Could CenturyLink’s Qwest buy prevent a future cloud infrastructure play?

Ben Kolada

Contact: Ben Kolada

Almost exactly one year after they announced their intention to merge, CenturyLink and Qwest Communications are set to close the largest US wireline consolidation play in the past half decade. But while the deal will more than double CenturyLink’s revenue, the debt assumed could prevent it from making another significant acquisition anytime soon. And that’s a shame, since the combined company’s datacenter business could use a boost.

Even in retrospect, the Qwest purchase is still a smart deal, since CenturyLink needs Qwest to expand its own meager business services division – especially since the telecom industry’s focus between consumer and businesses is increasingly leaning toward the latter. But while the move grows CenturyLink’s revenue, in the near term the assumption of Qwest’s debt will actually prevent the company from moving into the datacenter and hosting industry, which is showing more long-term potential than wireline services.

Neither Qwest nor CenturyLink are providing aggregate financial projections for 2011, but numbers from 2010 show the combined company will be weighed down by a hefty amount of debt. Last year, CenturyLink and Qwest held an aggregate $19bn in debt; that’s nearly equal to the revenue the two companies generated over the same period. Further, that mountain of debt is more than five times the combined company’s free cash flow. Debt repayment obligations will likely put a halt to CenturyLink’s steady M&A history, thereby forcing the company to focus on organic growth.

And this comes at a time when telcos are increasingly seeking growth by buying into the cloud infrastructure industry. With Qwest’s debt, CenturyLink may be the last to the table to acquire a large hosting provider, even though the company certainly needs one. Qwest’s datacenter footprint is already fairly small when compared to the other Regional Bell Operating Companies. In its last-ever annual report, the company cited 17 hosting centers in operation – that’s the same amount as many of the medium-sized private providers. Without an inorganic boost, the company could lose out on cloud infrastructure market share. Consider this: Qwest doesn’t break out datacenter revenue, but the business division’s sub-segment that includes this service only grew 8% in 2010. For comparison, in its 2011 Global Managed Hosting Market Overview, our Tier1 Research subsidiary predicted that the managed hosting sector’s global revenue will grow 19.8% this year.

Cornerstone: the newest — and priciest — HCM vendor

Brenon Daly

Contact: Brenon Daly

So much for the ‘debut discount.’ Cornerstone OnDemand hit the market Thursday at an eye-popping valuation, going against the recent trend toward conservative pricing for new issues. The human capital management (HCM) vendor priced its shares at $13 each, above the indicated range of $9-11 each. (Goldman Sachs & Co and Barclays Capital are leading the IPO.) By early afternoon Thursday, the stock was changing hands at about $19.

The offering gives Cornerstone one of the richest valuations of any recent IPO. At $19 per share, the company’s market cap is roughly $900m. That’s 15 times trailing bookings (not sales) and likely in the neighborhood of 9x projected bookings. (Our math: Cornerstone reported 2010 bookings of $61m, up 74% from the previous year. Assuming that the growth rate comes down a smidge to 60-65% for 2011, that would put Cornerstone’s full-year bookings at $100m, give or take.)

Cornerstone’s valuation vastly outstrips what the market says rival Taleo is worth, and even puts it ahead of SuccessFactors, which had been the HCM industry’s ‘favorite child.’ (That’s been the view on Wall Street, anyway.) SuccessFactors, which went public in late 2007, currently garners a $2.7bn market cap, roughly 10.5x trailing bookings and about 8x projected 2011 bookings. We should note that both SuccessFactors and Taleo are about four times the size of their newest rival on the public market. But for now, both of them are looking up at Cornerstone.

Mentor Graphic’s looming showdown

Brenon Daly

Contact: Brenon Daly

Lost in the din surrounding Carl Icahn’s recent effort to take out Lawson Software is the fact that the activist shareholder is already much further along with his stirrings against another target, Mentor Graphics. In less than two months, the electronic design automation company is slated to hold its annual shareholder meeting – a get-together where Icahn hopes to replace several board members as a way to spur a sale of the company. It’s shaping up to be a real showdown.

Last month, Icahn floated an offer of $17 for each of the roughly 112 million shares of Mentor, giving the unsolicited bid an equity value of $1.9bn. (Icahn already owns 15% of Mentor, which is nearly four times more than all the company’s directors and executives hold collectively.) Icahn has been joined in his efforts – in practice, if not officially – by another hedge fund, Casablanca Capital, which has a 5% stake in Mentor.

Mentor has told its shareholders to stick with its current board and strategy. In the proxy filed Tuesday, the company takes a swipe at Icahn’s efforts, saying his selections to the board lack ‘the collective knowledge, skill and experience’ of the current directors. Recall that Mentor’s ‘just say no’ defense successfully stymied an unsolicited bid from rival Cadence Design Systems nearly three years ago. Cadence pulled its offer just two months after launching it, but not before blasting Mentor for refusing to even open its books to a prospective buyer. We doubt that Icahn will go away as quickly and quietly if Mentor continues to stiff-arm him

HP’s ‘cloudy’ strategic vision

Brenon Daly

Contact: Brenon Daly

Under Mark Hurd, Hewlett-Packard looked to bulk up all of its divisions through M&A. But software was definitely an afterthought. Hurd’s most-notable transaction, of course, was the $13.9bn purchase of services giant EDS. In his half-decade at the helm, Hurd also sprinkled in deals for companies selling gear for printing, storage and networking, among other areas.

Ever since Leo Apotheker replaced Hurd, people have been speculating that software would become a renewed focus at HP, if for no other reason than Apotheker spent some two decades at software giant SAP. Indeed, as he laid out his grand plan on Monday for HP in his first major strategy speech as CEO, Apotheker hit on software a number of times. (At least we think he did. It was hard to tell what was actually being announced in HP’s buzzword-laden release, which was heavy on ‘convergence’ but light on specifics.)

Apotheker also appeared to indicate that HP would continue shopping, with both security and information management as focus areas for M&A. Actually, that’s already showed up in deal flow since he took over. HP’s three most recent acquisitions (Vertica Systems, Stratavia and ArcSight) have all been done by the software group.

But if we’re brutally honest, we might suggest that the issue with HP’s software business isn’t so much adding to what’s there as it is just making what’s already there actually deliver. While other tech giants rely on software for outsized growth and rich cash generation, neither is particularly true for HP.

HP’s software division is growing in the mid-single digits while posting an operating margin that’s just half the level of most other rivals. To underscore the underperformance, consider this: even though HP’s old and dusty printer business is 10 times larger than its software division, they have the same growth rate. Dare we say that HP’s software unit could probably benefit from a Hurd-like focus on operations by Apotheker?

Lawson ‘Infor-med’ of unsolicited offer

Brenon Daly

Contact: Brenon Daly

In the middle of last year, we penciled out a takeout scenario for Lawson Software that gave the old-line maker of ERP software an equity value of about $1.7bn. Turns out we were off by just $100m. On Friday, the acquisitive, private equity-backed rollup machine Infor Global Solutions floated an unsolicited $1.8bn offer for Lawson. The target said only that it has retained Barclays Capital to advise it on the process.

We thought Lawson might find itself in play because activist shareholder Carl Icahn had taken about 10% of the company’s stock and started talking about ‘maximizing shareholder value.’ (Some of that has already showed up in Lawson’s recent stock chart. When Icahn revealed his stake last summer, shares were changing hands at about $8 each, compared to the $11.25 offer from Infor. We would note that the stock traded through the bid on Monday, hitting a high of $12.87 before settling down at about $12.25 in afternoon activity.)

In many ways, Lawson presents something of an easy target for Icahn and the would-be buyout group. License revenue has slipped in both of the company’s quarters so far this fiscal year. Meanwhile, it has been deemphasizing its consulting services, which is still one-third of total sales. So that business is dropping, too. The only growth has been seen in Lawson’s maintenance revenue. That business runs at an 80% gross margin, one of the main reasons Lawson generates so much cash.

Over the past four quarters, Lawson has thrown off some $116m of EBITDA on $745m of sales, a healthy 16% margin. If we put that trailing performance against Infor’s bid, Lawson is garnering a not-too-shabby multiple: 2.4 times sales and 15x EBITDA. Infor’s bid represents the highest price for Lawson stock in nine years, and would be CEO Charles Philips’ first deal since coming over from Oracle last October.

The cloud expands overseas

Ben Kolada

Contact: Ben Kolada

Although the US hosting, cloud and colocation markets are still growing, cloud infrastructure providers are already expanding overseas. This international expansion is driven in part by enterprises demanding global cloud platforms, as well as the vendors’ desire to tap into emerging markets.

Verizon Communications’ Terremark Worldwide purchase seemingly set the stage for international expansion (although the telco was primarily attracted to Terremark’s cloud platform, the deal also provided Verizon with deeper penetration in Central and South America), and colocation and hosting providers soon followed suit. Shortly after the Terremark sale, Savvis announced a partnership in India with Bharti Airtel and claimed to be looking for similar partnerships in South America and China. Meanwhile, Savvis competitor Equinix has already moved into South America with the $127m pickup of Rio de Janeiro-based ALOG Data Centers. The company also has a presence in China with facilities in Hong Kong and through a partnership in Shanghai with Shanghai Data Solutions.

While international expansions will continue, we expect that the announcements will eventually turn from partnerships to outright acquisitions as cloud infrastructure providers look to get the most out of their investments. Equinix has already shown a willingness to make international deals, and we anticipate that the company will announce additional overseas transactions. The company could make further inroads in China by entering the Beijing market. My colleagues at Tier1 Research believe that large cities in China such as Beijing, Guangzhou, Shenzhen and Tianjin are underpopulated with datacenters and predict that these cities will see significant datacenter investment over the next five years.

Although the US hosting, cloud and colocation markets are still growing, cloud infrastructure providers are already expanding overseas. This international expansion is driven in part by enterprises demanding global cloud platforms, as well as the vendors’ desire to tap into emerging markets.

Verizon Communications’ Terremark Worldwide purchase seemingly set the stage for international expansion (although the telco was primarily attracted to Terremark’s cloud platform, the deal also provided Verizon with deeper penetration in Central and South America), and colocation and hosting providers soon followed suit. Shortly after the Terremark sale, Savvis announced a partnership in India with Bharti Airtel and claimed to be looking for similar partnerships in South America and China. Meanwhile, Savvis competitor Equinix has already moved into South America with the $127m pickup of Rio de Janeiro-based ALOG Data Centers. The company also has a presence in China with facilities in Hong Kong and through a partnership in Shanghai with Shanghai Data Solutions.

While international expansions will continue, we expect that the announcements will eventually turn from partnerships to outright acquisitions as cloud infrastructure providers look to get the most out of their investments. Equinix has already shown a willingness to make international deals, and we anticipate that the company will announce additional overseas transactions. The company could make further inroads in China by entering the Beijing market. My colleagues at Tier1 Research believe that large cities in China such as Beijing, Guangzhou, Shenzhen and Tianjin are underpopulated with datacenters and predict that these cities will see significant datacenter investment over the next five years.

Slimmed-down LSI catches eyes on Wall Street

Brenon Daly

Contact: Brenon Daly

Wall Street’s vote on NetApp’s purchase of the Engenio division from LSI is pretty clear: the seller got the better end of the deal. On an otherwise tough day on the market Thursday, LSI shares were one of the rare spots of green on trading screens as investors backed the company’s move to focus more on its chips business. The stock closed up 3%, with volume was more than twice as heavy as average. On the other side, NetApp slumped 6% on trading that was four times heavier than a typical day.

The reaction comes after LSI, advised by Goldman Sachs, announced plans after the closing bell Wednesday to sell its Engenio external storage systems business to NetApp for $480m in cash. (Over the past decade, LSI had several plans to spin off that unit in an IPO, but never managed to get it done.) The deal, which is expected to close within 60 days, continues a run of divestitures that LSI has undergone, including shedding divisions serving mobility and consumer products.

We would note that Engenio is garnering a valuation of just 0.7 times sales, a smidge below the more typical 1x sales seen in many divestitures. (For instance, when LSI shed its mobility products unit in mid-2007, that business garnered 1.2x trailing sales.) Still, the discount doesn’t seem to have mattered to Wall Street.

Big Data means Big Dollars for VCs

Brenon Daly

Contact: Brenon Daly

Just since last summer, the data-warehousing industry has seen a wave of consolidation sweep most of the sizable startups into the portfolios of larger vendors. While dramatically reshaping the industry, the concentrated dealmaking has also generated outsized returns for venture firms that have put money into some of the startups that are tackling the problems of ‘big data.’ By our calculation, the four recent data-warehousing exits – on average – have been 10-baggers for their backers.

The eight-month M&A spree started last July, when EMC reached for Greenplum. Two months later it was IBM’s turn to take out Netezza, the sole data-warehousing startup that had actually made it to the public market in recent years. In mid-February, Hewlett-Packard reversed its long-held strategy to stay with internal data-warehousing development and gobbled up Vertica Systems. And then just last week, the granddaddy of the industry, Teradata, snagged Aster Data Systems.

This run of deals has been a welcome development for venture capitalists, who have been starved recently for moneymaking exits. Consider this: the quartet of data-warehousing startups that have been snapped up have returned some $2.5bn to their investors, an astonishing 10 times the $245m that they collectively raised. (The total funding for the startups comes from The 451 M&A KnowledgeBase, which recently added venture information to many of the deal records.) Taking a dime and turning it into a dollar is a pretty nifty trick – and it’s one that most VCs haven’t been able to pull off across any sector of enterprise IT in a long, long time.

Select recent data-warehousing deals

Date announced Acquirer Target Price VC raised by target
March 3, 2011 Teradata Aster Data Systems $295m $57m
February 14, 2011 HP Vertica Systems $275m* (excluding earnout) $25m
September 20, 2010 IBM Netezza $1.8bn $73m
July 6, 2010 EMC Greenplum $400m* $90m

Source: The 451 M&A KnowledgeBase *451 Group estimate

Limelight raises cash, could go shopping

Contact: Jim Davis, Ben Kolada

Fresh off its recent secondary, Limelight Networks could well look to put some of that recently raised cash to work in some shopping trips. (It now has more than ample resources. Last week’s offering netted Limelight $77m, essentially doubling its cash holdings.) If it does look to do a deal or two, we expect that Limelight’s next acquisition will complement its core content delivery network (CDN) business. The company has already been broadening the range of services it can provide in the video ecosystem, most notably with the $110m purchase of EyeWonder’s ad campaign creation business in December 2009 and most recently with the tiny acquisition of Delve Networks, a provider of online video platform services.

One area Limelight could buy into is peer-to-peer (P2P) delivery, since the CDN industry is facing growing concerns about the ability to manage increasing loads of Internet video traffic. There are some providers making a go of P2P by creating tools and services around P2P-assisted game delivery, including Pando Networks and Solid State Networks, that would complement Limelight’s HTTP delivery service. Limelight could also take a look at Octoshape, which has done a significant amount of work in live video transport via P2P-assisted delivery. Octoshape’s service can utilize multiple cloud platforms to scale video-streaming delivery – so even if Limelight isn’t used as the origin CDN, it could gain a tool for providing extra streaming capacity to content owners dealing with delivering large events (think the Olympics or World Cup Soccer) to massive audiences that might wind up overwhelming even the largest CDNs.

If Limelight continues to structure its purchases as it historically has, the company could use its cash and securities to make a fairly large acquisition. To date, slightly more than half (57%) of the $117.6m Limelight has spent on M&A has been in cash, with the remainder in stock. Combine that structuring with the nearly $150m of cash and marketable securities Limelight now holds, and it could wield $300m in buying power. However, the company would obviously have to temper any equity use so it wouldn’t significantly dilute existing shareholders. And we would add that Limelight’s shareholders are a fairly satisfied bunch, with the stock having doubled over the past year.

Western Digital goes big in storage

Contact: Henry Baltazar, Brenon Daly

After flirting with a potential IPO, Hitachi Global Storage Technologies (GST) is set to be snapped up by its hard drive manufacturing rival Western Digital (WD) for $4.25bn in cash and stock. The deal would be the largest transaction in the storage industry in more than seven years, and would solidify WD’s position as the biggest hard drive vendor.

Beyond the benefits of consolidated manufacturing and increased market share, the Hitachi GST acquisition provides WD with credibility in the enterprise market, which was the key handicap it had to overcome against its longtime rival Seagate. Wall Street certainly saw it that way, sending WD shares up 14% in heavy Monday-morning trading. (WD indicated that the combination, which is expected to close in the third quarter, would be immediately accretive to non-GAAP earnings.)

We would also note that Hitachi GST’s expertise in enterprise SAS and fiber-channel hard drives was the key asset that led to its partnership with Intel for enterprise-class solid-state disks, and WD will now benefit from having these high-performance NAND flash products in its lineup. In the Hitachi GST/Intel partnership, though Intel manufactures the drives and supplies the NAND flash for the units, the products have Hitachi GST branding and are sold through Hitachi GST’s business partners.

The logic behind that strategy stemmed from the fact that Hitachi GST already had relationships with major enterprise storage and server providers, which would have made it easier for the products to get through qualification cycles at OEM partner sites. With this deal, WD will also attempt to leverage these relationships to build up its market share well beyond the consumer space.