freenet: getting paid to sell

Brenon Daly

Contact: Brenon Daly

In a time when nearly all divestitures are done on the cheap, freenet’s recent sale of its mass-market hosting business Strato generated an unexpectedly rich return for the German telco. In fact, freenet more than doubled its money in the five years that it owned Strato. Back in December 2004, freenet handed over $177m ($107m in cash, $70m in equity) to German network equipment provider Teles for Strato. When freenet shed Strato to Deutsche Telekom (DT) two weeks ago, it pocketed $410m. (Arma Partners advised freenet on the divestiture.)

On top of that return, of course, freenet will hold on to the cash that Strato generated while owned by freenet. That’s not an insubstantial consideration, given that Strato ran at an Ebitda margin in the mid-30% range. We understand that Strato was tracking to about $50m in Ebitda for 2009, up slightly from about $46m last year. Revenue at Strato was also expected to show a mid-single-digit percentage increase in 2009, despite the tough economic conditions in freenet’s home market of Germany. DT’s bid values Strato at roughly 3x trailing sales and nearly 9x trailing Ebitda. That’s a solid valuation for corporate castoffs, which typically garner about 1x trailing sales and maybe 4-5x Ebitda.

Freenet’s divestiture of the Strato hosting business to DT comes a half-year after it sold its DSL business to United Internet, a sale that was also banked by Arma. The company has been looking to shed businesses as a way to pay down the debt that it took on for its $2.57bn acquisition of debitel in April 2008. Since that landmark deal, freenet has focused its operations on mobile communications, and had been reporting the DSL and Strato businesses separately. We understand that there may be additional divestitures by freenet, but they will be smaller transactions for more ‘ancillary’ businesses.

Navigating a decent exit

Brenon Daly

Contact: Brenon Daly

When we last checked in with Networks In Motion (NiM) two weeks ago, we noted that the turn-by-turn navigation vendor had just been stepped on by the not-so-gentle giant, Google. As it turns out, NiM’s valuation got stepped on a bit, too. The Aliso Viejo, California-based company sold itself Tuesday to TeleCommunication Systems for $170m. Terms call for TeleCommunication to hand over $110m in cash and $20m in shares, along with a $40m note. Raymond James & Associates advised TeleCommunication Systems while Jefferies & Co advised NiM on the transaction, which is expected to close by the end of the month.

The offer values NiM at 2.3 times 2009 revenue and 1.7x the company’s projected sales for next year, according to our understanding. NiM’s expectation of $100m in sales in 2010, representing 33% growth, strikes us as a bit aggressive. The reason? Google has started giving away a turn-by-turn navigation product for select Android devices that run on Verizon Wireless, the only network on which NiM currently offers its service. Although the threat of Google completely wiping away NiM’s business is grossly overblown, we suspect that it did put some pressure on the price of the company. NiM’s early focus on feature phones gave competitors such as TeleNav an early lead on smartphones such as BlackBerry and Windows Mobile. According to one rumor, T-Mobile and NiM had been close to a deal earlier this year. Without the ‘Google overhang,’ we could imagine that NiM would be selling for quite a bit more than the $170m that TeleCommunication Systems is slated to pay.

That said, it’s actually a decent exit for seven-year-old NiM. Although it’s getting an admittedly so-so multiple for its business, the company is providing a solid return for its backers, largely because it didn’t raise much money. It drew in a total of less than $20m, with Mission Ventures and Redpoint Ventures as early NiM backers and Sutter Hill Ventures joining in the third – and last – round of NiM funding in March 2006. (There was also some money from unnamed strategic investors.) Unlike rival TeleNav, NiM was unlikely to go public because of concerns about competition from Google. (TeleNav, which put in its IPO paperwork a month ago, isn’t immediately threatened by Google because the latter’s service isn’t yet available on TeleNav’s networks, AT&T and Sprint.) A solid (if not spectacular) trade sale of NiM in the face of growing competition from Google isn’t a bad bit of navigation for the startup at all.

A quiet end to the year

Brenon Daly

Contact: Brenon Daly

As we flip the calendar to the final month of 2009, it’s worth noting that December is almost always a quiet month for M&A. That was particularly true last December, which saw just $6bn of spending on tech acquisitions. The spending level represented a scant 2% of the total $301bn of spending on deals in 2008. (If the month had recorded its representative one-twelfth (8%) of the annual total, spending would have come in at roughly $25bn.)

Of course, last December was a pretty bleak time, with investment banks reeling and companies ratcheting back their financial projections for the coming quarters. But even in times of more robust dealmaking, December has been a below-average contributor to annual M&A spending. For instance, deals in the final month of 2007 and 2006 represented just 6% of the totals in both years.

So what does all that mean for M&A in the final month of this year? Assuming we return to a more normalized level of activity in which December accounts for about 6% of total annual spending, we’ll be looking at about $9bn worth of deals between now and year-end. Overall, that would put total spending for 2009 at just $151bn – exactly half the amount that we saw in 2008.

A month off

Year Total spending in December December spending as % of annual total
2008 $6bn 2%
2007 $26bn 6%
2006 $29bn 6%
2005 $38bn 10%

Source: The 451 M&A KnowledgeBase

Cyber Monday’s here

-Contact Thomas Rasmussen, Brenon Daly

Even though the receipts from Black Friday, the traditional retailers’ launch of the holiday shopping season, weren’t much bigger than they were last year, online retailers on Cyber Monday appeared to be ringing up a pretty good business this year. Amid all of the cyber-shopping, we couldn’t help but notice that there has also been a fair amount of buying of the shopping sites themselves. For instance, Amazon recently wrapped up its $847m all-stock acquisition of online apparel retailer Zappos. This stands as Amazon’s largest purchase, nearly three times larger than its second-largest buy. (We should also note that when the deal closed earlier this month, the equity was worth a whopping $1.2bn thanks to the recent surge in Amazon shares. The stock, which hit an all-time high on Monday, has risen some 62% over the past three months.) While overall M&A spending this year appears likely to be half the amount of 2008, online retail dealmaking is still going strong. We expect spending on Internet commerce acquisitions to come in roughly where it did in previous years, at some $2.3bn worth of transactions in the sector.

Meanwhile, another e-commerce vendor continues its push for a different exit. Newegg.com filed to go public in late September, and appears to be on track for a debut early next year. The online electronics retailer, which was founded in 2001, has more than doubled sales over the past four years while also posting a profit in each of those years. Although growth has slowed so far this year, Newegg still raked in $2.2bn in revenue and $70m in EBITDA for the four quarters that ended last June.

Given the recent trend in dual-track offerings, we wonder if Newegg might not get snapped up before it hits the Nasdaq under the ticker ‘EGGZ.’ Granted, this is pure speculation, but there are a fair number of parallels between Newegg and Zappos, which could mean that Amazon will reach for it. (Both Newegg and Zappos have developed profitable, growing businesses by specializing in a slice of the market that Amazon has tried – but failed – to dominate.) Additionally, electronics retailers such as Best Buy could well be interested in bolstering their online sales units with Newegg. Although Newegg and its underwriters haven’t set an initial valuation, we suspect that any buyer would have to be ready to hand over slightly more than $2bn to add Newegg to its shopping cart.

Online retail M&A

Period Number of deals Total deal value
2005 30 $1.27bn
2006 53 $3.78bn
2007 36 $2.62bn
2008 45 $1.36bn (excluding the sale of Getty Images)
2009 YTD 55 $2.34bn

Source: The 451 M&A KnowledgeBase

Corel: ‘What a turkey’

Brenon Daly

Contact: Brenon Daly

As many of us get ready to sit down with friends and family for our annual Thanksgiving dinner on Thursday, our thoughts inescapably turn to poultry. When we look around at some of the deals out there right now, our thoughts also turn to poultry. For instance, whenever Corel comes up, we can’t help but think to ourselves, ‘What a turkey.’

By ‘turkey,’ we don’t just mean that Corel has been a second-rate software company and an even worse investment. (Although both are certainly true. Corel shares have never traded above the price at which they were spun off in mid-2006, and currently change hands at just one-quarter of that level.) But we also mean that since the grab-bag software vendor went private in mid-2003 with Vector Capital, Corel equity has been carved up like a Thanksgiving turkey. And now there’s a fight brewing over one of the drumsticks.

As we’ve chronicled in the past, Vector has been angling to repurchase the chunk of Corel that it spun to the public three-and-a-half years ago. Vector recently offered to repurchase the one-third of Corel shares that it doesn’t own at $4 each. While that was a bit higher than it initially offered in late October, the bid is substantially below its offer of $11 per share back in March 2008.

Vector’s effort received a new urgency this week when Corel warned that it runs the risk of falling below certain covenants and defaulting on its loans unless the sale to Vector goes through. The deadline for being in line with the covenants is November 30. The buyout shop contends, among other things, that the costs of Corel being a public company get in the way of making the necessary investments to keep the 24-year-old firm competitive. Corel’s investors aren’t necessarily buying that, at least not at the price offered by Vector. Corel shares have traded above the $4 bid for the past two weeks.

M&A ‘chatter’ around salesforce.com

Brenon Daly

Contact: Brenon Daly, China Martens

Official word from salesforce.com is that its recently announced Chatter product was developed in-house. And that would certainly be in keeping with the company’s history of staying away from M&A. Since it opened its doors a decade ago, salesforce.com has done just five tiny deals. The vendor certainly has one of the lowest ratios of total M&A spending (probably around $70m) to market capitalization ($7.7bn) of any of the big software vendors.

Nonetheless, there was some chatter (if you’ll pardon the pun) that salesforce.com may have acquired some technology from a small startup to shore up the recommendation engine portion of Chatter, a collaboration/social networking offering that’s slated to come out next year. The M&A speculation centered on a startup that perhaps provided some natural-language search capability. We would note that a small shopping trip by salesforce.com – if, indeed, there was one – to get some social networking/natural-language technology wouldn’t be without precedent. Rival CRM vendor RightNow tucked in HiveLive, which had just 25 customers, in a $6m deal last summer.

Whether or not salesforce.com went shopping for part of Chatter, it’s worth pointing out that the firm has used M&A as a way to go after Microsoft’s SharePoint in the past. In early 2007, the company picked up Koral, an early-stage content management startup that salesforce.com had effectively been incubating. (And on a smaller scale, several months after that, it quietly acquired a tiny social networking startup, CrispyNews.)

However, we’re guessing that those purchases, particularly the Koral deal, haven’t generated the returns that salesforce.com might have hoped. The vendor originally said that Salesforce Content – an add-on, extra-cost module based partly on Koral – could do to SharePoint (among other document management offerings) what salesforce.com did to Siebel in CRM. That hasn’t come close to happening. In fact, salesforce.com just announced that Content will be available free of charge to all customers.

Bets on casual games are paying off

-Contact: Thomas Rasmussen, Brenon Daly

Fittingly enough, on the one-year anniversary of our piece predicting continued consolidation of the social and casual gaming space, Electronic Arts announced the industry’s largest acquisition. The Redwood City, California-based videogame giant acquired Playfish on November 9 for $275m, although an earnout could mean that EA will pay as much as $400m over the next two years for the company. We estimate that Playfish, which will be slotted into the EA Interactive division, generated about $50m in trailing sales. Overall M&A continues to be strong in the still-niche gaming sector, with deal volume up about 25% from last year with about 35 transactions inked so far in 2009.

With the gaming industry seemingly in recovery mode after not-so-horrible earnings announcements from industry bellwethers EA and Activision Blizzard, we’re confident that more videogame and media companies will look to add social networking games. (After all, the big gaming players have used M&A as a way to buy a piece of a fast-growing, emerging market. For instance, EA spent $680m in cash four years ago for Jamdat Mobile to get into wireless gaming.) With Playfish off the board, which other social gaming startups might find themselves targeted by one of the big gaming vendors?

While there are literally hundreds of promising startups, most are too small to be important enough for a big buyer. Nevertheless, there are a few firms that have grown – both organically and inorganically – enough to make them attractive acquisition targets. For instance, Playdom, which develops games primarily for MySpace and Facebook, recently reached for a pair of smaller gaming startups. The company also recently raised $43m. Similarly, Zynga recently raised a funding round ($15m) and has also picked up two small startups this year. Two other names to watch in the emerging social gaming market are Digital Chocolate and Social Gaming Network Inc.

NetApp: Single and lovin’ it

Brenon Daly

Contact: Brenon Daly

Jilted earlier this summer, NetApp is nonetheless doing just fine on its own, thank you very much. Shares of the storage giant are now changing hands at their highest level in more than two years, giving the company a market capitalization of a cool $10bn. (The stock tacked on 4% on Thursday after NetApp topped Wall Street expectations for its fiscal second-quarter results and indicated that its current quarter is shaping up stronger than investors initially projected. Shares closed up $1.21 at $30.83 Thursday in an otherwise down day for the market.)

Thursday’s move higher continues a recent bull run for NetApp shares since the firm got elbowed aside by EMC in the fight over Data Domain. In the six months since NetApp unveiled its unsuccessful bid for the data de-duplication specialist, shares of NetApp have soared 70%. (In comparison, the winner in the bidding war, EMC, has returned ‘only’ 40% over that period.) We mention the relative performance of the shares of the two vendors because originally, NetApp planned to use its equity to cover slightly more than half the cost of Data Domain. (With its deeper pockets, EMC always planned to pay all cash for Data Domain, as it did when it wrapped up the acquisition in late July.)

So, from the outset, we agree that our back-of-the-envelope calculation is a bit academic, given that the Data Domain deal has been done and dusted for nearly four months. (And we’ll acknowledge that it’s a bit inexact because NetApp never formally announced the precise amount of stock, or even the specific conversion price, that it planned to use.) Nonetheless, it’s pretty clear that Data Domain owners would have done pretty well if they had taken NetApp equity. (Of course, shareholders did just fine with the $33.50 in cash from EMC, which, at 7.4 times trailing sales, was the highest multiple paid for a US-listed public company since March 2008.)

With all of those disclaimers, here’s our math: When NetApp first announced the bid on May 20, its shares traded at about $17.30 each. Although it didn’t reveal the exact breakdown of cash and stock in its offer, which had an equity value of $1.75bn, we understand that NetApp was planning to hand over about $800m in cash and cover the remaining $950m in equity. Assuming that’s roughly the breakdown, that same chunk of NetApp stock would now be worth about $1.8bn – more than the full value of its initial cash-and-stock offer. Add the $800m in cash into the mix, and the total consideration for Data Domain (based on NetApp’s current share price) hits $2.6bn. That’s roughly $300m more than EMC ended up paying for Data Domain.

A thaw in the market

Brenon Daly

Contact: Brenon Daly

In recent weeks, there’s been a lot of talk about a thaw in the once-frozen M&A market. While that’s true for overall activity, it’s also turning out to be true for specific deals that for one reason or another found themselves on ice at some point. Whether the transaction originally froze because of financing, regulation or pricing, a few of the notable deals are now looking like they’ll get done. That warming trend in dealmaking stands in sharp contrast to the climate at the beginning of the year. The Ice Age that spanned the first few months of 2009 is the main reason why total M&A spending for this year is likely to come in at just half the level it was in 2008.

Among the transactions that have been reheated in recent weeks: JDA Software’s consolidation play for i2, the sale of once-hot-but-now-cold 3Com and Cisco Systems warming up to the shareholders of Tandberg, who had given the networking giant a Nordic brush-off in its first bid for the videoconferencing company. (Incidentally, the additional $400m that Cisco will kick in for Tandberg will deplete its overseas cash stash by a whopping 1.3%.) What’s interesting in this trio of deals is that all of them involve the target company pocketing more money than was offered in an earlier proposed transaction. That’s certainly a change in the climate from this time last year, when we were writing about bidders ‘recalibrating’ their offers lower.

A management ‘buy-under’ at Silicon Storage Technology?

Brenon Daly

Contact: Brenon Daly

In the third-quarter earnings report for Silicon Storage Technology at the end of October, chief executive Bing Yeh went out of his way to tout the vastly improving outlook for the flash memory vendor. Yeh noted that end-market demand had recovered and pricing had firmed up in what had been a pretty tough market. Third-quarter sales picked up sequentially and the company actually posted black numbers after three straight quarters of losses. The rebound was expected to continue in the fourth quarter, with a profit forecast for the period, as well.

And yet, the price that Yeh and his buyout partners at Prophet Equity bid for SST last week is actually lower than the vendor’s share price on the day Yeh made his comments about the rosy outlook for the company he heads. In fact, over the past two months, shares of SST have only traded below the proposed sale price of $2.10 in 11 of the 46 trading days. Looked at another way, the proposed management buyout (MBO) of SST represents a ‘take-under’ (rather than a takeover) when compared to the closing price in three out of four sessions since early September.

By their very nature, MBOs are fraught with conflict. In cases like SST, where executives plan to roll over their stakes in the company, the executives are effectively both buyers and sellers of the firm. (According to SST’s proxy, Yeh holds roughly 11% of all shares, making him the single-largest owner of the vendor.) The conflict emerges when we look at the basic economic self-interest on both sides of the transaction: The owners of SST (including Yeh) want to get as high a price as possible in the sale of their business, while the buyers (including Yeh) want to pay as low a price as possible to purchase the business.

Beyond the mismatch of motivation in MBOs, there’s also the thorny issue that executives almost certainly have insights on their business that aren’t available to other owners. We would guess that Yeh, who helped found SST 20 years ago and also serves as the chairman of the company’s board, probably knows more about the firm’s business and its prospects than anyone else on the planet.

At least one other insider at SST, however, didn’t share the support of the below-market MBO. Board member Bryant Riley, the founder of the Southern California investment firm B. Riley & Co., voted against the proposed buyout and then resigned from the board. (It’s worth noting that Riley got his seat in May 2008 only after agreeing to stop pestering the company about ‘strategic alternatives.’) Most SST investors – at least those who don’t stand to have a stake in the privately held company – have also voted against the deal. Shares have traded above the offer price since the bid was revealed November 12.