Small purchases add up big for IBM

Contact: Brenon Daly

Shortly after IBM bagged Netezza, we noted that Big Blue had been doing some big-game hunting in recent deals. It turns out that’s also true when it takes aim at private companies. In fact, we estimate IBM has spent more on startups than it has on the public companies it has taken home over the past year.

First, we should qualify a bit of our math. In the past 12 months, Big Blue has announced 17 acquisitions. Included in that flurry of dealmaking is the purchase of a pair of public companies (Unica and Netezza), the pickup of a billion-dollar carve-out (the Sterling Commerce business from AT&T) and the acquisition of 14 privately held companies. IBM has not disclosed a single price for any of the more than dozen private companies it has snared since last October, even though some of them are costing the company – that is to say, its shareholders – several hundred million dollars a pop.

Nonetheless, we have estimates of the price tags of nine of the 14 deals. (These estimates have all been corroborated by at least two sources familiar with the transactions.) According to our estimates, more than half of the acquisitions (five of nine) cost IBM more than $200m each. Altogether, we estimate the nine deals set Big Blue back $2bn. That incomplete bill for the private company purchases is only slightly less than the $2.3bn that IBM disclosed it is spending on Unica and Netezza.

EA flies into mobile

Contact: Jarrett Streebin

Electronic Arts (EA) recently shelled out a reported $20m for mobile game publisher Chillingo. The UK-based startup published the popular iPhone game Angry Birds. Although the acquisition didn’t include the game or its developers, it will help EA market and distribute its mobile games. This small deal is the latest in a hot streak in mobile entertainment transactions this past year.

Last year, EA bought mobile and social game developer Playfish for $300m, plus an additional earnout of up to $100m, making EA one of the largest developers for mobile and social games. The company followed that up with the purchase of mobile game developer IronMonkey Studios earlier this year. The Australian company had already built mobile games for existing EA titles such as Medal of Honor and Need for Speed. Now, Chillingo will provide the channels to better market and distribute these and future titles to iPhone as well as handheld consoles such as Sony’s PSP Mini and Nintendo’s DSiWare and WiiWare platforms. It’s likely that this distribution will extend to Android titles as well.

Not that EA is alone doing deals for mobile gaming companies. In mid-October, DeNA dropped a whopping $400m on ngmoco, one of the largest acquisitions ever involving the iPhone. These are just a few of the transactions that have helped double the M&A activity in the mobile gaming sector. So far this year, there have been 29 deals, up from 17 last year, according to The 451 M&A KnowledgeBase.

No celebration for this anniversary

Contact: Ben Kolada

One year ago, Equinix announced that it was acquiring Switch and Data in its largest-ever transaction. The deal gave Equinix an immediate presence in several new markets, and alleviated capacity constraints in existing ones. However, the acquired properties haven’t lived up to their expectations, and Equinix was forced to trim its revenue guidance as a result. (Equinix will provide more details on its Q3 results on Tuesday.)

With the revision, investors sliced $1.3bn (about 25%) in market value from the combined company. For perspective, that’s nearly twice the amount that Equinix paid for its rival. And it’s not as if the Internet infrastructure industry is anti-acquisition. Digital Realty Trust closed two major deals this year worth a combined $1.1bn. Meanwhile, its shares have climbed 20% since the year began, compared to the Nasdaq’s 8% return.

With its hands full on its consolidation play and the market having punished its stock, Equinix won’t be announcing another acquisition anytime soon. In fact, we wonder if Equinix might not be a seller before it once again returns as a buyer. We wouldn’t be surprised to see the company divest legacy Switch and Data assets that are outside its core footprint.

The thin air around Isilon

Contact: Brenon Daly

Regardless of the fact that Isilon Systems hasn’t traded on anything remotely connected to its underlying financial performance for a long time, the NAS vendor nonetheless reported third-quarter results earlier today. As these things go, it was a strong report: sales up 77% and a solid profit, reversing a year-ago loss.

The results pushed shares up about a buck to $28 each in mid-Thursday trading. That continues a run that has seen the stock nearly quadrupled so far this year, giving the storage company a mind-blowing valuation of nearly $1.8bn. The third-quarter report notwithstanding, much of that run has been spurred by acquisition speculation, with EMC reportedly in exclusive talks to acquire Isilon.

To understand how detached Isilon’s valuation is from reality, consider this: For every dollar of earnings that Isilon is projected to bring in this year, investors are valuing that at $100. That’s right, a single greenback is worth almost 100 times that amount to Isilon’s market cap. Through the first three quarters of the year, Isilon posted GAAP net income of $7m. Even assuming that the company has a blowout fourth quarter, full-year 2010 earnings are still likely to come in below $20m. Meanwhile, its equity value continues to creep toward $2bn.

Even on a more conventional measure, Isilon’s valuation ratio is still highly inflated: For every dollar in sales the company brings in, investors are valuing that at $10. At an equity value of $1.8bn, Isilon is currently trading at 10 times current-year revenue, and almost eight times next year’s revenue. Keep in mind, too, that those valuations don’t take into account any acquisition premium that would undoubtedly figure into the deal. Every dollar that a bid comes in above Isilon’s current market price adds more than $75m to the company’s price tag. That’s assuming, of course, that a bid comes.

To scale or not to scale

Contact: Ben Kolada, Brenon Daly

For businesses that both had ‘scale’ in their name, neither MaxiScale nor ParaScale got very big. Nor did they get very big exits in their recent sales. In the crowded cloud storage market – dominated by multibillion-dollar incumbents IBM, EMC and HP – startups have only a short time to prove themselves to potential customers. We suspect that both MaxiScale and ParaScale shared similar fates because VCs are becoming quicker to pull the plug on storage investments that aren’t lining up customers.

That’s particularly true for MaxiScale, which we covered a year ago as it emerged from stealth. While ParaScale chalked up some customer wins, rumors have it that MaxiScale was unable to actually generate any revenue from its product. The bleak outlook forced the company to sell its assets last week to Overland Storage at what we expect was a fraction of the $25m that investors poured into the firm. We doubt that Overland paid much more than $5m for the acquired MaxiScale assets.

However, not all cloud storage startups are landing on the scrap heap. While MaxiScale and ParaScale were unable to secure lifeline funding, rival Caringo raised a fresh $5m round in July. In the past year, the company claims to have increased its customer count from 150 to more than 400, and is set on reaching profitability by the first half of next year. We don’t consider the firm an acquisition target just yet, but if it continues to do well, it could draw some interest down the road.

Software AG does a bit of MDM shopping of its own

Contact: Brenon Daly, Dennis Callaghan, Krishna Roy

A little more than a year after scrapping its OEM agreement with master data management (MDM) vendor Orchestra Networks, Software AG has picked up its own MDM and data-governance technology. The German company recently reached across the Atlantic for Data Foundations, which we gather was a small purchase of a startup generating less than $10m in sales. Nevertheless, the deal continues the recent consolidation in the MDM market, which has seen fellow big-name buyers such as IBM, Informatica and TIBCO Software make acquisitions here.

A bit of a wonky area of information management, MDM has increasingly become a complementary tool for application integration and business process management software as it helps to make sense of the many different data types that underpin these applications. Further, other rival players have taken a platform-based approach to MDM, combining data-integration and data-quality capabilities into the MDM mix.

We wonder if Software AG will follow suit and enter the MDM platform fray by pairing the Data Foundations buy with another MDM-related purchase. If it looks to do that, we wouldn’t at all be surprised to see Software AG add a data-quality provider to its portfolio. A few names that might be worth a look for the acquisitive German company are Datanomic, DataLever, DataMentors, Datactics, Clavis Technology and Human Inference.

Ulticom’s shareholders cash out

Contact: Brenon Daly

Cash is king. We got a reminder of that tried-and-true business adage when we were skimming the terms of Ulticom’s sale to buyout shop Platinum Equity earlier this week. While the pending take-private is hardly a regal outcome for shareholders of the telecom software provider, the structure of the deal helps them get a bit more back from the business than they would have otherwise.

According to terms of Tuesday’s buyout, Platinum will pay $2.33 for each of the roughly 11 million shares outstanding at Ulticom. That works out to about $26m of equity consideration for the company. Far more important, however, the buyout shop will hand back roughly $64m of Ulticom’s $77m in cash to shareholders. This is actually a rare case of a cash ‘rebate’ being pocketed by the existing owners of a business (shareholders) rather than the soon-to-be owners. The bid works out to an enterprise value for Ulticom of about $16m, for a business that was likely to do around $38m in revenue in the current fiscal year.

Further, this is actually the second time that Ulticom has parceled out its cash. A bit of background: Ulticom is majority owned by Comverse Technology. The scandal-tainted company acquired Ulticom in 1996, which then spun off a chunk in a public offering in April 2000. That offering – along with a secondary shortly afterward – gave Ulticom way more money than it could ever use. While the company was sitting on a mountain of cash, interest in it was muted because Ulticom had to restate several years worth of financial filings because of options grants and revenue recognition issues. Those concerns pretty much sank Ulticom’s M&A plans in 2008, when it was being advised by Jefferies & Company.

Last year, however, Ulticom got itself back together. It settled with the SEC, got relisted on the Nasdaq and even threw a bone to long-suffering shareholders, paying out $200m in cash through a dividend. (Part of the reason Ulticom emptied out its treasury, we suspect, is to make it more attractive to private equity firms, which wouldn’t have to write such a large check for the company.) The move paid off for Ulticom, not to mention its shareholders. Morgan Keegan Technology Group (the former Revolution Partners) advised Ulticom on the deal, which is expected to close by January

Is GeoLearning the next to go?

Contact: Brenon Daly

While the employment market may still be sluggish, the market for software that helps companies with their employees is bustling. We recently noted that both the number of deals and spending in the human capital management (HCM) market so far this year is rivaling the records set when the overall M&A market was much healthier. Add to that, there’s even an HCM vendor that’s eyeing the other exit: Cornerstone OnDemand filed to go public two weeks ago, one of the few tech companies that’s willing to brave the chilly IPO market.

As to what’s the next likely deal in the HCM market, recent indications have pointed toward a sale of GeoLearning. (We understand that the Des Moines, Iowa-based company has retained Raymond James & Associates to advise it on a process.) Founded in 1997 by current CEO Frank Russell, GeoLearning sells its learning management software (LMS) through both a hosted and on-demand model to more than 700 customers. In February 2008, GeoLearning took in its first and only institutional money – a $31m investment from Volition Capital, which was known as Fidelity Ventures at the time.

A little more than a month ago, fellow LMS startup Learn.com got snapped up by Taleo for $125m. Sources have indicated that ADP may have been the initial bidder for Learn.com, looking to add to the half-dozen HCM acquisitions the services giant has already done. We would expect ADP to at least look closely at GeoLearning. But from our perspective, the more likely acquirer for GeoLearning is SuccessFactors. The two companies have had an integrated offering on the market for more than four years, and continue as close partners. We gather that GeoLearning is slightly larger than Learn.com, which was running at about $30m in sales.

Zynga buys beyond Facebook

Contact: Jarrett Streebin

Zynga has become a serious collector of small to medium-sized game development studios, acquiring seven companies so far this year. Beyond just buying more titles, the company has used M&A to get into other markets. For instance, Zynga has expanded internationally with XPD Media in China, Dextrose in Germany and Unoh in Japan. With the latest purchase of Bonfire Studios, which was announced October 5, it goes beyond Facebook gaming altogether into console and PC gaming.

Founded in 2007, Zynga has grown from a small social games developer into the largest shop on the block. The San Francisco-based firm is the leading developer of Facebook games and makes its money by selling virtual goods in its games. (We looked more fully at the market for virtual goods in a recent Sector IQ.) Users can pay real cash to buy weapons for their mafia or crops for their farms. Things were going well until Facebook unveiled Facebook Credits earlier this year. There was even a standoff between Zynga and Facebook due to the 30% cut that Facebook takes. Eventually, Zynga gave in and signed an exclusivity agreement.

Still, we sense that the company learned a valuable lesson about being overly dependent on a platform that it doesn’t own. At least that’s how we might read the fact that six of Zynga’s past seven deals are in other areas of gaming. The diversification has seen Zynga broaden its international business with the acquisitions of Chinese firm XPD Media, German game engine developer Dextrose and Japanese social gaming company Unoh. And most recently, Zynga’s reach for Bonfire Studios added a startup that was founded by three gaming veterans with PC and console experience.

Internet infrastructure in Q3: a dip in deal volume

Contact: Ben Kolada

In the just-closed quarter, we noticed a slight dip in the number of announced deals. In fact, the deal volume has continued its slide ever since the industry hit its peak in the first quarter of 2010. That’s not to say that our readers should make like Equinix’s investors and run for the exit. True, deal volume did slide downward, but the brand names of the Internet infrastructure industry continued to make long-term investments.

The total number of transactions announced in the third quarter declined 13.5% from the second quarter and 27.3% from the first quarter of the year. However, we must note that Q1 deal volume was, in fact, artificially inflated somewhat as some deals that were put on hold during the worst part of the recession in 2009 were finally closed in Q4 2009 and the beginning of 2010 due to renewed optimism in the economy and the ability to once again access capital at reasonable rates.

Overall, the number of transactions is up year over year, with Q3 2010 yielding 23% more transactions than the year-ago period. In fact, the total number of deals announced in the first three quarters of this year has already topped the full-year total for 2009. Furthermore, well-established names in the Internet infrastructure sector, including Digital Realty Trust, Limelight Networks and TeleCity on the industry side and GI Partners, Sequoia Capital and Welsh, Carson, Anderson & Stowe on the investment side, just to name a few, came to the table in the third quarter. We’ll take a deeper look at Q3 deal volume in a report that will be included in tonight’s Daily 451 sendout.

Recent quarterly deal flow

Period Number of transactions Percent change from previous quarter
Q1 2009 12
Q2 2009 17 42%
Q3 2009 26 53%
Q4 2009 28 8%
Q1 2010 44 57%
Q2 2010 38 -14%
Q3 2010 32 -16%

Source: The 451 M&A KnowledgeBase, Tier1 Research