April 2010 Corum Flash Report
Mark Reed
Welcome to the Corum M&A Flash Report for April 2010,
which we host on the first Thursday of every month, putting current events and
economic news in a context relevant to software executives who are building
their companies and planning for strategic transactions like M&A. Today, we are looking at what it takes to
successfully pursue M&A in the new economic realities of today.
I'm Mark Reed, Executive VP based here in Seattle, thanks
for joining us. I think with the last
roster I saw, we had about 250 executives registered for this event, from 18
countries around the world.
Today we'll have Bruce Milne, the CEO and founder of Corum
Group, starting off with an overview of the economy and big picture factors driving
the M&A market. Next we'll go to
Dougan Milne, who is the head of research here, who has a briefing on the
M&A activity metrics and valuation trends.
Then we'll go to Nat Burgess, President of Corum Group, who is going to
give very practical and focused insights about what it takes to sell a software
company in today's market. Then we'll
wrap up with our usual Q&A session.
We'll keep this event to about 60 minutes. You will want to stay tuned for the Q&A
at the end, after our guest speakers. As
to the logistics, please ask questions at any time, using the Q&A box on
the right side of your screen. We'll
address all the questions at the end, but ask them whenever you want. When you do, please address it to all
panelists. If you select host or any
other option, your question will not be seen and will not be included in the
queue.
Today's conference is being recorded and will be rebroadcast
on Thursday, April 8. Also, in about 24
hours, you should find a link on the Corum Group website.
With that, I'll turn the floor over to Bruce Milne.
Bruce Milne
Thank you, Mark, and good morning or afternoon on the East
Coast and good evening in Europe and Asia.
I'm going to be covering a brief overview of the market because we have
a very content rich presentation towards the end. We'll be then covering market valuation and
analysis. The presentation I referred to
is actually one that we gave in Lyon, France, last week and of course we'll
have a few minutes for Q&A.
I'm Bruce Milne, founder of the Corum Group.
Let me start off by talking about Asia and what is happening
there. These are headlines from business
publications around the world that we monitor in our research group.
“Japanese Business Sentiment at Pre-Crisis Levels” It looks like things are settling down, which
is great. So the Yen is a bit weaker,
which the Japanese love, so they can sell us more Lexuses.
There's an M&A surge in Asia, which we've seen a
difference there, they are continuing to do well while the U.S. and Europe suffer,
according to this. And this, by the way,
is not for tech, we'll be covering that in our Corum Index later, this is for
the overall economy.
China continues to create headlines, but not the kind I
think they want. They're trading barbs with
Australia and a lot of our administration is worried that we're in a currency
and trade collision course with China.
The Yen is probably way over valued, for example, and this is creating a
lot of concerns. As we'll see later on,
Google is also in a fight with China.
In the Euro Zone, moving west, they have their
problems. We all know about Iceland and
they are still underwater. Greece, as
you know, has been in the headlines, causing the biggest drop in the Euro in
years. Spain is right behind them and
there are problems in Portugal and Ireland is not doing very well either, which
all contributes to the drop in the Euro.
Then we look at UK housing, which has actually been doing
fairly well. Their housing prices ticked
up and so did their economy.
However, the big concern here is the IMF lowering the German
growth rate. I shortened this, because
it said there was considerable downside risk to the economy, just not
performing. And this is the big engine
in Europe, the one really strong economy, and this again, contributes to
weakness in the Euro.
Greece in order to dig itself out of its hole, is offering a
5x spread over Spain, who themselves are in trouble.
Ireland has to come up with €43 billion to save their banks
and they're still having some problems there.
Let's move further west to the United States. Corporate bonds have been on a tear, with the
longest winning streak since 2004 and the biggest turnaround in history. So that's the positive. The bond market is good.
The Chicago Purchasing Index has been going up, up, up, but
it unexpectedly declined last month to 58.8 percent, raising some
concerns. Everybody was looking for a
hot job market after February's turnaround, the first positive month since
2007, and the ADP numbers came in yesterday and they had an unexpected job
loss!
We're going to hear about bankruptcy in the States, they're
fighting hard, cutting back, and in 15 major states they are beginning to
rebound.
But some of these should concern all of us. I can't believe that it didn't get a bigger
headline than this, and that is that the U.S. lost its AAA rating. I'm not sure everybody believes in us
anymore.
Let's take a look at real estate, because that affects all
of us. We're seeing a lot of sold signs
being dragged down the streets these days.
U.S. home prices have continued to go up, they weren't
expected to go up too much, but they did, for an 8th straight
month. Although, frankly, these are
really small increases.
New York skyscrapers, which is the commercial market, which
we've talked about in the past, they faltered, and this has been a strong
point. As you know, I have a bias here,
I think that we have not seen the full impact of the commercial marketplace. We're in the third year of a five year lease
cycle, everybody I know is renegotiating their lease or taking less space and
going more virtual, as we have talked about in the past.
Now, new home sales fell to a record low. I think that is a little bit of a
misperception because, frankly, nobody has been building homes for the last
year or so, so the inventory is way down.
Here is one that concerns me, though. Bank of America has one million mortgages
that are technically in default. That
is, the house value is lower than the loan value. So they have taken extraordinary steps to
reduce mortgages up to 30%, so it'll be interesting to see how that goes into
play.
This one last headline is from one of the economists,
“Foreclosures Still Going to Bite Market.”
I've read a number of analysts and economists who are concerned about
another downdraft in the real estate marketplace.
So, let’s shift gears into something very positive, and
that's technology. “iPhone for
Verizon.” Thank God. I don't know about you guys, but my AT&T
service is not as good as they advertise.
Then, with Google versus China, I probably should have had
that on the first page, about Google getting into fights with everybody and
having conflict. Now the word is that
China has caused their blocked search engines through their Hong Kong
operation. We'll see. It's kind of interesting to watch how that
plays out.
iPad sales, the reviews were out this morning, and from one
of them I heard it was great. They will
be going on sale over this weekend. This
I am really excited about, because I think this sector is going to
explode. There are a lot of people who
want more than their phone and less than their computer as they go around in
business, and I'm one of them, I can't wait to get the iPad.
We had the biggest jump from quarter to quarter in history
from Q1 of 2009 to Q1 of 2010, according to our friends at 451 Group. This is amazing and we'll take a look as we
peel the layers of the onion back a bit on this one to see why. One factor in tech leading stock prices
higher is Google, which we'll cover in a minute.
I love this last headline here, “AAPL Market Cap Poised to
Pass MSFT.” Isn't that interesting? That caused me to ask, 'Hey, can I see the
prices on the top companies out there?'
I want to see why this happened.
Now what I think is interesting about this is that at one time
Microsoft, Bill Gates bailed Apple out by making a private investment in the
company.
So, with that headline, I asked the staff to take a look at
the prices of stocks, year over year run up in public valuations. Now, how many of these did you invest in,
guys, at the bottom? We all missed some
of those. But look at the one at the
bottom, Apple. Isn't that amazing? That's the reason why it's believed that they
will pass Microsoft in valuation. Up
124%, which brings an average change of 50.8%.
Now, if you dig a little bit deeper and look at the really
high cap companies, the Microsofts, the Ciscos, the IBMs, the Googles, the
Oracles, and the Apples, for example.
You look at the chart and you realize that they are just below, at, or
in some cases above the highest prices for the last 7 years. On top of that, they have record cash, which
I think is a great segue into doing a market valuation analysis and see why
this is happening. Dougan?
Dougan Milne
Thank you. Yes, those
year-over-year growth numbers are quite remarkable. It has been a very interesting month, actually
it's been a very interesting Q1 and certainly a great start to 2010. Like usual, they have asked me to make my
section as brief as possible, so I'm going to hustle through my graphs and
charts. We'll talk a little bit more
about how to prepare your company for sale in the present market with Nat.
We start with our public market slide. Note that the red line, our S&P tech
index. That's us. So you'll see that it continually keeps pace
above the Dow and the NASDAQ. We had a
little bobble in January, but overall a great close to the quarter.
March transaction volumes definitely positive, we're up
about 25% from what we saw in March of 2009.
Actually, you know they are at 10% from what we just had in February of
last month. You can see that we still
haven't caught up with the volumes we had in 2006 and 2007, which are
represented by the green and purple lines there. But frankly, I'm okay with that. It was part of the whole over hyped cycle
that got us into our 2009 mess and the cash was cheaply and readily available
in 2006 and 2007 and honestly, I think there have been a lot of companies that
didn't need or shouldn't have been making acquisitions at that point. So we're hovering at that 250 to 300 volume
number and I'm more comfortable with those numbers.
Moving on to our Corum Index, this is a bird's eye view of
some of the important totals, averages, and percentages that we have in
software M&A and here you have a brief snapshot of March 2009 versus March
2010. The transactions we just saw, that
first line there, we had four megadeals this past month, versus none in March
2009. Of course, the biggest software
deal of the month, which caught quite a few headlines. Interestingly, it was actually a hedge fund,
Elliott Associates, taking Novell off the public market. We don't see the hedge funds in our space so
much, but this was a welcome surprise.
Elliott did own about 10% of the common stock prior to making the deal,
which is for roughly $2 billion. So, I'm
looking forward to seeing the outcome of that.
Average deal size, which is up because we had a few healthy
deals in there. Median seller size,
clearly our multiples look better than they did 12 months ago. If you look down at the percentage of public
buyers on the last line there, I'm glad to see how active they've become since
the downturn, and they're back up at about almost 50% now.
Speaking of public companies, we're going to move on to
Corum's six broad markets. Remember that
these six markets are further broken down into a total of 26 subsectors, so,
for example here in the Horizontal Application market, we have subsectors like
business intelligence and content management, there is ERP and HR and supply
chain, to name a few, and there are others in this market as well.
If you are looking for more information on your specific
market and your subcategory or something in here piques your interest, you can
visit our website, you can fire some questions at us during the Q&A here,
or please, you are welcome to call me or send me an email, I'd love to make
personal contact and talk to you a little bit more about your company. Oftentimes it is actually difficult to pigeonhole
some of the smaller software companies into a specific sector, but I'm sure we
can figure that out with a phone call.
Let's look at the Horizontal Applications though. Our enterprise value sales multiples dropped
a little bit, but it's funny, the EBITDA multiple is actually at a healthy
rise, so there are no complaints here, I don't feel any sore spots here.
Looking at the deal spotlight on the right side, and this
one was pretty interesting. Pegasystems
picked up Chordiant. Pegasystems is a
business process management player, so this is a pretty big departure for them,
an unlikely acquisition, so to speak. Chordiant is a major CRM vendor and among
the public CRM vendors, Chordiant had sort of a rough time of things during the
past 18 to 24 months. If you look at
their primary competitors, that would be Salesforce.com and Right Now
Technologies, and of course all the small to mid size private players who have
been running up the pipeline, most of whom are software as a service, they have
a highly profitable revenue mix. Chordiant
doesn't quite fit that profile, but they have been making a lot of changes to
bring their SaaS model online and stay competitive. If you remember, they were in a deal with China.com,
they were inches away from signing an acquisition contract, and that fell apart
in January.
We move onto the Vertical Applications market, and there is
a very similar story here to what we had on the Horizontal chart you just
saw. We take a look back 12 months and
you can see how far we've come. We've
done very well in this space. Also, in
the private sector, we're seeing really good multiples paid out for strong and
strategic vertical acquisitions. Corum
has a history of working with a lot of very vertically-focused companies, but
private or public, we're definitely seeing a good run up in valuations over the
past 12 months.
In the deal spotlight, we have a very important deal. People don't seem to pay enough attention to
the education vertical, but in fact, education has been very strong and our
target here is PLATO, and they are a perfect example. They were a small public company and they
performed tremendously well, despite public pressures and the downturn in the
market and then the buyer here, Thoma Bravo, a PE firm with an amazing
portfolio. They had Attachmate, Consona,
Embarcadero, Highland, JDA, NetIQ... But
they also have a solid education portfolio, but PLATO is going to be the only
software focused company in their education portfolio. It's exciting to see how that works out with
some of Bravo's guys.
Let's look at the Consumer Market. It is always difficult here, because at the
smaller private level, the consumer space is actually doing pretty well. If you look at some of the public numbers, I
keep wondering when they're going to come up for air, it seems like they've
been held under for a long time. Then,
as far as products go here, it seems like, unless your consumer product starts
with an “i” you're getting slaughtered in this market right now. Apple is in this category and they are really
the only outperformer here and speaking of, Bruce mentioned that Apple is
poised to overtake Microsoft here, possibly in the coming weeks, and it's going
to be very interesting, there could be some psychology games there.
Onto our spotlight deal, and this may not be a perfect fit
for the Consumer space, but we need to talk about it. YellowPages, these guys are on an absolute
rampage. They have done six deals in 2010
so far and that is more than any other major company that we've been
tracking. The deal here is with
CanPages, this is their largest deal this year, with a price tag of $220
million, mostly cash, and these are the two biggest online directories in North
America coming together, which is very interesting.
To give you an idea of some of the other deals they've done
in 2010, they've picked up Clearsky Media, Four In One information in Canada,
they picked up Restaurantica, and then their European branch, based in Malta,
just bought Zeta Group, so that is a lot of acquisitions.
We also had some healthy gaming deals in this space, a
couple to note were A Perfect World acquiring CNC Media, and Game Now bought
Red 5 Studios for $20 million.
I mention this every month; Infrastructure is one of my
favorite markets. There is a lot of
activity here, some really brilliant technology that comes out of this space,
and as for subsectors in this market, we have things like network management,
systems management, storage, development tools, virtualization, and
security. And, as usual, it's one of our
strongest performers for public companies as a whole and also, as usual, some
of our highest valued deals come from this space as well.
Corum has put together some very powerful deals in this
space over the past couple of years.
We've had deals in storage, systems management, virtualization, cloud management,
tools, and of course, we've had a long and successful history in the security
sector as well.
I know that I've said this for almost all of our spotlight
deals so far, but let's take a lot at this one because it is very important
stuff. CA, Computer Associates, they
have been averaging nearly a transaction a month for the past six months, which
is very healthy for them. If you look at
those transactions, they're all focused on relatively the same thing, which is
cloud management. So the question here,
then, is what is the Nimsoft transaction?
It is also cloud management. So,
despite the assumptions we can make about the direction of CA's technology
focus, some of the particulars we can look at this with transaction. This one might be a major milestone for
CA. This could be a catalyst for their
market offering because when you look at CA's target market; they are almost
exclusively focused on the enterprise and public and private cloud servers, the
Fortune 1000 and Fortune 500. But with
Nimsoft they're getting cloud management that is exclusively focused on small
business private cloud servers.
So this is a major move for CA, they're going to be moving
downstream, tapping a market that they never really had before and it is likely
a difficult venture, but I think with Nimsoft they are certainly getting the
right ammunition. You see that huge 10.9x
multiple that they paid, but that's because they see huge potential in this
downstream SMB market.
Internet Market valuations continue to perform really
well. They have had perhaps the most
dramatic increase since that floor that we saw last February and March, in 2009. As for companies in this space, you know a
lot of them, they're going to be the Googles, eBays, Amazons, and you also get
the infrastructure guys like Akamai, Juniper, and Cisco, some very strong
companies.
So, I chose this spotlight deal because I think it is
interesting to watch the social consolidation that is happening and will be
happening over the next few years. You
know, whenever a new, heavily embraced platform gets introduced, it seems like
particularly in the internet sector, we get this immediate spawn of third party
development applications and integration and even some copy cats. This sector seems to make a lot of headlines,
so it's an easy area to track and follow, but it's also difficult because, you
know, everybody and his brother seems to be building an app for Facebook or
Twitter or iPhone, LinkedIn, whatever it may be. Our buyer here is Agora, a technology holding
company, a management firm out of Texas, and they did both of these deals within
a couple of days of each other, which is TweepML and Qwitter. Both of these are Twitter app studios and my
guess is that they aren't done with system consolidation just yet. My guess is that we're going to see a lot of
this toward the back half of 2010, certainly more of this in 2011 when the
revenue streams really start to open up for these social platforms.
IT Services seems to be running well. Remember that we tend to base services
valuations on the EBITDA multiples, so whenever we are hovering in that 6x to
8x zone we have healthy companies. For
our last deal spotlight, we're looking at a software company acquiring a BPO
company here. Simmplus is the
target. The significance here is
actually personal to Corum. We talk to a
lot of companies; Corum does, both buyers and sellers, every single day. Until about four years ago, I was based in
our Swiss headquarters in Zurich. We
talked to an entrepreneur from the Netherlands; he was still in startup phase
with his pre-revenue software company. Ron
van Valkengoed is his name, he was the founder of Ezwim and he was in a
position, like a lot of entrepreneurs, where he was very excited about his new
company, he just wanted to talk to somebody, he just wanted to get some ideas,
he wanted advice, he wanted guidance. And
the guys here at Corum, you know we often get mistaken for being these possibly
stingy investment bankers if you don't know us, but the truth is that everyone
at this company has been a former CEO or a founder or a VP of a software
firm. Everyone at Corum has been in
Ron's shoes before; you know that feeling of excitement and nervousness, so we
completely understand the need to talk to others who have been through all this
before, who have the experience, for that advice, that guidance, those
ideas. Ron built an excellent company in
Ezwim, he has an exciting product line, and otherwise his industry is not that
exciting, that is telecom expense management.
But he has seen great growth, a very promising future, and we
congratulate him on his first major acquisition.
At this point, I'm going to turn the presentation over to
our president, Nat Burgess. He has built
an abbreviated version of our long-standing conference series, and he is going
to talk to us now about how to sell your company in today's market.
Nat Burgess
Thanks for that, Dougan.
I'm excited about the presentation today, because we have been doing
this for a long time and we are passionate about it. We were invited to present at IBM, we've had
Microsoft, Lotus here, the RSA conference, and we're typically looking at a 4
to 8 hour session. Today we have 250
technology company CEOs logged in and we're going to hear the distilled version
in the next 20 minutes. As I said, we're
passionate about this and I know there's a lot of value here and we're happy to
spend more time to go into a more detailed version with you individually.
So, the abbreviated topic: How to Sell Your Company
Now!
You've heard Bruce and Dougan talk about the fact that tech
stocks are up 50%, that we have a 300% increase in M&A volumes, now what
are you, individually, going to do about that?
Now, one of the places we look for lessons in what works
today are recent transactions. These are
deals that Corum has closed in the last six to nine months and I won't dwell on
each one of these. We will, however,
focus on lessons learned. You see some
familiar names here like Hitachi, maybe some less familiar names like
Geoservices in France that was subsequently acquired by Schlumberger. What do we learn from recent deals?
First of all, over 60% are cross border, that's true of both
our deals and the tech M&A world at large, so we recognize that you need to
think globally and have a global presence.
Second, these deals are mostly strategic. The PE firms are less active, but the strategics
are very active.
Third, a big focus on the quality of teams, interview
processes as part of transactions.
Fourth, profitable business models. That doesn't mean you're profitable today, it
means you are building a technology or a business model that has the potential
to scale up and be very profitable.
Fifth, relevance to growing market. During the down turn, everyone remembered how
to be profitable, meanwhile they forgot how to grow. A lot of these smaller deals are bringing
growth to the table.
Finally, most importantly, you have to run a process. I was in Europe last week and I drove halfway
across Germany. Did I just get in the
car and start driving? No, I spent half
an hour first figuring out how to get the GPS to talk to me in English and once
I solved that problem, I drove to my destination and I knew where the traffic
was congested, I knew where the accidents were, I knew where to turn, and I was
able to focus on keeping the car under control at 200 kph rather than figuring
out where to turn next. You have to run
a process. You can do this without a
process if you want to sell for less and have a higher potential of failure, or
you can run a process and control it.
So, why do this?
First of all, our research shows that on average, the offer from a first
bidder will increase by 48% in terms of liquidity in the transaction. This is across all of our transactions, if
you respond with a process rather than negotiating with one buyer.
In one recent situation, we had a bidder triple their offer
to meet a competitor's bid. This doesn't
happen when you sit by the roadside and wait; this happens when you go out and
proactively make a market in your company.
75% of the time there will be a better offer from another
buyer, if you run a process.
Thirdly, for your shareholders, you get certainty that you
are not leaving money on the table, that you are getting the best possible
offer.
So we all agree, we need to run a process, we need to
establish control over the elements that we can control. What does that mean in execution?
First, we have to look at a road map of where we're
going. This is a deal chart that starts
with the decision to do something or respond to something. From there, you go through your due
diligence, you prepare the company, you prepare the offering docs, you make
contact, you follow up, you do the valuation, you defend it, you set up the
structure, you go through the due diligence, you negotiate the contracts, and
you close.
How do we do this specifically? Well, first you have to think about the
timeline. We're starting here with the
assumption that you're going to need about a month to prepare and that includes
completing what we call the CDO worksheet, for our purposes, but really laying
out the business, working with our professionals to get everyone educated,
preparing executive summaries, finalizing a buyer's list, figuring out
synergies with buyers. These are
step-by-step processes that all move in parallel and they are all designed to
prepare the company to meet the market and negotiate effectively and not
surprise buyers.
Then, there is a concerted outbound selling process. When I was at Morgan Stanley, we could
publish a book and set a deadline, and the five or six buyers would come to us
and submit bids. Working with small tech
companies, that doesn't happen. We have
to sell. We have to understand their
value, we have to push it out at the marketplace and we have to do that
exhaustively and globally, and it takes a lot of work and a lot of effort. That can eat up a month to two months to four
months, but at the end of the day what you are looking for there is to enter
into deal negotiations with more than one buyer at the table in a managed auction
process. That allows us to lever up the
valuations, the structures, select deals that offer the least execution risk
and that are most likely to close, and then go exclusive with a buyer that can
close the deal.
What do you need to do to prepare for that?
First of all, you need to go through your own due diligence
checklist. Here is an interesting fact
about due diligence. These checklists
all look pretty much identical. So why
not do this first? We're happy to send
you some samples if that would be of interest to you. It's a great homework assignment, to just go
through and see how you would fare in diligence. Believe me, when you have an interested buyer
and they just want to close, the best possible thing you can do is respond to a
diligence request in a couple of days and show just how professional you
are. So, we encourage you all to take a
look at a list and think through this process.
Then, in terms of presenting the company, you need to know
who you are going after, and not just the name of the company, but who in that
company and who is their executive assistant and how have they negotiated in
the past, and how are going to approach them?
This is nuanced and detailed and you do it across 20, 40, or even 60
companies.
You need to have a strategic analysis for every buyer,
introductory letters, and executive summaries.
You need to have an NDA that you can put into place quickly to encourage
the next level of discussion. You also
have to prepare the financial story and make sure that it is very
accurate. Then, as you go through this,
you also need to have a valuation prepared and ready to defend.
Now, all of this is important, but let’s bear in mind one
other important fact, which is that buyers are probably not buying you for your
P&L. Why did CA pay $350 million for
a company with $35 in revenue? It wasn't
for that revenue. There is a lot more to
this equation and a lot of it is intangible.
So here you see some of those elements, the growth rate, the
profitability, the documentation, and the patents. When we're negotiating with a buyer who is
not in the tech industry, sometimes they'll focus on the balance sheet, and
I'll show you a great example of that later and why this is almost completely
irrelevant.
Now, when we talk about buyers, how do we segment the buyers,
is it domestic versus international, is it by size? Not really.
We look at the world in terms of two broad categories, strategic and
financial, and then secondly, we have companies that are an obvious fit, the A
list and the B list, companies that may not have a strategy in your space, but
could have an interest. One of the
classic mistakes is ignoring that B list and only focusing on the short list of
buyers that really make sense. We don't
know what others are cooking up in their kitchen, we have to go talk to them
and see what their strategy is, and in fact, somewhere between a quarter and a
half of the interest generally comes off that longer B list.
We have a pretty obvious way of getting at who the top
strategic buyers are - we just look at who has done the most deals over the
last 10 years. Microsoft is at the top
of the list with 94, Cisco is working to catch up, but even the big guys doing
big deals - Cisco spent $6 billion in October of 2009 alone. This is the very top, but you can extrapolate
down and see companies of almost every size level making acquisitions in the
current market. Why do they do this, why
are software companies so valuable?
I like this chart because it is a good reminder of why our
business is so different. If you look at
the chart on the right, you see a traditional business, as it scales, variable
costs scale, the cost of building widgets, the cost of distributing widgets,
etc. On the left, we see software
businesses. Fixed costs stay static, as
volumes grow, profits rise. This is less
true of IT services, but very true of software businesses. So, when we sold Ghost to Symantec 10 years
ago, they took a very small business and turned it into close to $100 million
in profits in just a couple of years because they had the distribution channel
to do that and a 99% gross margin.
That's what we're talking about with the software business and the value
we bring to buyers; it is not the balance sheet.
What do we learn from the balance sheet? Almost nothing of relevance. Here is text from an LOI that came in a few
years ago, they just felt obligated to mention the balance sheet because...I
don't know, why not? “Based on your
forecast and a net book value of $307,000, we'd like to make an offer of $8
million in cash and $4.5 million in stock and another $2 million in earn out.”
What does that have to do with the balance sheet? Nothing. What does it have to do with the
value of the technology and its earnings potential? Everything.
Okay, we're not at the next step in the flow, we have some
interested buyers, we're going to start doing some negotiation and range
finding around valuation. We're not
going to sit at the table and look at each other and argue over who goes first. We're going to go first. We're going to put some metrics out there
that we believe are supportable and here they are. We'll talk about sales multiples. We'll talk about earnings multiples. We'll talk about comparable
transactions. We'll do a discounted cash
flow analysis and we'll also do a replacement value.
Where do we start with that?
We need forecasts. We need at
least three years and this is hard for most tech companies, even going out 18
months is challenging, but you're buyers going to do it, so we've got to do
it. We also have to identify a good,
comparable public company peer group and Dougan's work in our research
department, segmenting out the market and identifying these different peer
groups is a great start, so I encourage you to look at the work that he has
done. We also need to find M&A
transactions for comparable sales. This
is the case of “What did the house next door sell for?” What did a similar company sell for? We track this, we track 10-Qs and disclosure
and we also subscribe to proprietary data and we have our own database, so we
have a lot of information about comparable transactions.
Finally, we have to look at your financials and make sure
that they really reflect the P&L as it would look as a subsidiary of a
large company that acquires you, so there is generally some recasting that
needs to happen. There may be above
market compensation to principles, there may be a building that is owned by the
CEO where rent is above market, you generally have some add-backs and some
changes that do impact the valuation.
When we're talking about valuation, we're looking at two
different categories. One is
market-based, what are the public companies trading at, what did the house next
door sell for, so what are the comparable transactions. These don't generally tell you exactly what a
company is worth, but they give the buyer comfort that they are not the crazy
Ivan in a process, that they are not overpaying. That gives us a framework.
Secondly, we get into more intrinsic value. If a buyer is doing a make versus build
analysis, what will it cost to build the technology? Then, if they are going to build the
technology, what is the cost of having it in a year or two years, or however
long it takes to actually build it?
A quick anecdote here, I was negotiating with a guy who
later became the CFO of Expedia, Greg Stanger, at Microsoft, and we had a
replacement value analysis that said it would take $9 million to rebuild the
technology that we had. We were arguing
for some other metrics, we thought it was a $30 million deal. He came back and said they'd done their
analysis at Microsoft and they agreed with the $9 million replacement cost and
they were going to apply a time to market multiplier of 3x. I wasn't unhappy about that, we wanted $30
million and that got them to $27 million, and I said, “Greg, what's your
analysis, how do you get to this 3x multiplier?” Greg told me, “Well, Nat, we want to pay
about $27 million.” So, sometimes there
is science to this, sometimes there's art, but this can be a great way to
support your value.
Then, we get into a discounted cash flow. This is not a traditional deal. At Morgan Stanley, I worked on the
divestiture of a copper extruding plant from AT&T. We had a 15 year forecast, very precise with
cost of goods and infrastructure, plant, and equipment. In software, we don't have that luxury, but
we have to go out three years, and then we have to be clever about how we get
to a terminal value and that is often based on an M&A value, multiple of
EBITDA and multiple of revenue. Again,
this is hard, it is an uncertain science, but the buyer is going to do it, so
we need to do it, too.
What are some of the common mistakes that people make in
valuation? Well, one is not providing
clean financial data. Let's take the Nimsoft
deal. They negotiated to sell for $350
million, which was roughly 10x revenue.
I'm sure everyone there was aware of that revenue multiplier. If they suddenly come back and say, “Whoops,
we didn't properly recognize revenue, the revenue is actually $9 million,” then
that could cost significantly in transaction value if everyone is focused on
the multiple. So getting it right the
first time is important. Again, that
relates to revenue recognition, which is one of the most common reasons that we
have restatements. A company
transitioning to SaaS, still recognizing everything as the cash comes in, we
have to restate later and that causes problems.
Forecasting. We can't
be scared, we can't go out and just do a take it to the bank forecast, we have
to be optimistic about our business. We
also can't be ludicrously optimistic. We
need a balance between aggressive and timid.
We also can't give ourselves credit for the infrastructure that the
buyer already has. When we were
negotiating with Symantec on the Ghost deal, we knew they were going to scale
it up quickly, but we also already knew they had spent billions on building out
their distribution channel and they weren't going to pay us for it again when
they bought our company.
Using outdated comparables is obviously a bigger problem in
a falling market. In a rising market,
we're kind of almost in a waiting mode, looking at the latest deals, because we
are getting better every week and every month.
Ignoring a liquidity discount. This can sometimes be important, especially
in mature markets. Also, using improper
time periods, such as comparing my trailing 12 months to their next 12 months
forecast, for example, creates a timing issue.
So, we have valuation.
We also have structure, which is often more important than price. Do you want to sell your company for a $20
million earn out or a $7 million check?
How do you analyze which is worth more?
This is one element worth consideration.
Another element is structure. Are
you a C Corp selling your assets? You
might have a double taxation issue that scales up over 50%. So, structure can be critical, both in terms
of liquidity to the shareholders, from a tax standpoint and also from a pure
liquidity standpoint.
You see here a graphical representation of what I just
talked about. Your earn out, you will
have an easier time negotiating for more of that, because you're going to pay
for it yourself out of what you can generate with the company they are buying. Meanwhile, cash is much more expensive to the
buyer, both to generate and to use.
Okay, so we're moving forward through our chart. We've got the typical flow of a
negotiation. We've delivered our opening
gambit on valuation. We've talked about
that, we've gone back and forth in some emails, we've had the buyer issue a
draft letter of intent that was have shared with our board. Now, we're negotiating back and forth with
multiple parties until we get one that we're comfortable with and we're willing
to go exclusive with.
What are we negotiating for?
We want the buyer to pay at least the intrinsic value on the deal. The buyer, of course, would prefer to pay
less. Assuming that we have a strategic
buyer, there will be some additional value based on their infrastructure and
synergies. We want to share that. Meanwhile, on the risk side of the equation,
as a seller I want the buyer to take all the risk, forever, but he's not going
to do that, so we're going to have a negotiation, we're going to spend a lot of
time sharing this risk.
I'm going to pause here, because there is something that has
happened, just in the last six months, that is new and really exciting from a
deal maker's standpoint. Let me tell you
exactly what it is. In every deal there
are roughly five to ten issues that are heavily negotiated, sometimes over a
period of months, in the purchase agreement.
Even after we get the LOI signed, we're always going to have the lawyers
going to war for weeks and sometimes months over a very specific set of issues,
and on that list are things like the survival period and warranties. Does the seller stay liable for breaches and
warranties for twelve months? For
eighteen months? For four years? So that's one battle we're going to
fight. We're going to fight over
liability caps. If there's a problem
after closing, can the buyer come back for unlimited funds? Are they capped at the deal value? The escrow?
How much escrow is there, what percentage of the deal goes into
that? These are some of the issues, this
is the lawyer's dream come true, because they can negotiate them serially and
rack up $100,000 in fees, all in the name of protecting the client.
Now, we have long been an advocate or pushing those key
issues right up front and putting them in the LOI. We've been able to do that sometimes,
sometimes the buyers have balked or resisted because they say they can't
possible know everything they need to know to cap liability or look at that
kind of structure in the LOI. We've had
buyers resist it sometimes as well. When
we have been able to do it, it has accelerated deals, decreased friction, and
it has been a good thing.
What we've seen over the last six months is some of the
biggest buyers in the industry and I won't name names, but you know who they
are, they were on that list of most aggressive buyers, we have seen them
starting to adopt this and basically forcing their outside council to adopt it
as well. We end up with an LOI that
includes those hot button issues and we negotiate them over the course of a few
days, from a business standpoint. They
get memorialized in the LOI and instead of two months of grinding on the stock
purchase agreement, we have an agreed STP in a week or fourteen days. It's so efficient. This is a best practice that we have been
pushing for a while. It is wonderful to
see it start filtering down now into the buyer practices in the larger buyers
and we'll continue pushing it with the smaller ones.
This is another example of where you turn on the GPS, and it
knows where the traffic is congested and where the problems are going to be,
you not only have a preview of the problems that are coming up, but you have a
way of driving around them.
Okay, back to negotiation.
We can't be shy about asking questions of the buyer. When they come up to you and say 'hey, maybe
we should buy your company,' and they're interested, that's the point where you
can go ask some key questions, like why are you interested? What element of our company is interesting to
you? The answer may surprise you. If your product does 100 things and they care
about two that maybe your customers don't even pay attention to. But, it is useful to know that. Has their company does acquisitions
before? How did they work out? Can you talk to the people who were involved? You'll be amazed, in this early stage when
the buyer is trying to sell you on their organization, they'll be very open
with this stuff. Do they have a
preferred deal structure that they have used in the past, and what is it? What is their approval process? Do they force relocation? Who is involved in their decision making
processes? What is the fit, who would
you report to, what process do they use for integrating acquisitions?
These are all really useful discussion points ahead of
valuation, for two reasons. One is that
it gives you a preview of what they care about and highly value. The other is that it kind of creates the
glue. Now you're talking strategy and
integration and when you shift over to valuation, they're interested, they've
decided they want to work with you. If
the negotiation starts with 'how much do you want?' you know it's going
nowhere. Because no matter what your
answer is, it's going to be too high.
The glue hasn't set yet. So, a
lot of the negotiation that happens here is critical to setting the framework
in the stage for valuation.
The buyer is smart; they recognize this, so they're going to
use some tactics as well. They're going
to hide the level of interest that they actually have in the deal. They are going to propose all sorts of other
schemes to get the value they need, they care about those two features of your
technology; for example, so maybe they should just license it or do a minority
investment or get exclusive rights to it or buy that asset. So watch for
that. That's their job, to get access to
what they need at the minimum cost and minimum risk. Your job, meanwhile, is to protect the value
of your business and make sure you're getting appropriate compensation for
it.
They will dispute the quality of the valuation, they will
encourage you to negotiate against yourself.
Again, beware, watch for these tactics, use judo to push it right back
at them.
Meanwhile, the seller has tactics, too. One, you need competition. Remember my story from earlier? The price triples when the competitors steps
in. That doesn't happen on its own. Reveal problems early, while leverage is
highest. The fact is, once you sign the
LOI and you are exclusive with the buyer, you don't have a lot of
leverage. Let them know what the
problems are earlier rather than later.
Be specific in the LOI.
This goes back to my earlier point.
The lawyers will resist it, but go ahead and raise issues of escrow
percentages, survival of (xxx) and warranties, because if you can get those in
the LOI, you will save a lot of pain and suffering and time and money later
on. Be creative on structure, and
absolutely close as quickly as possible, because nothing good happens between
LOI and closing. I have one client who
is, I think, two weeks away from closing, and we talk every morning. Every day he starts with, “Well, Nat, I
looked up in the sky and didn't see that meteor coming...yet.” But he's waiting for it and we're pushing as
hard as we can, because we know that you could have a stock market crash, a
terrorist event, a management team replaced, a reorganization, so many things
could happen to just get in the way, so you just need to push ahead and get
these things closed.
Okay, so we've reached a deal in principle, we have an LOI,
and now we go into the next phase, which is drafting the definitive purchase
agreement and going through due diligence.
Everyone's tired at this point, but we have to pay attention because
what we come up with in due diligence matters a lot. The fact is that the risks that are exposed
in the due diligence process end up being allocated in the definitive agreement
and you as the seller can continue to own them or you as the seller can push
them on to the buyer, it's all in the negotiation. But this is a critical phase of the
deal.
So, your letter of intent, going back to the overall terms,
is going to include high level topics, such as purchase price, payment
structure, the time frame and procedures for getting to a definitive agreement,
registration rights, pricing adjustments, a standstill agreement...now, we have
a question here about exclusivity.
Typically, this is decided in the LOI and it typically runs for a
specified amount of time, it might be 45 days, it might be 60 days, at the very
outside, it might be 90 days, this gives both parties a chance to put their
nose to the grindstone and close the deal without a lot of distractions. It might have break up fees and other
contingencies, although we don't typically see that in smaller deals, and then it
will typically have a conduct of business clause that says you won't impair the
value of the business after you've already agreed on terms in the LOI, so you
won't divest subsidiaries or sign away rights in the technology.
Then you get to the definitive agreement and this is your
binding contractual obligation. This
allocates the risks. It comes with a ton
of attachments, these typically show up with a box of pens, you're going to
have employment agreements, non-competes, promissory notes, private placement
memos, public stock registration issues, private stock registration rights,
opinion of counsel, fairness opinions, etc.
What are our takeaways from going through a lot of these? You need experienced counsel, someone who has
experience in all these areas of the law, who has done M&A deals before in
the tech sector, number one, and number two, you want to get a first draft of
the agreement early in the process, as quickly as possible, so you can refine
it and get to closing.
So, we've closed the deal.
We look back to see what we've learned.
What are some of the myths and misperceptions? There is an assumption that the buyer might relocate
or fire staff, which is typically not the case, with the small tech deals, the
value is in the staff. One of the points
I raised at the beginning of this sessions is that team matters a lot. Everyone gets interviewed, they typically
want everyone, that's why they're buying you.
Same goes for management, we see marketing people retained in these
deals, in some cases we're even seeing CFOs retained as GMs.
The third myth is that if the company has lawsuits or
problems, it can't be sold. This is not
true. You can sell around just about any
problem. You can't sell around a problem
that causes you to not control your intellectual property or not actually be
able to sell your shares, but just about anything else, you can manage.
Smaller companies cannot sell, again this is not true. Smaller companies are selling every day.
Buyers only focus on technology. Well, they do care about technology, but they
also care about all the other intangibles that we threw up on the sheet
earlier, patents, which is a technology issue, but also channel, sales
teams, marketing position, global expansion, and the list goes on.
The company isn't profitable, it has a negative net worth;
therefore, it can't sell? Again, this is
not true. Go back to our chart, the one
we showed earlier about what happens as software companies scale. Not only do they become profitable, they become
very profitable, and a buyer offer is to scale.
What are some of the actual mistakes in the partnering
process? I'd say the biggest one is
dealing with just one buyer. You need to
have a process, you need the competitive leverage of other buyers in the game
and you need a timeline and a defined GTS, the roadmap, that is going to move
you to closing. Otherwise, if you're
dealing with one buyer, they'll just bat you around like a cat playing with a
mouse and six months later they'll walk away and you'll wonder what happened to
your business.
Other mistakes: Not including the B list in a search,
because again, 25% to 40% of interest is coming from the B list. Not understanding the buyer's process. Not being prepared for due diligence, not
qualifying the buyer properly, and finally, not orchestrating all buyers
property. Again, process!
We run these processes constantly, on a global scale, and we
know that it takes a lot of work. On
average, 700 to 1,000 and sometimes more discrete communications, from TF to
conference calls to get things moving, to get the meeting. There are typically 10 to 30 expressions of
interest in one process, 15 to 20 NDAs, 8 to 10 qualified parties, and one to
two offers, sometimes it’s more, sometimes it’s just the one offer, but having
a process helps move that offer forward and make it real.
Again, we talk about the process and we talk about global search. The result is the same; you get significant
benefits as a business from going through this.
You establish a better business model because you are preparing to sell,
preparing to be under the spotlight, you improve your business. Ultimately, even if you don't sell, you're a
better business for it.
You understand what your competitors are doing because
you're talking to them and they're telling you their strategy and you are
learning from that, getting incredible market intelligence, market feedback
from buyers.
You are establishing business relationships, both in the due
diligence process, but also for the buyers who maybe don't want to buy you
right now, they could be an OEM partner, they could be a reseller and
ultimately a meaningful transaction with a strategic or a financial buyer.
So, at this point, I'm actually going to go ahead and turn
the floor back over to my colleague Mark Reed.
He is going to tell us about some of the events that are coming up that
actually offer the full content that we have only touched on in today's meeting
and then we'll go ahead and take some questions.
Mark Reed
Thank you, Nat. Also,
thank you Bruce and Dougan for the input that you gave. We are going to go to Q&A, although we're
running very short on time. Before we do
that, I would like to offer all of our audience members today the chance to
join us in person. We host a number of
events around the world. One that we
host is the Merge Briefing, which is a very focused 90-minute event which
brings software entrepreneurs current information about the M&A
marketplace. We also have the more
detailed event that Nat was talking about, which this was a condensation of,
which is called the Selling Up-Selling Out conference. It is a very intensive “How To” for preparing
for successfully executing an M&A transaction. It is very tactical. We have events coming up in Frankfurt on the
20th of April, New York City on the 22nd of April,
Portland, Oregon on the 27th, and Vancouver, B.C. on the 29th. We're back in Vienna, Austria on the 5th
of May and in Irvine, California on the 11th of May and in San
Francisco on the 13th of May.
There is a full roster of the events that we run on our website and I
would encourage you to go to that.
We do charge for these, but I would like to offer all our
audience members today a promotion code that will get the fee waived. That code is “april flash”, all lower
case. On the registration page you'll
note a box for a promotion code.
With that, let's go to a short Q&A session, and maybe
Bruce, we can start out with you. The
question is, “We were flat in revenue growth in 2009, we're going to grow about
15% in 2010. Are we better off to wait
for the market to improve or go to market now?”
Bruce Milne
No, I definitely wouldn't be waiting. A lot of my friends who run software
companies are asking the same question and with the ramp up we've seen in stock
prices, the cash hordes that buyers have, and the amount of activity we're
seeing, I definitely wouldn't wait. I
think at a minimum you benefit from what Nat talked about in the prior slide,
that you get a better business model, great research, better feedback, you
build relationships, you'll at least be able to calibrate. Frankly, a lot of companies were flat or even
down in 2009, similar to what we saw in the dot com era. That doesn't mean you shouldn't go out. I would be going out, the market is talking
to you right now, and it's saying you should calibrate the market and see what
the opportunities are for you.
Mark Reed
So, Nat, here's a question I'd like to direct to you, it has
to do with the terms that we've seen.
Have the terms of deals changed since September of 2008? I guess that's kind of when the down turn
kind of began to happen. And also,
another variation on the theme is, “Are you seeing more earn out components and
closed deals and does this vary between market sectors and maturity of the
seller?”
Nat Burgess
A quick response there.
Between the first half of 2008 and the first half of 2009, this is not
the period that was referenced in the question, but it is the period that
matters, the number of transactions stayed the same, but the total dollar
volume went down by 75%. That was
catastrophic. What we're seeing now, as
you saw, is a 300% year over year increase.
So, the market has come roaring back.
The public market is up 50%, so what more do you want? It's really happening and we are running as
fast as we can. I wouldn't say we're in
a bubble, because it is a little more pragmatic, and the buyers are going to
get indigestion once they've done a few deals.
That's the quick response.
I'm also just going to jump in and take another question
here, which I think is a good one, if you don't mind, Mark.
We have a question from an audience member here, “Why is
orchestrating all of the buyers the tough part?
Here, I'll just say that we can control a lot of things in
this world, but when you talk about getting an HP or a Cisco or a Microsoft to
make an acquisition, it's like turning a ship, and there are lots of reasons
why they might not be able to do anything just now, they might have another
deal in the works, they may have a reorganization under way. Multiply that times 50 buyers and you have a
lot of uncertainty and a lot of moving parts and you may need to slow some down
and speed some up. That takes a lot of
work and a lot of experience, so that's why we make that comment.
Mark Reed
Thank you, Nat. The
next question I'd like to direct to Ward and then I think we're out of
time. Ward Carter, Chairman of Corum
Group. The question is, “We're a smaller
player, a fast company. Is there a
specific level of revenue that we need to achieve before we are saleable?”
Ward Carter
Good question. Fast
deals certainly get a lot of attention.
We've done a lot of work in this space.
I'd say you need to understand the market and make sure you don't wait too
long; the market can consolidate around you.
SaaS deals are getting a premium and traditional license models, and
often 100% greater. So, your values are
going to value depending upon the market opportunity, the rate of growth both
in your market and in your company, your profitability, your competitive
posture, and a lot of other factors, so you need to look at timing. A driver can be one of the requirements of
you and your selling shareholders. You
need to get a $20 million valuation, as an example, and the market is telling
you it's a 2x multiple or whatever the number is, the math is pretty easy. You need to get to, let's say, a $10 million
revenue number to meet your objectives, so we're happy to discuss issues that
are specific to your situation and market, and if you'd like to give us a call,
we'd be happy to have that discussion.
Mark Reed
Thank you, Ward. That
brings us to just beyond the top of the hour.
We do like to keep these to around 60 minutes. There are a number of questions in the queue
that we were not able to address in this forum, but we will address them
offline, so we will answer the questions that you have asked.
Thank you very much, we appreciate your attending today, and
that does conclude the flash report for April 2010.