Bleak outlook for social networking M&A

-Contact Thomas Rasmussen

In a sign of just how far the social networking market has fallen, brightsolid’s $42m purchase earlier this month of Friends Reunited from ITV Plc stands as the largest deal in the sector so far in 2009. The price is a mere 5% of the value of the largest social networking acquisition in 2008, which was AOL’s $850m all-cash pickup of Bebo. (We would also add that the sale of Friends Reunited netted ITV just one-fifth the amount it originally paid for the property in 2005.) On top of the notably smaller transactions, deal flow so far this year has been characterized by relatively paltry valuations. Friends Reunited garnered just 1.6 times trailing sales, compared to the estimated 42 times trailing revenue that Bebo got from AOL. Add all that together and it’s pretty clear that the bubble of social networking M&A has popped. In the space so far this year, we tally just 28 deals worth a total of $55.5m, compared to 53 transactions valued at more than $1.3bn in 2008.

As an aside, we would note that the acquisitions of Friends Reunited and Bebo have more in common than just ranking as the largest deals of their respective calendar years. The stalking horse bidder for Friends Reunited, Peter Dubens through his investment vehicle Oakley Capital Private Equity, has a close business relationship with Bebo founder Michael Birch. Dubens and Birch formed PROfounders Capital earlier this year under Dubens’ Oakley Capital umbrella. Oakley Capital reportedly offered to buy Friends Reunited for $25m, but declined to bump up its bid above even one times sales. Without reading too much into that, we might be tempted to conclude that except for Facebook, the little value that remains in most social networks is likely to only decline.

Red Hat rumors: a reheat or something more?

Brenon Daly

Contact: Brenon Daly

When VMware reached for SpringSource earlier this month, the $420m pairing represented the largest open source transaction in a year and a half. Now, the market is buzzing with rumors about another blockbuster open source deal, one that would be more than 10 times the size of VMware-SpringSource. Several sources have indicated that interest in Red Hat has been heating up lately, with Oracle and IBM popping up again as suitors.

The rumors, of course, are nothing new. We have been speculating about a possible pairing between Red Hat and IBM or Oracle for almost three years. (When Oracle launched its own support of Linux back in 2006, we wondered if it wasn’t a ‘beat ’em down and take ’em out’ strategy from the coldhearted Larry Ellison.) And when the rumblings surfaced again earlier this year, we did some back-of-the-envelope thinking about a bid from Oracle. Honestly, though, we think Big Blue is a more likely buyer for Red Hat.

While the speculation stays largely the same, however, there is one change: the price of Red Hat keeps going up. Since we noted the latest reports of Oracle’s interest in late March, shares of Red Hat have tacked on about one-quarter in value. The company currently sports a market capitalization of $4.2bn; however, its cash holdings lower the effective purchase price to about $3.5bn. Red Hat is just now wrapping its fiscal second quarter, and has already said it expects revenue to be about $179m for the period. The vendor will likely report results in about a month.

Where’s the hurry in Oracle’s reach for Sun?

Brenon Daly

Contact: Brenon Daly

Having gotten the all clear on this side of the Atlantic, Oracle is now waiting for the EU to sign off on its pending purchase of Sun Microsystems. And the company will have to wait a bit longer. The European Commission has a deadline of September 3 to determine if the deal would violate antitrust measures. If the body decides that it does, a subsequent probe could potentially drag on into 2010.

Granted, there’s a lot at stake in Larry Ellison’s plan to use the acquisition of Sun to turn Oracle into a systems vendor, as opposed to a company that just sells software. (Provided the transaction goes through, Oracle will be in a position to hawk Solaris and Linux servers, all running its own database, middleware and application software on the boxes.) And, as the largest tech buy since Hewlett-Packard purchased EDS in May 2008, Oracle’s $7.4bn reach for Sun is clearly not nickel-and-dime M&A.

But the pace of the review by regulators is absolutely glacial. Consider this fact: It took Oracle just two months to fully negotiate its purchase of Sun, according to proxy material. (Sun chairman Scott McNealy spoke with Ellison about a possible deal in late February; the companies announced the transaction on April 20.) More than twice that amount of time has elapsed since Oracle announced the deal – and regulators in Europe are still mulling it over.

Sourcefire: No sale turns into a great deal

Brenon Daly

Contact: Brenon Daly

With Barracuda Networks looking to gobble up Austrian IT security vendor phion, we thought we’d look back on the other time the rapacious privately held firm eyed a public company. Last summer, Barracuda launched an unsolicited bid for Sourcefire, initially offering $7.50 per share but later raising that to $8.25. The bumped-up bid valued Sourcefire at roughly $215m, but that wasn’t enough for Sourcefire’s board of directors.

We’ve noted in the past that the decision by a company to go it alone can prove very costly to shareholders, at least in the near term. Removing the takeout premium and letting a company trade on its own fundamentals can end up crushing a stock. Recovering that lost ground can be a long and painful process. (Just ask shareholders of Yahoo and Mentor Graphics, who see shares in those companies changing hands these days at just half the level that suitors were willing to pay for them last year.)

However, it’s a completely different story for Sourcefire. It has actually turned out to be one of those rare cases where a target says a bid ‘undervalues’ the business and Wall Street agrees. After telling Barracuda to buzz off, Sourcefire shares got dragged down by the recession and traded below the bid until early April. But since then, the stock has surged to its highest level since the vendor went public in March 2007. Sourcefire shares are currently trading at about $20, or nearly 150% higher than the price Barracuda was willing to pay for them. Looked at another way, Sourcefire’s decision to stay independent has created more than $300m of additional value for its shareholders than the Barracuda bid would have delivered.

VMware: a ‘table-clearing’ bid for the clouds

Brenon Daly

Contact: Brenon Daly

About a year and a half after Paul Maritz got picked up by EMC, the former Microsoft honcho has struck his signature deal for his new employers. When EMC reached for Pi Corp, which had yet to release a product, we figured the move was basically ‘HR by M&A.’ And that has turned out to be the case, as Maritz took over leadership of EMC’s virtualization subsidiary VMware in July 2008. He stepped into the top spot just as VMware’s once-torrid revenue growth had dwindled to a trickle. Sales at VMware rose 88% in 2007 and 42% in 2008, but are projected to inch up just 2% this year.

To help jumpstart VMware’s growth, Maritz looked to the clouds, pushing through the acquisition of SpringSource earlier this week. At roughly twice as much as VMware has spent on its previous dozen deals, the SpringSource buy is the virtualization kingpin’s largest purchase. It was also, as we understand it, a deal very much driven by Maritz. (Because the purchase topped $100m, it also had to be blessed by VMware’s parent, EMC. This indicates that Maritz enjoys a level of support at the Hopkinton, Massachusetts, HQ that probably wasn’t extended to his predecessor, VMware founder Diane Greene.)

As we have noted, no bankers were involved in negotiations and one source indicated that terms were hammered out directly by Maritz and his counterpart at SpringSource, Rod Johnson, in a scant three-and-a-half-week period. Not that there was much negotiating needed. As we understand it, Maritz approached Johnson with a ‘table-clearing’ offer of $400m. SpringSource didn’t contact any other potential buyers, and in fact, the five-year-old startup only weighed VMware’s bid against the possibility of going public in 2011. (Subscribers to the 451 M&A KnowledgeBase can click here to view our estimates on SpringSource’s revenue, both trailing and projected, as well as its valuation.)

However, the source added that getting to an IPO would have likely required another round of funding for SpringSource. The dilution that would come with another round, combined with the deep uncertainty about the direction of the equity markets, tipped SpringSource toward the trade sale. In the end, that decision – and how Maritz executes on his step into application virtualization – will go a long way toward shaping his legacy at VMware.

Will Fortinet go shopping after going public?

Brenon Daly

Contact: Brenon Daly, Paul Roberts

Not that Fortinet actually needs more cash to go shopping, but the company will likely substantially fatten its treasury by the end of the year. Officially, the security vendor, which has been generating cash for the past three years, said in its IPO prospectus this week that it plans to raise $100m. However, we suspect the actual amount that it raises could be as much as $200m, a fitting offering for a firm that may well hit the market with a valuation in the neighborhood of $1bn. (Which exchange Fortinet debuts on is still undecided. We can only imagine the fight between the NYSE and the Nasdaq over listing a big-time IPO like Fortinet in such a lean time for new offerings.)

Whatever the amount of money Fortinet ends up raising in the offering, it will have plenty to go shopping. (Not to mention the fact that it will also have freshly minted shares if it wants to do a larger deal.) My colleague Paul Roberts, who heads our security practice, put together a possible shopping list for the company back in April, based on our understanding that Fortinet was a few months away from filing to go public. Roberts discussed a number of possibilities for Fortinet, including network access control and perhaps WAN traffic optimization.

However, he argued that Fortinet would perhaps be best served by making a play for an enterprise security information management (ESIM) provider to make sense of all the information generated by the various offerings. And, as fate would have it, Fortinet already knows one ESIM vendor rather well. Since 2004, the company has been OEMing eIQnetworks’ Network Security Analyzer and reselling it as FortiReporter.

EMC and advisors: All or nothing

Brenon Daly

Contact: Brenon Daly

After EMC doled out no fewer than nine credits to different banks for working on its acquisition of Data Domain, we were curious how the deal credits would flow around the largest-ever purchase by EMC subsidiary VMware. (The unusually long list of advisers for EMC on Data Domain made us think – of all things – about the quip about compensation under some communist regimes: People pretended to work and the government pretended to pay them.) As it turns out, EMC/VMware swung to the other extreme, with not a single bank working for the virtualization giant in its purchase of SpringSource.

That’s not unusual, since VMware hadn’t really used bankers in the dozen or so acquisitions that it had inked before SpringSource. But those deals were mostly small. In fact, the cumulative spending for all of its earlier buys totals only about half of the $420m in cash and stock that VMware is set to hand over for SpringSource. By our tally, VMware’s pending purchase is the third-largest pickup of a VC-backed tech firm so far this year. Not that the print will show up for any bank. SpringSource didn’t use an adviser, either.

Versata bags Everest

Brenon Daly

Contact: Brenon Daly

In half of the recent buys by Versata Enterprises, Updata Advisors has worked on behalf of the acquisitive enterprise software provider. In the latest purchase, however, the boutique advisory firm swung to the other side of the desk. On Friday, Versata, the Austin, Texas-based company that used to go by the name Trilogy, picked up Everest Software for an undisclosed sum. (We hear from a source that Everest was running at a bit more than $10m in revenue. However, the vendor’s top line suffered recently because it sold predominantly to retailers, as well as SMB customers – both of which have been hit disproportionately hard by the ongoing recession.)

Since December 2007, Updata has advised Versata on its acquisitions of Nuvo Network Management, TenFold and Evolutionary Technologies International. Switching over to the sell side for Everest is perhaps understandable for Updata because its sister firm – Updata Partners, which does venture investing – had put money into the CRM vendor. Other backers of Everest include Sierra Ventures, Boulder Ventures and Actis Capital. Founded in 1994, Everest had pulled in around $20m in funding.

Incidentally, we would note that in a press release announcing its sale, Everest took the unconventional step of thanking all of its backers. Even though we understand that the investments in Everest didn’t necessarily produce the returns that had been hoped for, it’s nonetheless a classy move by Everest. Too few companies do that. Most executives and investors simply and quietly move on to ‘the new, new thing’ without taking time to acknowledge the money and time that people put into the first venture. So the sale of Everest probably wasn’t a high-dollar deal, but the firm did take the high road.

A transatlantic shopping trip for Concur

Brenon Daly

Contact: Brenon Daly

After being out of the M&A market for two years, Concur Technologies reached across the Atlantic earlier this week for a small Paris-based startup to help expand its business in Europe. Currently, business outside of the US accounts for about 10% of overall revenue at Concur. The company has indicated in the past that it plans to triple the level of international revenue in the coming years. Concur said it will pay up to $40m in cash and equity for Etap-On-Line (including unspecified earnouts), but guided not to expect much from the acquisition right now. (Deutsche Bank Securities advised Concur on the transaction.)

There are a number of reasons for the muted initial expectations for the purchase. First, much of Etap’s revenue will likely get washed out because of differences between French and US accounting standards. (Not that there was likely a lot of revenue to start with.) And even the sales that Etap has booked have come primarily from offering its travel and expense management software through licenses. That means Concur will have to convert the technology to its on-demand platform.

Of course, Concur knows a bit about that process, having transformed itself earlier this decade to an on-demand software provider from the license model. In the words of one banker, the transition was ‘a valley of death’ experience for Concur. But now the company has emerged from the valley and carries the rather alpine valuation of about 6 times fiscal year sales. (Concur currently has an enterprise value of about $1.5bn, compared to the projection of about $250m in revenue in its current fiscal year, which wraps at the end of September.) A number of other software firms quietly (and not so quietly) envy Concur’s makeover – and how it has played on Wall Street. Shares of Concur, which spent much of 2001 at less than $1, closed at nearly $37 on Thursday.

A first for Google: reaching for a public company

Brenon Daly

Contact: Brenon Daly

In the five years since Google went public, the serial shopper has picked up some 40 other companies. It has bought its way into security, collaboration software, mapping, video and voice, among other areas. And it has inked deals ranging from the low seven figures all the way up to $3.1bn for DoubleClick. But in all of its shopping, Google had never reached for a fellow public company. That changed Wednesday with the search giant’s announced $106m purchase of Amex-listed On2 Technologies. The transaction is expected to close by the end of the year.

Fittingly for a vendor that hangs ‘beta’ tags on products for years, Google didn’t immediately indicate its plans for On2. But we suspect that the video compression technology that On2 developed could well come in handy to lower bandwidth costs and sharpen up the performance of Google’s YouTube property, for instance. (Whatever the strategy, we’re pretty confident that the deal was a pure technology acquisition. Google certainly didn’t snag On2 for its financial performance. Money-burning On2, which has rung up an impressive $183m in accumulated deficit since its founding in 1992, has had negative working capital so far this year.)

As an aside, we would note that there are actually a few ties between Google’s YouTube buy and its pending pickup of On2. Both transactions are the only ones we’re aware of where Google used its own equity to cover the purchase price. (For those On2 shareholders who might be curious, Google shares have handily outperformed the market since the vendor handed over $1.65bn worth of stock to YouTube owners. Google shares are up about 12% since the company announced the YouTube deal in October 2006, compared to a 12% decline in the Nasdaq over that period.) Also, even though Google rarely uses a sell-side adviser, Credit Suisse Securities banked the search giant in both deals. In fact, we understand that the same banker, Credit Suisse’s Storm Duncan, handled the two acquisitions. Duncan worked across the table from Covington Associates’ Tom Cibotti, who advised On2.