What’s behind door number two? An IPO

Brenon Daly

Contact: Brenon Daly

For tech startups considering the two possible exits so far this year, an IPO is clearly door number two. Sure, there’s plenty of money to be made in taking a company public. And the valuations that Wall Street is handing out for recent debutants – notably the double-digit multiple for Varonis Systems and a solid 6x trailing sales for A10 Networks – are far from paltry. But there hasn’t been anything that comes close to a ‘WhatsApp’ in the IPO market so far this year.

Granted, the $19bn sale of the five-year-old mobile messaging startup is something of an anomalous event, so we will go ahead and set aside that transaction. But even leaving out the largest-ever sale of a VC-backed vendor, there were still three other sales of VC-funded firms in the first quarter that went off at more than $1bn. When we look at the other exit, we would note that not a single tech firm that went public in the first three months of 2014 created more than $1bn of market value.

Further, as we skim down the list in The 451 M&A KnowledgeBase of VC-backed startups that have opted for a trade sale so far this year, it’s hard not to see that IPOs – despite all of the talk about how the JOBS Act has made it easy to go public and a ‘record’ Q1 – have fallen out of favor.

Consider Mandiant, a 10-year-old information security provider running at more than $100m in bookings. Last summer, the company indicated to us that it was looking to raise one round of late-stage capital and then go public in 2015. Instead, it sold to FireEye for just under $1bn, mostly in the acquirer’s own freshly printed stock. Elsewhere, AirWatch garnered some 15x bookings in its $1.5bn sale to VMware, a valuation that rival MobileIron is unlikely to trade at – not initially, anyway – when it comes public later this year.

And even down in the mid-cap market, Coverity gave up on its long-held plan to go public, selling instead to one of its customers, Synopsys. From our perspective, Coverity certainly looked like a reasonable candidate to be a public company: it had little pressure to sell (having taken in just one round of funding and sitting on about $25m) and was growing at a 20-30% clip while nearing $100m in sales. Instead, it sold for $375m, valuing itself at 4.7x trailing sales. That’s about a turn higher than the broader tech M&A multiple, but lower than what Wall Street typically hands out for companies sharing Coverity’s profile.

But the IPO, which has always enjoyed a sort of premium standing among most VCs and executives, appears on the cusp of reclaiming its top-ranked position. At least two enterprise tech vendors are currently on file for what will almost certainly be hot offerings. Both Arista Networks and Box will undoubtedly be ‘billion-dollar babies’ when they come to market in early summer. You can read more about both the recent M&A market, which is clipping along at a record level currently, as well as the outlook for IPOs in our Q1 M&A report published earlier this week.

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New dawn for M&A at Morningstar

Scott Denne

Contact: Scott Denne

Investment data and software company Morningstar makes its first purchase since 2010, reaching for ByAllAccounts, a data aggregation vendor. The deal supports Morningstar’s financial advisory software business by giving it technology that enables advisers to aggregate their clients’ portfolio performance data across asset classes.

In the years leading up to (and shortly after) the financial crisis, Morningstar picked off about four companies a year and inked 24 acquisitions between 2006 and 2010. While its revenue bounced back from pre-crisis levels by the end of 2010, it hasn’t put up the 25%-plus annual growth that it enjoyed for several years before that. Acquisitions weren’t the only reason for its higher growth back then (even its organic growth tended to be higher than it is today), but they did help.

The purchase of ByAllAccounts complements one of Morningstar’s underperforming units: software sales to financial advisers and wealth managers. While it’s the company’s second-largest business unit – accounting for 13.3% of its $698m in total revenue last year – its growth has been considerably slower than its institutional data business. With $93m in revenue, sales to financial advisers only grew 8% in each of the past two years, while the institutional data business grew 12% and 11% in those years.

Morningstar is paying $28m for ByAllAccounts. And though it’s the company’s first transaction in a while, it’s a typical one for Morningstar. This acquisition is just a hair above its $19m median deal value, according to The 451 M&A KnowledgeBase. Morningstar has never been a big spender, having only cracked the $50m mark on three occasions and never done a deal above $60m.

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For tech M&A, the go-go days are going again

Brenon Daly

Contact: Brenon Daly

At least for the opening quarter of 2014, the go-go days are going again. Overall M&A spending in the tech, media and telecom (TMT) market set a record for the first three months of any year since the Internet bubble popped in 2000. Across the globe, the aggregate value of Q1 deals totaled $128bn, according to The 451 M&A KnowledgeBase. That puts 2014 on a run rate to hit an astonishing half-trillion dollars in M&A consideration for the full year.

Spending in the just-completed January-March period came in at roughly three times the level of a typical quarter in the years since the end of the recession. (On its own, the equity value of the proposed Comcast-Time Warner Cable transaction roughly equals the amount spent on all TMT deals in a typical post-recession quarter. But even backing out that mammoth transaction, Q1 spending would still stand as a post-recession quarterly record of $83bn.)

To indicate just how far Q1 stands out from the recent recession, consider this: total M&A spending in just Q1 2014 came in only 10% lower than the full year of 2009. So far this year, we’ve seen such blockbuster prints as the second-largest TMT transaction overall since 2002 (Comcast’s pending acquisition of Time Warner Cable), as well as the biggest price ever paid for a VC-backed startup (WhatsApp’s $19bn exit to Facebook).

While those two deals helped push M&A spending in Q1 to a new high-water mark, we saw solid activity across a number of submarkets that haven’t been busy since before the recession. Large-scale consolidation continued on a steady pace (Comcast-Time Warner Cable, plus several European telco transactions), but underneath that, the midmarket saw an above-average number of deals, with the median value surging to a post-recession record high. (Also, valuations of those midmarket transactions in Q1 basically matched the big-ticket deals, which hasn’t necessarily been the case in recent years.)

And finally, deal flow at the start of this year reflects an unprecedented level of youthful exuberance. Facebook, with its back-to-back purchases of WhatsApp and Oculus VR, obviously stands out. But we would add Google and FireEye to the list of acquirers that did uninhibited, speculative transactions so far in 2014. Look for our full report on Q1 M&A activity and valuations, plus our assessment of the current tech IPO market, in our next 451 Market Insight.

Recent quarterly deal flow

Period Deal volume Deal value
Q1 2014 816 $128bn
Q4 2013 787 $59bn
Q3 2013 829 $73bn
Q2 2013 760 $48bn
Q1 2013 798 $65bn
Q4 2012 824 $59bn
Q3 2012 880 $39bn
Q2 2012 878 $44bn
Q1 2012 920 $35bn

Source: The 451 M&A KnowledgeBase

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Arista: new switches, but old-school IPO

Scott Denne

Contact: Scott Denne

Arista Networks, a next-generation networking vendor, aims to go public with a last-generation IPO – one from a company that boasts growth and profits. A decade of developing Ethernet switches based on innovative software and merchant silicon, rather than custom chips, has led to a 71% CAGR for the past four years.

The company wrapped up 2013 with $361m in revenue, up 87% from the $193m it posted a year earlier as its largest customers, mostly cloud datacenters, Internet providers and financial services firms, bought more of its gear. Arista’s 10 largest customers accounted for 43% of sales in 2013, up from 32% in 2011. Its largest customer, Microsoft, accounted for $80m of its sales last year, up from $14m in 2011.

Unlike most other newly minted enterprise IPOs, Arista’s growth hasn’t come at the expense of profits. Instead, it’s printing cash. Aside from a slight uptick in the resources it earmarks for R&D, all of Arista’s costs have risen in tandem with, rather than ahead of, revenue and it finished 2013 with $42m in profit, up 99% from a year earlier.

Having posted four straight profitable years removes some of the guesswork of estimating Arista’s future cash flows, and we expect that Wall Street will put a premium on that – and its stellar growth, of course. As disclosed in its S-1, shares of the company have traded hands this year at prices that value Arista at $3-3.5bn. As a public company, we’d expect it to trade far higher than that.

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Lithium takes a dose of Klout

Scott Denne

Contact: Scott Denne Matt Mullen

Lithium Technologies reaches for Klout, a measurer of social media influence, in a deal that aims to boost the marketing capabilities of the acquirer’s social media SaaS suite. The price tag was widely reported as $200m. While we think that’s a bit off, the mostly stock transaction suggests that Lithium’s valuation is growing beyond its nearest public-market peer, Jive Software – a company that’s about double the size of Lithium and trades at a $550m market cap.

In recent years, Lithium has expanded beyond providing tools for online communities into other elements of enterprise-focused social media, including social marketing and customer support via its acquisition in 2012 of Social Dynamx – a service that should get a boost from Klout’s technology, which can be used to determine the priority of each discovered support case.

Behind this deal is, perhaps, a desire for Lithium to get more involved in the marketing data management business. Oracle and Adobe have both made moves in that area, purchasing BlueKai and Demdex, respectively. If Klout’s consumer business remains open and the combined companies can resolve some of the misgivings concerning accuracy around scoring and categorization, then its 500 million profiles should give it a head start in assembling a form of audience-building technology that could be built out from its existing technical assets.

We’ll have a more detailed look at this deal in our next 451 Market Insight.

Lithium Technologies’ acquisitions

Date announced Target Offering
March 27, 2014 Klout Social media analytics
October 9, 2012 Social Dynamx Social media customer service
May 11, 2010 Scout Labs Social media sentiment analysis
June 2, 2009 Keibi Content moderation

Source: The 451 M&A KnowledgeBase

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Mobile gaming missteps loom in Facebook’s Oculus buy

Scott Denne

Contact: Scott Denne

Facebook’s $2bn purchase of virtual reality vendor Oculus VR, like every billion-dollar Facebook deal, is a bit of a head-scratcher at first glance. The overlap between virtual reality and social networking isn’t obvious, and virtual reality has a long way to travel to go from gaming-focused prototypes to a mainstream computing platform. But Facebook is, in part, a gaming provider and that’s what’s driving this transaction, despite the company’s breathless comments about a future with virtual classrooms and courtside seats for all.

At the time of its IPO in May 2012, gaming was Facebook’s fastest-growing business, but, unlike its core advertising business, gaming revenue failed to make the transition to mobile devices. The quarter before the company went public, revenue from its payments business (derived mostly from taking a cut of fees paid to game developers) doubled from a year earlier to $186m, accounting for 18% of its total revenue. In the most recent quarter, as many of Facebook’s users have migrated away from PCs, its payments (i.e., gaming) business revenue dropped 6% and was less than 10% of its overall revenue.

It’s tough to choke down Facebook’s vision of virtual reality as the future of social networking – its rapid transition to mobile shows that most people are finding PCs too cumbersome, so it’s unlikely that they’ll don headgear to interact with friends. However, the deal gives Facebook a front-row seat to a platform that stands a good chance of being the future of gaming. That level of access and influence during virtual reality’s early days will help Facebook avoid a repeat of its whiff on mobile gaming.

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Box shares its financials

Scott Denne

Contact: Scott Denne

Investors haven’t balked recently at bidding up an enterprise tech IPO with massive growth and no profits in sight. Box, however, will test the appetite for that kind of stock more than most. The file-sharing provider has put up impressive growth numbers, doubling its revenue last year to $124m. The prior year it fell just short of tripling revenue. That growth has come at a cost. In the year ending January 31, Box had a net loss of $169m driven by $171m spent on sales and marketing.

Plowing revenue back into sales and marketing is fashionable lately, but few are doing it to the extent that Box does. At the time of their IPOs, SaaS companies Workday and ServiceNow, for example, were spending less than half of their revenue on sales and marketing while putting up similar growth rates. Box is trending toward becoming profitable – its costs grew at a slower rate than its revenue and every dollar it spent last year brought it $0.44 in revenue, up from $0.30 in 2011. However, improving margins have done little to stem the flow of cash out of the business; its negative free cash flow rose to $124m last year, up from $101m a year earlier. At those rates, it will take at least three or four years for Box to get near being profitable or cash-flow positive.

We would expect Box to be valued in the same neighborhood as Workday and ServiceNow’s IPOs, which each priced at 22x trailing revenue. That would put Box’s debut valuation at about $3bn, a step above the roughly $2bn valuation on its last venture round. Given Wall Street’s bullish reception of other enterprise SaaS vendors, Box should trade up from there.

We’ll have a longer report on Box’s IPO filing in our next 451 Market Insight.

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Palo Alto Networks gets into endpoint game

Scott Denne

Contact: Adrian Sanabria Scott Denne

Palo Alto Networks buys into the endpoint security business with its $200m acquisition of early-stage vendor Cyvera. The deal moves the next-generation firewall provider into a new corner of the security market and mirrors other transactions by competitors that have also taken advantage of their rising stock prices to buy companies that can wring larger purchases from their customers.

Palo Alto will pay $112m in stock and $88m in cash for Cyvera when the deal closes. In exchange, it gets ownership of a service that protects endpoints by recognizing techniques used by hackers and preventing them from executing on endpoints. Cyvera, which has 55 employees and raised $13m in venture capital, isn’t expected to add notable billings or revenue to Palo Alto until later next year.

The deal is similar to FireEye’s $1bn acquisition of Mandiant earlier this year. In that transaction, FireEye, like Palo Alto, was aiming to extend itself beyond its focus on network security and into a larger total addressable market (TAM). While the price tag for Mandiant (which came with a large and lucrative consulting practice) was higher than Cyvera, the latter acquisition is more significant – with this deal, Palo Alto will immediately cover a larger swath of the security market.

We’ll have a longer report on this transaction in our next 451 Market Insight.

Security companies hunt larger TAM

Date announced Acquirer Target Rationale Deal value (stock portion)
March 24, 2014 Palo Alto Networks Cyvera Expanded into endpoint security $200m ($112m)
February 13, 2014 Bit9 Carbon Black Added network and forensic capabilities >$40m* (Not disclosed)
February 6, 2014 Imperva Skyfence Networks Brought cloud application control $60m ($57m)
January 2, 2014 FireEye Mandiant Obtained threat intelligence and nascent endpoint offering $989m ($889m)

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

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The man who unplugged Symantec’s M&A machine is gone

Scott Denne

Contact: Scott Denne

Symantec’s board has fired Steve Bennett, the CEO who brought the security vendor’s vigorous M&A practice to a halt. During his tenure, beginning in July 2012, Symantec bought just one company, compared with an average of four deals per year for the preceding decade.

Under Bennett’s watch, Symantec purchased only PasswordBank Technologies, an identity management firm that we estimate had $2m in annual revenue at the time. According to The 451 M&A KnowledgeBase, which tracks back to the start of 2002, the only other year Symantec acquired one or fewer companies was 2011, when it spent $410m on e-discovery vendor Clearwell Systems.

It’s hard to fault Symantec’s recent management for its M&A reluctance. The company built itself through acquisitions, but its biggest bet proved one of its worst. In 2004, it paid $13.5bn for storage software provider Veritas and every Symantec CEO since then has struggled with the legacy of that deal. Symantec’s current market cap, at $12.7bn, sits below what it paid for Veritas and it has taken nearly a decade to grow Veritas’ sales by just 25%.

Regardless of the failure of the Veritas buy, Symantec has been increasingly inactive as its competitors grabbed seats in several markets. Take security event and infrastructure management. Surveys of security customers by TheInfoPro, a service of 451 Research, show that Symantec ranked third in that category in mid-2011, shortly after HP spent $1.65bn on market leader ArcSight. Subsequent deals by IBM (Q1 Labs) and McAfee (NitroSecurity) pushed Symantec further down in the rankings.

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Ensighten eyes tag management market with TagMan buy

Scott Denne

Contact: Scott Denne

Ensighten picks up TagMan to bring additional customers and technology to its offering for tag management, a space that’s seen little M&A activity. The deal brings Ensighten a smaller competitor, but one that does about two-thirds of its business in Europe, giving it an opportunity for international expansion. The combined company will have less than 200 people. Petsky Prunier advised TagMan on its sale.

Tag management vendors have been a tough sell – TagMan was on the market for about a year and Search Discovery’s Satellite technology, which sold to Adobe last summer, saw little interest from potential acquirers beyond Adobe. Most large marketing software firms have already built or bought tag management technology to go with their own apps and view tag management as a feature.

Ensighten, which just closed a $40m venture round in January, and competitors like Tealium and BrightTag aim to build tag management systems that make it easier for marketing products from different vendors to share data. The market for stand-alone tag management software is still nascent, likely less than $50m in annual sales. While big software companies are focused on selling their own applications, they’re unlikely to put a premium valuation on a platform that would enable customers to integrate marketing apps from competitors. Deals in this space will remain small for the foreseeable future.

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