Sonic Solutions-DivX: a big swing back to the same place

Brenon Daly

Contact: Brenon Daly

The market giveth and the market taketh away. While the giving and taking are usually lopsided, there are rare occasions when it does balance itself out. Consider the recent swings in Sonic Solutions. The company announced the largest deal in its history, the $325m acquisition of DivX, on June 2. Along with the purchase, it also warned that financial results for the quarter were going to be a bit light. That started a slide in shares of Sonic Solutions that had lopped off 40% of the company’s market value by July.

The pain of that slide wasn’t lost on shareholders of DivX. The reason: roughly two-thirds of the consideration for their company was coming in the form of Sonic Solutions stock, with the remaining one-third in cash. (We noted near the bottom of the stock’s slide that the decline had cut the purchase price of DivX by about $50m, or 15% compared to the original offer price.)

But by the time the transaction had closed last Friday, shares of Sonic Solutions had regained the ground they had lost in the four months since the deal was announced. In fact, Sonic Solutions closed Friday at almost exactly the same price it did the day before the company announced the acquisition. So from the perspective of DivX, it was almost like nothing at all happened this summer.

Talk is cheap, but BMC isn’t

Brenon Daly

Contact: Brenon Daly

All the talk around an acquisition of BMC may be just that – talk. We have a hard time believing some of the rumored buyers for the IT management vendor. That skepticism was shared by a few bankers who we spoke with about the rumor. In fact, they reminded us that the most recent M&A buzz around BMC had the company as a buyer, not a seller. Several sources have indicated that BMC was an early bidder for security provider ArcSight, but dropped out quickly when the price got a bit rich.

Nonetheless, M&A speculation pushed BMC shares Thursday to their highest level in a decade. Currently, the company garners a market cap of $7.6bn. Fittingly for a 30-year-old firm, BMC sits on a pile of cash. It has some $1.4bn in its treasury, although a bit of debt lowers its net cash position to about $1.1bn. The company recently indicated that it would generate in the neighborhood of $700m in cash from operations in the current fiscal year, which ends in March. Sales for the fiscal year are expected to come in at $2bn.

With an enterprise value of roughly $6.2bn, BMC currently trades at more than 3 times projected sales and almost 9x projected cash flow. Even without a take-out premium, those are fairly rich multiples for a company that grows just 2% per year. A premium could take BMC’s equity value to around $10bn.

Obviously, there are only a few companies that could write that a check that big and if we were to short-list them we would probably put Oracle and Cisco Systems on there – but for different reasons. The $1bn of maintenance revenue that flows steadily to BMC each year would undoubtedly catch Oracle’s eye. But buying $1bn of annual maintenance revenue for, say, $8bn (on a net cost basis) doesn’t look like the kind of bargain Oracle typically strikes.

And while Cisco has partnered with BMC for the management within its Unified Computing System, it’s not clear to us that Cisco actually needs to own BMC to further its interest in outfitting datacenters. To our mind, Cisco should just put the money it would spend on BMC toward the company that it should really buy: EMC.

Virtual goods, real interest

Contact: Jarrett Streebin

It turns out there’s a real business around buying and selling make-believe items online. Although it’s still early in the so-called virtual goods market, companies have already begun positioning themselves for what looks to be a fast-growing market for personalizing and developing online games. On a small scale, e-Rewards acquired Peanut Labs last week, less than two months after Google announced a purchase of its own. Peanut Labs will become part of e-Rewards’ Research Now online sampling and data-collection business unit. We expect more activity in this nascent market, which is likely to be shaped by three main players: Facebook, PayPal and Google.

Each of these tech giants has shown serious activity around virtual goods, either through organic development or acquisitions, and each has a slightly different approach to the market. Earlier this year, Facebook unveiled its Facebook Credits, a payment system for the Facebook platform. These Credits can be used to buy gold or guns in games on the platform and are even sold in gift cards at Walmart. Meanwhile, PayPal currently handles roughly 50% of the volume for virtual goods. It’s a payment option for Facebook Credits and PayPal continues to improve upon developer relations with its payment platform X and developer conference. And finally, Google bought into the space in early August with the purchase of Jambool and its virtual goods payments processor Social Gold. We will have a full look at the approaches of each of these three companies, including where they might look to buy, in a Sector IQ on virtual goods in tonight’s Daily 451 and 451 TechDealmaker sendouts.

For CLECs, valuations flatline

Ben Kolada

Contact: Ben Kolada

As the retail wireline communications industry loses steam, valuations for competitive local exchange carriers (CLECs) have flatlined. Regardless of whether or not the firms were growing their bottom line, CLECs are being sold at just north of one times trailing revenue. We don’t see much that would change this metric.

EarthLink’s recent purchase of ITC DeltaCom is the third instance in the past year in which a regional CLEC was acquired by a larger provider. The deal was announced shortly after PAETEC picked up Cavalier Telephone and just under a year after Windstream Communications bought NuVox Communications. Of these three providers, we believe only NuVox was growing its revenue, while Cavalier was experiencing losses and ITC DeltaCom was lying stagnant.

Yet all three firms were valued nearly the same. EarthLink’s offer for ITC DeltaCom values the Huntsville, Alabama-based company at just 1.1x trailing sales, including debt, while both Cavalier and NuVox went for 1.2x. (As a side note, we would add that both Cavalier and NuVox were owned by M/C Venture Partners.)

We wouldn’t be surprised to see other similarly sized CLECs – such as Cbeyond, TelePacific Communications or Integra Telecom – fetch roughly the same valuation in any sale. For example, take Cbeyond, which is similar in size to ITC DeltaCom. The firm is currently priced at 0.9x trailing sales, nearly mirroring the 0.8x valuation ITC DeltaCom had in the day before EarthLink announced that it was buying the company.

Recent CLEC valuations

Date announced Acquirer Target Enterprise value EV-TTM sales multiple
October 1, 2010 EarthLink ITC DeltaCom $516m 1.1
September 13, 2010 PAETEC Cavalier Telephone $460m 1.2*
November 3, 2009 Windstream Communications NuVox Communications $664m 1.2

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

Oracle steps back into M&A market

Brenon Daly

Contact: Brenon Daly

After taking the summer off from M&A, Oracle on Monday announced the acquisition of authentication management startup Passlogix. The purchase is the first one by the normally acquisitive Oracle since it announced a pair of asset pickups in late May. Sitting out the summer slowed Oracle’s pace from steady deal flow earlier this year as well as other years. The Passlogix buy is Oracle’s eighth deal in 2010.

The first seven purchases, however, came in the first five months of 2010. That was ahead of the M&A pace Oracle held from 2005-2008, when it inked an average of a deal a month in each of the years. Oracle announced just eight acquisitions in recession-wracked 2009, when overall M&A activity was muted.

As we noted in our report on Q3 M&A, Oracle was one of the highly visible companies that didn’t announce a single transaction in the July-September period. Similarly, both Microsoft and Symantec sat out the quarter, too. But their inactivity was more than made up for by fellow tech giants Hewlett-Packard and IBM. That duo went on an M&A safari in the third quarter, with an eye toward bagging big game. In the just-completed July-September period, IBM and HP combined to announce 11 deals with a total bill of more than $7.3bn.

Via Oak Hill, ViaWest expands

Ben Kolada

Contact: Ben Kolada, Jeff Paschke

In its first acquisition under new ownership, ViaWest announced today that it is buying three Salt Lake City datacenter facilities from Consonus Technologies. The transaction is the first in a line of expected deals after the company received a capital infusion from its sale to Oak Hill Capital Partners in April.

Financial terms weren’t disclosed; however, our analysts at Tier1 Research estimate that the transaction was in the range of $35-40m. The acquisition brings ViaWest’s total Salt Lake City datacenter count to six, and comes just three months after the vendor announced that it was adding 14,000 square feet to one of its existing Salt Lake City facilities.

Indeed, even at the high end of our estimated range, $40m may seem to be a bargain for three facilities with a combined total of 100,000 square feet of datacenter space. However, we would point out that ViaWest is not in the business of owning the shell building, but rather just the internal infrastructure (generators, switches and all furniture and fixtures). Its facilities are generally maintained on a long-term lease basis.

Under Oak Hill’s wing, we expect ViaWest to continue to acquire additional properties. (The firm inked three other deals under previous ownership, according to The 451 M&A KnowledgeBase.) Given its past acquisitions, ViaWest appears to prefer buying into new markets, rather than acquiring properties in markets where it already has a presence. As such, we don’t expect to see another market-consolidating play anytime soon. The company has a strong foothold in the western US – Salt Lake City follows Denver and Dallas as the firm’s third-largest market, in terms of usable datacenter space – but ViaWest executives have told us in the past that acquisitions will not necessarily be limited to the western states.

Third-quarter M&A: Forget the headlines

Brenon Daly

Contact: Brenon Daly

To get an accurate read on M&A this summer, you have to look past the headlines. Undeniably, there were a few high-profile deals, including the sale of McAfee in the largest deal ever in the security industry, as well as a high-profile bidding war that pushed 3PAR’s valuation into the double digits. Beyond those transactions, however, deal flow in the third quarter, which wraps today, has been distinctly average. Spending is coming in at $46bn, only slightly above the average spending of $40bn in the eight quarters since the Credit Crisis erupted.

The $46bn also sits at the midway point of spending in the first two quarters of the year ($30bn in Q1 2010 and $62bn in Q2 2010). It also nearly splits the difference between the previous year’s quarter ($38bn in spending in Q3 2009) and the previous quarter this year ($62bn in spending in Q2 2010). We’ll look at why the value of deals announced in late summer dropped one-quarter from the record level in early summer in a special report tonight, but for now consider this: Of the five largest transactions so far in 2010, just one was announced in the third quarter. Again, we’ll have a full report on Q3 M&A in tonight’s Daily 451 and 451 TechDealmaker sendouts.

HCM deal flow nears high-water mark

Brenon Daly

Contact: Brenon Daly

Dealmaking in the human capital management (HCM) market has surged in recent months, pushing spending to near-record levels. So far this year, we’ve tallied 36 HCM transactions, with an aggregate value of $1.9bn. That basically matches the high-water mark of $2.1bn in the sector set during the first three quarters of 2007. (However, we should note that nearly all of the HCM spending three years ago came from the $1.8bn take-private of Kronos by Hellman & Friedman in March 2007.)

The number of HCM transactions so far this year (36) matches exactly the number during the same period in 2007. Another similarity between the two years is that strategic and financial buyers have both been active in the sector. Consider this: In the four deals announced so far this month, buyout shops have been behind two while corporate buyers have inked the other two. Valuations for this month’s transactions – and most other recent HCM deals, for that matter – have ranged from just below 2 times trailing sales to around 4x trailing sales.

However, in the sector’s latest acquisition, the valuation came in well north of that range. On Monday, private equity firm Madison Dearborn Partners (MDP) took a majority stake of Fieldglass in a transaction that valued the HCM vendor at more than $220m. (ArchPoint Partners advised Fieldglass in the deal between the two Chicago-based firms.) Fieldglass focuses on the so-called contingent market, which covers project-based contractors, offshore workers and so on. According to our understanding, Fieldglass generated nearly $30m in revenue and $5m in EBITDA in 2009 and was tracking to nearly $40m in sales and $10m in EBITDA for this year. That means MDP’s stake valued the company overall at about 6x trailing sales, according to our calculations.

salesforce.com patches a hole in its Service Cloud

Brenon Daly

Contact: China Martens

For some time, we’ve been expecting salesforce.com to make a second purchase in the service automation space. It’s a market the SaaS CRM and development platform player took a major step into back in early 2009 following its $31.5m purchase of French knowledge base provider InStranet in August 2008. It now appears as though salesforce.com has indeed made another foray with the acquisition of enterprise live chat player Activa Live, a move the companies aren’t commenting on but have confirmed to several third parties.

Based in St. Clair Shores, Michigan, Activa Live’s customers include American Apparel, Best Buy, Dun & Bradstreet, Endeca, LexisNexis and Procter & Gamble. The startup already had tight integration with Salesforce CRM. Its rivals include other chat specialists such as Bold Software, LivePerson and Velaro as well as a host of service automation software players that provide live chat modules such as eGain Communications, Kana, Moxie Software (formerly known as nGenera), Parature and RightNow Technologies.

Salesforce.com has been steadily building out Service Cloud and has found turning on-premises InStranet SaaSy a time-consuming experience. It’s keen to substantially grow the business, and owning more service automation components should further that goal.

Activa Live is another of salesforce.com’s under-the-radar purchases, deals that it barely refers to in public or doesn’t acknowledge at all. Such transactions already include the acquisitions of Welsh business orchestration firm Informavores, semantic analysis player GroupSwim, and reportedly Canadian SaaS website building, managing and optimizing tools provider Sitemasher.

Salesforce.com is still sitting on a boatload of cash after raising $575m in a private placement at the start of the year, and has only inked one substantial deal in its history – the surprise $142m acquisition of data-as-a-service (DaaS) provider Jigsaw Data in April. We continue to puzzle over what larger transactions salesforce.com might set its cap at, and would now add business information provider Zoom Information to the list as being potentially complementary to the vendor’s Jigsaw buy. DaaS is another arena where salesforce.com hopes to make big bucks

PAETEC’s risky business

Ben Kolada

Contact: Ben Kolada

As the communications industry continues to consolidate and the pool of desirable targets dries up, the remaining buyers appear to be stretching a bit in their M&A moves. But even within that, PAETEC’s recent pickup of Cavalier Telephone looks to us like the riskiest telecom acquisition we’ve seen in the past year. The reason? Roughly three-quarters of Cavalier’s business is outside PAETEC’s focus.

To be fair, other telcos have also made challenging moves. Windstream Communications took big bites in the past 12 months, acquiring four companies that set the telecom provider back $2.7bn. (That figure includes the debt at the acquired companies that Windstream will be taking on.) The vendor’s spree boosts its top line by about 50%, a substantial increase that brings a not-insignificant amount of risk. Even Cablevision Systems, which is typically a stay-at-home company, inked a deal, reaching across the country to pick up Bresnan Communications for about $1.4bn.

However, the deals by Windstream and Cablevision made sense, if just because they expanded on each company’s existing strategy. Not so with PAETEC’s purchase of Cavalier. When we look at the transaction, we suspect that PAETEC was really only interested in Cavalier’s fiber assets. Understandably, the Richmond, Virginia-based competitive local exchange carrier wouldn’t have considered selling its fastest-growing division. Since it was unable to just get the part of Cavalier’s business that it probably wanted, PAETEC was forced to shell out $460m (including assumption of debt) for the whole company.

Cavalier had $390m in sales in the year leading up to the acquisition. However, the company’s fiber division itself generated only about $98m, or 25%, of total revenue. That means that a vast majority (75%) of Cavalier’s business appears to us to be an ungainly match to the business its buyer is in. PAETEC serves enterprises, which generate an average of $2,300 in monthly revenue. On the other hand, the majority of Cavalier’s revenue comes from consumer accounts and small businesses with monthly recurring revenue of only about $500.

Rather than spend to get this odd pairing, we think PAETEC would have been better off buying one of the number of fiber operators looking for a sale. A juicy target would have been Zayo Group. The company is on a $240m run rate for 2010. Based on recent valuations for Zayo’s competitors, we believe it could be had for roughly $500m – only slightly higher than Cavalier’s price tag, but without the unwanted baggage.