Q3 2008 Vertical Application Software Market Overview
Vertical market acquisitions are consistently strong as strategic companies broaden and target their offerings and PE firms fill out their portfolios. Not surprisingly, Financial Services was hands down the most targeted sub-sector. Healthcare and Government verticals were also highly targeted M&A arenas.
Deals were done in nearly all aspects of Financial Services technology including banking systems, compliance, trading platforms, investment and portfolio management, payment systems, front and back office, and others. Though M&A was strong in the past quarter for the Financial Services software vertical, there could be a different picture for ensuing quarters, a picture that could impact the entire tech industry.
Companies that are vertically focused on financial services are likely to increasingly feel the direct impact of the current phase of the economic crisis. By most estimates, the Financial Services sector (the tech industry’s perennial biggest spender) represents about 18-20% of overall tech spending worldwide and about 27-28% of purchases of leading edge, advanced technology. This spending is going to come under pressure as IT organizations in finance are going to freeze and/or limit their discretionary spending budgets and try to contain their day-to-day operating budgets.
Vertical Applications - A/E/C
In the latest CFMA Technology Survey, the leading software tool for estimating, and the second most popular tool for job cost accounting and project management was “other.” According to the same survey, the product with the greatest market share, Timberline, has less than one-third of the job cost accounting software market and about one-sixth of the construction project management software market. Its biggest rivals are “other” and “none.” These numbers tell us this is an immature market with potential for growth and poised for consolidation.
In the Architect, Engineering, Construction (A/E/C) space there are signs of consolidation as the larger, better funded vendors expand existing product lines and buy adjacent market domain expertise to drive growth and solidify their defensive positions. Earlier this year Sage Software bought Tekton Group, a prominent construction software vendor in the British Isles. NetSuite's acquisition of Open Air in June gives the company a toehold in the professional services vertical (A/E) to complement its SaaS services for ERP, CRM and accounting, and indicates an interest in the space from vendors beyond the usual A/E/C complement of competitors.
Deltek’s return as a public company and their very recent acquisition of the MPM Earned Value Management solution and all related assets from Planview, Inc is interesting in the Project-Based Solutions (PBS) niche. PBS is Forrester Research's term for the array of software products that manage and support project-based business processes. Projects are a core activity in A/E/C and also in other vertical markets, so there’s some overlap; some of the companies named below are not competing vigorously in the A/E/C space.
Deltek is the A/E/C leader in this software category. In 2007 Forrester Research, which expects the PBS market to grow to $6.5 billion by 2010, named 15 vendor companies representing 17 solutions in this market niche: Agresso, BST Global, Computer Methods International Corp. (CMiC), Deltek, Epicor Software, IFS, Lawson, Maconomy, Meridian Systems, Microsoft Dynamics, Oracle, Primavera Systems, Sage Software, SAP, and Tenrox. All of these companies are challenged as their customers demand expanded solution scenarios, tighter integration to project management methodologies, industry specialized solutions and improved integration, deployment and collaboration support. Some M&A activity here is anticipated.
Vertical Applications – Financial Services
As we alluded to earlier, it has been a tough quarter for both banks and insurers. Around the world, beginning in the U.S., major banks have been either sold at spot prices, gone bankrupt or have been bailed out by their respective governments. You might have figured that M&A among the vendors serving these institutions would have been reduced during such stormy times.
However, to the contrary, once again the Financial Services segment of the software industry is one of the most active. After a brief drop in number of transactions in the second quarter, we monitored an increase this quarter for the second time this year. Quite appropriate for these times where financial institutions were not properly assessing risks associated with complex financial instruments they were buying (or creating and selling), risk management will see heightened levels of M&A activity. As we predicted at the end of the first quarter, we have seen many deals in the Governance, Risk, Compliance Management (GRCM) area. So far this year, GRCM has accounted for nearly one-fifth of all the transactions within the Financial Services vertical segment as we track it. Deals related to insurance were at a similar level, while acquisitions of companies providing payment solutions or trading-related solutions each accounted for roughly 15% of the volume in this sub-segment. The remaining one-third of the deal volume this year was with vendors supplying solutions for lending, portfolio management, core banking and EIPP.
Of the financial services GRCM-related transactions we tracked this past quarter, one of note is Moody´s $189 million acquisition of Belgium-based Fermat International. Moody, already a strong supplier of analytical tools for commercial banks, is accelerating its goal of offering a comprehensive, end-to-end risk management solution with this highly complementary acquisition. We are certain with the increased cry for governance and compliance by politicians in conjunction with governmental bailouts, we will continue to see more transactions focusing on those areas of the GRCM solution sets.
Deals involving insurance suppliers were also steady this quarter, one of which was the £198 million acquisition of SSP Holdings by private equity investors Helman & Friedman. A second one worth noting also involves a UK-based company, Vebnet. The insurance giant Standard Life acquired AIM-listed software vendor Vebnet for £24 million to gain deeper access to an important customer base and to open new routes to market.
Finally, an interesting deal highlights how effective online marketing can be and opens the discussion as to the value of a blog website. In July of 2006, a blog called bankaholic.com was founded to provide commentary on deposits, savings accounts, and money market accounts. The site also provides comparison shoppers the ability to shop for insurance and banking services. The company, employing only one person, enjoyed the popularity of 8,000 unique visitors per day and was just sold at the end of the quarter for a whopping $12.5 million plus $2.5 million in potential earn out. Now that is a fantastic price to employee ratio!
Vertical Applications – Other
Vertical market software companies have historically been attractive acquisition candidates. When these firms have strong technology, a focus on customer support, and a commitment to innovation they are positioned to add real value to an acquirer.
Vertical market software companies have natural advantages that are much harder for a broad, horizontal application to exploit. For example, domain expertise is clearly evident to their customers. Their marketing challenge is more straightforward, not only in creating a focused message but also in targeting that message to the interested audience. It is easier to build a brand in a highly defined market. When the vertical market software company has a high commitment to customer satisfaction, their customer base tends to be loyal and provide tremendous word of mouth advertising. Once established as a “standard” in the market, a vertical application achieves something like critical mass, which in turn can be leveraged into higher profit margins. Of course, every industry is competitive and vertical market software companies also face challenges. They operate in niche markets, limiting growth. Competition between the top players can be brutal, resulting in razor thin margins on new sales. Geographic boundaries may be difficult to cross as many distinct regulatory requirements or business practices may be difficult to address in one application.
A couple of specific sectors demonstrate how consolidation trends can benefit small vertical market software companies. In the late 1990s, the ERP software space began to consolidate. In short order only a few large players were left, such as SAP, Lawson, and Microsoft. It looked like the small ERP player who missed that wave of consolidation had no hope of selling. But a new wave of consolidation around vertical market ERP players began in about 2003. Newer players like Infor Global Solutions and Consona Corporation began acquiring vertical market companies, even “micro-verticals.” Consona has its roots in a public company called Made2Manage, which was taken private by Battery Ventures in 2003. Then Made2Manage launched a planned strategy to acquire small vertical market ERP companies that were leaders in their respective markets, providing liquidity to the shareholders of a number of small but focused software companies.
Another sector showing current consolidation is vertical market software for the mining sector. Opportunities for vertical market software companies are driven by the underlying strength of the industry they serve, and the fundamentals of the mining industry are excellent. Recent years have seen unprecedented demand for minerals and metals. Not only do the developed countries have a huge demand for commodities, the developing economies of China and India are requiring resources at an increasing pace. While mining is a cyclic industry, there does not appear to be a slackening of demand. Many experts believe mining is in a “supercycle” where commodity prices will remain above historic levels for years to come.
Big mining companies (Rio Tinto, BHP Billiton, Alcoa, Alcan, Xstrata to name some) have been jockeying for acquisitions. Software companies serving the sector are seeing the same phenomenon and private equity is playing a leading role. In May 2007, Francisco Partners, a $5 billion private equity firm focusing on technology, took Mincom Limited private in a transaction totaling AUS$315 million. The price reflected a premium of 110% on the most recent share price and a multiple of about 1.4x on prior year revenues. A major incentive for Mincom to accept the transaction was the ability of Francisco Partners to fund growth by acquisition. More recently, JMI Equity ($1.3 billion in capital) and Carlyle Group ($81 billion in capital) took Gemcom Software private in a transaction valued at about $190 million, a 17% premium to the trading price and a multiple of 3.5 on prior fiscal year revenues. These are two situations where smart money, committed to market leadership, has paid a premium to enter the mining software industry. No doubt we will see the private equity backers of both companies driving growth by acquiring other vertical software companies in the mining sector.
Their strategy looks well timed because the mining sector is ready for a consolidation of the individual point software solutions that exist today. Mine managers are becoming increasingly sophisticated about how to use technology to drive down operating costs and improve productivity. With many mineral prices at all time highs, mining companies want to do all they can to maximize efficiency. The larger software companies serving the mining industry have a vision of how they can contribute across the entire “pit to port value chain.” However, no company yet has all the pieces in place to do so. That spells opportunity for software companies in the mining industry who can fill in the product gaps as the larger firms build out their product suites.