March Webinar: Forecast 2012, Part 3 and The Facebook Effect
Ward Carter
Hello, and thanks for joining us and welcome to Corum’s March tech M&A monthly, and part three of our Forecast 2012, focusing on the increasing role of private equity in the tech M&A market.
I’m Ward Carter, chairman of the Corum Group, speaking to you form our headquarters in Seattle, Washington. You are part of a group of hundreds of software and technology executives from over 24 countries who have registered for this event.
Here is our agenda for the next sixty minutes. We will start with our global market overview, hear a special update on the Facebook Effect, and then review some concerns on the horizon regarding what could happen to valuations. Corum’s Research Department will provide an update on recent transactions and valuations in the major software and related technology sectors that we track. We’ll follow that with a special presentation on private equity, followed by our private equity panel, as they share insight on how PE is creating the next generation of valuable, enduring IT companies. At the end of our session we’ll open the floor for Q&A.
Our list of speakers today includes Corum presenters from around the world, and they will be introduced in more detail later. We also have a great group for our PE panel, that includes Michael Wand from the Carlyle Group, Dean Jacobsen from Accel-KKR, Ryan Ziegler from Edison Ventures, and Javier Rojas from Kennet Partners.
Now, I’ll turn the floor over to Corum’s president, Nat Burgess.
Nat Burgess
Thanks for that introduction, Ward. We’re very excited today about the presentation that we have for you. We’re going to cover a lot of ground, we’re going to move quickly, and we’re going to start at a global macro level and then zero in on the PE community that is driving a lot of the deals we see today.
To start us off in our monthly tradition, our Founder and CEO Bruce Milne, who is actually traveling today, back from Europe, has given us his thoughts on the current state of the market. Over to you, Bruce.
Bruce Milne
Good morning. Sorry I can’t be with you today. I just finished conferences in London and Stockholm and I’m in route. I’ll be quick today because we have an extraordinary private equity round table, one of the best in years.
We’ll start in China. Stocks have risen to a two-month high as consumer and property stocks advance. Despite that, we’re seeing a bit of slippage there, primarily because of European trade, and we’ll get to that next.
The UK economy shrank in the 4th quarter as companies scaled back investments. The German economy contracted in the 4th quarter as exports fell due to the debt crisis. The UK pound fell against the US dollar as the factor index climbed to a six-month high. The Euro Region economy is poised to shrink in 2012 as Italy contracts with Spain. Finally, the Greek rescue has left the European default risk alive.
These were the headlines that came out during the month. The point is, they’re still worried over here and I’m going to have a special report in just a few minutes on some of the red flags that we are seeing.
IMF: Global economy still facing major risk from Europe. Germany’s confidence defied the Euro Region recession as Italy contracted. Germany is an economic miracle, primarily in manufacturing. Spain sank deeper into the periphery with the debt crisis. The UK’s January producer prices climbed faster than expected on raw materials, and the UK’s factory output jump exceeded forecasts as the trade gap shrank.
In the United States, consumer sentiment has reached a one year high. Jobless claims are improving, now at a four year low, consumer comfort is also at almost a four year high. The Michigan consumer sentiment index has fallen, however.
The labor market gains have boosted US consumer confidence, the S&P 500 has risen to the highest level since 2008, we are looking at the best US auto sales streak, also since 2008, boosted by Toyota. Finally, US consumer confidence is holding near the four year high, according to the Bloomberg index.
Now we look at real estate and commodities. Home prices declined 2.4% in the 4th quarter. That is a little bit misleading, because that is compared to last year, not month over month. Foreclosures will climb in the US before the bank deal helps the housing market heal. This is really the huge overhang. The problems are so many foreclosures, so many houses with value nowhere near what the loans on them are, and there’s a huge backlog of foreclosures. The problem is they can only move through them so fast. Some of the foreclosures in some regions are limited by local laws.
Housing declines may have cost a generation of buyers, according to the Fed’s Bullard. Oil has risen to almost $110 as the S&P 500 closes at the highest level since June of 2008. Finally, new home sales exceeded forecasts in January.
Moving to technology and closing up the market overview, Facebook value declined to $93 billion in the SharesPost Auction ahead of IPO. The reason I brought this in, it is obviously old news, but there is this whole phenomenon of people like Zynga, Facebook, Groupon, where even though they are private, we know the value of them.
Yelp filed for an IPO, we’ll talk about them next month, and Facebook finally filed for an IPO. We’ll have a report on them later today.
Now, I’ll turn it back to Nat.
Nat Burgess
Thanks for that overview, Bruce. Exactly on that topic, we have a very interesting dynamic in the market today, where some companies have gotten so big, so influential, and raised so much money, that the lines get blurred between public and private. To report on that subject, we have our Senior VP, Jon Scott.
Jon Scott
Thanks, Nat. There are always changes and interesting influences on tech M&A and here’s a recent twist. It’s being referred to as the “Facebook effect on the new Public/Private Companies.” I want to quickly highlight this, it’s something I call “Mezzanine Financing at its best.”
First look at Facebook, still private but really making some significant moves as a Private/Public company. Keep in mind that these are still private transactions. In January 2011 they raised $550m from Goldman and Digital Sky Technologies, the Russian investment firm. In the same month they added another $1B to this capital raise.
What are they doing with this money? Well some of it is for working capital but a part of this “Mezzanine” capital goes into acquisitions. In fact as Corum research analysts pointed out in our recently published 2012 WorldTech M&A Report, Facebook did 12 acquisitions in 2011 including Beluga, rel8tion and Sofa. And this acquisition trend is continuing!
Here’s Zynga, same theme, they raised almost half a billion last year in private funding from SoftBank and Google, raising their total funding since 2008 to $845M dollars. Again a chunk of this went into the 13 acquisitions they did in 2011 including Newtoy and Page 44 Studio among others.
So what’s driving this? While not a totally new concept, the dollar values these tech companies are raising late in their “pre-public” stage are staggering. How are these values established?
Well, there are secondary markets being created like SharesPost and Second Market which allow private holders of these stocks to make them available for sale. Based on these selling prices a market cap can be implied. Second Market claims they have sold $1B in private company transactions in the past three years and SharesPost claims $625M in 2011 alone.
Based on these valuations investment banks are helping some of these growing tech companies raise large amounts of funding, pre-going public. This is helping them gain a strong competitive advantage and grow significantly, and delay their need for an IPO.
Here’s SharesPost from May of 2011 and the blue circle at the bottom shows Facebook with a $78B valuation.
Eight months later, from yesterday, SharesPost shows FaceBook with a $101B valuation. One question I have is that at yesterday’s valuation there isn’t much upside in Facebook stock for IPO investors if you believe what some analysts say, that they’ll go public at about $42 a share which would give them about a $102B valuation, where it stands today.
SharesPost even reports an index value of these Public/Private companies. Here is the Twitter and Facebook index recently reported. So what we have now are a number of hybrid companies that overlap in both the private and public space with the ability to raise significant funding before officially “going public.”
So, who might follow this Public/Private “mezzanine” trend? Companies I’m watching include Foursquare, Twitter, and DropBox, among others.
Nat, back to you.
Nat Burgess
Thanks, Jon, very interesting. One of the factors here with these quasi-public companies is that they have quasi-insider trading restrictions as well. We’ve seen a couple of key people basically be terminated from these companies as they have been trading shares on the private exchanges, which is maybe not an SEC violation, but is most likely a company management agreement violation. I’m sure we’ll see more of these coming along and we’ll see some of them going public.
We’ve been talking about markets and trends and opportunities, but we also need to bear in mind that although things are going very well and we’re putting in lots of miles and we have a bunch of deals now, I think four scheduled to close in the next thirty days, there are plenty of risk factors out there.
Bruce was over in Europe presenting to a group of industry people yesterday. They are a little more paranoid and concerned over there because they’ve had a tougher time recently with our economy. They were asking questions like what would happen if one of these events occurred, and this caused him to think it through a little bit and put together this special report.
Over to you, Bruce.
Bruce Milne
One of the current things here in Europe is that they are very cautious about futures. We have just gone through an extraordinary period with the debt crisis, and it is not over. One question that came up at both the London and Stockholm Merge Briefings, “We’re doing great, it looks to be a banner year, but what could kill it?” It reminded me to look to last summer, with the sharpest drop in the Dow in history over a very short period of time. We were decimated and people were quite desperate in September, how short our memories are.
I came up with five things that we talked about at the conferences, where there were nearly 60 CEOs. Number one is a fall in China’s growth rates. One of the problems is that we just saw Australia’s growth rate come in at half forecast. Some of the tiger economies are being readjusted downwards. Could that happen to China?
Second is interest rates rocketing. How long can they stay down? We’re getting some inflation, we’re seeing commodity prices going up, what happens if interest rates go up? We haven’t had recovery withy the interest rates down, what happens if they go up?
Oil prices. This is a huge one. We have oil going up at the moment, isn’t that what helped cause the last recession?
The crash of an inflated dollar. This could come just because people get comfortable again with other currencies and the US isn’t a safe haven. We have been way overspending, and everyone is predicting that our dollar will have extraordinary inflation or lose its value. What happens if it does?
The fifth is real estate takes a sharp drop again. We’re not done. They say that there are 10 million foreclosures that have to be worked through, and what happens if the job market doesn’t recover and we have another down draft? Guess what? It’ll probably drop again.
We are doing great, but there are some red flags on the horizon so we should be cautious and watch out.
Nat Burgess
Definitely, Bruce, and there is of course also the uncertainty in the Middle East on top of all of that.
With that, we’ll go into our monthly update on the most important trends and data in the tech M&A market. Over to you, Elon.
Elon Gasper
Thanks, Nat. And our thanks to Bruce for the warnings, but for now the good times roll as the public market indices printed a third monthly increase and their best February rise in the last 14 years, since the heydays of 1998. Across the board advances were led by technology issues and other growth stocks, and it looks like for tech M&A our Corum Index is showing a lot of shiny green too, particularly in terms of total value, with multiples and other measures pretty steady across the sectors, right Amber?
Amber Stoner
Right, Elon. The number of transactions and mega deals has stayed pretty steady year-on-year for the month of February, although we’ve seen the largest deal size increase from $1.5b to $2b. The largest deal was Oracle’s acquisition of Taleo for approximately $1.9 billion, net of Taleo's cash and debt, implying an equity value of approximately $2b. Oracle views Taleo’s talent management cloud as an important addition to the Oracle Public Cloud, especially in conjunction with Oracle’s recent acquisition of RightNow.
We did see a drop in the number of private equity deals, however the value of those private equity deals increased by almost 86%. The biggest contributor to that was another of our mega deals, Advent International and GS Capital Partners’ acquisition of TransUnion, a provider of information management and risk management solutions, for approximately $1.7b. Advent and GS Capital Partners, the private equity arm of Goldman Sachs, plan to grow TransUnion in both the US and key growth markets in Latin America.
We have a couple numbers that have changed pretty dramatically. The sharp decrease in percentage of deals with a public seller can likely be explained by the almost 46% increase in VC backed exits as being VC backed and public tend to be mutually exclusive. And 8% of the targets being public is actually pretty well in line with the percentages we’ve been seeing for that group over the last few months. Elon, shall we start the market sector analysis with Internet?
Elon Gasper
Sure, Amber. Internet valuation multiples rose last month, along with most of our market sectors. I think there’s one deal that stood out that we should mention. Pundits predicted for years that Apple would someday buy an internet search engine – for websites. Instead, last month it bought one that searches for apps! With 25 billion downloads of over half-million apps, even a tiny tweak to the App Store’s efficiency swings a lot of leverage, so the iCook and his team found it timely to tap a teensy bit of their hundred billion dollar cash stash to buy a better way to find what you want to load on your new i-phone, i-pod, or i-Pad number or no number.
This better way to discover apps, Chomp, features faster response, true search by function and advanced parameters, additional browesable surfaces and area, twitter and Facebook integration, plus an extra 2 years’ archive of user app reviews (Chomp’s Aussie-born entrepreneur and his friends got this one started waaaay back in ‘09). One suspects the Android side of Chomp may be shut down to boot, heh heh. So: superior search, social merchandising, a kick at the competition, plus a top Bay Area team. What will this mean for other app ecosystem value-adds, including other app search outfits like Germany’s App Meister? They should expect a bid if they can demonstrate an advantage now, because the big companies just can’t wait for dev projects as they watch Apple lock up these markets and lock them out. Particularly with the Apple spaceship able to beam up plenty more companies, since Apple could bite off another $50 million dollar Chomp a day for years without eating through the bushels of money it already has. An Apple a day is supposed to be healthy, isn’t it, Amber?
Amber Stoner
I have heard that, and I’ll call out a healthcare example in this next sector, the Horizontal Markets, where we continue to see Software-as-a-Service being a determining factor in consolidation within the horizontal space - something for growing companies to bear in mind as they develop their business models: there are many kinds of recurring revenues, but SaaS sells, and usually for higher valuations. In this case, Francisco Partners’ portfolio company, API Healthcare, acquired Concerro, a company that provides medical employee scheduling SaaS. The acquisition will enable API to accelerate the path to SaaS for its workforce management technology as well as enabling it to significantly increase its ability to deliver workforce management solutions to the healthcare community.
Elon Gasper
Speaking of solutions, in IT Services we highlight a classic case of buying growth while shoring up strategic capacity. Though the days are short, London-based BPO Services provider Capita Group craved growth enough to brave a cold march north to Newcastle to annex burgeoning UK ERP systems integrator Smiths Consulting for its SAP expertise and market presence in government, telecoms and finance. Capita satisfied its jones for Smiths with that quaint British currency, the pound: 10 million of them to be precise, plus 2 million earnout if they make their milestones, or about 16 million US dollars, for close to the classic 1x revenues -- about halfway between January and February IT Services averages. Capita also rushed to wrap up Salmat Speech Solutions’ UK ops in January, plus last Dec 23rd they placed Applied Language under their tree, too, and even acquired a couple non-techs in between these ITs! The take-away for entrepreneurs is not to think that a buyer always rests to integrate each new acquisition—clearly there was no winter hibernation at all for Capita’s corp dev team.
Amber Stoner
In the Vertical Market, also staying awake and active this winter is Carlyle’s portfolio company SS&C Technologies, which just acquired the PORTIA business unit of Thomson Reuters for $170 million. PORTIA is a middle-to-back office investment operations platform that will complement SS&C’s existing solutions portfolio, adding to SS&C’s offerings in the portfolio management software industry. What small company execs should understand from this, and from the API Healthcare deal I mentioned previously, is that Private Equity firms don’t just buy companies themselves, but often continue to pursue growth by funding additional M&A within their portfolio. Alina will talk more about strategic “bolt-on” moves like this in her report on the world of PE.
Elon Gasper
Let’s shift worlds now to the Consumer Market and its game sector, with an adventure for cutely named company, Little Text People. Imagine: you are a Seattle game development studio, in a maze of twisty little passages, all alike, filled with graphic action shooters and social network Zynga clones. To escape, with your bare hands you prototype a unique game architecture, a sort of old-fashioned conversational text game, but with innovative core neuro-AI that simulates emotional transactions with non player characters, or something like that. Now a possible exit opens—through M&A: You fill a strategic need for pioneering 3D virtual worlds company Linden Lab, which was searching for a touchstone differentiator to engineer its own escape from certain limitations of its aging codebase still hosting millions of users who’ve built virtual goods, environments and a “Second Life” therein.
This will be just one of hundreds of video game deals worldwide this year, predicts industry veteran and Corum dealmaker Jim Perkins. He told me yesterday that the space is hotter than he’s ever seen it in social, online and mobile gaming. So for you other companies with the next big game thing, little or not, text or graphics or AI, here’s a chapter of this market’s interactive non-fiction that’s writing up plenty of opportunity to experience your own tech M&A adventure as the buyers seek strategic value.
Amber Stoner
We see strategic value driving deals in Infrastructure, too, where Juniper Networks acquired start-up security software company Mykonos Software for $80 million. Mykonos provides Intrusion Detection Systems that protect websites and web applications, which will become a key component of Juniper’s long-term vision to deliver an always protected environment across devices, applications, the network and the cloud. Juniper probably wouldn’t be anyone’s first thought as the buyer for this company, but the buyers don’t have to make their direction clear to the public, an important fact to consider in searching for a strategic partner in any tech M&A sector. With that said this acquisition allows Juniper to extend its security footprint to bring next-generation, deception-based web application security to physical, virtual and cloud environments. But we’ll extend our sector analysis no further today -- Elon?
Elon Gasper
Right, Amber, instead we’ll learn more about Private Equity before convening our panel on that subject, in a special report now from Corum Senior Analyst Alina SOLTYS.
Alina Soltys
Thanks, Elon.
In this pre-panel segment, I thought it would be useful to put up a framework for how large and intertwined private equity companies participate and influence the tech world. We’ll take a look at the top acquirers, top spenders in 2011 as well as some investment philosophies different firms have.
Top Acquirers:
Here’s a collection of the top acquirers by deal number who either bought directly through the PE fund or through one of their portfolio companies.
The honors go to Hellman & Friedman whose portfolio company, Internet brands was especially busy with 12 acquisitions alone. They like to purchase web properties that have very dedicated and particular sets of users. For example they acquired 5series.net for BMW lovers and a blog called inhabitat with a focus on environmentally friendly and sustainable architecture.
Of course the top 3 firms are all based in Silicon Valley which continues to be the first stop for funding but other cities like Chicago, Atlanta and Boston are represented.
The PE community certainly has been busy acquiring as well as aggressive raising funds with announcements coming in every few days of newly closed funds.
So if we move on to the most spent by these firms…
Top Value:
These values are in the millions and only disclosed figures are represented here, so this picture and order could change drastically as further information become available.
To give you a sense of how large some of these firms are, the two largest Carlyle and KKR both have over $40B in Assets Under Management. Interestingly enough we’ve seen PE firms back off of writing those multi-billion dollar checks as they did 3 times in 2010. Last year saw only 1 deal done by Private Equity that ranked / hitting in the top 20 highest valued tech deals. This really points out that their corporate rivals have been spending some of that cash that has been coming in hand over fist.
Investing Philosophy:
So before I hand this off to Nat and the PE panel, let’s take a look at what certain firms keep in the back of their mind when making investments and where they find value.
Consolidating an industry is ideal for an investor who has specific market knowledge as well as the funds to take advantage in creating economies of scale. ERP was the chosen one last year when Apax Partners reached out to grab both Epicor and Activant for a combined value of $2B.. Right after Infor who’s backed by Golden Gate pick up a public Lawson for $1.8B
Themes:
Some firms, led by their MDs and founders have certain visions and themes they like to focus on. We heard from Brad Feld of the Foundry Group last month about the overarching themes that run through all of their investments.
Francisco Partners is also one of those firms that likes to keep some particular themes in mind when investing. One of which revolves around efficiently reaching the end consumer with marketing automation and data analytics.
EmailVision which fits the bill here has been used as a platform for bolt-ons, of which it added 3 in 2011.
In fact talking about bolt-ons, Corum’s client WhatCounts that we sold to RiverSide is now being used as a platform for bolt-ons like Blue Sky Factory.
Industry Focus:
Often times firm specialize as they become more knowledgeable around a certain industry and the players there. GTCR has been on the hunt for financial services companies acquiring FundTech and Bankserv last year. And there are always opportunistic one-off plays beyond the three listed here.
Let’s move on to our panel who I’m sure will share a lot more from an insider’s view on the industry at large.
Nat Burgess
Thanks, Alina, very interesting.
Now, we are lucky enough to have with us four of the most successful and experienced private equity professionals operating in the technology sector. For our audience, I want you to quickly ask yourself a question. If someone gave you a half a billion dollars and told you to go out and make money by building the next generation of great IT companies, where would you start? Technology is complicated, people are complicated to manage, the markets change quickly, you have to be profitable. This is one of the most complex ways that you could come up with to generate a profit. Some people have proven to be very good at it, and four of them are here today.
We’ve been very busy at Corum running around the world, trying to find deals that make sense for these guys, they’ve been busy making investments, this is a chance for us to stop and think through some of the themes that are driving the market and some of the themes that will be very interesting to our audience today.
As a starting point, I’ll ask each panelist to briefly introduce himself, his firm, and mention a recent transaction that could be relevant as we get into the deeper discussions. I’m going to go in the order of the photos on the slide here.
We’ll start with Michael.
Michael Wand
Hi, Nat. Thank you very much for the introduction. This is Michael Wand with Carlyle. I’ve been with them for about 11 years right now. I am in charge of two funds which invest in growth capital and expansion capital situations in Europe in the technology space. We are managing a total of $1B at the moment. Our sweet spot from an investment perspective is $20-70M, and as I will explain a little bit later, most of our companies are those which go for the next growth step, which could be internationalization, and increasingly acquisitions that change or add to business models.
We have a couple of examples if I could name two that are relevant in this context, one is called UC4, an IT process automation company, originally based in Austria, and which we moved more and more into the US. We also did an acquisition in the States, which means that at the present around 50% of our revenue comes from outside of the European marketplace. At the other extreme, a much younger company, we acquired the Foundry, a visual effects software company based here in London. Again, it was a company heavily geared to the international market and we are trying to help them to establish a stronger foothold, particularly in the film industry in the US.
The story is always the same in terms of starting with a local champion or a niche leader and then seeing over time if we can get them to a more global footprint and this is increasingly leaning toward not only the US, but also the Asian market.
Nat Burgess
Got it. Thanks, Michael, for that introduction.
Next is Dean Jacobson. He is normally just south of us here. Where are you today?
Dean Jacobson
I’m in Amsterdam. I’m doing exactly what we’re going to be talking about, which is helping our portfolio do acquisitions. I’m actually here in Europe for the week, working with a couple of our portfolio companies.
I’m a principle at Accel-KKR. A little bit about us, as the name would indicate, we have affiliation with two other firms, Accel Partners, a well known VC firm and KKR. That said, we are independent, in some ways very similar to Michael’s firm. We have $2B in assets, really focused on software and software-enabled services, in the lower end of the middle market, business with $20-150M in revenue. We are backers of management teams and I would say singularly focused on helping our portfolio grow. And that is, how do we help accelerate organic growth and how do we help augment organic growth with inorganic growth.
The example I would bring up is that we recently recapitalized through two other PE firms, a business called Endurance International Group, which is an online service company focused on SMBs. When we invested in 2008 that had historically been a flat organic grower, but had a very compelling technology platform that allowed us to do acquisitions very cost-effectively and creatively. What we did over the three years of our investment was dramatically accelerate the pace of acquisitions, more than tripling it in three years, and then invest heavily in growth, taking a 0 organic growth business to a growth rate in excess of 20%. That resulted in a pretty dramatic change. One of the things we like about software and software enabled service businesses is the operating leverage that is inherent in them. It was a business we were, with a lot of hard work, able to transform and grow the top line dramatically and in the process grow the bottom line by 5x. We ultimately sold it for $1B at the end of last year.
Nat Burgess
Great story, great return for your LTs. I’d like to shift over now to Ryan. How about a quick introduction?
Ryan Ziegler
Ryan Ziegler here with Edison Ventures. Edison, as a firm, has been around for 26 years now and investing out of our 7th fund, just closed that out at about $250M. We effectively manage about $1B in assets. We have invested in 180+ companies. From a track record perspective that is 17 IPOs, we’ve sold over 80 companies and we have a rich portfolio, about 60 companies ranging in revenue from $5M to about $220M annual revenue. There is a lot going on.
I fit a layer below most of my colleagues here. We define what we do as growth venture, we fill the financing gap between early stage investors and growth equity firms, where you can still create venture type returns, investing $5-15M in software and tech services companies, growing to enterprise values under $500M here and exits.
I manage our internet media and ecommerce team and the two other primary categories we invest in are healthcare IT and financial technology.
We made an investment in a company called Operative. It is effectively an ERP for digital media and they run online publisher’s businesses from an workflow and yield management perspective. That line item becomes a much bigger part of driving revenue and cost attainment as it grows, with a shift toward online advertising. We’ve recently acquired the number two operator in that space and sucked the oxygen out of the room. That created international growth and a lot of leverage that we are investing back into the business for accelerated growth.
Anecdotally, actually, in the past week, one of our original investments, the SaaS pureplay called Vocus, they went out to market in 2005, they just acquired a company for $169M to get them into the SMB space. Most recently we had a company go out this past summer, Tango, which is an on demand communications lifecycle management vendor which has growth through a strategy in the past couple of years, we’ve come to market here in what is a pretty successful IPO.
Nat Burgess
That’s great, Ryan, congratulations on those.
Our old friend Javier Rojas is also joining us.
Javier Rojas
Thanks, Nat, great to be here, I appreciate the invitation. A quick background on myself and Kennet. Kennet is a growth equity fund. We have some similarities in strategy with some of the other panelists, and some differences.
We have about $550M under management. We are currently investing out of our third fund and preparing to raise our fourth. We’ve invested in over 50 companies across multiple funds and we have realized about 80% blended returns on unrealized deals. Our model is a little different. We focus exclusively on companies that are growth 30% or more and companies that have gotten anywhere from $5-$50M. This summer we completed investing in a company that finished this year with $75M.
Typically we’re a first institutional investor, although we have done deals where we have bought out prior investors. We are active investors who join the board.
Usually our strategy is to focus on two growth opportunities. It’s all organic growth, we will look at acquisitions. In the majority of our deals, the companies have a lot of growth opportunities in front of them and they’re focused on that.
We look to grow the existing business, usually, and our investment capital supports that. Usually there is an opportunity to take the founder’s vision and look at a broader market opportunity with that and fund that opportunity. That’s where we look for the opportunity for a 10x outcome on the investment for ourselves and have a major win for the founding team as well.
So that’s basically our model. Two deals that I’d highlight. One is a deal we with Kennet Two. They were doing about $1M a month when we invested. Think of them as a managed service provider using VOIP, so kind of Skype for enterprise. They have grown to over $15M a month, while working together. There has been pretty strong growth over the past 5 years. I think what we’re probably most excited about is that we were able to take the platform and go after the enterprise market, a multi-billion dollar market, and the company now has a strong early lead in that large category. That business is now bigger than the entire business was when we invested and growing at over 100% per year. We have high hopes for that opportunity.
More recently we invested in a company in March. It is a company that does managed security. They are the leader in protecting against denial of service attacks and it is a good example of how we work with companies on a majority deal. A number of our deals are majority acquisitions, the rest are minority investments. More than half are minority investments. This was a company growing at 30% a year, didn’t have a CEO, wanted to move along the business, and we were able to bring in management to assist their strong executive team. The prior owners wanted to have a stake in the success of the business and benefit from the growth that would come from the capital and the team we pulled together. We brought in a seasoned executive in our network to run the company. The company is now growing at over 50% a year, they did $14M the year before we invested and they should do over $30M this year. They are well on their way to find a much broader market opportunity and that could be a high value outcome.
Nat Burgess
That’s great, Javier. Congratulations.
I want everyone here to note that as our professionals have been talking about their investments and how they manage them, they haven’t been talking about how much they invested or the financial aspects of the deal. They’ve been talking about things like internationalization, shifting the business model, getting more customers, all the things that help build value in businesses. And that’s really what I want to focus on today.
As a first question, in terms of a core theme, in many cases a CEO who has built a company, a lot of their net worth is on the balance sheet, there are a lot of you on the call today listening in, and you might be faced with a choice between doing a transaction between doing a transaction with one of our friends here or selling to a strategic buyer, someone who is in your industry, with whom you have synergies.
What I wanted to hear from our panelists, maybe starting with Michael, sitting in a CEO’s shows, what are the differences between doing a deal with you rather than selling outright to a strategic acquirer?
Michael Wand
Well, I think it starts with a fundamental question, whether you are a seller or if you want to keep investing and developing your business. If you are a seller, then obviously in many cases it is more advantageous to look for a strategic sale, because tentatively it gives you more value. If, however, you are in the position that you just described, where you have developed the business to a certain level and you either need fresh capital for the next growth phase or you want to take some money off the table because all your net worth is tied up, but there is still an opportunity to make the business bigger or move it in a new direction, and you want a partner who understands this, you can talk in the same language with them, and they can use their contacts and network to help you with that. Then, I think, PE or VC is the right option.
I think in contrast to many people’s beliefs we actually do have time. It’s not that necessarily immediately people are focusing on the exit a few years down the road, it is something where if you meet the right people, you define investment and growth together and work very hard to make this a reality and at some point, obviously, the exit will take care of itself.
I think the fundamental question, and I see this from time to time not appropriately being addressed in the very early meetings, do they want to sell or do they want to continue to invest? I can only appeal to everyone here and say that before you engage, on both sides, think about that fundamental position point, whether you want to continue to develop the business or whether it is time for cashing out.
Nat Burgess
I think that makes a lot of sense. It is an important enough question that I will open it up to the other panelists to see if you have similar reactions, and you might think further into the hybrid effect where you already have a portfolio company that is synergistic so you bring some of the benefits of a strategic acquirer with this opportunity for additional liquidity that comes from a PE deal.
Dean, why don’t I address that to you?
Dean Jacobson
Yeah, I would first of all reiterate what Michael said, at its core, PE firms have to be competitive from a valuation perspective. I think the reason why entrepreneurs choose to work with PE firms like those on the call is because they believe in the future of the company, and frankly the ability to, as we like to say, take two bites from the apple, one today and a larger one down the road, is very compelling.
For those who don’t see that opportunity, then strategic might be the right answer.
One of the things that we found over the years is that one of the most powerful things we can do for entrepreneurs out there who have 100-110% of their net worth in one thing, one company, just the ability to grow the business more aggressively, that enables growth. One of the most powerful things we can do is be an enabler. I think we’ve seen that time and time again.
Going back to the other point, Nat, we do have this unique ability to be financial strategic, as people like to say. Whether we have an existing portfolio or we have multiple companies that we are tracking, we put companies together and take that long-term focus on the combined business, but do it in a way where we can get the same synergies and benefits of a stratetgic.
Nat Burgess
That makes sense, we’ve watched you doing that. Javier, any comments from you?
Javier Rojas
Yeah, this is an issue we spend a lot of time on. We view the model for our funds is really around helping founders and founding teams realize their aspirations and meeting financial objectives. In my prior career I worked in banking and did a lot of work much like Nat does coaching people.
We have a model, we actually have a Powerpoint on it on our site, that lays it out. Generally there are variables that we feel are key issues. What are the personal goals of the founders’ management team? Most of the deals that we invest in either don’t have a lot of capital in them and so it is not investors driving it, it’s typically the owners who are operating the business.
What does the market window look like, and then what is the financial profile of the various options, because at the end of the day you have to make a smart choice financially.
In today’s PE market, it is quite competitive, so often the valuations that the firms at this table and others in the PE market will place on high growth tech companies with large market opportunities is quite attractive, especially compared to M&A offers, especially if one considers that the cash on what they get out and depending on how the deal is structured, there is a lot of future growth coming from that. Given the financials are often attractive in these options, it’s really a question of how much runway room do you have in your market, how much space is there in an adjacent market that you can go after and own with the right team and resources, and getting a partner to help you do that.
Finally, where are you personally in terms of what you’d like to do? I think a couple of people mentioned the de-risking themselves. That is often a fundamental problem that founders need to address when we come into the scene, or firms like ours. Founders are often comingling their personal balance sheet with the company balance sheet, and the aggressive steps they need to take to really maintain market share and broaden their market is not in sync with proof of financial of their cash flow, so we suggest a more defensive strategy. Sell some shares, de-risk a little bit, and bring some more capital to the balance sheet to help go after growth. I find that to be one of the biggest drivers in addition to looking at the market opportunity.
Nat Burgess
Those are great comments. I’m going to go to Ryan next with a nuance on that. You talk about additional capital to drive growth to make acquisitions. There is a different way of thinking about markets when you go through this process, and it’s kind of hard to articulate, but it is kind of a change in risk profile. A CEO is worrying about paying their kid’s way through college, and now they can think strategically about growing the business because the money is in the bank, they tend to change their perspective and it works, we’ve seen it work again and again.
Ryan, you referenced a deal that you worked with Operative, where you bought a competitor in order to create a better operating environment for the business. Now, is that the kind of strategy that you think that company, not to put them on the spot, but could have/would have pursued on their own or is that the kind of transaction that only became possible because of their partnership with you?
Ryan Ziegler
I think credit is due to both sides here. We invested in the company in 2005 when they were a $5M company and they are 10x over that now with good execution and some of those inorganic transactions that I mentioned before. I think they earned the right to build enough scale and sustainability in their current business to go out and look for different ways to grow the business in capital efficient ways, and once we’re on the same side of the table with our entrepreneurs, we’re obviously trying to accelerate growth in non-diluted ways, in the use of debt and strategic business deals where we can cut deals with others that would want to acquire the business. If they’d rather do that we could maybe structure a performance-based deal with warrant issuance in the future based on revenue attainment that comes in.
In the case of Operative, what was happening in their market is that they are essentially the plumbing for the digital media industry, it’s the un-sexy portion of that, but fundamental to the work flow, how these companies get paid, and manage inventory and the like. There was essentially two players in town. We believe there is never a merger of equals, so we acquired the other business, as we thought we had a better technology team and market approach, and had enough understanding of the landscape to make that calculated bet and architect that deal with the CEO through stock and a combination of debt. Fortunately there are debt providers that are investors, limited partners, so it was an insider transaction, and the company grew 75% while recurring revenue doubled in EBITDA and has now expanded internationally into South America, Asia, the Australian market, and has a larger footprint in Europe.
At the time, conceptually, it made a lot of sense, but with a lot of hard work in execution in supporting the CEO and the transition team, they were able to transition all the clients over to their software stack in a six month period and retain those relationships.
Nat Burgess
That’s fantastic, sounds like a great partnership. I’m going to put you all on the spot in a moment. When I do segments for CNBC, I always have to have something very brief that can stand on its own and doesn’t disclose anything confidential. I’ll give you all the same challenge. I want you to think of the three pieces of advice you would give a CEO seeking a PE recap in terms of what they should do in order to succeed. Let’s just take it for granted that they have built a company with a reasonably good profile for you.
We’re down to two minutes. Michael?
Michael Wand
I would say be honest, that is, if you want to retire from the business over the next few years, then let your potential investor know. It should be clear. Plan carefully what exactly you want from the deal, is it a recap, is it growth capital, how much do you really need?
Dean Jacobson
I guess the three things that I would say are talk to your advisors, make sure you have all your ducks in a row, this process can be trying, so do all preparation you can in advance.
The two things I would give the most focus to are 1: Figure out what you’re looking for. In the deal, do you want to sell a majority or a minority? Is it liquidity, growth capital, etc. Just as much though, 2: Who are you looking for? What are you looking to get out of the firm and who is the person you want to work with? This is like a marriage, a long term relationship, and you have to make sure that the firm you are working with is going to deliver what you’re looking for. The person you’re working with should be a person you will enjoy working with. If you don’t have that, it doesn’t bode well for a long term relationship.
Finally, I’d say is do your own diligence. I always tell everyone that I work with that they should do diligence on me, call our portfolio, call the CEOs of the companies when we made the original investment, etc. We’re going to do diligence on your business and you and you should do the same.
Ryan Ziegler
Sure. Building on what Michael said before, be candid about your strengths and weaknesses and that of your team. That shows maturity.
Javier Rojas
My number one approach is that often even in the case where you planned to sell 100% of your company, a lot of the times, once we meet with companies, the founders get excited about keeping a stake in the business. Often, you’ll make more money on the equity you have in the business than the initial deal, even if you get a fully competitive market price, just because there is a lot of growth left, at least in the kind of companies that we look at.
So, to me, the biggest issue is who is the business partner you are signing up with? Really, if you’re shopping for money, I think the way to think about this is if you are shopping for a business partner, they have to pay a fair price.
With that lens, the two things that jump out are to look at other deals they have done which are like yours. Look at how they worked out, talk to the CEOs involved, etc. Talk to CEOs in places where things haven’t gone well, too.
Nat Burgess
Makes a lot of sense. Guys, thanks so much. This concludes our monthly tech M&A webinar.