude to an outright acquisition. With valuations clearly deflated and venture capitalists nowhere to be seen, we believe mobile service providers are set to go shopping for payment companies. Who might be next?

Yodlee, mFoundry and Obopay are three companies that have made a name for themselves in the world of mobile banking and payments. Each has secured deals with the major banks and wireless companies, but still lacks scale. Further, all of them are facing increased competition from deep-pocketed and patient rivals such as Amazon, eBay’s PayPal and Google’s CheckOut. Still, we believe they are attractive targets for wireless carriers or mobile device makers, who are increasingly on the lookout for additional revenue streams.

In fact, Obopay received a large investment from Nokia last week as part of its $70m series E funding round. Nokia’s portion is unclear, but Obopay tells us the stake gives Nokia a seat on its board. (Additionally, we would note that this investment comes directly from Nokia, rather than its venture arm, Nokia Growth Partners, as has typically been the case). This latest round brings Obopay’s total funding to just shy of $150m. Although we wonder about the potential return for Obopay’s backers in a trade sale to Nokia, the mobile payment vendor would clearly be a great complement to Nokia’s growing Ovi suite of mobile services. (We would also note that Qualcomm put money into Obopay and considered acquiring the company, but instead went with Firethorn.) Likewise, Yodlee and mFoundry’s roster of strategic investors and customers reads like a short list of potential buyers: Motorola, PayPal, Alltel (now Verizon), along with other large banks and wireless providers. Yodlee says it has raised more than $100m throughout its 10-year history, and mFoundry has reportedly raised about $25m.

Back-of-the-envelope thinking on Red Hat-Oracle

Brenon Daly

Contact: Brenon Daly

If Oracle was seriously planning a bid for Red Hat (and we have our doubts about such a pairing), then Larry Ellison had better be prepared to reach deeper into his pocket. Following Red Hat’s solid fiscal fourth-quarter report, shares of the Linux giant jumped 17% to $17.60 on Thursday. That added about a half-billion dollars to Red Hat’s price tag, with the company now sporting a fully diluted equity value of some $3.5bn.

Looking back at the nine US public companies that Oracle has acquired this decade, we would note that Oracle has paid an average premium of 14% above the previous day’s closing price at the target company. (Note: We excluded the two-year-long saga around PeopleSoft.) If we apply that premium, which we acknowledge is crudely calculated, to Red Hat, the company’s equity value swells to $4bn, or about $21 per share. That’s essentially where Red Hat shares changed hands in August, before Wall Street imploded.

On the other side of the table, Red Hat recently cleaned up its balance sheet, which certainly makes it a more palatable target. (Again, we don’t think the company is in play, much less took the steps to catch Oracle’s eye. More so, that it was just good fiscal practice.) Specifically, Red Hat paid off all of its debt and finished its fiscal year, which ended last month, with $663m in cash and short-term investments. That would be a nice ‘rebate’ for any potential buyer, in the unlikely event that Ellison or anyone else reaches for Red Hat.

Bulging boutiques

Brenon Daly

Contact: Brenon Daly

In our league tables report, we noted that some 143 firms advised on at least one technology transaction in 2008. That was down slightly from the 153 firms we tallied in 2007, even as the number of tech transactions dipped about 17% year over year. Obviously, some of that decline can be chalked up to the investment banks that dramatically and abruptly disappeared in the last year. But more so, the thinning ranks of investment banks can be attributed to the fact that deal flow is drying up.

So far this year, the number of deals announced has fallen about one-quarter to just 574. (And don’t even ask about M&A spending, which has plummeted to just $7bn from $49bn during the same period last year.) That, combined with the fact that fees are increasingly coming under pressure, has meant much leaner times for the advisory business in general. So far, the impact of that has primarily been felt by the bulge-bracket banks, which have made sharp cuts in their ranks since September.

This has sparked a flow of talent from big shops to small. Earlier this week, for instance, a pair of former Bear Stearns bankers founded their own tech advisory firm, Stone Key Partners. We expect many more of the dislocated bulge-bracket bankers to follow suit and hang out shingles of their own. In the meantime, many bankers have joined boutiques of various sizes. Since Wall Street imploded in mid-September, boutique firms including Revolution Partners, America’s Growth Capital, Perella Weinberg Partners, Evercore Partners and Redwood Capital have all picked up former bulge-bracket bankers.

And there are additional moves we’ve heard about but have yet to be announced. We understand that Goldman Sachs’ software banker, Ian Macleod, is set to join Qatalyst Partners, the San Francisco-based firm launched by Frank Quattrone a year ago. We also heard recently that Richard Vieira, who worked a number of open source transactions at Jefferies & Co before leaving some two years ago, has resurfaced. Vieira is joining Shea & Company, a three-man shop founded in 2005 by JP Morgan Securities’ former head of software banking, Michael Shea.

IPO window opens a crack

Brenon Daly

Contact: Brenon Daly

It’s been exactly a year since SolarWinds put in its paperwork to go public. In that time, capitalism has been beaten and bloodied. To underscore that, consider that the late-great Lehman Brothers was one of the original underwriters of the proposed offering. Obviously, that bank has been erased – both on prospectus and elsewhere. Morgan Stanley now serves as the other major bulge-bracket underwriter on SolarWinds’ ticket.

As we noted earlier this month, the tech IPO market has had nothing to offer since the debut of Rackspace in the middle of last year. Last week, Omneon Video Networks pulled its planned IPO, two years after initially filing the paperwork. That withdraw came less than two weeks after GlassHouse Technologies also scrapped its planned debut.

But a funny thing happened after we declared the IPO market dead: We began to see some signs of life. Chinese online game developer Changeyou.com is set to hit the Nasdaq next week. We would guess that planned debut has much to do with the rebound in the Nasdaq, where Changeyou.com intends to trade. Since finishing a month-long slide on March 9, the Nasdaq has gained some 17%. The index has risen from below 1,300 (close to where it bottomed out in October 2002, after the tech wreck) to above 1,500 during Monday’s Treasury-inspired rally.

We wonder if SolarWinds, which has already amended its original prospectus six times, won’t also look to take advantage of this slim opening of the IPO window to go public. Of course, we’ve always thought that SolarWinds could go public in just about any market, given the fact that it mints money. Last year, the company continued to run at an EBITDA margin of more than 50%, even as revenue hit $93m, up from just $38m in 2006 and $59m in 2007.

Oracle’s stimulus package

Brenon Daly

Contact: Brenon Daly

One way to read Oracle’s novel announcement on Wednesday that it will start paying a dividend is that after years of handing out money to shareholders of other companies in the form of acquisitions, it will dole out some to its own investors. Word that the software giant will pay a dividend for the first time comes after a quarter in which Oracle acquired just one company, mValent. It was the lowest quarterly total for the company in recent memory, and compares with the shopping spree in the same quarter last year that saw it take home BEA Systems for $8.5bn, among other deals.

Although terms for Oracle’s most-recent acquisition weren’t released, we understand that it paid less than $10m for mValent, a change and configuration management startup. Viewed in light of the announced dividend of a nickel per share, even assuming that Oracle paid $10m for mValent, the purchase price works out to just 4% of the cash that the company is set to return to shareholders next month. (With five billion shares outstanding, Oracle’s dividend bill will be $250m per quarter, or $1bn for the full year.)

Even though time and money can only be spent once (as the saying goes), merely committing to paying a dividend doesn’t necessarily take a company out of the M&A market. Look at Microsoft, which has been a dividend-paying company since the beginning of 2003. It has inked four of its five largest deals even as it handed back billions of dollars to its own shareholders. And that corporate largess has hardly imperiled the Redmond, Washington-based behemoth. It finished last year with more than $20bn in cash and short-term investments on its balance sheet.

Oracle’s M&A, by quarter

Period Deal volume Disclosed and estimated deal value
Fiscal Q3 (December-February) 2009 1 Estimated less than $10m
Fiscal Q2 (September-November) 2008 5 $455m
Fiscal Q1 (June-August) 2008 2 Not disclosed
Fiscal Q4 (March-May) 2008 2 $100m
Fiscal Q3 (December-February) 2008 4 $8.5bn
Note: Oracle’s fiscal year ends in May

Source: The 451 M&A KnowledgeBase

A (Big) Blue-colored Sun?

Brenon Daly

Contact: Brenon Daly

Just two days after Cisco took the fight to its longtime allies in the server wars, IBM is now looking to buy some ammunition of its own. Big Blue is reportedly mulling a $6.5bn bid for Sun Microsystems, according to The Wall Street Journal. The deal would be the largest tech transaction (excluding telecom M&A) since Hewlett-Packard jabbed at IBM’s giant services division, paying $13.9bn for EDS last May. If it comes to pass, a pairing of IBM and Sun would also radically change the battle lines in the broader fight to build out datacenters, specifically around server, storage and software offerings.

Take the server market. If the deal goes through, a combined IBM-Sun would dominate the high-end, RISC-based, Unix-based symmetrical multiprocessor server market, leaving HP a distant third. However, one point that might pose a challenge for Big Blue is how long it would want to continue with Sun’s Sparc architecture, a direct clash with its own Power chips and System-p servers. Turning to storage, IBM is probably less excited about Sun’s assets in that market. Sun’s storage business has been languishing in the doldrums for years, despite Sun supporting it with its largest-ever acquisition, its mid-2005 purchase of StorageTek for $4.1bn in cash. Nonetheless, there are probably enough enterprise customers locked into Sun’s high-end, mainframe-centric tape business to interest Big Blue. And in software, IBM and Sun are both committed to open source, although we would add that they have slightly different models for monetizing their investments there.

Of course, there’s a chance that the reported talks may not result in a deal. However, we would note that Sun shares are behaving as if it will go through, soaring nearly 80% in early Wednesday afternoon trading to $8.80. That’s essentially where they were last September. That fact probably won’t be lost on Sun’s largest shareholder, Southeastern Asset Management. The activist investor, which has indicated that it talked with Sun to explore a possible sale of the company, among other steps to ‘maximize shareholder value,’ holds some 20% of Sun stock, according to its most-recent SEC filing.

Shopping with St. Patrick

Brenon Daly

Contact: Brenon Daly

Starting in the mid-1990s, Ireland joined the New Economy. The island shifted its economy from a centuries-old farming and manufacturing base into a services-oriented and technology-savvy industry. The historic economic isolation of the island gave way to brisk trade with its fellow European Union countries and beyond. Ireland prospered, with some dubbing the country ‘the Celtic tiger’ – a nod to the nickname for the fast-growing countries in Asia during that same period.

Recently, though, Ireland’s boom time has been slowed by the global recession. However, we would point out that the economic decline in the Emerald Isle has been nowhere near as sharp as in another European island nation that dramatically reinvented itself, Iceland. Of course, it helps to think of Iceland not as a country but as a hedge fund, as financial journalist Michael Lewis wrote recently.

What’s interesting to note on this St. Patrick’s Day is how Ireland’s flourishing tech sector has turned into a shopping center for other companies. Since St. Patrick’s Day last year, there has been more than twice the number of Irish tech companies sold than the number of acquisitions made by Irish tech companies. The gulf in spending by Irish companies compared to spending for Irish companies is even more pronounced. Just something to chew over today, in between bites of corned beef and cabbage.

Emerald Isle M&A

Period Acquisitions by Irish companies, $ total Acquisitions of Irish companies, $ total
March 17, 2008-March 17, 2009 11, $225m 25, $720m

Source: The 451 M&A KnowledgeBase

M&A at Accellos

Brenon Daly

Contact: Brenon Daly

Another supply chain management (SCM) rollup is getting rolling. Colorado Springs, Colorado-based Accellos has already closed four acquisitions and has a letter of intent in place for its fifth. Backed by a handful of private equity (PE) firms, Accellos began shopping back in October 2006 with the double-barreled purchase of Headwater Technology Solutions and Radio Beacon. The pair of deals gave Accellos $15m of combined revenue out of the gate. The company added one company in both 2007 and 2008.

As it was closing the purchase of Prophesy Transportation Solutions last September, Accellos also pulled in a $28.5m second round of financing. (That brought its total funding to $54m, although it still has $20m of that in the bank.) Accellos, which projects that it will wrap this year with some $45m in sales, says it’s only about halfway through its shopping spree. (It’s looking for companies with revenue of $4-8m.) The company indicated at this week’s Montgomery Technology Conference that it will probably need to close a total of 9-10 deals in coming years to hit its goal of more than $100m in annual sales.

If Accellos’ strategy sounds familiar, it’s because at least two other PE-backed companies have also set about rolling up the SCM market. Battery Ventures picked up HighJump Software for $85m last May, and then tacked on BelTek Systems Design last November and Insight Distribution Software a month ago. And since Francisco Partners acquired RedPrairie in May 2005, the company has inked seven acquisitions.

Are earn-outs cop-outs?

-Contact Thomas Rasmussen and Yulitza Peraza

Despite being derided by some as cop-outs, earn-outs are nonetheless popping up more frequently in deal terms. It used to be that the staggered payments were a way to keep the talent at the acquired company from bailing as soon as the ink was dry on the deal. Now, retention isn’t so much the concern, it’s more valuation. Earn-outs are being used to bridge the increasingly wide gulf between buyer and seller expectations.

So far this year, 18% of deals with an announced value of less than $500m had an earn-out provision, up slightly from 15% for the same period in 2008. However, the additional payments are making up a larger part of potential deal values. The average earn-out amounted to half of the deal value in transactions announced so far this year, compared to just one-third during the same period last year. We would attribute that to the leverage buyers have in the current M&A environment as well as their need to preserve cash.

And, anecdotally, we have been hearing that buyers are using their position to set unrealistic terms (thus avoiding payouts down the road, and preserving more of their cash). Consider the case of Mazu Networks, which sold to Riverbed Technology last month for $25m in cash and a potential $22m earn-out. Combined, the upfront and earn-out payments would have nearly made whole the investors in the Cambridge, Massachusetts-based security company. But a closer look at the terms reveals just how unlikely it is that Mazu and its backers will see much – if any – of that earn-out. The reason? To be paid in full, Mazu will have to more than double its bookings by the end of March next year at a time when the economy is shrinking and even tech stalwarts are struggling to post any revenue growth.