December Webinar

M&A Update + Cloud

 

12/02/10

 

Good day. Welcome to Corum's monthly M&A webinar for December 2010. This monthly event puts current events and economic news in a context relevant to software executives building their company and planning for strategic transactions like M&A. I'm Ward Carter, chairman of Corum, based here our Seattle headquarters. Thank you for joining us.  In keeping with the international nature of today's topics, I see the registration list shows over 300 executives from more than 20 countries in North and South America, Europe, Asia, and Australia.

 

This is our agenda for the next 60 minutes, including a special update on cash in the cloud, as well as HP's recent M&A activities, along with some interesting data on valuation trends. Our speakers today include: Bruce Milne, CEO and founder of the Corum Group, Bruce Lazenby, Corum's Vice President driving our activities in Canada, who will offer some tips on successful negotiating, Alina Soltys, from Corum Research Group, talking about valuation trends in the SaaS marketplace, Tomoki Yasuda, Senior Research Analyst, providing an update on the current M&A market, Dougan Milne, Corum's Vice President of Research will be leading a review of HP's acquisition history, followed by a special guest speaker, Bob Faulkner, a technology equity sector analyst from UBS group, who will speak further about HP's acquisition strategy. And, from our Munich office we'll hear from Miro Parizek, Corum's Managing Director for Corum Group International. As usual, we'll wrap up with a Q&A session. We will keep this event to about 60 minutes and you will want to stay tuned for the Q&A.

 

Regarding that, feel free to ask questions at any time, but we will only answer them during the Q&A session at the end of the webinar. To submit a question, please use the Q&A window on the right side of your screen and be sure to send your question to “All Panelists”.  If you select host or any other option, your question will not be seen and not included in the question queue. 

 

The recording of this event will be available on the Corum website, via the Conferences and Events menu on the left hand side. Or, you can email a request to us at pats@corumgroup.com for an archived copy. 

 

With that, I will turn the mic over to Bruce Milne. 

 

Bruce Milne

 

Thanks, Ward.  We have a lot of ground to cover today, and two major presentations, one on the cloud valuations and another on HP, so I will be quick in my presentation.

 

International growth is good across the board. Europe cut their debt, earnings are up, and they have had the fastest growth in four months, led by Germany. The biggest thing, though, that I'm going to cover later on, is that the Euro has been falling relative to the dollar, which is due to a couple things that we will cover later. 

 

China, we don't have too much on them this time, we've had several reports in the past and we have another one coming up at the beginning of the year, they are starting to see some dislocations, wages have gone up 20%, we recorded a couple months ago that there were some strikes. Acer has stated that China will be the world's largest computer market, over the US, and they are the world's second largest computer manufacturer now. China's inflation may prove to be a volcano, so let's keep tabs on that.

 

As I mentioned, there has been a change in valuation in currency, and a lot of this is due to the debt effect. Across Southern Europe, with Spain, Portugal, Italy, and Greece, with the currency converted to Euro, they basically started to see their prices go up. I was just with an investment group in Ravenna, Italy last month, I visited with a manufacturer, and his costs have gone up four-fold, he has lost a lot of his business to manufacturers in the East, in China and India, and it is not coming back. So, there are some real problems in that region. So, we're seeing the bonds of these countries drop, and we're also seeing, due to some Korean tensions a drop in the Aussie dollar and the Canadian dollar. These have been safe havens, and the Loonie is now on par with the US dollar, as is the Swiss Franc. So this is going to affect us. For example, our fishing trips are getting much higher up in Canada, so lets watch that, because these are huge swings. 

 

The United States is up in both consumer spending and confidence for five months. The economy gained strength in 10 out of 12 regions, and manufacturing grew for the 16th month. Cyber Monday, the Monday after Thanksgiving, showed sales up 16% and eBay was up 146%! Iphones dominated here, and we'll tell you a little bit more about this, they are clearly becoming a standard bearer. 

 

And this is interesting, the core inflation rate is the lowest on record, as are interest rates, basically.

 

In jobs and real estate we're seeing that the market went up 250 points yesterday, based on the news that ADP said we're adding 93,000 jobs. What's interesting is that at the same time, it was announced that the US had more job cuts in 8 months, and this is actually more from state and local governments, and along with that we see that Obama came along this last week and said he'd like to have a federal employee wage freeze for two years. I think he's a couple of years too late, the rest of us were freezing wages and cutting back a while ago. 

 

Home prices rose less than forecast and then we see that sales of existing homes, the bottom line there, fell more that expected. We just got revised projections this morning for October that were actually up, so that news is good.

 

Jobless claims are now at the lowest since 2008.

 

In technology, we're going to be talking about HP later.  Their new CEO, who came from SAP, is going to be stepping up research and we'll talk about that. HP is also in the news for the investors sued over Mark Hurd.

 

One of the things that we are seeing that is interesting is that TV sales are softening globally because people are getting more of their information over the web.

 

Earlier we mentioned Apple's dominance, JP Morgan is now giving bankers iPads, which is a danger to RIM. Branson is introducing an iPad magazine and he is always on the cutting edge, isn't he?

 

What is interesting is what we are seeing in finance, in the past we've been talking about the fact that we have the tech companies raising a lot of cash debt with almost no coupons and that is kind of creating a difficult situation for the bond market. HP's earnings were up. Soros still believes that gold still has a long way to go. Cisco's earnings were lower, and the reason for this is that they believe that orders from the government, such as state and local, are down.  Dell, however, has exceeded its forecast.

 

Finally, in our overview sector today, tech litigation is front and center.  We talked last month about Oracle and their litigation with SAP, they want $1.3B for illegal source downloads. Now, because of that there is a lot of news about Intel, Nvidia and others settling patent disputes. Apple is beefing up their legal department in a patent showdown with Nokia and Motorola. We have Google being probed by the EU and we have Microsoft getting high court reviews on their patent work.

 

Then we have the couple that beat Google in court on privacy issues, this is regarding Google Maps, someone walked down their driveway and took a picture for Google Maps, they sued and won, but they were only awarded a dollar. Thanks, guys. 

 

The point is that patent and litigation are a huge issue. You have to remember that the EU got $1B out of Intel when they after them and they seem to be doing this on a regular basis as a way of generating income.

 

Let's go head and switch over to negotiations. We have Bruce Lazenby from Canada, our regional Vice President. Bruce?

 

Bruce Lazenby

 

Thank you and greetings from Corum's office in Canada.  I was asked to talk today a little bit about some of the negotiation process that happens in an M&A deal.  We know that of the several hundred callers on the webinar today, about two-thirds are sellers and about one-third are buyers. We thought it was important to speak to the sellers here for a second. Most of you are senior executives in your company, many of you are closers, but virtually all of your are involved in the sales process in some way.

 

The sales process for selling your company is really different for selling your product.  Your product you sell to an area that you know and you sell it multiple times. Your company you just sell once, and by the way it is usually the most important financial transaction of your life. At least it is in the case of most sellers.  So this is really something you want to understand deeply. 

 

I thought we'd touch briefly on four points.

 

The first is the need to have multiple buyers at the table. Buyers are really smart and they are very experienced. Unlike most sellers, they have done a dozen or more deals, they know how to structure deals, and they know how to get the best deal possible. Buyers are never rewarded for overpaying. It is the job of the seller to make sure that he presents the company in such a way that he creates this understanding of options.  What buyers will do is understand clearly how the technology is valuable to their company and what they can do with it, post acquisition. It is the job of the seller to make sure that the buyers understand that if Buyer A doesn't move on this product, Buyer B will and then Buyer B becomes a competitor to Buyer A and this is one of the circumstances that we really want to encourage buyers to enter that environment of auction to make sure that the seller gets the best price and the best structure.

 

The second point is to understand the buyer's issues. Buyers are approached with alarming frequency from companies that think they need to be sold, that X  buyer needs to acquire their company. It is really difficult for buyers to screen this and so it is really incumbent upon the seller to make sure that they are very clear on what a particular buyer needs this product and to make that crystal clear.  The other thing to understand is that buyers have processes that they need to follow through with, most of the larger ones have a very strict process, you can't short-circuit that process, you need to work with them on that process.

 

The third this is that you need to make sure that the deal structure that you want is one the buyer can actually do. If you think, for example, one way to bridge an expectation gap of valuation might be earn out, but if that buyer flat out culturally does not do earn outs, then there is no point in having a long debate about that. So understand where the buyer is coming from.

 

Another question we get is when do we stop negotiating? If you're talking about a sales process, I used to tell my sales guys, when the prospect says, “I'll take it”, then you can stop selling. It's different in the M&A game, this is a very long process, and there are dozens and hundreds of things that can come up between the negotiation and the letter of intent, due diligence, definite agreements. So you're really constantly in negotiation mode. I tell people to stop negotiating when the final check clears and if you have earn out, buy back, or some other long term transaction component, it can be a matter of years and you will always be in negotiation mode during that time.

 

The final point is that contrary to popular beliefs, most buyers these days seem to keep the selling team intact, so if they like what the CEO did with the company, they want to keep the CEO and maybe the CFO engaged and keep the company together as a whole, which means that the seller then is negotiating with the future boss, and that can be a challenge. If you have to, and you really do need to get into tough negotiations some times, some real nose to nose, toe to toe discussions on sticky points, it can be difficult when you are negotiating against your future boss. This is the place where third parties or advisers can come in and take some of the heat off of the seller, and this is one of the reasons that pro athletes have agents: so that the agent can have all the difficult conversations and the athlete can show up and say “I'm delighted to be here,” etc.

 

So these are the four key issues, and I think the core message here is that this sale is unlike a product sale. This is a special sales process and probably the most important sale of your life, so take the time to get it right.

 

If you have questions, please hold them to the end and we will be happy to include them in our Q&A portion.  Thank you.

 

Bruce Milne

 

Thank you, Bruce, that was a good presentation. 

Next we're going to go to our cloud update. Last month we gave a live report from the cloud conference that was here in Seattle. We're working on a major conference that gets all the players together, called Clash in the Clouds, that will be a fairly major event, we're doing that as a co-sponsorship, and we'll be offering that in Q1 of next year. A key part of that, though, is the part about valuations, which we thought, given the recent transactions that are happening, would be of interest, and we call that Cash in the Clouds. Alina Soltys, from our research group, what have you got for us?

 

Alina Soltys

 

Thanks, Bruce, for that introduction.

 

Cloud computing, cloud infrastructure, Amazon, pretty much anything in the cloud has been a buzzword all year long. Today in our Cash in the Clouds segment, we'll go over a few of the cloud sectors, and then go over 25 deals that have hit the spotlight this year. 

 

My name is Alina Soltys and I'm in the research department here at Corum. So let's get started. 

 

This is an overview of the various sectors and what they involve, starting with Infrastructure. Infrastructure as a service provides a hosted cloud solution for companies. A service provider has amassed storage servers and huge amounts of computing power, as well as the support on the back end to bring their customers up on the cloud without purchasing the hardware up front. This is usually very appealing for companies that need a lot of processing capabilities in random, unpredictable bursts, such as all of a sudden your product is highlighted on Oprah and your website crashes, or you need large amounts of data processes all at once. 

 

This form of infrastructure as a service has completely redefined the way many companies approach product development and deployment. The one true leader in this space is Amazon, with their EC2 offering. Rackpace and  Terremark have gained some ground, but they still come in a distant second and third, with a $110M in revenue for Rackspace and $30M for Terremark. Amazon controls the vast majority of the $700M market this year, but this is projected to grow with $3B within 2 years.

 

Moving on to our next sector, cloud-based applications have certainly come into their own over the past several years, and never has it been so apparent as this year. One of the major changes that we have seen from developing and deploying solutions through the cloud is that is has allowed for variations on the traditional licensed business model. Now SaaS and various offshoots of subscription models are the hot ticket, with predictable and identifiable user reoccurance.

 

The largest and most recognized player is certainly SalesForce, with a market cap of over $18B. It has grown over 20% in the last year. Other companies in this space include SuccessFactors, Taleo, Blackboard, and Concur, and they have all displayed growth rates of over 15% in the last year.

 

Lastly, is virtualization. In the past, computer users were limited to the machine on their desk, includin the hardware, limited processing ability, and the files physically stored in the machine. By turning the machine into a virtual image, the inflexibility goes away and now the user can access their data from anywhere. This is a huge time saver and productivity booster for IT staff. 

 

VMware, Citrix, and Microsoft are the big players in this space, and there are too many small players to name, but some include Hyper9, DynamicOps, and Vkernel.

 

Cloud has been a very hot tech sector this year and we are just seeing the beginning of what the true potential is when a fully-deployed cloud solution is in action.

 

The following two slides showcase Corum's industry sectors and the companies that fall into these categories, as a reference point for comparison. So, let's take a look at what we have in the cloud sector. There are companies such as Amazon, Blackboard, NetApp, and SalesForce.

 

Moving on to the next slide, we have the traditional license basket, which includes companies such as Adobe, Electronic Arts, and OpenText.

 

We have gathered the data points to compare the two groups on the next slide. We have comparison points such as revenue multiples, EBITDA multiples, trailing twelve month's revenue, and forward multiples. In all cases, cloud significantly outperforms the licensed peer groups. If you look at the EBITDA multiple for cloud, it is more than double that for regular licensed, and this is the case across the board. 

 

So let's take a look at what is happening in the M&A deal space with cloud. Highlighted below are 25 deals that have occurred in the last year. In the first column, you can see that all the big players are in this space, making acquisitions, including HP, IBM, Symantec, and SalesForce. If you take a look at their deal values, there is a great range; there are the billion dollar deals of course, that make the news, there are deals for hundreds of millions, but there are also quite a few for under $100M. This is just a select group. This really shows that deals are happening all over the board, no matter the size. 

 

The one thing here that really stands out is the revenue multiple. There are companies that get revenue multiples of 50x, which is unheard of. The median revenue multiple here is 7x. Now, normally software companies get 1.5x to 3x, depending on the sector. This median of 7x is extraordinary. There are a few companies that have significant revenues, but many are just in the $20-50 million range, and even a few around $5M.

 

Let's look at five specific deals in depth. I had a lot of information for these deals, and luckily I got a few extra minutes to really delve deeper into them.

 

A few months ago, tech M&A entered the spotlight with a $1B battle between two giants for 3PAR. HP and Dell went back and forth, starting at $1.13B originally to the final offer price of $2.4B by HP. Last year, many of you may not be aware, HP lost a bidding war with EMC on the high-profile Data Domain deal. This time around, HP decided they could not walk away without having a solution. They did have an OEM partnership with Hitachi, but with 3PAR under their belt, they now own that solution, as well as targeting a high-end business and a high-end storage space, serviced by 3PAR.

 

The next deal is a local company based here in Seattle.  Isilon Systems, which was acquired two weeks ago by EMC for $2.25B in cash. That is an astounding 12.5x revenue. Isilon was more richly valued than both Data Domain and 3PAR, which is probably why we didn't see any bidding battles. EMC bought Isilon for two reasons. First, to scale out managed solutions, and secondly for its 1,400 corporate customers, many in sectors that EMC wants to get more traction in, such as media entertainment and life sciences. Isilon has a very special storage solution that gives customers a low-cost, but highly scalable way to manage data, such as online streaming by media companies, and DNA research in life sciences.

 

Corum recently released a white paper on the Data Domain deal and it highlighted how EMC's acquisition strategy focuses specifically on integration, which leads to great returns. They expect a $1B buy rate out of this historic acquisition, coupled with their existing solutions, within the next few years.

 

Now, a highlight from the infrastructure sector, Windstream Communications bought Hosted Solutions, early last month for an extraordinary valuation of 6x revenue, pricing the deal at $310M. Compared to 3PAR and Isilon, that is about half the revenue multiple, but for a data center hosting solution to receive valuations in this range is very rare. Typically deals in this space average between 1x and 1.5x, hovering at 2.5x or 3x at the most. Hosted Solutions did a tricky thing by saying that they provide cloud computing services, when in fact after some deeper digging, cloud-hosted services only brought in 1% of their revenue. This shows that even though the revenue is not sufficient, just having the cloud computing solution in place sweetened the deal for the buyer and boosted these multiples. 

 

To highlight the richest deal in the spotlight, the award goes to Integrien, which was bought for a reported $100M, a whopping 50x revenue multiple. Integrien has developed a application performance monitoring and analytics software that works hand in hand with VMware. Coupled with previous transactions, VMware now has the ability to provision, monitor, and analyze physical as well as virtual assets, effectively cutting out all Integrien's competitors. Clearly a strategic move by VMware to acquire this technology, even though there was very limited market penetration by Integrien and very competitive players in the space. Now both concerns go away with VMware holding the keys. 

 

Lastly, our final highlight deal was just two days ago, when RedHat announced that they acquired Makara, a two-year old company, along with its 15 employees. Makara is a developer of deployment and management solutions, which provides RedHat with a jump start on their platform as a service offering, which they only introduced in June of this year, just five months ago. To date, RedHat is the only vendor in the open source flexible cloud stack that incorporates the OS virtualization.

 

So as we can see, this sector is moving at lightning speed. Stay tuned for more developments.

 

There are some conclusions that we can draw from the high multiples that we are seeing both in public and in M&A industries. First, all of these companies are in early stages, and they hold the highest multiples compared to more traditional or even level growth companies. A lot of these companies have pretty low revenues for receiving the valuations that they do, so they have extremely explosive growth. All the biggest players are watching this and jumping into the waves, buying the technology. Expect to see a lot more deals happening in the near future.

 

Back to you, Bruce.

 

Bruce Milne

 

You know, in the 26 years that Corum has been operating, we've tracked around 35 waves of activity and new trends in technology and classically at the very beginning you see the giant jockey for position, you see these small companies being bought up for high multiples and then of course it settles down.  Next we'll go to Tomoki Yasuda. He is covering Corum Metrics today, so let's see how valuation is going in the rest of the industry. Tomoki?

 

Tomoki Yasuda

 

Hello, everyone, my name is Tomoki Yasuda, team analyst at the Corum Group. Long time listeners should know that this a boilerplate section of the webinar and we go over some metrics and markets in detail.

 

For first time listeners, the information can be a little intense, especially as I fly through these slides, but if you want more details, please give us a call or shoot us an email.

 

Getting right into it, the public market has slowed down in November, as Bruce alluded to, primarily due to the news of a weaker housing report and concerns about Europe's economy. However, we do have some good news that stocks rallied 249 points on Wednesday (December 1), on reports of an uplifting economic forecast for the US and China. Hopefully, we'll have a further update next time.

 

Here we have the Corum Index. This represents an overall view of some important totals and averages that we keep a record of. For deal volume, we're currently seeing about a 5% drop compared to last year's numbers, which was really one of the peak months for M&A, due to the surge in economic recovery, so we're not too worried about this drop.  Moving down, we see that there were three strategic megadeals, referring to deals over $1B. One of the more surprising deals was Oracle's acquisition of ATG. A very interesting play, which I'll get into more later.

 

I would also like to note that all cash deals are now at a strong 66% percent. Last year we say this go down as buyers were trying to mitigate risk, offering deals that combined a number of other things, such as stock, debt, or earn out. We are seeing the trend that sellers are finally able to negotiate more favorable deals and that it is not strictly a buyer's market anymore. 

 

Next we have one of the first six broad markets that Corum covers, the Horizontal market. This is looking to make good gains. This is actually the second-highest multiples that we have seen in terms of EBITDA and sales this year. The highlight here is the acquisition of Quadrem by Ariba. Both companies provide on-demand procurement and inventory management software, with Quadrem being a private company that caters to global mining firms and Ariba being a public company. This move really highlights Ariba's strategy to align themselves with large international firms by building and monetizing large scale collaborative commerce programs. This is a smart strategy, as currently large scale firms have sunk enormous costs into IT infrastructure and are finding the legacy systems can't fulfill the demand quite as well. On-demand solutions like Quadrem and Ariba provide a band-aid in which they can improve their supply chain needs without causing implementation or integration.

 

Next we look at the Vertical Applications market segment. EBITDA multiples have stayed about the same, around 9.5x, and just under 2x for sales. We would like to focus on the education sector, with the pickup of Wireless Generation by NewsCorp. This is very interesting. Wireless Generation provides mobile and web software for the K-12 education sector and why I say this is interesting is that typically we see NewsCorp run around in circles with their acquisition strategy, in terms of technology and digital media. However this year we have seen them focus their strategy into leveraging the enormous resources they have, picking up companies that focus on information services or online content delivery. The next bet is going to be in the education sector, which generates half a trillion in revenue in the US alone, and they are looking to access the public education market specifically.

 

Next we have the Consumer Application market, probably our most dynamic market, going through some obvious peaks and troughs throughout the year, very cyclical in nature. The deal spotlight in this sector focuses on the ATG acquisition by Oracle. This acquisition was a play by Oracle to use ATG's ecommerce platform as a broad product portfolio which includes the likes of CR, retail, ERP, and supply chain applications. The key thought here is to integrate all of these applications via ATG's platform and build an offering where the customers are aware of how their various commerce operations, whether they take place online, via email, or in stores, are faring with consumers. This really gives the company that operates these multiple channels the ability to quickly react to changes in market and adjust their strategy accordingly, which is very cool.

 

The next slide is the Infrastructure market, which continues to grow the strongest as it hits its highest peak for the year. We are really pleased with the strong gains in this sector, there are vast arrays of companies included in this market. This gives us a good indication of how tech companies are faring overall. Now, the deal spotlight here is one that Alina already covered, so I won't go into any detail, but on top of the improved technology that EMC acquired from Isilon, I'd like to add that they have quite an impressive customer list, with the likes of NBC, Kodak, and Sony.

 

Next we have the Internet market, which had a downward trend during the summer months, but started to pick up during the fall. As with last month, I'm focusing on a Facebook acquisition, but using it more as a bridge to discuss the broader messaging strategy that they have announced in the past month. They picked up three email product engineers from Zembe, an acquisition that alludes to Facebook's real effort to provide a modern messaging system with a platform that looks to rival email services. The concept and idea has always been there and it is unique to the social networking atmosphere, that is, the ability to look someone up on Facebook, and depending on the picture of public information, to zero in on whether this is the person you want to contact. This is a distinct feature that is not available through email. Usually you have to go through a Jigsaw to find that contact information. This is a convenience factor and an opportunity that Facebook wants to maximize.  Obviously this puts some pressure on traditional email services like Gmail and Hotmail, what will their reaction be? And also pressure on vendors like Jigsaw, what do they offer against this new messaging system?

 

Lastly, we have the IT Services market. This has historically been a flat, stable sector, and we can see EBITDA multiples that stay constantly around 6-7x and sales multiples around 0.7-0.8x and this is still the same since October. The spotlight for this sector focuses on the emerging mobile software development that is happening in China, which is very interesting stuff. China currently has a boom in the number of mobile phone developers, number in the hundreds! This is servicing a market of over half a billion mobile subscribers. Emerging companies like Mediatech are enabling saleability and managing costs, with a reduced time to market for mobile handsets, by going cheaper. How they are able to pull this off is by licensing hardware and software together, as a module kit to smaller phone manufacturers, or “OEMs”, some of which have no experience building phones and some of which are literally running shops out of their garages. This allows these small manufacturers to bypass the conventional business model and increase competition for traditionally big OEMs. The traditional OEMs are really missing out in China, due to the fact that business and consumers are opting for these cheaper handsets, and frankly they can't afford to miss out on an opportunity, especially in a half-a-billion subscriber market. Accenture here has made a play to be part of the process instead of missing out on it, and I expect to see similar acquisitions to follow in China.

 

With that, I'll turn the mic back over to Bruce.

 

Bruce Milne

 

Thanks, Tomoki. That is fascinating about Accenture getting into buying in China. We will have advanced info on that next month, on the largest IT services firm in China and the fastest-growing company in the world over the last three years. Also, I am kind of fascinated by EMC. We did a white paper with them and we will have them on in the few months, and they'll also be in our Clash in the Clouds.

 

Let's go to our spotlight on HP today. As I mentioned, we have IBM, Google, Microsoft, EMC, and Cisco over the past six or eight months, and HP is the real big dog, the largest information processing company in the world. To cover them, Dougan Milne.

 

Dougan Milne

Thanks, Bruce. Yes it's true we have seen minor slow down in acquisition levels for Q4 versus the previous quarter, but it is almost unfair, especially if we look at last year when there was so much pent-up demand in Q3 and Q4 as we were coming out of the economic crisis, there. In Q3 of this year, we had huge bidding wars between the giants, we had huge multiples, great deal volumes and then in Q4 up until now, it certainly doesn't look shabby, by any means.

 

Speaking of huge bidders, I'm happy to introduce our spotlight segment for the month, the Hewlett-Packard report. In a few minutes we'll have the chance to listen to Bob Faulkner, a chief technology analyst from UBS, but to get us going here first I thought we'd take a brief look at this massive company, from sort of a historical and fun fact perspective.

 

Let's start by going way, way back here. HP was founded by Dave Packard and Phil Hewitt back in 1939. They started the company on a whopping budget of $538. They set up benches, tables and milling machines in their garage in Palo Alto, there's a picture of that garage here. Today their trailing twelve month's revenue exceeds $123B, with around 300,000 employees, doing business in in nearly 200 countries around the world. It is among the most valuable and recognizable brands in the world, and they were ranked 10th in the 2010 Fortune 500, behind Wal-Mart, Bank of America, Chevron, and others.

 

They are officially the world's largest IT company. And then, in the broad technology scene, they are only second to Samsung, which is the world's largest technology company. Samsung, of course is more prominently an OEM and a manufacturer of a lot of consumer goods.

 

The first financially viable product from this company was the HP 200A, an audio oscillator, essentially a testing device. And among their first customers was the Walt Disney company, who purchased a handful of 200As for their theater orchestra testing during the production of the film Fantasia. Then, by the arrival of the '60s, familiarity and the rise of Silicon Valley in California was becoming ubiquitous across the globe. Today, there really isn't a soul that will deny that HP was the founding anchor of Silicon Valley.

 

Also, 1968 was the launch of the 9100A for about $5,000 a pop, one of the first widely-distributed commercial products from HP. They toyed with the idea of calling it a desktop computer, but they knew at the time that no one would buy it if they called it a computer. So they called it a desktop calculator. 

 

In the '70s, with marvels of engineering, they were able to shrink the calculators and they built the first handheld, the HP35 and there were a series that followed after that. Alongside that was a desktop computer series, and then in the late '70s they miniaturized even further, they released the HP01, I have the picture of that on the left there, ti was a wristwatch calculator, by the way, if you happen to have one of these that you are looking to sell, please email me.

 

By the 1980s, HP was the first to release both a lineup of both inkjet and laser printers for the desktop. Then, in 1986, the fifth domain name ever registered in the world was HP.com.

 

Priorities began to shift a little bit in the 1990s when HP began a heavy expansion into consumer territory. They had a slew of new consumer computing products then in the beginning of this past decade, Carly Fiorina was named as CEO, and that was about the time that HP began to start a really deep plunge in the aftermath of the bubble burst. Their enterprise value was cut in half around 2004, they were laying off massive amounts of employees, which included Fiorina in about 2005.

 

We listed some of the major milestones in terms of founding, products, and even key people, but really I want to give us all a better understanding of how HP came to be the largest computer company in the world. There are really two important points here. One is innovation. HP was founded on a culture of research and innovation. Our guest speaker mentions a bit more about HP's recent announcements in research in just a moment. But the second factor is growth and innovation through acquisition. In their history, HP has made more than 120 acquisitions, this is going back to the first years of establishment, really, and over 60 acquisitions, just in the past 10 years. These acquisitions have been a major growth mechanism for HP.

 

I talked about innovation being part of the culture, and I want to put a little more perspective on that. I was at a conference in London a couple of years back, and I was listening to an academic who analyzed the culture of major technology companies around the world. This was one of the most interesting take away points I've ever heard. It came from the speaker's presentation. He pointed out that over the course of the past 50 years, past employees of HP had built somewhere in the ballpark of 200 spinoffs and startups after leaving HP, which puts some perspective on that. Past employees of SAP have generated roughly 20 technology startups in the same time frame. That blows my mind, I think it is so indicative of the innovative culture that comes out of that Palo Alto company.

 

So quickly, let's look at some of those major growth mechanisms that I mentioned. Some truly landmark acquisitions that helped catapult HP to be the company that it is today. Do we remember Apollo Computer? From 1980 to 1987, Apollo was the largest manufacturer of network workstations in the world. By the late '80s they'd started to give up some market share, their market share dropped to third place, behind Digital Equipment Corporation and Sun Microsystems. HP bought them for a smoking deal in 1989, I think it was $476M, that would eventually be a multi-billion dollar business line, once they integrated that with the HP9000 servers and workstations.

 

Several years later and several acquisitions later, HP made a big move in 1997 to acquire Verifone. Verifone was the leader in retail terminal and smart card technology, you go to most any grocery store and you'll see Verifone transaction terminals there. In the long run, actually, this deal didn't workout for them, it went south and they sold it off in 2001, but it was still considered a truly landmark deal at the time.

 

The next deal here, of course, was one that shook the industry, and I'm sure everybody here remembers this deal, the merge with Compaq was monumental on various fronts, really. If you remember, I just mentioned Apollo, they had given up ground to DEC and Sun in the late '80s. Compaq eventually acquired DEC, so when this merger between Compaq and HP took place, we are literally looking at a merger of not two, but four of the largest computer companies in the world. That is really significant.

 

In 2005, HP made their largest software deal to date. Before their acquisition of Mercury, HP's software business was only about $1B. They assured investors that with Mercury they would increase their software line to $2B. Needless to say, but 2008, their software line was generating over $3B in revenue.

 

I'm watching my clock here, so I'm going to jump forward to the EDS deal. This was the largest deal HP has ever done. There was a very specific reason that HP did acquire EDS. That was to compete directly with IBM. IBM's global services division was doing a tremendous job of upselling IBM products to their service clients and HP realized that they needed to have a services division that would put them at the same table to compete with IBM.

 

The 3COM deal was another whale, giving HP ethernet network switches, routers, security products, and this acquisition was, of course, more squarely aimed at Cisco than any other competitor.

 

I'm going to leave the last acquisitions for our guest speaker to touch on, but we'll briefly have a look at some of the acquisitions that HP has made over the last 18 months here. 

 

There are some obvious ones, and I'm actually going to leave a few of these for our guest speaker, but I'll touch on a few of the other ones. They picked up Stratavia for their database and application automation, and that covers the application stack, but that could be physical, it could be virtual, it could be cloud-based, a very smart investment there. They picked up Fortify with their software security assurance, and this was an acquisition that kind of falls under the governance, writ and compliance space, software security.

 

Melodio, this is kind of an interesting one, this is a media and music delivery for mobile company, definitely a consumer oriented deal, this is right on the tail of the Palm acquisition, and I think overall looking at these deals you see a consistent trend of pretty high multiples, with perhaps the exception there being the Palm acquisition, but that was a little bit more of a desperate state, but certainly very high multiples. 

 

With that I'm going to wrap up my portion and turn it over to our guest speaker. Because of his travel schedule, he didn't have the chance to dial in live this morning, but he was generous enough to prerecord his thoughts for us to present to you know. I'm very pleased to present Bob Faulkner. He's a chief analyst with UBS, he is based out of their New York office. He has a great amount of experience working with and analyzing some of the biggest enterprise technology vendors in the world, and he has some very interesting insights on HP's recent acquisition strategy as well as some forward-looking insights as well. 

 

Thanks a lot, Bob.

 

Bob Faulkner

 

Hi, this is Bob Faulkner, I'm the information technology sector analyst with UBS wealth management research in New York. I've been asked to make a few brief comments about HP's acquisition strategy. As you know, HP is the largest computer company in the world and obviously they intend to stay that way. When I look back at their strategy over recent years, it seems pretty consistent. Their objective has been to become a full service solutions provider, not just somebody who sells you hardware. Along those lines, they have picked up a number of software tools, largely in the development area, the big acquisition was EDS for bulking up their services operation. Then they made a fairly bold move into networking to compete directly with Cisco via their 3COM acquisition. More recently they added Palm, which gave them something in the mobile space, and I think everybody has recognized that this was really to go after the web OS that runs on Palm.

 

As we moved into the 4th quarter of fiscal 2010 we first had a management change, which was followed by the introduction of the new chairman of the board, Ray Lane, from Oracle and Leo Apotheker from SAP. Both were software guys and the street got very excited about the idea that this was going to be a change in direction, that a lot of the acquisitions would now be focused on software. And when you look back at the acquisitions that were closed in that fourth quarter, they closed four of them, Stratavia, Arcsight, Fortify, obviously software companies, and I'd argue that with 3PAR, the value added there is in the software as well. In the fourth quarter you had four software companies acquired and Ray and Leo had no real input into those, so I think from the standpoint of a new strategy, the strategy is actually the same, and the objective was to shift to software, but now they have two people from the software industry who may do a better job that previous management at integrating some of those acquisitions.

 

Right now, I think most of the building blocks are in place for them, and what you're going to be seeing HP do over the coming years is fill in the gaps between a lot of those solutions. Let me give you an example. In their networking group, the old 3COM business, they don't have a firewall, they don't do acceleration, they don't do load balancing, or application acceleration, and those are all obviously areas where they could go out and pick something off.

 

Another thing that I was thinking about, as I was commuting this afternoon, you're finally starting to see things like Apple's iPhone and Android phones penetrate the enterprise space. One of the reasons that they are able to do this is because the product is from a company close to the technology, it is just between those phone's and the enterprise's email system, and provides a level of security that didn't exist before. That's the type of thing that would be a perfect acquisition for somebody like HP. I'm not saying that they're going to go out and buy the technology, but it is the classic type of fill in the gap solution, is it owned by venture capitalists, the founders are long gone, it would be a great candidate from where I'm sitting. 

 

I really don't think you're going to see any big buys, like the EDS acquisition, for a number of reasons. First, gross cash is only about $10B, they added about $10B in debt when the did the EDS acquisition, so that takes the debt to equity ratio down to about 0.55. Nothing wrong with that, but I think most investors really don't want to see them going and adding on a lot of debt. At this point, they are generating a little over $3B in cash from operations each quarter. That's not a tremendous amount, but it's not going to fund a lot of big acquisitions. So I think they're going to be along the lines of the $1-3B type and if you remember my last conference call, management indicated that we should expect R&D to go up as a percentage of revenue. It has been one of the areas where the former management team had been “saving money” so I think that is a good idea on its own.

 

I also think that what you're going to see is that a number of these acquisitions that they will make will be in a little bit more of, let's call it a rough state, and will require more integration to create the kind of suite that I think HP envisions.

 

There was another point on the conference call when Leo was introduced to the investment community a couple of months ago, and I think it epitomizes what HP sees and what the new management team sees. Right now software is only about 3% of total revenue, so it's not a big area. Leo says “Software is how we differentiate our industry standard platform”. Now think about the Apple iPhone. Virtually all the hardware in there is off the shelf, Apple really didn't have to create anything new. But it is the software and the way that it makes the hardware dance, that has been something that has caught people's attention. I think that is what HP really wants to accomplish, make that hardware dance. 

 

Thank you very much for your time, I appreciate it.

 

Bruce Milne

 

Thank you to our friends at UBS. We're going to transition now to our Q&A. I have to tell my HP story. By the way, one of the reasons that HP has bought so many companies is that they hire very bright people. Phil Hewlett and David Packard actually played a major role in the growth of Stanford Business School and they as a company had a mantra of basically hiring the best and the brightest, which is one reason why so many of their alumni have started other companies.

 

I worked with HP in the '80s when they released the inkjet printer. This was a game changing technology and actually was one of the reasons that HP really grew in the '80s. Up until that time, you had to have hard, heart-attack printers, or you had to go a graphics printer that cost around $50,000. I built a company called AMI -- Accountants Microsystems -- and we were trying to do tax forms, a natural application for computers, all these accountants wanted to do it, because up until that time you had to pre-feed all of the tax forms, and there were hundreds of them for the various states.

 

When they released the inkjet printer, we all believed that it was going to be the future. I wasn't going to wait for HP, so I went over to the research lab in Idaho and paid the guys to develop a graphics cartridge. They asked what I wanted, because I was willing to fund it and I did. I said all I wanted was an exclusive and they said they couldn't do that, but I assured them it would just be for a little while. How long of an exclusive? Until April 15th. So I had the only graphics cartridges in the world for tax preparation forms at the time, and we grew 400%. Based on that, IDC rated it the fastest-growing computer-related company in the world and the rest is history. So thank you HP, I've always wanted to tell that story.

 

So let's move on to the questions here. We have some upcoming events we are hosting, some leading tech executives have been invited to a Christmas cruise tonight. We rebroadcast this webinar next week. There is a merge briefing in Montreal, this is a 90-minute event, a bit of an overview covering the process and what is happening in the market, this is a live event in Montreal, I hope you can join us there. Ward is doing a presentation to 600 leaders in the industry through YPO. January, you can join us for Forecast 2011, this is our annual event and the rebroadcast will be January 18. We will see you in Asia in February, and we have a much larger schedule coming up shortly. 

 

We have one plug we'd like to do, Miro Parizek, our managing director of Corum International, Miro, what's up with the World Financial Symposium next week in London?

 

Miro Parizek

 

Thanks. The World Financial Symposium is a symposium that Corum has been sponsoring for nearly a decade now, it takes place once a year on the West Coast, the East Coast, and in London. The one in London takes place next Tuesday. We have 30 speakers from 8 different countries, speakers from as you see here, Carlyle, Cisco, Google, HgCapital, Silicon Valley Bank, UBS, but also many others, and sellers selling companies from ten million pounds to over 100 million Euros, talking over what it takes to get through the process, a buyer's panel, including the head of corporate development from Wolters Kluwer, there is a $1B software company within the publishing industry and it has been on an acquisition binge for the past couple of months, and that will be interesting, joined by the CEO of Cisco UK and Ireland. At the symposium you will find CEOs of software and internet companies meeting with the financial community to talk about all aspects of growth and exit options, covering IPOs, are they coming back, are they coming back to Europe? Raising capital, recaps, buyouts with private equity, use of debt, I'm looking forward to seeing what Silicon Valley Bank has to say about that, and we're looking forward to it. If you can make it to London next Tuesday, be sure to check out the website, worldfinancialsymposium.com and join us there.

 

Bruce Milne 

 

Thank you, Miro. These events take place in Silicon Valley, New York, London and soon in Asia. This has been going on for eight years and we are proud to be the platinum sponsor. Registration is already the largest in the history of this event, so we hope you can join us.

 

Let's move onto Q&A with the few minutes that we have left. Ward, what do we have?

 

Ward Carter

 

Thanks, Bruce.  One last thing on conferences, on the Selling Up Selling Out conferences and the Merge Briefing, as an attendee of the conference today, we'd like to offer you a complimentary pass. You can go to our website at corumgroup.com and you'll find the schedule, which will be posted here shortly for 2011. There you'll find a link for the conferences and you want to use the conference promo code of MADEC10. That will give you a complimentary entry to those events. 

 

A couple of questions that came across from the audience, this first one I will direct to Miro. Miro, I think this is looking at the upheaval we are seeing in the economy and the challenges that Europe is facing. The question is, how do you see the relative currency valuations and the shifting value of the Euro versus the dollar affecting M&A.

 

Miro Parizek

 

Interesting. You know, currency fluctuations is something we have been looking at for over a decade for various reasons, from an investing perspective, but also for the impact that is has on M&A. I'll tell you, firstly I don't think that the Euro and US currency deviations have been so extreme. It has been very short-term periods with fairly large deviations, but in fact it has been hovering around this 1.3 area, give or take 10 cents, for a while. Obviously it went and peaked when the financial crisis peaked, for many people illogically, then it went all the way back down, so it felt highly volatile, but the reality is, the Euro might even be a bit overvalued, it came out at 1.18, we've seen it go down all the way to $0.80, and now its up to 1.3 or so.

 

But with the impact that we've seen in Asia, the Japanese Yen has obviously been an issue for Japan for the last few years, it has been continuing to go up despite their efforts to get it down. What have they done, they've turned the tables and they are using a strong currency to make acquisitions. We've seen that with a company called Rakuten, which is an ecommerce platform company making acquisitions in the US, like Buy.com, a quarter-billion dollar acquisition, but also a company in France, we see NTT making acquisitions, for instance Apex, which we represented out of Singapore, but also in the US and in Sweden, so they're very busy taking advantage. So if that's an indication, I think that if the dollar continues to gain strength, we shall see more acquisitions from American companies of European targets in the next quarter or two, if they also take that to heart and use their strong dollar to buy cheap targets in Europe.

 

Ward Carter

 

Thanks for the insight, Miro. This next question I'll direct to Jon Scott. He is Vice President and one of the deal markers here at the home office. Jon, the question is, with the economy still pretty rough, what is driving the volume of technology transactions that we see today.

 

Jon Scott

 

Well, that's a good question, and I get asked that a lot. I think one example that we can go back to is the R&D expenditures for the big tech companies. HP is an example. When Mark Hurd became CEO, they were spending about 4.1% of revenue on R&D and when he stepped out just a couple of months ago it was down to 2.4%. I think what happened is that with the economy dropping as it did, going through the turmoil of the last few years, R&D spending across the board in tech companies dropped. Microsoft is another example, spending less on R&D. So what has happened is they cut back, and as they see the economy beginning to come out and corporations starting to spend money on IT again, the attitude is what did we miss, where are we behind? So I think what is happening is they are looking for those gaps to fill in technology, so they are going after tech companies competitive, so that's part of it.

 

The other thing is, when you spend less on R&D and your revenues don't drop too much or they continue to grow, you're building big cash balances, so a lot of tech companies are sitting on high cash balances. 

 

Finally, the private equity players are also getting back into the market. They tend to follow trends and now they are out there realizing they actually have to put money to work. So I think those are some of the reasons that you are seeing transactions continue to grow.

 

Ward Carter

 

Excellent, thanks, Jon. Here's a question that maybe I can pose to Dougan. Regarding SaaS valuations, Dougan with valuations as high as they are, can we expect them to go higher as the market improves, or have they possibly peaked?

 

Dougan Milne

 

I'm looking at the time, so I'll give a real short answer, I think the short answer is no. I don't think they're going to go a whole lot higher. We have actually talked about a couple of other reasons today. One of them is that a lot of the acquisitions that have been done over the past couple quarters, and Alina pointed out in her slides a lot of the value of those acquisitions, but there has just been a lot of pent-up demand and a lot of need for innovation through acquisition. We talked a lot about that with HP's acquisitions, we have seen CA make a lot of acquisitions for SaaS and cloud-based companies, and this sort of immediate need for companies that are Sass-based and/or cloud-based, I think that will come down or level and come to a more balanced state as we go forward over the next several quarters.

 

Ward Carter

 

Okay, great. Thanks, Dougan. That takes us to the end of our session today. If there are any unanswered questions, we'll get back to you directly via email, and as always, please feel free to contact us directly and members of our research staff or deal makers would be happy to get back to you on a specific question. With that, we conclude today. I'd like to thank all of our speakers, and our audience members for participating. I hope you can join us in person at a Corum conference and hopefully join us again for the next webinar on January 11. That concludes the Corum M&A report for December 2010.