Corum Webinar
July 8, 2010
Ward Carter
Thank you for joining us.
I'm Ward Carter, and this is our 10th annual mid-year M&A
update and forecast for July, 2010. Our
special guest is Mike Wetter from Microsoft.
This web event is part of our monthly, global online seminar series,
designed to put current events and economic news in a context relevant to
software executives who are building their companies and planning for strategic
transactions like M&A.
Today we have over 330 attendees from 18 countries, and
seven speakers covering a range of topics, which will include an overview of
the current market and what you should be concerned about, a review of the most
popular valuation methos used today, a breakdown of the M&A market,
covering 26 sectors, our China update, and then our special guest speaker from
Microsoft. As usual, we will wrap up
with a Q&A session.
The speakers today, in addition to myself, include Bruce
Milne, CEO and Founder or Corum Group, John Scott, VP of Corum at our
headquarters office in Bothell, Washington, Dougan Milne, our Director of
Research, Cecelia Yuan, Corum's China Analyst, Nat Burgess, who is Corum's
President, and Mike Wetter, Director of Corporate Development of
Microsoft.
As far as the logistics for today go, we'll keep the event
to about sixty minutes, and you'll want to stay tuned till the end for our
Q&A session. As for the Q&A
process, feel free to ask questions at any time, but we'll answer them only at
the end. To submit a question, please
use the Q&A window on the right side of the screen and make sure to send
your questions to All Panelists. If you
select Host or any other option, your question won't be seen and won't be
placed in the queue.
Today's conference is being recorded and will be rebroadcast
Thursday, July 15. Thereafter, the
recorded event will also be available on the Corum website via the conferences
and events link on the left side of the web page. You can also email a request
for the archive to pats@corumgroup.com.
With that, I'll turn the floor over to Bruce Milne.
Bruce Milne
Thank you, Ward, and welcome. This is the largest mid-year report in the
last decade. Thank you for joining us.
Let's start with Asia, moving east to west. I thought that this particular headline was really
very appropriate as two months ago we ran a webinar called Asia Rising with a
report from China. General Motors' first
half China sales passed their US sales!
They sell more cars in China now than in the US. Of course, the growth rate is much greater,
with over a million cars last quarter. The manufacturing is slow, they have
been trying to slow it down, also in the real estate, as we have talked about
in the past.
The Agribank IPO may be the world's largest, ever. Things are happening there.
This morning I saw that the World Bank increased the growth
rate a bit from 4.5 to 4.6 next year.
India is trying to control inflation, there is so much
activity there, and in Thailand the demand has outpaced the car production by
double. Asia continues to rise.
In other international issues, in Toronto, TD sees Euro
parity. We've been down to under $1.20
exchange, we've up to around $1.25. What
they are concerned about is that with the ongoing debt issues, which we've
talked about, so we won't address those today, the Euro may see parity. Others are saying around $1.10, $1.15. One of the things they are concerned about
other than the debt in the country, is that there may be hidden losses. There are 91 banks going through a stress
test now and the big concern is that they don't yet know the whole story.
The dollar has been advancing, as you know. What has also been happening, and this is
interesting, is that you start to see that with concerns about the Euro that
investors are flocking to havens like Canada, investing in the Loonie and the
Aussie Dollar. They have not done that
in the past, they have gone to the Swiss, the Kroner, the yen and others, but
now they are going to other currencies.
In what is kind of our comedy minute, Chavez shut down the
brokerage firm that trades in currency, believing that the reason for the
Bolivar's loss was because they were a bunch of thieves. So much for when you have and ex-paratrooper
running a country.
In the United States, the Dow slid 10% in a volatile second
quarter. Of course it has rebounded in the last few days to over 2,000
again. The VIX, which is a volatility
index, is at 28, which is very high, so you will see continued huge swings like
we have seen in the past months.
The bad news, the US payrolls in basically all sectors grew
less than forecast. Not just in
industrial, but also in home and self-employed, which is a concern because we
need to be re-employing if we're going to put those 8 million people who lost
their jobs back to work.
Speaking of that number, there are also 8 million loans in
delinquency that still need to be worked through. If you noticed during the last few months as
it was heating up, I know our friends on the east coast don't think that's
funny right now because of their heat wave, but the number of houses that were
on the market went up. They have been
pacing the delivery of these defaulted homes and this is at various stages of
defaults to the market, they don't want to flood it.
In retail sales, there is good news, there's always good
news and bad news. Retail sales two days
ago came out as the best in four years.
However, last week consumer confidence dropped from 62% to 52%. That almost seems an aberration, because that
is a record drop in one month.
More good news, mortgage rates have fallen to the lowest
ever, so if you want to refinance, get out there, 4.56%. Wow.
“Nobel Economist Krugman says US in for Long Seige.”
There's the issue about how long this will last. We used to have these online questions and we
would poll you. I'm not going to do that
today, but here we have Obama saying cutting debt will be our project and we
also need more stimulus, this was all said on the same day. Merkel in Germany is saying that they have to
cut government expenditures. We have
these two polar opposite positions on what we must do in the economy today and
both sides are getting a lot of criticism.
Do you continue to print money for stimulus or do you cut back?
Technology is where we'll finish. The Apple iPhone 4 debut flooded eBay, with
three times the demand for the old phones.
Samsung, speaking of Apple, which provides chips for both Apple and
Dell, recorded record $4.1 billion profits, their best quarterly profit
ever.
Google is still having fun with China, getting their license
reviewed. I think it is appropriate
since our speaker is Mike Wetter from Microsoft, online Xbox sales will
probably top $1 billion. Make Mike will
address that.
With that, let's move on.
We get questions all the time about valuation. John Scott has been in the industry for 30
years and was most recently President and CEO of Powertech Group, which we sold
and then John joined us. John, let's
talk about valuations.
John Scott
Thanks, Bruce. As
experts, there are a number of valuation models that we use when working with
clients, and the reason for multiple methods is to establish a real-world
valuation model based on metrics and measurements that apply to today's market
conditions. Let's begin with market-based
methods.
In this model, you compare yourself to a group of
publicly-traded peers, so you select companies that operate in the same or
similar industry as yourself, similar products, target market, and financial
profile. If you can divide a company's enterprise value through sales to get a
ratio or conduct a price earning multiple comparison, there are several other
similar ratios.
Now, in these analyses, you can use last years figures,
12-month expectations, or most constantly used, trailing twelve months, or
TTM. This is most generally used because
it reflects the company's most recent performance.
In situations where we have a client that is experiencing
significant growth, we will use the forward twelve month projections, insuring
that the increased revenue is well-valued.
Also there is a comparable M&A transaction analysis, and
in this model you look for recent comparable transactions in your sector. Again, you want companies that operate in the
same or similar space, etc. This tells
you what a willing buyer and a willing seller were able to put together. You can then create an enterprise to sales
ratio and other multiples. Some of this
information is easily available in reports, and if it is not, Corum's own
research group will use its own databases to scour SEC documents to find
it.
The next really is the income-based method and this simply
looks at the value of the some of future projected cash flows discounted back
to present value. This is commonly used in software companies with three years
of projections along with a terminal value that captures the values of the cash
flows after the forecast period.
Then there is cost-based methods. This is the classic make versus buy analysis
that buyers make. It considers the tame to
reproduce technology, to gain market traction, or the time that it takes to
build a customer base.
Finally, there are some other seldom-used methods, book
value, liquidation value, etc, but I'll skip those for the sake of time.
So, the question is, what is the most popular method being
used right now? That is the sales
multiple, a company's enterprise value divided by sales. In today's M&A environment, a sales
multiple model works even when there are losses or minimal income. If a company has an enterprise value of, say,
$50 million and sales of $25 million, it would have a two times or 2x sales
multiple. So the real question is what
did the sales multiple look like in the past 12 months in some of the key sectors
that Corum follows.
Horizontal Software is between 1.35x and 2.1x. Vertical
Software is from 1.4x to 2.1x. Consumer
Software is lower, 0.5x to a just under 1x sales. Infrastructure is 1.5x to 2.5x sales. Internet and Software is 2.19x to 2.7x. IT Services, which is people intensive, is
lower, 0.6x to 0.74x.
Bruce, back to you.
Bruce Milne
Great stuff, John.
The issue is that we get a lot of questions about this, because as we
are going to see in the next presentation, we use a lot of these sales multiple
metrics. Software, IT and
internet-related technology companies have different valuation methods than
really any other kind of business. You
can have essentially a bankrupt company, one that is losing money or making no
money and it can still be worth a great deal of money. This is not the case in most other
businesses.
With that in mind, let's move on to Dougan Milne, who will
give our Corum M&A Update report.
Dougan?
Dougan Milne
Thanks, Bruce and John.
That was very interesting. You
talk a little bit about those comparable transactions as another one of the big
factors in valuation and they are important, but from the research side, and
this has become more and more of a challenge, the problem today is that fewer
and fewer of these deals are being publicly disclosed. That is to say, the deals are announced, but
the prices paid on these deals is often omitted from the public. There is an interesting argument that has
been swirling against all that for quite a while now. I just read Brendan Daly's blog where he brings
up the idea again, which is, don't these public companies have a responsibility
to their shareholders to let them know how much of their money they are
spending on acquisitions. I won't try to
answer that now, we just don't have enough time. But thanks for those insights on valuations,
John, that was great.
I have so much information to cover this month, it has been
such an active second quarter and such an exciting first half of 2010, and I
hope you don't mind, but I'm going to start by throwing us directly into the
deep end.
Folks, we've just witnessed the highest quarterly M&A
spending rate since the credit crisis began and that was nearly two years
ago. There were 773 transactions between
April 1 and June 30, accumulating a total of $62 billion in real value. To throw some perspective on that, as you can
see from the numbers here, we more than doubled our deal value from Q1 2010 and
we beat out the previous “new normal” as we're calling it, of $55 billion, in
Q4 of 2009.
As an extra anecdote of perspective, in Q2 of 2007, three
years ago, our deal volume was just barely shy of 1,000 transactions, with an
announced deal value of around $190 billion.
Don't try to read into that too much, that was then and this is now, the
times are different.
Coming back to the current period, the bulk of these
transactions and the bulk of this value was generated by who we consider to be
our traditional strategic buyers, your Symantec, IBM, Microsoft, Google,
Oracle, SAP, the rest of your peers, you know who they are. Each of these big buyers made multiple
acquisitions over the past few months, and that is despite the fact that nearly
all of them saw declining love from Wall Street. In some cases their stock
prices are dropping much faster than the poor performance of the NASDAQ.
Speaking of our public markets, what we see here now is the
trending equity market's clear landslide over the past couple of months. We'll show you the numbers in more detail
over the next slide, but note here the Dow in green, the NASDAQ in blue and the
S&P tech index in red. The fact is
that the tech index, which is usually able to out-perform the other trading
markets, seems to be caught in the same downward trend as the other indices.
With a little more detail, I look at some of the info
published by the 451 group that they published earlier this week. I stacked up
the NASDAQ returns on a monthly basis for 2010, versus those growing software
M&A volumes and the values in the corresponding months. Clearly we have an
inverse relationship there. There has been a disconnect between where the
public markets are trading and what the M&A markets are doing.
If you look at our top three rows there, April, May and
June, an aggregate drop of roughly 13% of the public market value, but M&A
manages to hold there, maintaining these high levels of $20 billion for consecutive month, its remarkable really, the
most linear consistency we've seen in the past few years.
With numbers like this, we're already starting to hear
speculation that if the public markets perform this poorly that M&A markets
won't be able to sustain these high rates into the second half of 2010. Let me point out that despite Wall Street's
opinion and despite the dropping stock values, this is somewhat of a phenomenon
that is unique to our industry. These companies, the big companies that
continue to make money and continue to build those huge cash strongholds, they
were making money during the credit crunch and they're making even more now. That is what is paying for all these
acquisitions. It's not bank loans.
So, looking at the public market and, perhaps more
importantly, at the direct impact these equity markets are having on the recent
tech IPOs. You read any newspaper, they
are all pointing out the following examples that I'll point out here.
Motricity, our friends down the street here in Bellevue,
Washington, are providing mobile content solutions for many of the big carriers
and manufacturers. They cut their
initial offering in half and their prices are now at the low end of the range,
they are still under water. Broadvox,
VoIP, still trading below their offering price.
SPS Commerce, which is SaaS, they are a supply chain vendor, their
shares are now underwater. Convio, the
fundraising solution, fundraising as in NSC type fundraising, thy are currently
trading 20% below their offering price.
Lastly, I picked this up, the news that Tesla, and they're a little bit
out of our range, that electric car company, out of Silicone Valley, they are
now trading below what their release price was, and it just goes to show that
in a market like this, their only choice is going to be an exit through
M&A, a strategic partner, a private equity player, something like that,
even though there are plenty of, what we would consider in normal times, great
IPO candidates.
This is the Corum Index.
It is a bird's eye view of some of the important deals, some of the
averages and percentages in software M&A.
Here you have a brief snapshot of Q2 2009 versus Q2 2010. On the first line there is number of
transactions, we spoke about this on the previous slide, 773 deals for the
quarter, by no means a record breaker, but as we saw, the deal values were way
up. The second line there is megadeals,
and remember we define those as ten digit deals, those over $1 billion. Megadeals are very healthy right now, and
they continue to get healthier. They are
up 50% over where they were last year.
We have a total of 22 megadeals so far in 2010 and if you look at, say
2009 or 2008, there were 33 for the entire year. So, we are well on our way to pass that
up.
To play the perspective card again, from 2005 to 2007, we
were averaging around 70 megadeals a year.
Of course, our largest deal this year, SAP purchased Sybase for $6.1 billion. We also saw big deals from Silverlake Private
Equity, they acquired (xxx 20:24 sounds like IEC, can't verify) for about $3.4
billion. IBM purchased Sterling Commerce
from AT&T, that was a $1.4 billion deal.
Symantec took that big chunk of core assets from Verisign, finally, for
about $1.3 billion.
If you remember back to last year, the biggest news on the
wire was Oracle's acquisition of Sun Microsystems for $7.4 billion. That was a big deal in many ways.
Take a look at the VC-backed exits. It would be easy to assume that we would see
more of these exits happening now, in a better market, but what happened in the
first and second quarters of last year was that the VCs had a fire sale in
their portfolios. They had to dump the
poor performers and they tried their best to hang onto the better portfolio
companies. We're just starting again to
see a surge in VC-backed exits again, but this time they aren't fire sales,
they are quality, high value deals.
Then, jumping down a couple of lines, to the All Cash deals,
not as prevalent as they were in, say, 2007.
2010 is the least cash rich year in the past several, but that is
certainly not due to a lack of cash on the part of the buyers, but really these
big companies and buyers are definitely playing things a bit smarter with
acquisitions. We're seeing a lot of cash
plus earn-out deals, we're seeing a lot of cash plus stock, either in private
or public stock, but basically the current structuring of deals is a way for
buyers to bridge that gap between their comfort zone on price and the sellers
expectations on price. They are trying
to set realistic and reasonable performance milestones for the sellers that
have these big cash bonus incentives.
In the last few lines there, public buyers and sellers. In 2009, I saw the greatest number of public
divestitures I've ever seen in this business.
There were some months, I think October was one of them, where
divestitures were nearly 30% of all the deals on the market. Granted, that was a mix of public and
private, but you see where I'm going here.
Public players were dumping assets in technology that were no longer the
focus of our core portfolio in 2009.
This is why we have far less public targets in 2010's market. They did their cleansing, so to speak.
Now, on the last line there, with the public buyers. They are usually a majority force on the
market, and they were actually pretty quiet during most of 2009 and certainly
the first half. What we see today, the
public buyers are the majority, over 50%, that is far more typical.
Now, I've been talking about these public buyers, I've been
talking about VC-backed exits, and it is fair at this point to talk about the
re-emergence of private equity buyers.
In Q1 of 2009, their contribution to deal values was under $1
billion. In Q4 of 2008 it was even
less. Today we're certainly seeing them
as a competitive force, all those big strategic buyers, you can tell buy the deal
values that they are definitely in play.
So, at this point we're going to change gears a little and
move into the standard Corum territory by looking at our six broad
markets. Twice per year, for the annual
and mid-year reports, such as today, we take a closer look at those six board markets
and how they are further broken down into the 26 subcategories that Corum
tracks on a daily basis. You'll see what
I mean by subcategories when we flip the slides here, but I'll put the chart
into context for our new participants who aren't familiar with the way we track
this data. As John mentioned a few
minutes ago, the most popular method for quickly determining a company's
valuation is by using enterprise values and sales. One of the other methods, certainly very
popular as well, particularly with the growth in returning revenue business
models is that enterprise value to EBITDA.
So, when you're looking at these charts it is important to remember that
we are tracking public companies and that is where the public data is. It is easy to capture and easy to measure and
you'll get a much better understanding of which companies make up these
valuations in a moment.
But lets have a look at how they perform in the Horizontal
Application space. Now remember back to
Q2 of 2009, with the resurfacing or the rebuild of the public market. So, since we're only going back 12 months,
you don't really see how bad, and how low those multiples got in, say, early in
2009. It got really ugly there for a
while. But as you can see our multiples really bounced back. We hit a peak for public performance in early
Q1 of this year, even overshooting, what we would consider historically
normal. We've had a bit of aggression
since then. We're still in a very
healthy zone of valuation in the Horizontal Application market.
Let's take a closer look at some of the performance that we
saw. Here you have the subcategories for
the Horizontal Applications market.
Under each subcategory datablock, just a couple examples of the kinds of
companies that Corum has within a corresponding group. So, look at the top middle, there, Human
Resources, totally outperforming, enterprise value to sales is 4x TTM revenue
and EBITDA nearly 30x. High performing
companies in this space are those like Kinexa and Vitalio (xxx 25:54 best guesses),
Success Factors is doing incredibly well, and you get the idea. The idea here is that hopefully you as a CEO
or a director of a small or mid-size software company, hopefully you are able
to find a suitable public peer group for your private firm which will help to
give you a little better calibration and a little better understanding of the
general value range your company is currently trading in according to public
opinion. Understand that as a public company, these valuations are by no means
definitive to your situation, but they are an excellent guide to what is
considered normal in the software, internet and IT industry.
That's enough with the valuations, I think we get the
picture. Other notable subsectors,
business intelligence always seems to perform very well, as evidenced by Micro
Strategic Informatic doing amazing. We
also have Actuate in there as well. I
said there were multiple companies in every category and I lied, in fact. Open Tech is really the last remaining
independent content management vendor on the block. There are some others that start to creep
into this category, but they stand alone and do very well. The ERP group is large, I'm sure you know
just about every company in there, go ahead and include Microsoft. You have Oracle, SAP, Netsuite, even Lockton
and a few others. This group is truly
large and in charge, they always seem to keep stable and a promising
performance in the trading multiples.
Lets quickly name off a few deals. The Horizontal space is so big, they also
take credit for some of the most acquisition activity every month, there never
seems to be a shortage. On the smaller
side, his picked up Quantitative Micro, which is a business intelligence
vendor, a $40 million deal. DELTEC
bought Maconomy in the ERP space, that was a great deal. Success Factors, I
just talked about them being a big performer in the HR space. Success Factors purchased CubeTree, they may
be looking for more acquisitions soon.
In getting bigger acquisitions, Lexmark picked up Perspective Software
for their content management product, that deal was $280 million, it was 3.3x
TTM for Perspective. That was a great
deal for them.
Of course, there are plenty of other transactions in this
space, too many really, but I can't list them all. We have a lot of ground to cover, so lets
move on to the other broad markets.
Here we are with the Vertical Application space. This is an area where Corum has traditionally
done a lot of deals. Try to think of the
most obscure industry you can and there is probably some niche little vertical
software company in there making solutions for that industry. You'd be totally amazed. We've sold companies that were taking
measurements for flat glass manufacturing, vacuum environment endurance for
composite materials, if you want to know the impact strength of your car's
front bumper, well, there's an app for that.
If you can fathom it, there's a software for it somewhere in the
world.
Performance has dropped a bit below that 2x mark, primarily
at the public level, because among the private transactions that we are doing
here at Corum and that we are seeing, the multiples tend to be above 2x
TTM. However, when you consider that
these public players were running at about 1.2x revenue just 18 months ago,
we've definitely come a long way. You'll
see on the next page that the subsectors paint a different picture
entirely. When you look at them, you
start to understand that every subsector is doing quite well, with the
exception of the government space. We've
seen a number of cuts to their business model, cuts in defense spending, etc,
and that has hurt them as a hole. In
this sector we've also seen some companies go private recently, too, public
companies that were performing pretty well.
Thoma Bravo, one of the biggest names in private equity,
took Plato Learning off the public market.
Learning tends to fall into that government space often. The deal was $143 million, that was 2.7x
Plato's TTM revenue stream. In another
PE play, we have Silver Lake partners making one of the biggest acquisitions of
the year, that's a $3.5 billion deal for IDC, which is the subscription
financial research firm.
We also saw ABB, a Swiss engineering company, they acquired
Ventix, a billion dollars in the energy and public utilities space, it fits
nicely into our positively performing energy and environment vertical
there.
Some of the highest multiples we say this quarter, we say
Visa, as in the credit card company, paid 7.1x revenue for the transaction
processing service Cybersource Corp.
That deal was for a lot of money, $2 billion, divide that by about 7,
the revenues were probably right around $280 million, which is not a bad return
for those Cybersource guys.
In the health care space, it has been playing really strong
with the new government initiative and financial services, the group on the
bottom left there. A few companies have
privatized there in the past twelve months, but those financial service
software vendors always seem to perform really well.
Okay, lets jump on the next group here. It is important to
remind folks that our calculations of these multiples are based on median
values, not on averages. In the case of
Consumer Applications, even though we have some great performing companies like
Apple and Adobe, their numbers are the outliers from that median section, so
they aren't factored into the final result.
The point here is that of the couple of handfuls of companies that are
in the consumer space, you'll notice that we only have two subcategories here
and they are both listed below. The
point is most of the public companies in this area got annihilated during the
credit crunch. We're just seeing them
bounce back in a meaningful way.
For categories, we have visual content and gaming. Visual content includes the big companies
like Adobe and Apple as mentioned before. We also see companies like Avid
Technologies, Real Networks, Web Media Brands and Concurrent Computing, most of
whom are having a rough time with things.
But if you shift gears over to the game sector, I spent a lot of time
focusing on this sector recently. I was
at the E3 conference in LA a few weeks ago, formerly hosting the funding exit
strategy session at the Casual Connect conference in Seattle on July 19, but
what I want to point out there is that there is a really interesting story
brewing in the gaming industry. We see
all of our traditional gaming companies at the public level, EA, Konami, THQ,
etc. They aren't doing so well, but just
below the surface of the public companies is a swath of new casual gaming
companies, private companies like Zynga, Playdom, Playfish, although Playfish
was recently acquired by EA. But these
casual gaming companies are some of the fastest growing companies on the planet
right now, hundreds of millions of dollars, even billions of dollars in market
capital, huge revenues and huge profitability, they are redefining the business
model for gaming revenue with subscription gaming, micropayments, and it is
tearing the traditional gaming companies apart.
I need to move ahead here.
Transactions for the Consumer space.
Yellow Pages has done six deals so far in 2010, that's a lot of
deals. We also had some healthy gaming
deals in the space, Perfect World acquired CNC Media for $21 million, Game Now
bought Red 5 Studios for $21 million, and Zynga just made a number of
acquisitions, XTD in China, and they bought Challenge Games in Austin,
Texas. Playdom has been no slouch
either, they bought Hive Seven just a few weeks ago. Apple has done three deals this year that we
know of, Quattro Wireless being the most recent at $275 million.
Moving on to the Infrastructure space, and I often mention
this, its one of my favorite markets to watch, no shortage of cutting edge
technology, there's a lot of innovation, many highly strategic M&A
endeavors happening here, and a lot of competition. That said, they also have boatloads of cash
for acquisitions here, so lets take a closer look.
What I love about these groups is the broad mix of old
captains of industry and the mix with some of our hot newcomers. On one side of the industry you have IBM and
Progress Software and on the other side you have like a VMware who is the EMC
lovechild spinoff IPO explosion. Double-Take
Software was recently acquired by Vision Solutions, which is a PE backed Thoma
Bravo. That was an amazingly strategic
deal with a price tag of $242 million.
IBM paid a huge multiple for Cast Iron, which is cloud based application
integration. It was 6.7x TTM. A lot of other deals in this space. Of our groups, really everyone is doing well
except for communications infrastructure space.
This is a very competitive space.
Some of the companies there are hurting.
I have a lot of love for Nokia, but I truly hope they can bring a
competitive mobile offering in the near future, perhaps its that MeeGo
platform.
Also, there is that HP Palm deal which will be very
interesting to watch.
Another fun group to watch is Internet, and gain we only
have two subsectors here to watch.
Behind the scenes is in the internet infrastructure players, which
includes companies like Akamai, Juniper, Digital River, etc. Then, of course
there are the more recognizable pure players, you already know who they are,
Amazon, Google, Yahoo!, AOL, eBay, etc.
AOL rejoined public players earlier this year. Actually it is our pure play section that has
been most affected by the public market slide these past few months. We have some great companies here, so I don't
think there's too much to worry about. A
lot of competition. Someone recently
pointed out in an article that Google has the propensity to go bust in the
future. In order for them to continue to
grow the way that they have, they need to grow a division the size of Yahoo!,
every single year. And that is a real
challenge. That said, Google is the
reigning king of acquqitions. That
acquisition to innovate model is all theirs and they have done 13 deals already
this year. I think we might see a new
record this year if they continue their shopping spree.
So many other deals, we have the Digital Sky Media buying
out ICQ, which I was using back in 1996, which was probably the first widely
adopted instant messenger. Salesforce, a
great idea, bought Jigsaw. We love
Jigsaw here at Corum, a great online contact database, innovative business model. The deal was for 7.9x TTM. Great deal for Jigsaw, very smart indeed by
Salesforce.
I need to wrap this up with IT Services and BPO
players. There isn't a specific
subcategory, but with the changing business models we've seen in the past 18 to
24 months, there is certainly a divergence in the way that many of these
companies are building their profit.
I'm getting the signal to finish up as I am running out of
time, but you get a lot of cross border deals that happen here. I would say that the multiples that we see
here are still very healthy and so at that point I think it is best I wrap up
with this section.
That's what I've got for you for this month. It's been a pretty exciting start of the
year, we certainly had a booming second quarter and there is a lot of
information in a short period of time.
If you have any questions or this has sparked any ideas regarding the
future or current situation with your company, you guys know you are always
welcome to contact us here at the Corum Group, we are happy to make the
connection.
Before we introduce our guest speaker, we have a quick
update that we will be implementing into our presentations on a quarterly
basis. You may remember that a few months ago we gave a spotlight we called
Asia Rising. It was one of the most
widely attended events in Corum's history, it was a focused look at the current
and future activity and implications of Asia's continued influence on the
global software market. They are becoming a very recognizable and in some cases
a dominant force. So, along with Corum's
success in the Asian software market over the past few years, we just closed a
deal last month, our client Apex Systems from Singapore, we sold them MTP Data
in Japan and we've had a few others as well. Along with that success we've had
continued commitment to building out our presence in Asia, which is why we've
been putting together a stronger Asian research department to support our
efforts over there. At this point I'd
like to introduce and pass the microphone over to Cecelia Yuen, she is a Corum
Research analyst who focuses specifically on the Chinese market and in a short
amount of time she has become a vital part of our international team. With that said, Cecelia, I'm looking forward
to your time.
I'm going to break in here before Cecelia, just a note here
to all of our attendees who are dialing in from all over, since this is our
mid-year report, we will be running a little bit longer as we did with our
annual report. I expect to run about 15
minutes later to make time for our guest speaker and Q&A. Cecelia.
Cecelia Yuen
Yes. Thank you,
Dougan. My role here at Corum has been
focused on the tremendous growth and opportunities in the Chinese software
industry and the Asian markets at large.
Make no mistake, while China, India, and the neighboring Asian Pacific
countries have yet to compare with their Western counterparts for software
exports, there is no doubt that the coming decade, even the coming years, will
see an explosion in cross-border partnerships and in positions going both ways,
east to west and west to east.
On my first slide, we have been able to compile data from a
number of Chinese domestic research groups that give a clear indication as to
the direction of software M&A within greater China, which includes Hong
Kong, Macau and Taiwan. While deal value
has nearly tripled, the volume of transactions has also gone up significantly,
from single digits a year ago to over 20 notable Chinese software transactions
in the past three months. We expect that
second half of the year to continue on an upward trend for value and volume,
though perhaps not as dramatic as the first couple quarters of growth.
With plenty of deals, there is always a handful of notable
players that make the highlights. Kingdee is the leader in Chinese ERP
software, specific to the domestic markets.
Corum has talked about them plenty of times before in monthly webinars
and other international presentations.
Watch out for this company, they have done a lot of deals in the past
couple of years and they have announced that they will continue with their
domestic shopping spree through 2010.
The interesting thing about to know here, they are only
acquiring Chinese software companies and they have yet to move outside of the
Chinese market.
Among the largest and most notable Chinese software
companies, Shanda has an absolute strangle hold on the Chinese gaming
market. This is a territory they have to
defend to the bitter end, as they know that the big US companies like EA and
Vivendi are quickly moving into their home market. Shanda has decided to play the same game,
acquiring the San Francisco-based Mochi Media, a casual games distributor and
integrator for Facebook and other social media outlets.
Lastly, Alibaba.com is perhaps one of the most well-known
Chinese companies from an international perspective. It is a sort of eBay/Amazon/Craigslist for
Eastern manufacturers to sell their goods directly to US customers, retailers
and importers. Their acquisition of Vandio services in California will be an
excellent stepping stone to a further US presence and is likely to help adapt
the business model to other US retailers.
My time is just about up, so back to Dougan.
Dougan Milne
Thank you, Cecelia.
With that we'll turn it over to Nat Burgess who will introduce our guest
speaker today.
Nat Burgess
Thank you, Dougan.
First of all, Mike Wetter, from Microsoft, its great to have you with
us, thanks for joining us today.
Mike and I negotiated a deal three years ago and we both
ended up slightly unhappy and I think that is the sign of a successful
negotiation. A great background on Mike,
he was a banker at JP Morgan and since 2007 he has been focused entirely on Microsoft. I'd like you all on the webinar today to
think about where Mike sits. He is
covering entertainment and embedded.
Gaming has become a bigger industry than movies, Blumberg estimates that
Xbox sales, as Bruce pointed out, topped $1 billion in the first half, and that
is not Microsoft's number.
Secondly, for embedded, Gardner predicts that mobile devices
and various devices including phones, slates, readers, etc, are going to be the
dominant mode of access to the internet within just a couple of years, and
again a really exciting seat to occupy over at Microsoft. The final note I will make, by way of
introduction, as you all know, Microsoft has companies in almost all of the
sectors that Dougan reviewed in today's presentation, Infrastructure, Vertical
Markets, Horizontal, Internet, and one of our goals today, with Mike as our
guest, is to get a better idea how Microsoft, as a company, creates structure
and focus in its corporate development efforts in order to further the
strategies of all of those divisions.
Finally, feel free to ask questions as we go, but I will point out that
Microsoft has not provided any data today and will not be able to comment on
specific transactions or financials, so please structure your questions
accordingly.
Mike Wetter
You bet, thanks for having me, Nat. I'm happy to join today's discussion.
As Nat mentioned, I'm a director in the Corporate
Development Group at Microsoft. Our
team's primary mandate is execution of acquisitions, maybe investments. We also engage in a number of divestitures
here and there, although a little bit less so.
I've been with the team since early 2007, involved in deals across a
number of divisions, including the online services business, Windows, Server
and Tools, etc. As Nat mentioned,
currently I am focused on the entertainment and devices division which includes
everything from Windows Phone to Xbox and the entertainment business, which
includes music, video, etc, and the Windows embedded business, so this is, as
Nat mentioned, a very dynamic market and an exciting time to be engaged.
Per Nat's guidance I'll spend a chunk of time on our team's
structure and how we approach the M&A process. I'll also touch on key attributes we look at
across transactions and how we evaluate them.
Also, to spend time at the back end on any Q&A you may have
On the organizational side, Microsoft's Corporate
Development team is divided into four different groups, basically representing
the company's major divisions, whether that be Windows, Server and Tools,
Online Services, or the Entertainment and Devices division. We also have some verticals that are covered,
such as healthcare, as well as Microsoft Research, by Corp Dev. I think the main reason that our team is
focused divisionally, is it really facilitates decision making at the
divisional level.
All in, there are probably 15 to 20 Corp Dev professionals
across Microsoft, representing each of those divisions. It is a fairly tight community. We spend a lot of time together, both with
our M&A legal team and with our venture integration team to insure we still
have consistent practices across each of those divisions.
Also, as I mentioned, it is worth noting that we do partner
heavily with our M&A legal team and the venture integration team. The VI team's primary responsibility is on
the back end of transactions, the integration process, as well as planning and
confirming due diligence. Their team is
primarily made up of integration managers and functional leads, or experts at
levels like HR, finance, etc, so we have a wealth of knowledge when it comes to
M&A across Microsoft.
As far as our main activities, the Corp Dev team really
focuses on the execution phase of transactions., starting from sourcing,
through the evaluation structuring, right up until about close, and thats'
about where we pass the torch to our VI team as well as the business group, to
execute the plan.
On the deal sourcing side, we do have a number of folks at
Microsoft that are involved generally in the M&A process and are sourcing
deals, everywhere from our strategy team, to business development team, to
business leaders, etc.
Typically, the majority of the transactions that we do
execute come from these organic, internal processes, where we identify a
product or a strategic gap at Microsoft and identify the company that may
sufficiently fill our needs in that particular category. Obviously we also get a ton of inbound
acquisition referrals from Vcs, bankers, executives, and those are obviously a
key input into the acquisition process at Microsoft as well.
Once we have identified a target internally, if a business
group wants to pursue an acquisition, really we get into a few internal stages,
including our preliminary evaluation of that company and and there is both an internal process there as well as an
external due diligence process. We also obviously have a confirmatory due
diligence process as well as the definitive agreement drafting and closing and
integrating that transaction.
First and foremost, up front, when we engage in a
transaction, we need to answer some very basic questions and on some level they
seem very simple, but it is core to get these right up front to have a
successful transaction. We try to do all this prior to engagement with targets,
where possible. Sometimes deal dynamics
force us to have these discussions while in discussions with a target, but the
ideal is that we have had this internal evaluation prior to real engagement
with the other side. The key criteria
there are what is the rationale? What
are the value drivers of this deal? How
does this draft stack rank versus other priorities in the division and is this
an appropriate use of our resources? And
then, where are our strategic alternatives? Is the appropriate method to move
forward on this particular opportunity and acquisition? Is it building the technology or is it
potentially a license or partnership.
Then lastly, is this the appropriate target. For any particular opportunity there is a
number of companies that could be trying to solve that problem, so we need to
do our homework to make sure that we are targeting the right target.
Once we're through that kind of preliminary phase, that's
when we get into engagement with the potential target. This will include the preliminary due
diligence, everywhere from the company technology, business model, structure,
employees, etc. This is to enable us to
build a business case, an integration plan, and get key risks identified up
front as we prepare for our internal approval processes as well as extending a
potential offer to that company.
It is really of note that this preliminary due diligence
process can really vary significantly as far as topics and items, but there is
obviously a pretty keen focus at Microsoft on the technology aspect there, what
is the development process of that company, what is the use of Open Source, how
available is the technology, etc.
Once we have completed our preliminary due diligence, and
we've had our internal approval meetings and we have gotten the go-ahead to
move forward, that's really the significant up front work that we do and that
leads to extending an offer to a company and getting an LOI on the table. It is really worth noting that once we move
to that stage and enter an LOI, we are very successful in getting to the conclusion
of those transactions, so we take that LOI step very seriously and that is
really one of the key steps in our process.
Once we are past that step, that's when the VI team's
involvement really ramps up, as we prepare for drafting legal agreements as
well as completing the transaction and integrating the company.
That process, from a timeline perspective, can take a varied
amount of time. The front end probably varies the most, which is the
identification side. That can take days,
months, etc. But on the execution stage,
once we extend and sign an LOI with a potential target, we tend to average in
the 45 days category. Really the key
driver at that stage is the responsiveness of the target. That is the key variable as we look to close
transactions and that can vary widely and it is worth noting that the Microsoft
virtual team that may be working on a transaction can actually outnumber the
target company's employee count. So,
that can be quite a process on the other side as they answer these questions
from all angles. We do try to make the
process as painless as possible, but that said, it is an M&A process.
From there, we're really working on integrating and closing
transactions. I was asked to talk a
little bit about primary attributes that we look at, on acquisition targets. I
think the one that jumps off the page the most is unique and strategic IP,
obviously. Something that is
differentiated, something that is going to market strategically to Microsoft. Scalability is important, obviously, given
the size and scope of Microsoft, we need to know that the technology that we
acquire can scale.
Then, thirdly probably talent and on that side, obviously it
is essential to the success of a potential acquisition, both from the
integration perspective and the execution post-close. Like I said, all of these transactions are
very situation and unique, the drivers tend to vary a bit, but those are some
of the ones that we tend to look at.
On the consideration side, there are a number of things that
are considerations and risks we think through as we are looking at
acquisitions, including everything from Open Source, where we have gotten
creative at mitigating those issues at companies, as well as onerous customer
contact that may have been entered into, is there a small startup trying to win
business, specifically if there are areas regarding IP ownership, that can be
quite problematic for Microsoft. Also,
we're obviously always looking at recent performance, whether there have been
setbacks with their sitting budgets, things like that, but again this is
situational. Those are some of the
considerations that we are typically thinking of or red flags that we are
looking for.
Nat, any topics I didn't cover that you wanted me to dive
into before we go to the Q&A?
Nat Burgess
No you hit them all, thank you. I'll just make a quick comment there on
something you said, that Microsoft takes the LOI stage very seriously. Our experience working with Microsoft
reflects that. They never rush in with the
highest offer, they don't move the fastest, but in the last five or six years,
they've had 100% close rate with deals that they issued LOIs on and I also have
a lot of respect for the way you guys do code and new code review without
exposing proprietary information to their internal people. Very professional process and our experience
has reflected your comments.
We do have a number of questions that I want to pose to you
for further discussion, but also before we hit the end of the hour, we want to make
a few announcements about upcoming events.
We'll briefly cover those and then return for Q&A.
Ward Carter
Before we go to Q&A, I'd like to remind our listeners of
the rebroadcast of this event next week on Thursday, July 15. We'd also like to invite you to join us live
for some of these upcoming events. Corum
is the host M&A speaker at the Casual Gaming Conference in Seattle on July
19, the keynote speaker at the SIAA conference in Dallas on the 17th,
and lead valuation speaker on the SaaS University conference in Washington, DC
on July 21. We'll also be offering our
Selling Up Selling Out conference on July 27 in Singapore. There is an error on this slide, the M&A
update will be on August 5, that's our next monthly webinar, and then we're
hosting another Selling Up Selling Out in Seattle on August 12.
We're offering complimentary passes to a couple of events
specifically designed for software entrepreneurs, which you will receive by
entering a promo code on the registration page.
Each year around the world Corum hosts and sponsors educational events
for software entrepreneurs. Our merger
briefing is a local focused software event bringing software entrepreneurs
current information about the M&A market place, plus an overview of the
M&A process. For a more completely
presentation on M&A and software, IT and internet and related technologies,
plan to attend the Selling Up Selling Out conference. This is an intensive how to session,
giving you a full road map on how to
prepare, position, research, value, negotiate, and execute due diligence and
contracts for a successful M&A transaction.
This is the most attended executive conference in the history of the
tech industry and attendees have executed over a $1 trillion in transaction
value. Our next one is August 12, here
at our headquarters in Bothell, Washington.
I'd like to offer you a complimentary pass to any one of our
Selling Up Selling Out conferences or merge briefings. On our website, at corumgroup.com, you'll
find a link to conferences and events, for upcoming event schedules and
registration information. On the
registration form you can enter a promo code, which will waive the registration
fee. The promo code for today is
julyflash. Or, you can contact me or any
of the Corum deal makers.
Please reserve this slot on your calendars for Corum's next
M&A monthly on August 5, which will feature a panel of CEOs of private
companies like yours, who have just sold.
Find out the lessons they learned and learn what you can do to insure
that you sell your firm for maximum value.
You won't want to miss this valuable session.
With that, I'd like to turn it back over to Nat for
Q&A.
Nat Burgess
Great, thanks, Ward, now, Mike, now that you've had a chance
to catch your breath, we can get to the questions. We've had a couple of questions come in that
relate to why does Microsoft do small deals when you have massive resources and
you are so big? Let me flesh that out a
little bit. Microsoft has, what, $40
billion in cash and $60 billion in revenue, you have 90,000 people working for
you, you can presumable develop whatever you want, presumably anything you buy
would need to move the needle on revenue, and yet paradoxically most of the
transactions that you guys do are relatively small and I think we're getting
this question partly because most of the attendees on the webinar are running
privately held software companies and they are interested in what gets your
attention and why you do these smaller deals.
You gave us some good insight earlier, you talked about the importance
of IP, you talked about scalability, you talked about talent, but is there
anything else that you can add in terms of some of the sparks that jump between
a small company and Microsoft that cause you guys to step up and make these
smaller deals, because you make a lot of them?
Mike Wetter
Sure. I think its
worth noting that there is not particularly a philosophy doing big deals versus
small deals at Microsoft. That said, our
transaction volume distribution is certainly toward the smaller size deal end
fo the spectrum, typically companies that have less than 50 employees,
typically deal values that are in the less than $100 million range, even
smaller, less than $25 million or $50 million is a very typical situation for
us. I think one of the primary drivers
of the smaller transactions is the ability to take unique IP and really tuck it
in to core products at Microsoft. The
bigger deals are ones where we are really looking to accelerate time to market
in an area where we have a presence, where the smaller transactions are really
about augmenting current products, adding features, etc.
Nat Burgess
Okay, that makes sense.
One other question that came in which relates specifically to your role,
I think you sit in really the only seat where hardware is as important as
software. The question is around how
different is your analysis and approach from looking at hardware deals versus
software deals. We're all seeing the
press on the Kinnect add-on for Xbox, it's doing extraordinarily well, you have
to have your eye on other hardware opportunities. Do you look at those differently from
software deals?
Mike Wetter
Good question and yeah, Kinnect is an exciting product. I got to demo it and it is awesome. I'm looking forward to it being available on
the market. On the hardware side of the
equation, I would say we still take a pretty uniform approach to our core
valuation and our evaluation process, regardless of whether the product is
hardware or software. We are still
looking at whatever our strategic alternatives are and I think with hardware
some additional elements that are added to that mix are, is owning the hardware
the appropriate method or is there another route, ie an ODM model or something
along those lines. What do we need to
own on the technology side for the hardware piece? But we're still going back to what are our
strategic alternatives for executing that particular opportunity and is it best
for us to own that through an acquisition, build it internally, or license it
from a third party?
Nat Burgess
That answer relates to both questions, really, because there
is a question of should we buy this small company and that always begs the
question of should we build it? What
exactly does a buy versus build analysis entail? Is it a back of the envelope,
finger in the wind estimate, or do you guys actually deploy resources and
really dig into what it would take to build something.
Mike Wetter
It's probably the most significant portion of our valuation
analytics is building the business case for both the buy and build scenarios
and comparing the relative values. It is
also worth to note that we will also run discounted cash flows on what the
license scenario will cost, what's the next alternative to an acquisition to
really compare the value that we're getting out of that acquisition versus the
value we may be able to obtain via build or license transaction.
The details that go into that are the number of people
required to build that technology, obviously the time to market, the time it
will take to build that technology, the time to catch up in the market, etc.
Nat Burgess
Interesting, okay. I
have one other question that came in which is you already addressed some of the
things that immediately get your attention about transactions. This is really the converse of that. Are there any elements of companies that
immediately scare you away, red flags.
Mike Wetter
Sure. I would say the
inverse, so I spoke a little bit about IP ownership. If they don't have clean IP ownership, then
that is a huge red flag for Microsoft.
If the technology is built significantly on Open Source then that is a
red flag for use. We have gotten
creative and figured out ways to remediate that and replace it, remove it,
document it, etc. Other red flags are
things such as, as you're going through a process, if a target is limiting
their disclosure or it feels like they're holding things back, that's an area
where we always have concerns. I think
the guidance, at least from my end, would be disclose early and often in the
M&A process to avoid surprises on the back end. Those are areas where we run into some of the
major SNAFUs is when the surprise disclosure comes to me at the back end of the
transaction.
Nat Burgess
That's a great point. The question that I personally really
want to ask is off limits because I know you guys are cooking up some really
cool stuff in your labs and Kinnect is out in the open now, so we'll save that
for another time.
Mike Wetter
It's worth of note, Nat, that while our M&A volumes have
been a little bit slowed in pace, some of that has been driven by, obviously
there is the economy and the prioritization that we're doing internally, but
we've also had major product releases in the last, say, 12 to 18 months,
everything from Windows 7 to Office 10, Windows Phone 7 coming out this fall,
as well as the Xbox Kinnect product, so major releases and I think as all those
teams go back and start product planning for the next cycle of those products,
we'll start to see more activity again.
Nat Burgess
I have one last question from our participants that I'll
pass along to you. Does the fact that
I'm a Microsoft Partner help me do an M&A deal with Microsoft.
Mike Wetter
It's an interesting question. Certainly it is not a per-requisite to be a
partner with us to do an acquisition with us, but it certainly helps both
parties get comfortable with one another. It is a great introduction obviously
to Microsoft and a great way for us to get to know you. A lot of our acquisitions stem from
partnerships that we have and a company becoming key input to Microsoft.
Nat Burgess
And obviously if someone is a partner and they are
disappointing, then that's only going hurt.
Mike Wetter
It's not going to help their chances for a potential M&A
transaction, no.
Nat Burgess
Okay, again, Mike I really appreciate you taking the time
with us today, all the opinions expressed here today are our own. Again, we don't have data from Microsoft, but
we really appreciate the broad overview that you've given and thanks very much.
Mike Wetter
Thanks for having me.
Ward Carter
Great, thanks a lot, Mike, great to have you, and thanks to
all our speakers and a special thank you to all our audience members for
participating. I hope you will join us
in person for an upcoming Corum conference or an event where we are speaking.
Bruce has one last comment here.
Bruce Milne
Mike, I have a question I'll deal with off line. How does my youngest son become an Xbox game
tester?
One thing I forgot to mention, every year for the past 20
years we take clients who recently sold as our guest to Langara, Canada. Here
are pictures that came in yesterday, a 250 pound halibut and a 56 pound
halibut! I can't wait. Those of you who
are online that are coming with us, it's going to be a great trip guys. With that, I'll hand it over to you, Ward.
Ward Carter
Thanks all, that concludes our mid year update for
2010. Thanks for attending.