February 2010 M&A Flash Report

“Software and IT Industry Market Update”

Mark Reed

Good morning, afternoon, or evening, wherever you happen to
be in the world. Welcome to Corum's M&A flash report for February 2010,
which we host the first Thursday of every month.  After the big forecast 2010 event that we had
in January, we are back to the monthly format, which puts current events and
economic news in a context relevant to software executives charting the future
of their companies and planning for strategic transactions like M&A.  I'm Mark Reed, Executive Vice President based
here in Seattle and I'll be moderating. 
At last count we had about 250 executive registered for this event, from
17+ countries in North America, South America, Europe, and Asia. 

We have a great slate of speakers again for you today.  Bruce Milne, founder and CEO of Corum Group
will start off.  Next we'll turn to
Dougan Milne, director of research at Corum Group for strategic insights into
M&A transactions happening in the current market and for details about
valuations trends and dynamics in six different software sectors.  We are very honored to have today as our
guest speaker Rob Adams, Senior Director of Corporate Development at Cisco, who
will share some insights about that company. 

After our speakers, please stay tuned for the Q&A
session.  I will address that in a
moment.  But first, some logistics.  Today's conference is being recorded and it
will be re-broadcast again Thursday, February 11 at 9:30 a.m. Eastern Standard
Time and 15:30 Central European Time. 
About 24 hours from now you'll find the link on the Corum Group website
to the recording of this event, or you can email a request for the archive to pats@corumgroup.com. 

We keep this monthly event to about 60 minutes.  Q&A will follow our guest speakers.  Feel free to ask questions at any time using
the Q&A window on the right side of your screen.  When you do so, please direct your questions
to all panelists.  If you select “Host”
or any other option, your question will not be seen or included in the
queue.  With that, I'll turn it over to
Bruce Milne.

Bruce Milne

(talking in progress)

...we'll be talking about current events and changes in the
market place.  We will then turn to
market and valuation analysis, and as Mark mentioned, Rob Adams from Cisco will
be our guest.  He will speak and then we
will have some Q&A. 

To begin with, we'll just sort of go from east to west.  The Asian stocks extended their January slump
and we're going to be talking more about that. 
The market was down today quite a bit. 
We are seeing some adjustments because we had such a record run up. 

“China's January Manufacturing Expands.”  In fact, the interesting part of this
headline is that it was double from the prior year. 

But at the same time, China's regulators are concerned about
having third mortgages, imagine.  So,
going from a country that didn't have a lot of mortgages to allowing third
mortgages…

Also in Asia, we have Japan, who has raised 2.96 trillion
yen.  This was the biggest amount of
money raised in a decade.  So, clearly
there is a lot of activity on the economic front, which we will see mirrored in
Europe. 

In Euro Zone, one of the big problems we're seeing now, and
we're seeing it affecting currency, is with the default possibilities in
Greece.  Greece is trying to get their
hands around this, but then the unions are jumping in and going on strike.  We have problems also in Spain and Portugal
which are affecting concerns about currency in the Euro Zone. 

Now, I mentioned that we would see a mirror here with Asia,
with Europe raising money.  They had a
record 110 billion raised in bonds, similar
to what we saw in Japan. 

Spain's jobless rate hit 4 million, which is a huge number
for this country, close to 20% now. 

“BP Sees 'Slow' Recovery After Missing Numbers.”  What is happening, if you noticed that the
dollar has been jumping up, they had a new record move for a short period of
time, I think it was about 7% in just a week or so.  What's happening is that there are concerns
with the Euro being a reserve alternative, with the problems they are having in
some of the Euro Zone countries. 

In the U.S. we have our own problems.  The $1.6 trillion deficit is going to come
back to bite us.  The next headline, from
Geitner, states that this deficit poses a “corrosive” threat.  The response in the administration is to
raise taxes on the rich.  Why am I
surprised?  So, they're going to tax the
rich $1.9 trillion over a number of years. 
They're going to try to go after foreign tax harbors so that American
companies will have to pay more taxes on a foreign operation.  To help small businesses, though, the
administration has put together $30 billion for small business aid.  It'll be interesting to see how that comes
about.

So, we are seeing a lot of news about economic
expansion.  The U.S. manufacturing index
expanded more than expected.  We're
seeing that the corporate spending index has shown the highest rise since
2006.  At the top of the list we see Alan
Mulally, a good Seattle boy who went over to Ford from Boeing.  He has been running that and they're doing
great.  The stock is up from two dollars
to twelve dollars and sales have risen 25%. 
U.S. homes sales are muddling along, slightly ahead.  The job cuts in January were the lowest in
two years, according to the ADP, but we'll wait for the Fed numbers to come
out. 

So, we have some good news, but let’s take a look at going
forward.  We still have commodities up,
both the Real in Brazil and the Rand in South Africa, which are commodity-based
economies, are doing quite well.  Ditto
on Australia.  Rubber prices hit a
56-year high.  Which is amazing that with
this economy we're seeing commodity prices so high.  A lot of this is due to the Chinese
buying.  Oil is steady and gold is back
up to $1100 an ounce. 

But there are some concerns, as we see in the next
slide. 

“Roubini Sees Very 'Dismal' U.S. Growth.”  He was at the DAVOS summit and he gave a
speech on his concern about that. 

Muhammed El Arian, who is with PIMCO, the largest mutual
fund in the world, noted that a retreat in stocks would worsen the U.S.
joblessness and economy. 

Headlines are as we discussed last time, the worst is yet to
come for commercial real estate, I think all of you were with me last time when
I talked about a concern that there is a major shift in the virtualization that
is hitting this marketplace.  The service
industry is growing at a slower pace than expected and “Summers talks of 'Human
Recession'.”  I don't know, the jobless
recovery and human recession, I wonder where they get these terms.  If you're out of work, then I guess it's a
human recession and we'll call it that. 
Anyway, they keep making these terms up. 

Technology, though, is doing really quite well.  Google plans a store for business software,
Apple released the iPad to good reviews and that may affect that whole
area.  Cisco's profits exceeded
estimates.  Microsoft is motoring
along.  Comcast beat estimates, and this
morning, just as I got on, we were able to slip this in, Cisco's John Chambers
on a conference call said that Cisco plans to hire 3000 workers in the near
term, which is great news.  In fact,
Cisco today is the only job component that is actually up.  I think that makes it appropriate that Rob
Adams is speaking later on. 

As to what is happening in the deal-making environment, we
have had three closings since Christmas or so, so that there is a lot of stuff
happening.  The vertical markets with
SaaS companies and medical staffing space, education with software focused on
secondary education institutions, and in infrastructure, under network
management and event logging.  These were
the three that closed.  We're not
announcing them because we're still in the process of finalizing and getting
approval, but you'll the tombstones shortly. 

In terms of deals in LOI and offers, it's still very
active.  In current LOIs we have
financial services, these are firms that are going to close and that are in the
process of working through their documents, due diligence and contracts, and
there's retail and distribution.  Other
firms that are negotiating offers are under insurance and financial, content
management, and business intelligence. 
This is basically across the board that we're seeing good activity. 

Let's take a more details look at what's going on in
valuations and the Corum Index.  Dougan,
will you take it from here?  Thank you.

Dougan Milne

Yeah, thanks for that. 
There's a lot of mixed signals, it seems like there's a lot of residual
fear out there.  Let's drill down and get
a better view of the software, internet, and IT sectors on this next
slide.  We'll take a look at how we did
in the first few weeks of the new decade. 
This is our Public Markets slide. 
The equity markets are off to a rough start, but I'm not too worried
here.  You see the S&P Tech Index
represented by the red line.  Frankly,
tech has been one of the few outperformers in the past 12 months, consistently
outpacing the broad public market.  There
was a little bit of a downturn in January for public companies, but M&A
were up this month, so let’s see how we did there with the next slide. 

This is M&A activity. 
Have a look at this bar chart and I'll explain it.  This is transaction volume, with the number
of software M&A deals in January by year. 
So, 2004 is represented by the dark blue bar down at the bottom, we had
around 150 deals in that year.  January
of 2010 is represented by that lavender colored bar up top, which shows right
around 300 deals in the past month, which is great.  You can see that we are coming in just a hair
below where we were in the golden years of, say, 2006 and 2007 and the
beginning of 2008.  But looks how we did
versus 2009.  This is a record jump,
nearly 45 percent gain in the number of transactions from the same time last
year.  That is something to be hopeful
about.

So, let's look at January in a little more detail on the
next slide.  This is the Corum
Index.  Normally, I compare the current
month to the previous month, but I was so intrigued by this year over year
comparison, I decided to look at the Januaries with a little more
granularity.  Here you're going to see
the details from 2008 and 2009 and on the right side you have January 2010. 

With the number of transactions, we saw that on the last
page.  With megadeal, these are $1
billion-plus deals.  There were none in
January of 2009 and only one this past month, but we had a tidal wave of them
back in the back half of 2009.  The
largest deal this past month, take a look at that, it was Tyco's purchase of
Brink's Security, which, it starts to get a little outside what we consider a
software deal, but there is certainly software inserted into the massive
component of that business. 

Average deal size and median seller size: These are getting
more and more difficult to track with any accuracy, simply because the
percentage of undisclosed deals is going up and up.  In other words, when deals finalize, the
numbers are rarely reported these days. 

The only other line I want to touch on is the number of
VC-backed exits.  It looks like the VCs
are feeling a little more comfortable with the market; they are putting their
portfolio companies up for sale.  As you
can see, we're somewhat back on par with where we were at the beginning of
2008.  That was before the market took a
dive.  Let's take a look at the next
slide. 

Now, normally I take these graphs out just a few months or
by the quarter.  We had the deal
spotlight crammed into the same page, as well, usually.  But, I decided to take this opportunity to
show the full January to January spectrum, the full scenario, and then we'll
have some deals to look at when we get to the end. 

So the Horizontal Application vendors have done very well as
a group.  Remember, our subsectors here
are Human Resources, Business Intelligence, CRM, ERP, and Content Management to
name a few.  Enterprise value in sales
has come back from 1.4x trailing 12 to 2.48x. 
You couldn't ask for a better recovery than that.  Enterprise value to EBITDA, off about 1 point
as we finish this holiday season out, and many of the public companies
reporting their profitability was slightly off and others were reporting that
it was very good.  Not really too much to
worry about there, though.

Let's look at the Vertical Application Market on the next
slide.  So, with vertical application
vendors, we saw the multiple hit the floor in February, but clearly they have
made a tremendous comeback these past few quarters.  Sales multiples are back up near 2x, EBITDA
pushing toward 10x.  Vertical, from an
M&A perspective, is going to do very well this year.  We expect to see strong strategic deals in
Government, Healthcare and Energy.  The
ERP will be doing a lot of the verticalized deals and buying the unclaimed
private companies in this space.  Watch
out for the private equity making big moves here as well. 

Let's take a look at Consumer Applications on the next
slide.  You know, these guys are still
getting crushed in a lot of ways.  The
public companies in this space, the gaining companies in the other consumer
facing software, this is one of the groups where the state of the economy is
having a big impact.  Consumer spending
numbers have not yet bounced back in a meaningful way, so we're left with very
depressed companies in this space. 
You're going to see the numbers across the bottom have remained pretty
flat, but hopefully we'll find a rebound in 2010. 

Let's look at Infrastructure on the next slide.  You know, in general, the infrastructure space
tends to report really proud numbers. 
Again, we saw that floor for both EBITDA and sales multiples in February
and look how far we've come, nearly doubling on both accounts.  There has been very steady movement since Q1
of last year.  I think I say this every
month, but I am a big fan of the infrastructure segment, there's just a lot of
interesting and innovative technology that comes out of this sector.  So expect to see a number of highly strategic
deals happening here for 2010.  I'm
excited about that.

Let's look at Internet on the next slide. 
Literally doubling in the time frame of twelve months.  This is a relatively young group when you
compare it to, say, the Infrastructure Market as the public companies go.  This sector has only been trading for a
little over a decade, but they have done very well for themselves in this
decade.  Now, there are two primary
subcategories here.  Both of them are
stocked with very cool companies.  On the
Internet Infrastructure side, we have companies like ATG, Akamai, Juniper, and
Digital River.  On the Pure Play side, we
have Google, eBay, Amazon, recently rejoined by AOL, who hasn't exactly leaped
out of the starting gate, but we'll keep our fingers cross there.

Our last broad segment here is IT Services.  Nothing to be ashamed of here.  They stay very steady at the public
level.  Honestly, a little boring to
watch the public level, I mean it's kind of like watching changes in Swiss monetary
policy or something, but actually, on the acquisition front, there's nothing
boring about it at all.  IT Services had
a swath of strong deals in the back half of 2009.  2010 is already shaping up well and so
despite what these public market numbers say, the private transactions are
trading quite well, generally around that 10x EBITDA, so we hope. 

Okay, on the next slide I promised you that we'd have some
deals lined up and I'm going to go ahead and apologize for the density of
information on these last couple of pages. 
I'm not a fan of packing slides with this much data, but sometimes it
has to be done.

You can see I have divided them up into our six broad market segments.  You'll get the next three on the next
page.  At the bottom of each page you'll
also see a couple of other deals within the market segment from January.  So let’s take a look here.

From the Horizontal on the far left, here's an interesting
deal.  Certainly not the biggest deal,
but we're talking about it because of the buyer, Kingdee and the regional
implications.  Kingdee has done something
like six vertically focused ERP deals in the past twelve months.  These deals are small.  They are all sub-$25 million deals and they
are all being done in the People's Republic of China.  Kingdee is starting to remind me of some of
these North American ERP roll-up umbrellas. 
I'm thinking of Consona, which was formerly Made2Manage, I'm thinking of
their Canadian counterpart Constellation Software, out of Toronto.  The target here, Jiama Info Systems, is a
small ERP, focused on the real estate market. 
This is certainly going to help round out Kingdee's product portfolio
for the local and huge Chinese market.

Understand, and I realize we don't have time for this
conversation, but the Chinese market, despite its size, is vastly different
from what we see in the Western world. 
Software margins are incomparable and software prices are generally on a
completely different scale, in most cases. 
Software adoption, to the degree that we understand it, is not quite as
impactful, I suppose.  So, figure that in
some cases it is still cheaper to employ technical labor to, I want to say
manually automate, that sounds like an oxymoron, some of these business
processes that software would be doing. 
It sounds like an oxymoron, but I think you get the point.

Other deals you see there at the bottom, I like that
EMC/Archer deal.  EMC has been hot on the
tail of Archer for a while and Archer got a heck of a deal here.  Archer doing governance, risk, and compliance,
$175 million deal, that's 5.8x Archer's trailing 12 months revenue. 

In the middle column we have the Vertical Spotlight.  I like this deal a lot.  You know at Corum, we have so many of our
clients that are sold to, what I suppose we could consider unlikely
buyers.  I know that everyone thinks that
the obvious buyer is Microsoft or Google or SAP, but the reality is, that of
the 3000+ or 3500 deals that are done in our market every year, those obvious
buyers, the SAPs, the Microsofts, the Ciscos, they only make up about 100,
maybe 200 of those deals in a big year. 
So you start doing the math on that one and basically we here at Corum
are always trying to look outside the box. 
We're looking for buyers with adjacent or somewhat overlapping or
intersecting sectors to present to our clients. 
But not necessarily the obvious. 

Okay, so the deal here. 
Molina, is non-tech healthcare provider, not a software company, just
managed healthcare.  So in this deal they
are buying the healthcare information systems division of Unisys.  They got a pretty good deal, this was a
divestiture.  They are broadening their
foot print and picking up a whole new revenue stream. Now, this can be tricky
sometimes, low-tech buying high-tech. 
Sometimes we see it fail and sometimes the end result is just
great.  $135 million in cash with 1.2x
trading 12 month's revenue of the Unisys division. 

Others, I like that Orc Software and Neonet
acquisition.  That was a 3x deal, $176
million, all stock, which is kind of fitting when you understand that both Orc
and Neonet are mid size security trading platforms from Sweden, which makes
this a nice market share consolidation.

On the far right side we have the Consumer space deal
spotlight.  This is a fun one.  32Red is our buyer, publicly traded in the
U.K. on the LSD, if you're interested in picking up some shares.  If you don't like wasting your money in the
stock market, you're welcome to waste it with these guys instead.  Both the buyer and the seller are in the
online gambling business, specifically online casinos, sports, horse
betting.  Maybe this isn't a perfect fit
for the Consumer space, but I put it in here. 
It is a well-executed consolidation effort.  Nedplay, the target and 32Red, the acquirer,
are both showing excellent profitability, surprise, surprise.  Unfortunately the transaction values are
undisclosed here. 

Others, take a look at the bottom here.  Time magazine buys Stylefeeder.  Despite having died a kind of horrible death
over the last couple of years, it is interesting to see a traditional
publication at least trying to embrace this fast pace of technology.  Certainly News Corp, in case you missed their
earnings call, the “Other” category is what they call their business line,
which is basically their entire online and software related business, and it
went down significantly in Q4. 

Let's take a look at our last slide, here, and see what we
have for deals.

We'll start with the Infrastructure spotlight.  You know, I was actually in New England last
week meeting with clients or potential clients. 
We were riding around in a rental car, it was probably 15 degrees
Fahrenheit, I'm with Nat Burgess, who is Corum's President, and I think we're
on Highway 3, somewhere between Boston and New Hampshire.  I say I think because we had a GPS unit that
was kind of like a drunk sailor on a Friday night.  Anyway, we're just outside Bedford and sure
enough there is a huge Progress Software sign slapped on the side of a massive
technology park which is where they have their headquarters. 

Progress is a fascinating company.  They filled a number of very unique business
models over the years, not to mention a vast array of platform technology.  In this deal with Savvion, they are finding
value in a few different aspects.  Some
technology expertise among the 150 employees of Savvion and of course the 300+
enterprise clients they'll be getting in the deal. 

Some other deals at the bottom.  Aonix and Artisan Software Tools, both of
whom are Java tool vendors in Europe. 
You know, there are quite a few other deals recently in this space as
well, I don't have the time to go into them, but if you do want some more
information, feel free to call me or any of the professionals here at Corum; we
have more data than we know what to do with. 

Moving into the center column with the Internet sector, the
media does love this space, so we always have these high-profile internet pure
play deals.  Let’s not forget, however,
that there is a lot more to the internet than those billions of images we see
on the screen every day, the end result 
The Internet Infrastructure sector is where a lot of the behind the
scenes work is happening and we have seen some great deals there recently.  Our buyer here is Dentsu, a multi-national
advertising company out of Tokyo.  This
is a traditional advertising company, these guys are doing magazines, TV, etc,
but they're one of the largest in the world. 

What is exciting is that we've seen companies like Dentsu,
like WPP, like Publicis, these traditional media advertising firms are making
big waves in the software space.  They
are focused primarily around Internet Infrastructure, Internet Media, and of
course Internet Advertising.  For a
highlight, Publicis alone, which is Dentsu's biggest competitor, has done
something like 25 deals in the past 36 months. 
So this is another case of getting outside our obvious buyer group.

Lastly, on the right, with IT Services, our last deal
spotlight shows Schneider Electric.  They
are a beast of a company - they serve everything from large scale industrial
projects and products all the way down to the micro and nanosensors for the
life sciences industry.  A great deal
here, certainly broadening their geographic footprint, giving them that
geographic domain expertise they need. 
Cimac is the leading systems integrator for industrial automation solutions
in the Middle East, kind of the Gulf region. 
They are implementing and integrating most of the big automation
projects for the oil and gas industry out there.  Having that kind of clout is certainly going
to bring Schneider some benefit.  We
don't have the closing price numbers, but I think Cimac is doing about $70
million in revenue during the past 12 months, they have about 400 employees.

So that's it for this month, for my section anyway.  I'm really looking forward to see what
happens in the rest of the quarter, and of course I'll be back here next
month.  You know, if you just can't wait
that long, if you need some updated info or if there is anything that jumps out
at you today that raises questions or piques your interest, please, give me a
call, drop me an email or contact anyone of the professionals here at
Corum.  I promise you, we aren't going to
charge you for a chat. 

But with that, I'm going to turn it over to Bruce and let
him introduce our guest speaker for today. 

Bruce Milne

Thanks, Dougan, good job. 
Lots of deals happening.  Rob
Adams, thank you for joining us.  I think
it's very appropriate given the announcement by John Chambers this
morning.  You're hiring new people and
your stock is doing fine, and you beat the numbers.  Rob and I were on a panel last year, called
the Fast Pitch panel at the WTIA.  We had
a chance to meet and here he is.  Thanks
for joining us, Rob. 

Rob Adams

Oh, my pleasure.  Just
to clarify, where Progress Software is, that's 13 Oak Park, Bedford, Mass., and
it used to be my office address, because I worked at Progress at one
point.  You're right, it's a fascinating
company in many respects, typically for the people, too.  It was a very nice place to work, let's put
it that way, very innovative. 

So, the slide does talk a little bit about what I do
today.  I am responsible for Cisco's
Corporate Development Technology group. 
I am part of our CD team under our Chief Strategy Officer, Ned
Hooper.  We are responsible for M&A
activity at Cisco and we are also responsible for our investment portfolio, as
well as a number of different corporate strategy functions. 

The team that I lead does four things.  We do technology diligence on all investments
and acquisitions that Cisco makes.  We
are responsible for managing a good chunk of our investment portfolio.  We do technology advisory for Cisco senior
staff and for others occasionally.  We
also do some targeted software development and sometimes hardware development,
depending on the needs that we have.  An
incoming acquisition needs some bridging software, for example, we might build
that. 

I thought that I would talk a little bit about Cisco's
evolving strategy overall, to start with, then talk with a little bit more
detail about Cisco's current strategy and then how acquisitions and then
investments fit into that strategy. 

So, back in the 1990s it was pretty easy to see what Cisco's
strategy was.  It was 'build the
internet'.  You can't get any simpler
than that.  We wanted to build out the
internet and make sure it was available for everyone as a business
accelerator.  It was very simple.  To execute on that strategy we just drove new
technologies through our sales channel and they made the network itself more
intrinsic to peoples' business and helped them accelerate productivity.  Productivity was a very large message from
Cisco at the time.  And, of course, we
leveraged acquisitions as entry points into new technology areas. 

From 2002 to 2008, it was really about expanding networking
through growth in what we called event technologies.  These include things like security, voice
over IP, optical, and a handful of other things as well.  This was really about diversifying our core
business into those new event technologies. 
We used what we call platform acquisitions to extend our competency
across those new markets, technologies, and sometimes even business
models.  Platform acquisitions are large
acquisitions that we make where we build new businesses upon them.  Usually they are in a market adjacency, not
too far away from core networking, or they are a business that we are currently
in.  But it is something that we really
need to be able to jumpstart that new business.

Currently, the strategy can be summed up in probably three
points.  It is really about expanding the
network's strategic relevance to customer's businesses.  As things like cloud computing, software as a
service, and the higher forms of collaboration come into play, the network is
really an intrinsic part of all of those functions.  How do we create that strategic relevance in
the network for our customers?  It's
really about driving major market transitions as well and I'll talk about some
of the macroeconomic things that we see coming up that are really stressing the
way technology is used by consumers, enterprises, and even service providers
that will be those inflection points where we are going to try to work with
those market transitions.  It's really
about building a couple of new $10 billion businesses.  I mean, in the end that's what we want to
do.  We want to build some new
businesses, diversify, and make sure that we are enabling that transition of
network's strategic nature for our customers. 

To do that, we're going to work with innovation and drive innovation
in our core business; we're going to scale some of our technology businesses to
the $10 billion level.  That's the goal,
anyway.  If you tease apart some of the
numbers that you saw in our earnings announcement yesterday, you'll see that we
have a pretty strong focus on operational excellence and we have some really
interesting capabilities around keeping our operational excellence very
high.  We're going to innovate across a
couple of different market adjacencies, and I'll talk a little bit about
those.  Something that you'll hear sort
of baked into my speech as a mantra is “Build, Buy, Partner”.  This is something we always think about.  How do you solve a new problem at Cisco, you
either build something new, you buy something, or you partner with somebody to
do it. 

So, as a whole, the company takes a very broad approach to
innovation.  Now, how do I say this? In
our dedication to innovation, I guess is how to put it, we look for growth and
sustainability in market leadership positions for all the businesses that we are
in or going to enter.  In pursuit of that
goal, we take a pretty broad approach to innovation strategy.  We develop new technologies, design new
products, obviously, build new business models, even, stuff that is completely
outside of our expertise model.  We
pursue acquisitions and investments, obviously, and we work with other
companies in those market adjacencies to build new technologies or create new
go-to-market methods that meet the needs of our customers.  My team is responsible for the acquisition
portion of that strategy and the investment portion of that strategy as
well. 

From a macroeconomic level, or sort of a macro business
paradigm level, there are really sort of three areas that we are paying
attention to these days.  There are
pressures on our basic market.  Consumer
leadership is one of those pressures, where we're seeing the rise of consumer
devices affecting both the way service providers behave, anybody who has paid
attention to the iPhone and AT&T who's responsible for network problems
recognizes that those consumer pressures are really having an effect on service
providers as well as enterprises.  We see
many of our large enterprise customers telling us that the technologies that
people use at home are now bleeding their way into requirements from employees
for large enterprises.  And the rise of
the digital native, social networking, everything else, a well-worn topic for
many people, I'm sure, but it does have a very big impact on our thinking about
how we take our business in the future. 

There are economic shifts that are happening.  Emerging markets are beginning to rise, as
everybody knows, we're paying much more attention to emerging markets.  We see a lot of business model innovation
going on out there, with cloud computing and software as a service and just
about anything as a service.  I saw
somebody coin an acronym the other day: XAAS. 
X meaning we don't know what's going to be a service next.  Put your favorite variable in here. 

So there are a lot of pressures on networking as well.  The network is becoming incredibly
complex.  With the rise of so many
different kinds of end points out there, and more to the point, not simply the
ubiquity of end points, but the capability of those end points becoming higher
and higher, as the end points become more sophisticated.  You know, back in the 1990s, we used to talk
about having your refrigerator attached to a network, or your hot tub, so you
could turn it on whenever you were on your way home.  Those are silly today.  I mean, they were silly back then, too, but
they are silly today given how intelligent devices tend to be.  I saw an interview with somebody from CES who
had an Android-powered microwave.  It is
hard to imagine that kind of compute power and sophistication in a microwave,
but in the end, if that thing is going to be out there, the complexity of the
network is going to get far greater than it is today.  There is also ubiquity, which I talked about,
in the mobile nature of things. 

Steve Jobs, the other day, whenever he was doing the iPad
introduction, characterized Apple as a mobile company.  They build laptops, iPhones and iPods.  All of those are mobile devices.  All of us and every application that we are
using are becoming mobile.  That puts a
great strain on the complexity and ubiquity of network issues and also makes
pervasive connectivity much more of an interesting problem. 

Now that we've identified sort of the pressures on there,
how do you look for market disruptions and opportunities in those? 

So, the CD team that I am a part of, we are constantly
looking for new opportunities to capture these kinds of shifts, thinking
outside of Cisco's core business, identifying some unique, complementary market
transitions that we can play a part in and drive.  Making sure, all the while, that the network
is really the underlying platform, so we can bring our expertise to the party,
as it were. 

And, of course, one of the things that makes this a really
workable situation for us is that our culture is incredibly open to new
technologies and new ideas.  We used to
have this accompaniment to our badge where one of the most prominent things on
it, which kind of defined our culture, was “No technology religion.”  There is no one right way to solve a problem,
there are many ways to solve problems. 
However that might happen, we need to bring that in and do the best we
can with them. 

Whenever any of these market opportunities come up for us,
the CD team applies our integrated approach to a business life cycle from market
entry to expansion and acceleration.  In
that integrated approach to a business life cycle, acquisition and investment
are obviously good parts of that for us. 
What we do in the CD team is we sort of bring the expertise that we have
and the capabilities that we have, to bear on figuring out which, investments
first and acquisitions second, are really going to help us achieve the
strategic goal that we are after.  And,
of course, with all the expertise that we have brought in with us in the past
and that we have inside the company and with the broad portfolio of businesses
that we are in, with the large number of very good partners that we have, and
with a lot of input from our customers, the team that I'm on takes all of that
information along with the strategic pressures we see out in the marketplace,
combined with the very strong balance sheet that Cisco has, and all of our
diverse businesses to really figure out how to take the next step, and often
that means investment or acquisition.

From an acquisition perspective, the things that we look to
do, particularly, are capitalize on market disruptions, really, where are the
disruptions out there in the marketplace? 
We really want acquisitions to focus on building new markets for us;
it's not just about bringing in a technology or talent.  It's really about bringing in the ability to
really work in a new marketplace.  And,
of course, in this day and age, specifically, that means to pursue global
markets.  Things that are tied,
specifically, to a region or a submarket are less interesting than things that
things that can address global concerns.

We segment the acquisitions that we do into three
categories.  There are new markets,
something that we have not done before, that we are going to get into now.  There is expanded markets, something that we
are in that we need to refine.  And then
there is accelerate, something that we are in, that we are doing well at, but
that we can really use some energy in, by filling out our portfolio.  In particular, we want to make sure that
whatever we are buying ends up moving toward a billion dollar marketplace at
some point. 

If you pay attention to the way that we have done
acquisitions in the past, we have what we call, as I talked about before,
platform acquisitions, where we buy something substantial in order to create a
good footprint in the marketplace.  Back
in the fiscal year of 2003, we bought Linksys to start our consumer
business.  We were not in the consumer
market in any way before that.  The
purchase of Linksys was really our foray into that consumer business.  Since then we have added a number of
acquisitions in that space, most recently with Pure Networks, whose office I am
in today in downtown Seattle, and Pure Digital, in San Francisco, the maker of
Flip camera, in order to keep accelerating that consumer business that we
have. 

In our fiscal year of 2005 we bought Airspace, to really
accelerate our wireless business, but Airspace had some incredible talent, to
be honest.  They had some very good technology
that we did not have.  They also had
touch with a lot of marketplaces and customers that we had not been able to
build.  Mostly, through a lack of focus,
to be honest.  Airspace is now the basis
for our entire wireless business and we have added a number of acquisitions on
top of them in order to really accelerate that business as well. Scientific
Atlanta is another example of that, and Webex is also another example of that
collaboration for us.  In the last year,
we have added both PostPath and Jabber to the Webex portfolio through
acquisition. 

In the fiscal year of 2009 we did, I think, seven
acquisitions, including PostPath and Jabber, which I mentioned, Tidal Software,
which is a service firm in the data center and services space.  We did a building management company called
Richards-Zeta, which really works with a lot of HVAC and lighting control
vendors out there in order to be able to do integrated and consolidated
building management, as part of a green effort on Cisco's part.  And, of course, the two consumer products I
talked about, Pure Networks and Pure Digital. 

In fiscal year 2010, which started last August, we have done
two acquisitions.  We purchased a company
called ScanSafe that is based in London. 
They are sort of the pioneer and market leader in web security
solutions.  We paid roughly $200 million
in cash and retention incentives for the company, which has about 150
people.  This is a fascinating business.  We added it to our Ironport acquisition,
which is email security, so now we have both web and email security. 

We also purchased a company, the deal closed on December 18th,
I think, called Star Networks, in Massachusetts, which is near our Boxborough
facility.  We paid $2.9 billion for
it.  It's about 1000 people, if I remember
correctly, about 500 in India and the rest in the U.S. and other
localities.  You know, a fascinating
business.  Star was one of the few
companies out there at eye-popping levels. 
I think they exceeded their forecast, profitability forecast, not just
revenue forecast, nine straight quarters in a row.  The compound annual growth rate in their
revenue was, I think, 65% from 2004 to today. 
This is a very rapidly growing company, great management team, really
good product sets.  We added that to our
local wireless business to fill out the mobile wireless portfolio that we had,
so we can really address the 3G and 4G network providers out there and a lot of
their needs. 

I think Star was our 136th acquisition to date
and we have two more in the pipeline, which have been announced but not closed
yet. 

We also have a pretty extensive investment portfolio.  We have about $1.3 billion under
management.  We are a serial investor and
have many, many investments.  This is not
something we publicize all that much. 
But what investments do for us, is they allow us to, in some ways, do
some market learning before we go jump in. 
If we want to enable a new technology for current markets or new
markets, but we're not sure that the market is going to really take off just
yet, we'll do an investment to try and accelerate that market place.  We do it to understand the potential for some
of our advanced technologies and other emerging technologies in new
markets.  We do it to drive go to market
relationships, to be honest. 

We also try and target financial returns on top of just
strategic returns as well.  We have three
kinds of investments.  We do direct
investments in companies.  We do indirect
investments, which means in some place where we have no expertise we might work
with a venture fund, for example, and fund a new fund to invest specifically
and then we will sit on the board.  We
also do investment partnerships, where we will work with a VC or some other
large partners and create new investment funds in order to try and gather some
strategic intelligence and/or accelerate some markets in the areas where we may
not have the expertise. 

We do a handful of acquisitions every month, honestly.  We have gotten to the point where so far this
year we haven't done that many, simply because valuations are high and there
has been a lot of, in our view, money chasing the really good companies, so we
haven't been needed, to be honest.  I
think the latest ones we have done are a company in mobility, Gridnet and
SmartGrid, we've done Aravo in collaboration, and a company called Quantcast in
video.  We've placed investments in these
companies. 

So, with that, I think I've talked out my time and I guess
we'll open it for Q&A. 

Bruce Milne

Yeah, thank you Rob, that was great.  We are operating on one of your companies
Webex products, which is a lifesaver for us. 
I'm going to talk a little bit about some events coming up. 

So, we just moved our offices and we are all back to dialing
in today because we just moved this week, after 25 years.  With upcoming events, in Bothell, our new
headquarters, we moved out of Bellevue, for those who know the area, into North
Creek, the tech park there, expanded facilities for our expansion into
Asia.  We'll be in Houston,
Stockholm...our next Flash Webinar, by the way, which will be featuring the
private equity community, which has $400 billion of uncommitted funds to
invest, will be featured, and then Dallas, Lyon, France, Denver, Salt Lake
City, Dublin, and Santa Rosa. 

Just going forward here, to take a look at the next slide,
the Selling Up Selling Out is brand new, we have been doing this every week for
20 years, we've just redone it though, so it's a new format, 1-5, this is the
most-attending executive conference in the history of the Software IT business
and basically it gives you everything you need to know in order to prepare and
position value structure and negotiate a transaction or partnering.  This is definitive education. 

If you want to attend, please let us know.  As an attendee of one of our events, you can
actually get in for free.  The next one
that we have is coming up in Bothell, in our offices, and this is being
co-sponsored by the WTIA.  Past attendees
of our conferences and webinars can get in for free.  We're also having an open house afterwards at
our new facility.  So, the conference is
from 1-5 p.m. and the open house is from 5-7 p.m.  You can register by going to Events on our
website, www.corumgroup.com. 

This is a definitive boot camp for anyone who wants to learn
how to go through this process and the more education you have the better.  I'm sure, Rob, you've seen that, the more the
folks understand about what to do and the process you go through and due
diligence and such, the better off you're going to be in getting these
transactions done and having a successful post-merger environment. 

With that, Rob, thank you very much.  We're going to have some questions now, so
let's open it up to questions.  Mark,
I'll hand it over to you. 

Mark Reed

Thank you, Bruce. 
Actually, the first question, here, Rob, is for Dougan, maybe you could
take a quick whack at this, Dougan and then we'll move onto some of the
questions for Rob.  I think it was driven
by envy by the multiples that EMC paid for Archer, so could you give us some
insight as to why they paid such a high multiple for Archer?  What are the strategic hot buttons?

Dougan Milne

Yeah, I think so. 
There are really going to be a few elements here, really, Mark.  First of all, let me point out that this deal
was actually done by RSA, so EMC is, of course, the parent company, but they
own RSA who is a very large security and compliance company.  So, Archer is going to be going directly to
RSA.  I suppose there are a couple of
components as to why they had such a high multiple and we can talk about those
in bullet format, if you want. 

The first one is ease of implementation to RSA.  Archer has built their entire technology on
this smart suite frame where the whole idea behind it is that it is supposed to
be very easy to implement with other security and ERP systems. 

I suppose one of the other elements is GRC: Governance,
Risk, and Compliance.  This has been very
hot for the past few years; basically, ever since Sarbannes-Oxley and the other
major government regulations have come about this has been a pretty serious
issue.  So, companies that have been
working in this space have had high multiples in general and certainly this is
working in their favor. 

One of the other elements, going back to the technology side
of Archer, is going to be the fact that on their front end they built a
collaboration element.  The collaborative
front end is the ability for users to kind of have visibility and communication
with other users, which as you know, collaboration is sort of a hot word right
now, it has been for the past 12-18 months, and it will continue to be through
2010. 

The last element here, and probably the most important, and
maybe what you don't immediately think about, but it’s timing.  You have a situation here where they have 100
year storm, whatever you want to call it, but they have a couple of elements
working in their favor.  Timing-wise,
they have had really fast growth for the past few years.  We're talking 40, 50, 60% growth, year over
year.  The other element is, as Rob
mentioned just a couple of minutes ago, that there is a bit of a hot bed, there
is a frenzy going on in bidding wars for companies. 

So, take all these things into consideration.  I always say that it's best to sell when your
company is growing well, versus once you've already reached your plateau.  Certainly, that way your valuations are based
more on the growth of your company rather than on what you have so far.  I think this was a major part of that 5.8x
trailing 12 month's revenue. 

Rob Adams

Well, if I might add to that as well, as somebody who does
this regularly, and one of the questions we get repeatedly over the last year
is why haven't you bought more in the middle of an economic downturn with the
amount of cash you have.  The reason is
that good companies, even through this downturn, unlike other downturns, still
demand very high multiples.  In previous
downturns, like in the early part of the last decade, in 2001 and 2002, the
economy was depressed, people were looking for access, there were a lot of good
companies that were available at great prices. 

In this downturn, people viewed it as temporary, to be
honest, and even with their stock price, if their investors were looking for an
exit, they were looking for hefty multiples because they knew it was
temporary.  Stuff was really
expensive.  We didn't buy more because we
couldn't justify it financially in some cases.

Mark Reed

Thanks, Rob.  Here's
another question from the audience and it is about location-based
services.  “Does Cisco have an interest
in location-based products and services? 
We hear a lot about it.” 

Rob Adams

Yeah, absolutely.  It
goes toward one of those market driving factors that I talked about, the
complexity of the network and the mobility piece, right?  Mobility demands that we have location-based
services in many ways and it goes beyond location-based services into things
like presence.  Are you available, are
you not available, will you become unavailable soon, who are you available
to?  A lot of that depends on the
location that you are in, if you're in an office, on a cell phone, in a
car...  So, absolutely, location-based
services are something that we have been talking about for many years now,
trying to find the right way to gather that information, to distribute it, and
to have some serious reassurance that it is accurate.  That's the biggest problem with
location-based services is the accuracy. 
We haven't, to my knowledge, really jumped at that space yet, but it is
definitely a hot button for us.  It has
to be, just given all the things that are going on, it has to be. 

Mark Reed

Thank you, a lot of exciting stuff there.  Second question, actually I'm going to
combine two questions together because they relate, the first one is, is there
an intersection between Cisco's M&A strategy and Cisco's investment
strategy, and if so, what does that cooperation look like, and the second
question is, what percent of your direct investment do you then follow up by
acquisition, acquiring the investee company. 

Rob Adams

There is definitely a strong link between the two of them,
they go hand in hand.  The same group, my
group, works with both of them.  The same
deal managers that do acquisitions also do investments and are responsible for
those investments, sitting on their board and that sort of thing.  So, we do them in an integrated manner. 

As far as percentage of companies that we invest in that we
go to acquire later on, that is a very complicated question.  The answer [the percentage] is very small,
but it's not very small because we make bad investments or that our strategies
don't pan out.  It's very small because
if we think there is a potential for us to acquire in the future, we tend to
just acquire instead of just doing an investment.  One of our goals in our investment portfolio
is to make the investment companies that we have successful.  So, we work with them to get them into our
channel partners programs, our developer programs, we talk about them publicly,
we try to do everything we can to make them successful.  If our intention is to acquire them
eventually, we've just made ourselves pay more, right, by making them more
successful.  That's why it's
complicated. 

So, although the percentage is small, it is not because of
any other reason than when we want to acquire and think we might, we just
do.  When we're really insure, we
invest. 

Mark Reed

Okay.  Here's another
question, what are the top three qualities that Cisco looks for in a direct
strategic investment. 

Rob Adams

It's got to be in one of the areas that we are most
interested in, so a company that either has technology that is unique in the
marketplace, that will create some disruption in the marketplace, or that is in
a new market we know nothing about and that tends to be a leader in that
market. 

We never go for direct ownership, right, so we don't do more
than 20%, we don't do equity accounting, we always try and take a smaller
portion, so the deal terms have to be correct in order to get us to the right
position in the company. 

We also look for companies that we can actually do something
with.  If it is a company that is totally
outside of our expertise, that we don't have the ability to create a strong commercial
agreement with them, for some reason, then the probability gets a bit lower
that we will do something.  Now,
occasionally, for pure technology companies, where the technology hadn't been
made yet and none of that is possible, we'll still do those, but for a company
that is up and running and is going for like a C round, where they are
expanding their customer base, in that situation we can do a commercial
agreement.  Build a solution, fill out a
solution, get some expertise with the company and work with them to help them
be successful. 

Mark Reed

Thank you.  Here's
another question. I'm not quite sure how to interpret it, so I'll leave some of
that to you.  With the increase in
services, do you see security data, mobility, etc?  What is Cisco's view of service management
systems? 

Rob Adams

Well, it's easy to tell that Cisco would probably be
interested in this kind of thing given that services are a growing part of our
business.  If you look at our numbers
from yesterday, you'll see that services makes up a growing chunk of our
overall revenue.  A lot of that comes
from advanced services, where we help customers build new things or manage
certain installations.  With UC and
Security and Mobility being large parts of our business, I think it is pretty
clear that we're going to be interested in those sorts of things.  And, as you can see from past behavior, we
purchased Title, which is a data center management services, company and I
would imagine that it is easy to think about what we might do in the future
around those.  So, we're certainly not
adverse to it.

Mark Reed

Okay, thank you. 
We're here one minute before the top of the hour and so I think we
probably have time for one more question, if you don't mind, Rob. 

Rob Adams

Sure, no, not at all. 

Mark Reed

Okay, and I'll try to get two questions in for the price of
one here.  Here are the two
questions.  “We're a small technology,
under $10 million in revenue.  We think
we could help Cisco accelerate in one of your key markets.  Can you give us any idea of the size of the
company that you consider?  Is revenue or
profitability important?”  The second
question, which seems related to me, is, “You like horizontal technologies with
billion dollar potential.  Do you ever
find small acquisition in niche markets or geography to have this kind of
potential, or do you focus mainly on VC-backed companies in Silicon Valley?”

Rob Adams

Well, we don't focus on Silicon Valley.  We're pretty much all over the place so we
don't specifically limit ourselves to Silicon Valley for sure.  Even in our acquisition strategy, you know,
ScanSafe is in London.  So, we even buy
companies that aren't in the U.S.  We
have done quite a number of those, too. 

The size of company we typically look for, we generally come
in on a C-ground so there is usually a set of VCs involved at that time.  It is very rare that you see a company that
does friends and family the whole way through C, or angels the whole way
through C.  So, typically there is a VC
involved, although that is not a requirement. 
It does not always need to be post-produce.  We have a handful of companies in the
portfolio that are pre-product, but the technology is something that we need to
keep an eye on.  So, we did earlier
rounds with them.  So, there is no metric
that we impose on what we will or won't do. 
The only real basic thing we have is that we don't want to own a company
to the point where we have fiduciary responsibility for it.  So, angel rounds are typically very hard for
us because even a few hundred thousand dollars of angel money is enough to be
an owner and it is hard to say, with a straight face, that Cisco won't have an
undue influence on a company that small. 
Even if you don't have 20% ownership. 
So, we tend to like them a little bigger, but it is not necessary, as we
have done things like that before, too. 
So, no metric.

Mark Reed

Thank you.  Actually, if you don't mind,
let me lob one more question at you that just came in and maybe you can take
the specific case here and generalize it just a little bit for some of our
other listeners.  The question is, “Do
you do investments in specialty semiconductor startups that are providing
strategic chips to Cisco?” and secondly, maybe you can generalize that to talk
about investments in companies that you are working with that may have some
sort of relationship that you are working with already. 

Rob Adams

You're going to tease my knowledge of the portfolio.  We do, absolutely, invest in silicon.  PA Semiconductor, I think, was the name of
the company that Apple bought not too long ago. 
We were an investor in them.  That
was a very nice exit for us.  We have
invested in a handful of others as well. So, silicon is certainly something we
are interesting in and it is certainly a very big part of our business,
obviously, we do a lot of building of our own custom ASICs and so on.  So, we are always interested in new ways to
do that and investments are a great way to get some knowledge about what is going
on out there. 

Did that answer the question?

Mark Reed

Yeah.  Are there any
generality that you can lend to that?  Do
you look for investment opportunities in companies that are doing business with
you?

Rob Adams

Yes, absolutely.  When
we are currently doing business with a company, there are usually three places
where we are doing business with them. 

In the go to market setting, where they have some technology
that we don't have, whether that is hardware, software, appliance, whatever,
that is satisfying a set of our customers' needs, not a single customer, but a
set of them.  We may do an investment
there to make sure that they have all of the resources available to them to
continue to be successful.

We will do investment in suppliers, instead of doing NRE
payments and that kind of stuff if the company is very good.  We want to make sure that they are successful
as well.  I don't want it to sound like
we're doing it as a hedge against that company's failure, or as sort of a first
rite of whatever, so that they don't get scooped up from underneath us, that
we're too dependent or something like that. 
It's really about success and one of the things that is at the heart of
almost all of Cisco culture is that there is no such thing as a zero sum game,
there are wins for everyone.  When you
work with a company, you like what you're doing, and it's working really well
for both parties, sometimes the infusion of an investment just makes it better
and that's really what we're looking for. 
So, from a hardware supplier point of view, from a software partner
point of view, from a go to market point of view, and we can make the situation
better by leveraging the balance sheet as it were, we will do that.

Mark Reed

Great, thank you very much, Rob.  We hate to let you go, because it has been really
great to get these insights from you, but we are at 5 past the hour and we do
like to keep these events to an hour. 
So, with that, we will conclude this event. 

Thank you very much to our speakers today, especially to
you, Rob, I know that you have a busy schedule and you were on a plane all day
yesterday, so we appreciate the time you spent with us this morning. 

Rob Adams

My pleasure entirely. 

Mark Reed

I'm sure our audience was very grateful as well.  With that, we will wrap up this event and I
hope as many of our audience members who are able will join us soon for a Corum
conference.  That concludes the Corum
M&A Flash Report for February 2010.