Category: M&A

A little something for your trouble

Brenon Daly

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.

Google gets discounted Droids

Brenon Daly

Contact: Brenon Daly

Google didn’t have to reach too deeply to fatten its patent portfolio as it also becomes one of the few vertically integrated smartphone and tablet makers. Sure, it will have to hand over $12.5bn in cash for Motorola Mobility to cover its planned purchase of the hardware manufacturer. But it will immediately get back some $3bn in cash from Motorola Mobility, as well as an undisclosed amount of tax advantages that can be used to lower the amount of taxes that the wildly profitable search giant will face in the future. Even setting aside the very real tax breaks, Google is on the hook for just $9.5bn for Motorola Mobility.

The enterprise value of $9.5bn works out to just 0.75 times the $12.7bn of revenue that Motorola Mobility has generated over the past four quarters. That’s less than half the median valuation (1.8x trailing sales) of all tech transactions announced so far this year, according to our calculations. Further, it’s just one-third the multiple of 2.2x trailing sales that we calculated for the 50 largest deals (by equity value) so far this year.

More relevantly, it’s half a turn less than Hewlett-Packard paid in 2010 to bolster its integrated mobile strategy. Last April, HP paid $1.4bn for Palm Inc in a transaction that valued the struggling company at some 1.1x sales. (And we could certainly make the case that Motorola Mobility is in better financial shape than Palm, which was burning cash amid a dramatic sales slowdown.) Another way to look at it: Google’s bid values Motorola Mobility only slightly above the current market multiple for fellow mobile device vendor Research In Motion. But then, we should add that shares in the Blackberry maker are currently changing hands at their lowest level in a half-decade.

A ‘patently’ big deal for Google

Brenon Daly

Contact: Brenon Daly

Google said Monday that it plans to hand over $12.5bn in cash for Motorola Mobility, spending more for the mobile company than it has, collectively, on the more than 100 acquisitions it has done in its history. The deal makes it more likely that Google, which will continue to offer its Android OS free to other handset manufactures, will be able to more deeply integrate the hardware and software on future devices. Additionally, Google will be gaining substantial heft in its patent portfolio, with the Motorola division counting some 17,000 issued patents and another 7,500 pending. That’s a key concern for Google, which has found itself at the center of several IP-related lawsuits.

Under terms, Google will pay $40 for each share of Motorola Mobility, for an equity value of some $12.5bn. While the bid represents a premium of 65% over the previous closing price of Motorola Mobility, it is only slightly above the price the shares fetched on their own in the days following their debut back in January. (Under pressure from activist investors including Carl Icahn, 80-year-old Motorola split itself into two companies at the start of 2011. The remaining company, Motorola Solutions, sells primarily networking and communications technology and is unaffected by Google’s proposed acquisition of the smaller but faster-growing mobile division.)

In looking at the price, however, we should note that Google will enjoy a substantial ‘rebate’ when the deal closes because Motorola Mobility basically carried no debt but held nearly $3bn in cash. So Google’s net cost is closer to $9.5bn, which works out to just 0.75x the $12.7bn of revenue that Motorola Mobility has generated over the past four quarters. Google shares, which have underperformed the Nasdaq for nearly all of 2011, were down slightly Monday on an otherwise up day on Wall Street. We’ll have a full report on the transaction in tonight’s Daily 451.

Will a stabilized Cisco step back into the market?

Brenon Daly

Contact: Brenon Daly

After back-to-back quarters that roughed up the networking giant, Cisco reported on Wednesday a reasonably strong close to it fiscal year. Fourth-quarter revenue and earnings at the company topped Wall Street’s expectations, and included a rebound in Cisco’s core switch business. The company also projected that its overall growth would continue in the current fiscal first quarter, although the rate would be just 1-4%.

Chief executive John Chambers stopped short of using one of the metaphoric expressions like ‘air pockets’ or ‘uncharted waters’ that he has used in the past to describe economic uncertainty, but he said repeatedly on the conference call discussing results that the economy is facing numerous ‘challenges.’ From our perspective, we wonder if Cisco will get its M&A machine humming again if it continues to stabilize its business.

The company announced a deal in each of the first three months of 2011, but has been notably absent since then. In other words, Cisco has been out of the market since it first let on that business was getting tougher. Will that change now that business appears to be picking up again?

Are Internet infrastructure exits interconnected?

Ben Kolada

Contact: Ben Kolada

Providing further proof that it’s a tough time to be on the market, much less come to market, GI Partners has opted to sell its Telx investment rather than battle through an IPO. The company’s sale to ABRY Partners and Berkshire Partners closes the books (at least for now) on a proposed public offering that Telx initially filed back in March 2010. And we wouldn’t be surprised if Telx’s sale caused other IPO candidates in the industry to rethink their entry onto the public stage as well.

Terms weren’t disclosed, but we understand that Telx caught a fairly high valuation that would have provided a more immediate – and lucrative – return than an IPO. Although the Internet infrastructure industry showed resilience throughout the recession, consistently growing revenue, that hasn’t always been the case when it comes to the public markets. Chinese datacenter operator 21Vianet Group, for example, closed its first trading day on the Nasdaq with a market cap of $1bn. However, since then its shares have lost 40% of their value. (We note, however, that the success of 21Vianet’s IPO was due in part to success from other Chinese IPOs, as well as buyout speculation in the industry.)

Just as the Internet infrastructure market focuses on interconnection, we suspect that its participants’ exits are also interconnected. We feel that Telx’s recent sale to ABRY Partners and Berkshire Partners could cause the industry’s other IPO candidates to pause before hitting the public markets. Our colleagues at Tier1 Research maintain a list of the Internet infrastructure industry’s potential IPO candidates. Although speculation surrounds such fast-growing firms as SoftLayer Technologies, Peak 10, Zimory and Next Generation Data, an IPO for these players may be pushed to the back burner, at least for the foreseeable future.

Fusion-io’s ‘flash-y’ and jumpy M&A currency

Brenon Daly

Contact: Brenon Daly

In the same breath that it announced quarterly results for the first time, Fusion-io also announced its first-ever acquisition. The flash storage specialist reached for IO Turbine, a caching software startup that had only emerged from stealth mode earlier this summer. Our storage analyst, Henry Baltazar, points out that although IO Turbine was only just getting started, its software had been bundled with Fusion-io’s PCIe flash cards. Fusion-io says the pairing boosts performance, and should open up new markets in virtualized environments.

Fusion-io will use both cash and stock to cover the $95m price of its inaugural purchase. The exact makeup of the consideration wasn’t released, but it’s basically one-third cash and two-thirds equity. That breakdown is noteworthy, given that Fusion-io – with some $220m in cash, thanks to its IPO two months ago – could have easily just used greenbacks to pay for IO Turbine.

Instead, the startup felt comfortable enough to take the majority of its payment in Fusion-io shares, which have been noticeably volatile since their June debut. Consider this: During last Thursday’s rough ride for the overall market, Fusion-io was particularly jumpy ahead of its earnings announcement. Shares opened at $28 each, dropped as much as 14% in the first hour of trading, actually popped above the opening trading price at midway through the session, and then slid almost uninterruptedly to close at the low of the day.

Granted, the trading last Thursday for individual equities was overshadowed by the historic 500-point drop in the Dow Jones Industrial Average that day. But we would note that the Dow was in the red from the opening bell, while Fusion-io actually rallied into the green at one point before sliding. Given those sorts of swings, it might not be a bad idea for the new holders of Fusion-io shares to look into a hedging plan for their holdings.

IncrediMail reaches deep for deal

Brenon Daly

Contact: Brenon Daly

Almost exactly a year after taking the top spot at IncrediMail, CEO Josef Mandelbaum has announced his first acquisition at the digital media company. And it’s a big one: IncrediMail, which had just $33m in cash in March, will spend $25m upfront and another possible $15m earnout to add startup Smilebox. IncrediMail will cover at least the first tranche of the payment from its own treasury when the deal closes later this year, but it may look to tap the credit market for the earnout.

The transaction represents a significant bet by the Israeli firm, which has a market cap of just $70m. According to IncrediMail’s forecast, Smilebox should add more than $15m to revenue next year to the vendor, which, organically, has only generated about $30m in sales in each of the past two years. (We should note, however, that those sales are highly profitable for IncrediMail. Its operating margin runs at roughly 40%.)

The fact that Mandelbaum is doing deals for IncrediMail shouldn’t come as much of a surprise. Before taking the top spot at the small public company, he ran the interactive division of American Greetings, where it built out the digital business of the card provider through a series of acquisitions. Among the deals Mandelbaum put together included the pickups of BlueMountain.com, PhotoWorks, Egreetings.com and Webshots. In fact, during his tenure at American Greetings, we understand that Mandelbaum may have even been interested in buying his current firm, IncrediMail.

In Network Solutions’ sale, General Atlantic gets a bit of both exits

Ben Kolada

Contact: Ben Kolada

Web.com is acquiring Web hosting and domain name registration vendor Network Solutions in a deal valued at $756m, including the assumption of debt. And we expect that Network Solutions’ owner couldn’t be more relieved. With flat revenue and customer attrition in recent years, Network Solutions’ private equity owner, General Atlantic (GA), wasn’t likely to find much interest for the portfolio company on Wall Street.

However, GA structured the transaction in such a way that – at least for now – it is enjoying a good day on the stock market. Terms of the deal call for just over a quarter of Network Solutions’ price to be covered by Web.com shares. (That will leave GA and other Network Solutions’ shareholders owning 37% of the combined company.) Web.com initially valued that chunk of equity at about $150m. On Thursday afternoon, the value of the 18 million Web.com shares heading to GA and other owners had soared closer to $200m. The reason? Wall Street liked the acquisition as well as Web.com’s second-quarter financial results. (We’ll have a full report on this transaction in tonight’s Daily 451 and 451 TechDealmaker sendouts.)

Saying ‘Goodnight’ to a stand-alone SAS?

Brenon Daly

Contact: Brenon Daly

After years of politely – but unequivocally – rebuffing all M&A approaches, is SAS Institute chief executive James Goodnight suddenly listening to pitches? Rumor has it that Goodnight, who has fashioned the business analytics vendor in the manner of a corporate patriarch of the 19th century, may finally be ready to sell. Any deal for SAS, of course, would have to go through Goodnight, as he owns two-thirds of the company outright.

If SAS is indeed in play – which, granted, is a big, multibillion-dollar assumption – it would represent a dramatic shift in not only the corporate history of the 35-year-old company, but also, more broadly, the landscape for business intelligence (BI) software. Goodnight has steered his firm on a path of independence through the years of consolidation in the BI industry. Most notably, he sat out the spree of deals in 2007 that saw his three largest publicly traded BI rivals get snapped up for a total of some $15bn.

All the while, Goodnight has been shaping a culture at SAS that is a bit of a throwback to the cradle-to-grave employee benefits that other tech vendors, which have to appease outside investors, could never offer. (Among the perks: a pianist who plays in the employee cafeteria, Olympic-sized swimming pools and even onsite Montessori childcare.) SAS employs more than 12,000 people.

SAS’s unique corporate traits have made it not only one of the most valuable privately held software companies, but also one of the most difficult to know what to do with it. (We have referred to SAS as the ‘white elephant’ of the software industry.) A decade ago, SAS worked with Goldman Sachs to explore a possible IPO, but that came to nothing. Goldman is thought to be running the current M&A process for SAS, too.

So that leaves a sale of SAS as Goodnight’s only exit. Companies rumored to be interested in SAS include Hewlett-Packard, IBM, Oracle, SAP and EMC, which is thought to be the lead horse at this point. But there’s still the not-insignificant matter of price. While still loose, the numbers we have heard for SAS, which recorded sales of $2.4bn in 2010, value the company at $12-13bn. Even a price only slightly above that range would make a purchase of SAS the largest-ever software deal, eclipsing Symantec’s $13.5bn stock swap for Veritas Software in late 2004.

Windstream misses the message

Ben Kolada

Contact: Ben Kolada

As the telecom industry continues its buying spree, some firms are missing the bigger picture – hosting and datacenter services are the new growth channels for telcos. While CenturyLink and Verizon have each announced acquisitions in the growing datacenter services industry, Windstream Communications appears to be satisfied with consolidating telecom assets. The telco’s purchase of complementary competitive carrier PAETEC is its seventh telco rollup since its formation in 2006. And while PAETEC does provide a wealth of network assets, it contributes little in the way of revenue growth. For the price it’s paying for PAETEC, Windstream could have gobbled up a number of hosting properties at a fraction of the cost.

To be fair, Windstream’s PAETEC pickup does provide more than 50,000 high-revenue enterprise accounts and an expanded fiber footprint. But the target’s organic revenue has been flat in recent years, and growth this year is likely to come primarily as a result of the Cavalier Telephone buy it completed in late 2010. (We would also note that Cavalier’s revenue was in precipitous decline, due primarily to churn in its consumer division. Cavalier’s revenue dropped from $421m for full-year 2009 to an estimated $390m in trailing revenue at the time of its sale.)

Beyond fiber and enterprise accounts, Windstream is also interested in PAETEC’s datacenter services assets. And rightfully so, considering Windstream’s hosting assets could certainly use a boost. The company’s last pure M&A foray into the hosting sector was in November 2010, when it shelled out $310m for Hosted Solutions. That target only generated $51m in trailing sales, or about 1% of Windstream’s total revenue. But for the $2.2bn the telco is paying for PAETEC (including the assumption of debt), it could have easily expanded its hosting footprint in the US and abroad by acquiring both InterNap Network Services and Interxion. Applying a flat 20% equity premium to the pair would put their combined deal value at about $1.6bn on an enterprise value basis, or about three-quarters of PAETEC’s price.