Continued M&A activity in hosting sector expected in 2011

Ben Kolada

Contact: Ben Kolada, Aleetalynn Schenesky-Stronge

The past year set several records for M&A in the hosting and managed services sectors. Industry players, including fellow companies, private equity (PE) firms and telecom carriers, announced a total of 102 deals, eclipsing the previous record set in 2006. The aggregate value of last year’s transactions hit $4.8bn. True, records set in 2010 were partially the result of pent-up demand from the Credit Crisis, but we wouldn’t call the year a fluke. In fact, we expect that 2011 will continue the upward trajectory.

In 2010, we saw record acquisitions of all flavors. In terms of deal size, at an estimated $450m, SoftLayer Technologies’ sale to GI Partners and SoftLayer’s management topped our list of PE purchases of hosting providers. Buyout shops were also active internationally, with both Lloyds Banking Group and Montagu Private Equity each inking deals. Meanwhile, telecom providers were particularly active last year. Telco incumbent Cincinnati Bell announced the largest telecom-colocation transaction on record, and notable mention goes to Windstream Communications for its $310m pickup of Hosted Solutions. Meanwhile, wholesale datacenter provider Digital Realty Trust inked the sector’s largest acquisition of the year (in fact, the largest colocation transaction we’ve ever recorded), paying $725m for Rockwood Capital’s 365 Main portfolio.

On the macroeconomic side, we expect M&A in the hosting and managed services industries in 2011 to be driven by the following: enterprises converting capex to opex through IT outsourcing, increasing acceptance of outsourcing since that model successfully solved internal IT constraints; improving access to capital, allowing providers to continue to expand and innovate in order to meet market demands; and investment for growth, whether that be directly through M&A, via funding provided by PE, or both. On the microeconomic side, M&A will be predominately driven by consolidation and rollup to achieve scale, amass customer bases and add complementary infrastructure and service lines in order to create and expand new service offerings. Click here to see our full review of 2010 and our predictions for 2011.

Groupon buying in groups

Contact: Jarrett Streebin

While Groupon’s critics continue to roar about its ‘easily replicable’ model, the Chicago-based startup is busy working on something that won’t be so easy to replicate: market share. The coupons Giant is buying up ‘Groupon clones’ all over the world, further strengthening its foothold in the coupons market. Just this week it bought Twangoo, Grouper and SoSasta. As of its latest three buys, the company is in South Africa, India, Israel, Singapore, Russia, Japan, China (Hong Kong) and Germany (we won’t count Brazil since the acquired site proved to have bogus deals and fake profiles). The startup is also in the midst of a lawsuit in Australia over the Groupon.co.au URL and should be setting up shop there soon.

At this clip, it will be in all of the major markets by the end of this year. Groupon is also in the midst of raising a mammoth $950m funding round from investors such as Digital Sky Technologies, Andreessen Horowitz and T. Rowe Price (the valuation of which was certainly helped by its recent talks with Google). According to the filing, $345m of that will be for founders’ and executives’ stock. That still leaves $600m for international expansion, much of which is rumored to be going toward Groupon China.

Groupon’s nearest competitor, LivingSocial, isn’t taking this lying down. On Wednesday it bought Let’s Bonus, a 200-person coupons startup with offices in Spain, Portugal, Italy, Argentina and Mexico. And in November it invested $5m in Australian coupon site Jump On It. The Washington DC-based startup just raised $200m so it shows no signs of slowing down, either. This will be a busy year for these two and the clones.

A decoupled and depressed tech M&A market

Brenon Daly

Contact: Brenon Daly

As we were putting together our full report on M&A last year and the outlook for this year, we couldn’t help but notice the fact that 2010 basically slumped to an end. On average, spending hit just $12bn in each of the last four months of 2010, down from about $20bn for the summer months. Not only that, spending in the September-December period last year substantially lagged the same time in 2009, with three of the four monthly totals in 2010 actually declining, year over year.

The rather muted M&A activity toward the end of 2010 stands out even more because there was a lot of confidence in the equity markets during that time. Despite a long-standing correlation between the two markets, dealmakers basically sat on their hands during the tremendous rally in the final months of 2010, which essentially accounted for all of the gains on the indexes last year. The Nasdaq jumped 17% last year, although more than a few tech companies wrapped the year with tidy triple-digit gains in their stock prices.

To explain the unusual decoupling between the equity and M&A markets in 2010, we might point to the unprecedented government intervention in the debt and credit markets. In the short term, the measures have helped buoy those markets, even if some of the underlying problems (unemployment/underemployment and foreclosure rates) remain alarmingly unresolved. There was no Washington-brokered ‘stimulus package’ for dealmakers. (Again, see our full report to get more details on activity and valuations in the year that was, and what to look for in the year that’s here.)

SMSC picks up the final portion of once-mighty Conexant

Contact: John Abbott

The agreement this week by New York City-based analog and mixed-signal chip vendor SMSC (aka Standard Microsystems) to acquire Conexant Systems for $284m in cash and stock marks the end of a drawn-out breakup process for the target company. Conexant was formed in January 1999 as a spinoff of the legendary Rockwell Semiconductor Systems, best known for its pioneering desktop calculator chips in the 1960s and modem chips in the 1990s. Rapidly hitting hard times, Conexant was subsequently carved up through a series of smaller spinoffs.

The foundry business was the first to go, as Jazz Semiconductor in March 2002 (Jazz later merged with National Semiconductor spinoff Tower Semiconductor in 2008 to form TowerJazz). The divestment of radio frequency and mobile chips to Skyworks Solutions was completed in June 2002, followed by the sale of the communications chips business to Mindspeed Technologies in June 2003 – both are still active. Most of the rest went to NXP Semiconductors (broadband media processors for $110m in April 2008), Coppergate Communications (home networking, value undisclosed, May 2008) and Ikanos Communications (broadband access products for $54m in April 2009). SMSC now takes on the final vestiges, consisting of silicon platforms for imaging, audio, fax, embedded modem and video-surveillance applications. The market’s negative reaction to the deal reflects a lack of excitement in these remaindered industry sectors.

However, the fit isn’t without some logic. SMSC’s primary business comes from mixed-signal connectivity chips aimed at personal computers, automotive and portable devices, including USB and Ethernet system on chips. The Conexant IP will broaden SMSC’s activities in the computing, consumer, industrial and automotive sectors; strengthen its relationships with some key joint customers; and boost its analog/mixed-signal R&D team to more than 900 engineers. SMSC has agreed to pay $98m in cash and will issue 2.9 million to 3.6 million shares when the deal closes some time during the first half of calendar 2011. It also takes on $86m in debt. Both boards have approved the transaction.

Founded in 1971, SMSC only became a significant industry force after buying Western Digital’s Ethernet and Token Ring LAN chip business in 1991, paying $33m. The company has been showing healthy organic growth of late, while also seeking opportunities to acquire: Conexant is its fifth deal since July 2009, and by far the largest in its history, adding 600 staff (230 of them in Asia) to its current headcount of just over 900. Combined trailing 12-month revenue would have reached $632m. However, synergies resulting in cost savings of up to $10m are forecast by the fourth quarter of 2012, so cuts appear inevitable.

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SMSC picks up the final portion of once-mighty Conexant

-by John Abbott

The agreement this week by New York City-based analog and mixed-signal chip vendor SMSC (aka Standard Microsystems) to acquire Conexant Systems for $284m in cash and stock marks the end of a drawn-out breakup process for the target company. Conexant was formed in January 1999 as a spinoff of the legendary Rockwell Semiconductor Systems, best known for its pioneering desktop calculator chips in the 1960s and modem chips in the 1990s. Rapidly hitting hard times, Conexant was subsequently carved up through a series of smaller spinoffs.

The foundry business was the first to go, as Jazz Semiconductor in March 2002 (Jazz later merged with National Semiconductor spinoff Tower Semiconductor in 2008 to form TowerJazz). The divestment of radio frequency and mobile chips to Skyworks Solutions was completed in June 2002, followed by the sale of the communications chips business to Mindspeed Technologies in June 2003 – both are still active. Most of the rest went to NXP Semiconductors (broadband media processors for $110m in April 2008), Coppergate Communications (home networking, value undisclosed, May 2008) and Ikanos Communications (broadband access products for $54m in April 2009). SMSC now takes on the final vestiges, consisting of silicon platforms for imaging, audio, fax, embedded modem and video-surveillance applications. The market’s negative reaction to the deal reflects a lack of excitement in these remaindered industry sectors.

However, the fit isn’t without some logic. SMSC’s primary business comes from mixed-signal connectivity chips aimed at personal computers, automotive and portable devices, including USB and Ethernet system on chips. The Conexant IP will broaden SMSC’s activities in the computing, consumer, industrial and automotive sectors; strengthen its relationships with some key joint customers; and boost its analog/mixed-signal R&D team to more than 900 engineers. SMSC has agreed to pay $98m in cash and will issue 2.9 million to 3.6 million shares when the deal closes some time during the first half of calendar 2011. It also takes on $86m in debt. Both boards have approved the transaction.

Founded in 1971, SMSC only became a significant industry force after buying Western Digital’s Ethernet and Token Ring LAN chip business in 1991, paying $33m. The company has been showing healthy organic growth of late, while also seeking opportunities to acquire: Conexant is its fifth deal since July 2009, and by far the largest in its history, adding 600 staff (230 of them in Asia) to its current headcount of just over 900. Combined trailing 12-month revenue would have reached $632m. However, synergies resulting in cost savings of up to $10m are forecast by the fourth quarter of 2012, so cuts appear inevitable.

More than just Chatter at salesforce.com

Ben Kolada

Contact: Ben Kolada, Kathleen Reidy

Fresh from closing its $249m acquisition of Ruby developer Heroku, salesforce.com recently announced, and closed, its purchase of Web-conferencing startup Dimdim for $31m. The Lowell, Massachusetts-based target provided a cloud-based open source Web-conferencing service for businesses, and with this deal salesforce.com now claims 60,000 Chatter users, though with its ‘freemium’ model we suspect that only a fraction of these are paying customers.

Salesforce.com paid $31m in cash for Dimdim, which had raised a total of $8.4m from venture investors Draper Richards, Index Ventures and Nexus Venture Partners. Per salesforce.com’s conference call, Dimdim has 75 employees spread throughout its offices in Lowell and Hyderabad, India. Although the target’s annual revenue wasn’t disclosed, we estimate that it closed 2010 with about $2m in revenue.

Like salesforce.com’s previous collaboration pickup – GroupSwim, in December 2009 – Dimdim’s services will be shut down, and its capabilities will be rolled into Chatter, salesforce.com’s social collaboration software service that first launched in 2009. As my colleague Kathleen Reidy notes (click here to see her full report on the acquisition), as evidenced by the almost immediate shutdown of the Dimdim service, salesforce.com isn’t interested in the pure Web-conferencing market. Salesforce.com will honor contracts with Dimdim’s existing customers, though these will not be eligible for renewal, and it has terminated Dimdim’s free service. Dimdim also had an open source distribution and while this is still available, it won’t see any further updates. Instead, Dimdim will provide features to Chatter, which is also incorporating semantic analysis technology from GroupSwim.

What’s ultimate destination for Ultimate Software?

Brenon Daly

Contact: Brenon Daly

After 20 years in business, Ultimate Software may be looking for a new owner. The human capital management (HCM) vendor is rumored to have retained Lazard to shop the company, market sources have told us. The bank will run a narrow process, likely approaching about a half-dozen possible buyers rather than running a full auction, the sources added.

The decision by Ultimate to test the market comes as deal flow in the HCM sector has hit a record level. In 2010, we tallied some $2.4bn in spending on deals, slightly eclipsing the previous record of $2.1bn in 2007, according to The 451 M&A KnowledgeBase. Valuations across the space have been soaring, and Ultimate is no exception. This time last year, shares of the Weston, Florida-based company were changing hands at about $30 each. Now, they’re at $50 – an all-time high. That gives Ultimate a market value of $1.25bn, roughly 4.6 times projected 2011 sales of $270m.

Much of the gain can be chalked up to the company’s decision a few years ago to switch from selling software licenses to a subscription model. (It’s a move that has proved incredibly lucrative for other old-line software companies, as well. Shares of Concur Technologies, which underwent a similar shift in sales model a few years ago, have quadrupled over the past five years and are now valued at $2.8bn.) Ultimate stopped selling new software licenses in April 2009 and recurring revenue (made up of both subscription and maintenance revenue) is now more than three-quarters of total sales.

Sourcefire’s risky bet to re-spark its M&A program

Brenon Daly

Contact: Brenon Daly

As deals go, Sourcefire’s first acquisition hardly set the world on fire (if you will). Back in August 2007, the open source security vendor picked up the open source ClamAV project. The deal only set Sourcefire back $3.5m, but not much has been heard from the project since the acquisition. Undeterred, Sourcefire stepped back into the M&A market on Wednesday with an even larger – and (potentially) much more significant – transaction.

Sourcefire is paying $17m in cash for Immunet, a cloud-based anti-malware provider. (Immunet could also pocket a $4m earnout, which depends on the company hitting some product milestones, as well as a smidge of Sourcefire equity.) It’s still early days for Immunet, which raised just one round of funding and only started generating revenue last year. (The company claims some 750,000 users, but we suspect that the vast majority of those would be using Immunet Protect, which is available for free.)

There’s always a risk when a company reaches for an early-stage startup like Immunet, which has yet to really prove itself commercially. That risk is somewhat mitigated, however, by the fact that the two companies had worked together for almost a year, and all of the Immunet employees, including the founders, will be joining Sourcefire.

But, as my colleague Andrew Hay notes in his report, the deal brings a much bigger risk: Can Sourcefire, which is primarily focused on network security with its well-known Snort product, step into the endpoint security market without a stumble? How will it fare in selling antivirus against giant rivals that generate more revenue each quarter than Sourcefire has in its entire history? Sourcefire has fought through some tough setbacks in its history, including a broken sale to Check Point Software and breaking issue in its IPO. Now, with Immunet, it needs to show that it can actually pull off an acquisition.

Qatalyst strikes again, but bigger

Brenon Daly

Contact: Brenon Daly

When Jason DiLullo joined Qatalyst Partners last April, the boutique firm announced that he would play a major role in expanding the firm into semiconductor deals. Indeed he did. Qatalyst is getting sole credit for advising Atheros Communications on its sale to Qualcomm, the largest chip acquisition in four years. (On the other side, Goldman Sachs and Barclays Capital advised Qualcomm.) With an equity value of $3.6bn, it is Qatalyst’s largest deal – by about $1bn, no less – since it opened its doors in March 2008.

The chip deal brings the total value of the 10 transactions that Qatalyst has worked on to more than $17bn. Of course, the firm is primarily known for its role in helping to consolidate the storage sector, working on the sales of Isilon Systems and 3PAR last year, as well as Data Domain in mid-2009. (All three of those companies were erased from the market at their highest-ever valuation.) Collectively, the equity value of those three storage deals is about $7bn – ‘only’ twice the amount of Qatalyst’s sole chip deal.

The IPO pipeline just got even drier

Brenon Daly

Contact: Brenon Daly

Scratch another company off the list of potential IPO candidates for 2011. Managed security services provider (MSSP) SecureWorks got snapped up by Dell on Tuesday for what we understand was a table-clearing bid. (Subscribers can see our full report on the transaction, including our estimated price for SecureWorks.)

The trade sale comes two years after the MSSP was putting the final touches on its prospectus. That offering, which got derailed when the Credit Crisis knocked the equity markets for a loop, was set to be led by Merrill Lynch and Deutsche Bank. (Merrill Lynch, which got picked up by Bank of America later in 2008, got the print on the sale.) We understand that SecureWorks was getting ready to dust off the prospectus, update the numbers and (finally) get it on file with the SEC later this year.

Instead, Dell moved quickly to secure the deal, which will serve as the foundation for its security offering. We gather that talks only really got going after Thanksgiving, going exclusive almost immediately. And Dell had to pay up for that. Of course, Dell could consider its pickup of SecureWorks a bargain, compared to the last dual-track company it acquired. Recall that Dell paid an eye-popping $1.4bn, or 10 times trailing sales, for EqualLogic back in November 2007. The storage vendor, which had formally put in its prospectus, generated almost exactly the same amount of revenue as SecureWorks.

Big is back (sort of)

Brenon Daly

Contact: Brenon Daly

The number of big-ticket deals in 2010 jumped by one-quarter from the level posted in each of the past two years, an indication that buyers are once again open to a bit more risk. We tallied 40 transactions valued at $1bn or more last year, up from 32 in 2009 and 33 in 2008. One of the reasons for the rise in 2010 – unlike the two previous years – is that the acquirers had to top a pretty bullish tech market to secure their deals. Companies including Isilon Systems, Netezza, ArcSight and 3PAR all got taken off the board last year at their highest-ever valuation.

Also unlike the two previous years, we had a number of ‘serial shoppers’ on the list. Hewlett-Packard inked three 10-digit deals in 2010, while IBM and Intel each closed two of the big transactions as well. And it wasn’t just strategic buyers. The Carlyle Group announced a pair of billion-dollar acquisitions – on back-to-back days, no less. Overall, buyout shops accounted for seven deals last year valued at more than $1bn, up from four in 2008 and five in 2009.

10-digit transactions

Year Number of deals worth $1bn+
2010 40
2009 32
2008 33
2007 79
2006 74
2005 70

Source: The 451 M&A KnowledgeBase