March 2010 Tech M&A Monthly

March 2010 M&A Report 

“Private Equity: The Biggest Buyer of All”

Mark Reed

Good morning or afternoon or evening.  I guess we have people from Romania, from
Australia and New Zealand, so we have all time zones represented, so wherever
you are in the audience, welcome to Corum's M&A Flash Report for March
2010.  We host this on the first Thursday
of every month and it is designed to put current events and economic news in a
context relevant to software executives who are charting the future of their
companies and planning for strategic transactions like M&A.  Today were looking at the impact of private
equity funds on software M&A, which has been pretty staggering over the
past decade. 

I'm Mark Reed, Executive Vice President, based here in
Seattle.  Thank you for joining us.  At last count, we had more than 200
executives registered for this event from all over the world.  We have a great slate of speakers again
today. We have Ward Carter, who is chairman of the Corum Group, who will start
off.  He will be followed by Tomoki
Yasuda, a research analyst here at Corum, who will brief us on M&A
activity, metrics, valuation trends, etc, and then we will move to our panel of
speakers who are senior members of leading private equity firms.  We have David Golob of Francisco Partners,
based out of San Francisco, David Reuter of LLR Partners, based in
Philadelphia, and Michael Wand with Carlyle Group in London.  We'll keep this event to about 60 minutes;
please do stay tuned for the Q&A session that will take place after our
panel of speakers. 

As for the Q&A logistics, please ask questions any time,
of any of our speakers, but the questions will be answered at the end during
the Q&A session.  To ask questions,
use the Q&A window that you see on the right side of your screen.  When you do so, please make sure to send your
question to all panelists.  If you select
host or any other option, your question will not be seen or placed in the queue. 

Today's conference is being recorded and it will be
rebroadcast next Thursday, March 11, at 9:30 a.m. and 1530 Central European
Time.  Also, in about 24 hours, you'll
find a link on the Corum Group website for a recording of this event.  Or, you can just email pats@corumgroup.com
and she can give you a link. 

With that, I'll turn the floor over to Ward Carter.

Ward Carter

Thanks, Mark, great to be here.  The agenda for today, we'll give you a brief
overview of the current global market, provide you with some updates on
valuation trends and key deals in the software and technology sectors that we
track, and then we'll get to our private equity panel.  The encouraging news is, and I know we're all
looking for signs of direction in this economy and for recovery, and there are
some positive headlines in the news. 

Let's take a look at some of the events that are shaping the
market and influencing valuations, along with M&A and investment activity.

The U.S. economy is now likely expanding at about half the
brisk 5.9% pace at which the government estimated was running last quarter.  Business spending, including technology, will
make up for some of the slowdown that we see in consumer spending, but not
likely enough to reduce the jobless rate very much.  You all know that Congress approved the jobs
bill and the U.S. taxpayers are now going to fund tax credits for hiring new
workers and other tax benefits for 2010. 
This should provide a boost to employers, including technology companies
thinking of hiring.  As factories are set
to re-hire, it suggests that there is economic recovery on a more solid
footing, which bodes well for spending on technology as the economy
recovers. 

Mortgage delinquencies are still down, maybe the worst is
behind us, but unfortunately banks are still feeling pressure from regulators
to be more prudent while suggesting that demand for loans just isn't there, so
the lending that is vital to economic growth is still faltering. 

And, fair's fair, over rising capital gains tax rates, Medicare
taxes, and income taxes to fund healthcare, which could create incentives for
sellers to consider M&A now before the tax rates rise. 

In the Euro Zone, we're seeing further challenges in Greece,
as wages are frozen; entitlements are cut, while taxes are rising.  So, we see continued bad news originating in
Spain and elsewhere in the Euro Zone. 

Earlier this week, Germany moved to rescue Greece and the
markets in Europe and Asia rallied on hopes of the bailout news.  But there are still continued Euro Zone
problems wreaking havoc for the U.K.'s exports to their largest market, further
unsettling the U.K. economy. 

There are new worries as some of unexpected complex
financial instruments come to life in the debt markets of Europe.  There are so many issues creating a drag on
the Euro. 

Looking eastward, in Japan, the impact of Toyota recalls has
had a ripple effect on the world's second largest economy, and the BRICs, which
had been relatively solid until now, in some cases based on continued events
and in some cases based on basic commodities, but the finance boards have hurt
across the board, especially in China. 
The trouble even spread to Dubai and the Emirates and to the sovereign
wealth funds, hit hard by failing debts. 

Over on the technology side, we continue to see good
activity and rising valuations.  This week,
Novell received an unsolicited offer of $2 billion, which some anticipate could
trigger a bidding war.  Recessions can be
a good time to do acquisitions as deal values fall, but as the markets pick up,
as they are, we could see more buyers pushing to get deals done before
valuations rise further. 

Areas we see likely to be deal leaders include cloud
computing, internet firms, semi-conductors etc.

We've seen recent positive results forecast by industry
leaders like HP, HP especially on strong PC sales, Cisco, and Qualcomm, who
reported record projected earnings and sales which bodes well for the mobile
handset market, as well as the stock buyback announcement by Juniper Networks,
so good activity there.  But continued
turbulence in the mobile market creates challenges for firms such as Palm,
while rewarding winners such as Apple and Google. 

There are some indications of an uptick in the IPO space and
cross-border deals continue to be strong and consistent with our recent
activity on behalf of Corum clients. 

Looking specifically at PE in the technology sector, we saw
last week where Intel, along with 24 BC firms pledged over $3.5 billion in the
U.S. over the next two years to fund start ups in computing, information
technology, and so called green tech.  As
we have indicated earlier in our research, PE investments have moved up after
being down 50% from 2008 and 65% from 2007 in terms of completed deals.  Deal value was down even more dramatically,
reflecting a trend toward smaller deals and the challenges of securing funding,
resulting in a higher percentage of equity in the average deal. 

We did see more focus on add-on investments with the PE
firms, looking to bolster their current portfolio companies with new
technology, customers and markets, all to foster growth in anticipation of an
eventual exit.  PEs found that 2010 is
still a very difficult year for fundraising and lack of financing from hesitant
banks has continued to hinder many private equity funds. 

While listening to our panelists for the PE community, I'd
like to suggest to our listeners that PE can potentially play a very important
role in your future exit strategy.  PE
represents a huge pool for growth investments, recapitalizations, and buy
outs.  It is estimated that currently over
$400 billion in uninvested funds are looking for a home.  More often than not, PE firms look like
strategic buyers bringing strong strategic resources that are so vital to the
success of smaller technology companies and technology is still a great target
for PE funds looking for high returns. 

So, before I go to the panel, I'd like to introduce you to
Tomoki Yasuda, research analyst at Corum, who will talk about some recent
transactions and valuation metrics in the software and IT space.  Tomoki?

Tomoki Yasuda

Thank you, Ward. 
Hello, everybody.  First and
foremost, let’s get a better view on the Software and IT sectors and a deeper
analysis of the market.  I'm going to
speed through these slides a little bit, please bear with me. 

First we have the public market.  The first slide includes the NASDAQ,
highlighted in blue, the S&P, highlighted in red, and the Dow Jones
industrial average, highlighted in green. 
The graph goes all the way back to February of 2009 and gives us an
annual overview of how public companies have been performing over the course of
the year.  Equity markets have continued
to trend up since last year and the S&P technology index, our strongest
performer in the bond market, good news for our industry.  You can see that January had a bit of a steep
dip, but the market has recovered steadily over the last month.  The second especially has been outperforming
other markets with positive earnings, besides a few outliers like Palm, which
has had a tough year trying to sell its Pre handsets.  Despite February being a slow month,
historically, in M&A, the numbers show that the pace of acquisitions has
not slowed down at all. 

This slide represents M&A activity in terms of
volume.  This bar chart shows the number
of deals done in February, by year.  The
light blue on the very top represents 2010 numbers, the orange, 2009, the
turquoise 2008, and so on down the chart. 
You see that transaction volumes for the previous month were definitely
positive, much higher than the previous year, and even outperforming 2008.  This is our third best February on record and
we are coming without range of 2006 and 2007 numbers, considered the best
numbers we've seen in terms of transactions since the dot com era.  If you remember the data from last month, we
had around 20 more deals in the month of January.  But, since we typically see a slight drop off
in February due to it being a shorter month, I'm not too concerned with the
slight dip in volume.  We are still
seeing a lot of positive signs in the M&A market and I'm going to get more
granular with our next slide.

Here you see the Corum Index, a table we use to track
specific metrics in the M&A market. 
As you can see, our deal numbers from February 2009 is up to 268 this
year.  The number of megadeals, which
refers to deals that are over a billion dollars, are up from 0 to 3 this
year.  This is a very promising sign as
leading firms give the broader market direction and it spurs more M&A down
the chain in the second and third tier players. 
The top deal in this February was the Bank of New York acquiring PNC
Financial Services Group, a transaction process vendor to the financial markets
for $2.3 billion.  Another notable one
was the acquisition of SkillSoft, an e-learning and training shop to a
consortium of PE buyers for $1.1 billion. 

Looking down we see the average deal size, which has jumped
from $41 million to $150 million.  We
also see the median sales size has gone down from $25 million to $16
million.  A slight caveat to these
metrics, though, it has been harder to track these metrics accurately because
of the percentage of undisclosed terms, which has gone up as well.  It is probably the only statistic we don't
like going up in this table and it is a bit disturbing that we are seeing over
80% of undisclosed deals this month.  But
it relieves me to see that, although the volume of M&A is up, we are seeing
more activity from private companies which traditionally do not have to
disclose terms to anyone, including the FCC or any governing body. 

However, one metric I really do like is that the all-cash
deals made a dramatic increase.  In 2009,
we were seeing more buyers trying to mitigate risk and get discounts by putting
together more complex deal structures with stocks, earn outs, and debt on sellers.  Perhaps with the uptick in the market,
sellers have been able to negotiate more cash deals. 

A few other metrics we have, the number of VC-backed exits
was up, signifying that VCs are more comfortable putting their portfolio
companies on the market.  Percentages of
public targets were down, which can offer another explanation for the number of
undisclosed deals going up.  Percentage
of public buyers remains consistent around 50%.

Going even more granular to the individual markets, let me
start by reminding everyone that Corum covers six broad markets, with a total
of 22 subsectors.  Since we're on
Horizontal Applications, let me exemplify some of the subcategories.  We have business intelligence, content
management, HR, PRN, ERP, supply chain, and there are others in this group as
well.  If you are looking for more
information on a specific market subcategory, you can always give us a call or
visit our website. 

Looking at the graph here, we see that the EBITDA multiple
is represented by the dark blue and the enterprise value over sales multiple is
represented by the light blue.  The
multiples have been trading at a constant level since the beginning of the
year, trading at 2.4x sales and 11.16x EBITDA, respectively.

The deal I wanted to highlight this month was the recent
acquisition of Nstein Technologies by OpenText. 
Total amount was $33.5 million at 1.5x, trailing 12 month revenues and
an all cash deal.  Motivation for
OpenText was primarily driven by financial incentives, and technological and integration
considerations probably came in second. 
Nstein was a bit of an underperformer and OpenText knew they could get
away with paying a little bit over 1x revenues for the firm and it fits the
firm's acquisition profile pretty well. 
Previously bought firms include Vignette, Captaris, and Hummingbird for
similar multiples, all under 2x.  The
main technology grab here is Nstein's text mining engine, which targets web
content and which helps publishers increase web traffic by auto-generating site
maps, relay lengths, document summaries, etc, and some products aimed toward
media companies and web publishers.  That
will be a welcome addition to OpenText's growing web content management
portfolio. 

I'd like to comment for a second about the web content management
space overall.  For those of you not
familiar, this space has been increasing consolidation in a flurry of activity
over the year and I think it is going to be one of the hottest sectors this
year.  Here are some headlines from this
month: EPiServer, a European web content management vendor is planning an IPO
this year.  Flatwire, an ENT partnership,
possible lead to an acquisition? 

And this was just this month.  It has been a very busy quarter with lots of
opportunities for M&A for companies foreign and domestic, in this
sector. 

The next slide shows the Vertical Application market.  Market sales and EBITDA valuations have
continued to increase and have peaked in February.  The numbers are almost at 2x enterprise value
and 10.3 EBITDA.  This could be partially
attributed to a strong insurgence in the healthcare and financial services
verticals. 

The deal spotlight I would like to get into is the Initiate
Systems acquisition by IBM.  The deal has
been speculated to be worth around $400 million and about 4.5x trailing
revenues.  Initiate has a solid foothold
in the healthcare sector and a growing presence in the public sector as well
and it will help IBM take ownership of these verticals.  Not only is IBM bolstering their data
management offering, they are also getting a great player in the healthcare
vertical which is seeing a lot of funding from the government and is a very hot
vertical right now. 

On the competitive front, this was a smart move on IBM's
part to shut out competition.  A defensive
move, if you will, to stop companies like EMC and HP in particular from
entering the data management market and becoming contenders.  As they say, the best defense is a good
offense. 

There has been a flurry of activity in this sector since the
roll-up of Siperian by Informatica earlier this year in January.  It could be that other giants like Oracle and
SAP are next in line to make a data management acquisition to keep up with the
competition. 

Consumer and Application markets have seen their share of
ups and downs throughout the last year. 
The turnaround in September signifies a bump in consumer confidence that
we felt then and the multiples have started trading at a constant rate since
the beginning of 2010, leveling out at about 0.7x enterprise value and 4.67x
EBITDA. 

The deal spotlight for this sector focuses on mobility with
the acquisition of reMail by Google. 
This was a very interesting deal, that is, the deal itself wasn't unique
in any way, but what was unique, I guess, and more interesting, was it was a
message from Google to Apple.  reMail has
one core function, to grab an email download and search the application for
iPhone users.  The first thing, the very
first thing Google did was cut reMail's ties with Apple's apps, which were among
the most popular among the users and this speaks volumes about the internet
search company's attitude toward Apple and the iPhone.  However, the same can be said vice
versa.  We see an increasing dynamic of
companies aligning themselves in the Apple/Google “Cold War” and here are some
headlines from this week:

We see that HTC is being sued by Apple for patent
infringement.  HTC, as you know, is the
largest supporter and producer of Android phones.  We also see that AT&T removed Google
search from Android in favor of Yahoo. 
You see these proxy wars, essentially, being waged indirectly and a lot
of companies are starting to draw up battle lines now. 

On the positive side, what two companies would you not
rather see go at it than Google and Apple? 
The two great innovators of technology with competitive streaks turning
against one another will ultimately lead to better products and solutions.  In the end, consumers are the ones who will
benefit and I'm very excited to see what happens and what both firms hold in
the future. 

Here we have the Infrastructure market.  You can see a slight dip in the market from
the December high of 2.3x revenue and 10.2x EBITDA multiples, but the market is
still trading strongly at 2.24x sales and 9.83x EBITDA.  This market has subsectors in development
tools, network management, security, systems management, and virtualization to
name a few.  Fluctuation in this market
is to be expected.  It is one of our
broadest markets and includes an array of companies. 

The deal I would like to focus on here is the acquisition of
Mimosa Systems by Iron Mountain for $112 million, 5.1x revenue, and an all cash
deal.  Mimosa Systems is a vendor that
provides on-premises email archiving.  At
first this seems to be an odd play for Iron Mountain, who plays in the host
email archiving space, but it's a pretty straightforward deal and makes a lot
of sense.  Although the SaaS revolution
has taken over many sectors and turned a number of company's products into
hosted solutions, firms are still more comfortable having sensitive data stored
on location, especially things like email. 
This acquisition allows Iron Mountain to compete for more opportunities,
bringing a blended mix of hosted and on-premises solutions, and speaking more
broadly, the data archiving space has grown in recent years and is attracting a
lot of interest in adjacent sectors like records management, information
governance, security, and e-discovery. 
Main players include Symantec’s EV Solutions, ENC, and Autonomy via the Zantaz
acquisition. 

Next we have the Internet market.  This picks up after a cool down in October
and maintains a healthy multiple of 4.52x EBIDTA and 2.36x sales through
February.  You have internet pure players
like Google, Yahoo, Amazon, and infrastructure guys like Okmy and Lime
Networks, very strong public companies with a lot of cash behind them. 

This market's highlighted deal is the acquisition of
HotJobs, a Yahoo portal, by Monster Worldwide for $225 million dollars, all
cash, we didn't get the metrics.  This is
Yahoo's second divestiture in a month. 
Before this they sold Zimbra assets, an email provider, to VMwire in
January for an undisclosed amount.  With
this divestiture they will be getting about half of the $436 million they paid
for the website back in December 2001. 
The deal seems to be beneficial for both companies.  Yahoo gets an all cash deal for a flailing
business and Monster needs to gain more market share to compete with the likes
of Indeed.com and Craigslist, which has ousted this firm from the top
spot.  It has been very tough on
companies like Monster who rely on help wanted advertising for their
income.  With the high unemployment rate
dampening demand, Monster's profit plunged 85% to $19 million last year.  Just on a quick side note, Yahoo was
considering taking stock with this deal, but the reasoning behind the cash deal
was that Monster's stock fell 12% upon falling short of its earnings
expectations for the fourth quarter, so had Yahoo taken stock the value of the
deal would have likely fallen below $200 million. 

Last, but not least, we have IT Services.  This market has historically been a flat and
steady sector, as you can see the EBITDA multiples have stayed constantly
around 5x to 6x and sales multiples have mainly fluctuated between 0.6x and
0.8x.  This is not an explosive sector by
any means, but an even and stable one. 

The spotlight for IT Services focuses on the re-emergence of
the Burroughs name.  For those of you not
familiar with it, the firm was a major American manufacturer of business
equipment in the mid to latter part of the 1900s and it was only second to its
rival, IBM, which was at the time, and still rightfully is, a behemoth.  In 1986 it merged with Sperry Corporation to
form Unisys.  Interestingly enough, both
have roots in Philadelphia.  Fast
forwarding to now, in 2010, the current Unisys needs to divest its payment
system assets, it is the second divestiture for the firm; we highlighted their
first divestiture of Help Information Management which was on the previous
webinar, which you can find on our website. 
The buyer was Marlin Equity and bought out the payment systems and named
the new company Burroughs Payment Systems. 
This is a smart play by Marlin, which basically repurposed assets into a
recognizable brand, especially in areas heavily invested in IT, such as
India.  It will be interesting to see
where they take the company from here on out.

So, that's it for my section, and we'll be back again next
month.  If you have any urgency on some
issue or would like to chat, please feel free to drop me or any of our
executives a line with a phone call or an email and we would be more than happy
to chat.  With that, I'd like to turn the
mic over to Ward, who can introduce our guest speakers today. 

Ward Carter

Great, thanks Tomoki, good update.  We look forward today to spending time with
our panel of private equity experts and to let them express their views on the
current state of PE investing and what the outlook might be for the year
ahead.  I'll start by asking each of our
panelists to introduce themselves and provide background on their firms and
perhaps their area of focus, and if they would like, to highlight any notable
portfolio companies or recent deals they'd like to share with the audience to
kick this off, so first, I guess we'll go in alphabetical order and I'd like to
ask Michael Wand from Carlyle Europe. 
Michael? 

Michael Wand

...Carlyle European Growth Technology Fund, we are on our
third fund, which is a €530 million fund,
which is about, what, $700 million.  We
are predominantly oriented toward technology companies in Europe, if we look at
subsectors it would probably be the traditional IT, i.e. software, digital
media, hosting, telecoms, business, as well as fintech.  However we also look at healthcare as well as
green tech, increasingly over the last two years.  Traditional investments for us would be
between €20 million and €50 million in equity and
probably up to an enterprise value of €150 million.  It is a multi-cultural, multi-national team,
all based in London, 12 people, which covers the main European market and if
you can appreciate cultural as well as language skills are necessary to be
close to the entrepreneurs locally and I think maybe one other distinguishing
factor is that we pride ourselves in being relatively flexible in deal
structures.  We can do minority
transactions or majority transactions, we operate with or without debt and we
also don't shy away from making investments in public companies, whether it is
in a minority position as well as in a P to P situation. 

To address my specific area of
interest and activity is the software space and if I were to mention two
companies which are probably typical of our investment style and the investment
phase that we are going through, which is mainly buy and  build and internationalization and changing of
business models, one company would be a business called UC4, which originally
was an Austrian beta center automation vendor which we internationalized toward
the States with a merger over there and this is a leading workload automation
company today. 

Another one is a company that is
called Everest Global, which is a risk management vendor for the banking world
by selling regulatory reporting software. 
With this company we changed the business model from a classical
perpetual license model into a subscription model and given what had happened
to the financial environment, logically it is a business which is seeing
significant growth right now. 

Ward Carter

Okay, excellent, thanks
Michael.  I'd like to now go to David
Golob of Francisco Partners out of San Francisco.

David Golob

Good morning or good afternoon as
the case may be.  I am David Golob with
Francisco Partners.  We are a San
Francisco-based private equity investment firm. 
We manage two funds with a total of capital commitments around $5
billion.  We focus exclusively on the IT
industry and we are active across all segments, software services,
semiconductors, and systems.  We have a
mid-market orientation, so a typical investment commitment for us is between
$50 million and $150 million, although we can go substantially higher or lower,
opportunistically.  We have a value
orientation and a control bias, but we also make selected minority investments
from time to time.  We have 30 investment
professionals, 20-odd of them are in San Francisco, we also have an office in
London, we have been operating from London, in Europe, for the last five
years.  Technology is a global industry
and you need to have a global perspective. 
We operate as one firm, worldwide. 

In terms of recent transactions
that might be notable for the firm, we have had a couple of recent exits.  We sold a semiconductor company by the name
of Pneumonic to Micron Technology recently acquired with a transaction value of
about $1 million.  We have announced the
sale of a software company called Red Prairie to a financial buyer for an
undisclosed sum, but it was previously on file to go public when the sales
transaction was announced.  We also
recently refinanced a company called GXS and in conjunction with that we
announced the acquisition of another company, not another player in the space,
called Innovis and this is notable just because it was the largest tech high
yield issuance since 2007. 

Personally, I cover the software
and services markets, primarily.  Thanks.

Ward Carter

Great, thanks David.  I would not also that we have had some very
successful negotiations with Francisco over the past several months and we're
able to say that one of our clients in the SaaS space was acquired by their
portfolio company, which we always like to see. 
With that, I'd like to move to David Reuter, out of Philadelphia. 

David Reuter

Good morning and good
afternoon.  LLR Partners is a $1.4
billion middle market private equity investment firm.  We have been around since 1999 and today we
manage a fund that is $800 million.  I
think we're pretty similar to the stories you just heard, so I'll just complement
the perspectives.  We are looking to put
out investment sizes from $20 to about $100 million.  The companies we are looking for typically do
$20 million to couple hundred million in revenue.  About a quarter of our portfolio and where I
spend my time is in the software and technology services space.  Similar to Carlyle, also, we will invest in
both minority growth capital transactions and buy outs and our portfolio is
split about 50/50. 

A good example of a deal that we
did that I think touches on a couple of points, as we will go into the public
markets as well, is in the summer of last year (2009), we took a public company
called I-many, which was a software company focused on contract management
solutions into the pharmaceutical and some other healthcare verticals.  It was about a mid $40 million revenue
company, taken private for around that price range as well and I think it is
pretty representative of what we're dealing with. 

As I said, today about a quarter
of our portfolio is in the software and technology services space.  So that's a little bit about us.

Ward Carter

Okay, great, thanks.  Thanks for that, David.  So, we have some questions coming in from the
audience, I've also got some questions here that I would like to propose to our
panelists.  We've seen a lot of mixed
data on private equity investing and I'd like to give the audience, panelists, some
ideas about your outlook on private equity investments going forward, let’s say
for the next 12 to 24 months.  Do you see
a dramatic increase in investment activity, or is it going to be slow, are
there any particular sectors or business models that you find particularly
attractive?  Michael, maybe you could
tackle that first?

Michael Wand

Right, Ward.  I wouldn't necessarily say I see a
significant increase.  I still think the
environment is very cautious.  We have
been investing across the trough, actually last year we closed two deals and we
normally do between two and four deals a year, deploying somewhere around $100
million to $150 million.  I do think that
you will see some uptick because people have looked at valuations in the stock
market and project them to the private assets as well.  I also see a significant improving in exit
environment, which we experienced as well. 
However, I do think that people will remain cautious in terms of saying,
is the worst over, are we through the doldrums? 
I also think that the window for relatively low valuations, was, this
time, relatively short, compared to the previous recession, and unless there is
a backdrop, we had a relatively quick recovery in valuations, which is what you
have shown in your slides earlier as well. 
I think that is a little bit counter intuitive.  I think you can continue with your normal
pace of investment, but I don't see, necessarily, a return to the figures of
2007 and 2006. 

In terms of areas of investments,
we love recurring business models, we like situations where there are vertical
applications which are kind of ring fenced for example in tech software or
insurance software, this kind of stuff, because they are relatively recession
prone have good and loyal customer bases and have leverage-able revenue
distribution as well. 

Ward Carter

Okay, thanks Michael.  David Golob, would you like to tackle that or
add anything to it?

David Golob

Sure.  I agree with much of what Michael just said,
but I would just make a couple of comments. 
I think that with respect to the likely pace of investment activity by
the private equity industry, it is somewhat challenging environment in that
valuations have snapped back very quickly, as Michael said.  The fundamentals are improving, but they are
not great and the valuations that we see tend to show steady continued recovery
when it is not actually clear that that's what's going to happen.  I think it is an environment where a certain
amount of caution is warranted, but at the same time, you have an enormous
overhang of unfunded commitments in the hands of general partners in the PE
industry and the industry invested at a dramatically reduced pace in 2009, for
a variety of reasons.  When that happens,
the pressure starts to build.  I think
you're going to see an increase in investment activity this year, certainly,
from last year's depressed rate, and I think that is going to happen for what
are, in part, technical reasons even though the market environment isn't
particularly attractive, certainly by comparison to the times when you have
high economic performance and valuations that are comparable to this or when
fundamentals are weak but when valuations are also low.  So, it is a challenging investment
environment. 

In terms of segments, obviously as
Michael said, businesses with large recurring revenue, I think, because they
performed well in the down turn, are an area of obvious appeal to many
investors and that is factored into the price in many cases, in segments like
healthcare IT that are very good segments in a lot of ways, but they can still
be bid up to levels where they are not as interesting as they might otherwise
be.  We fundamentally take an
opportunistic approach so we will invest in just about any company as long as
we can capitalize it and price it appropriately and if anything, in segments
that are more cyclical and currently out of favor because their recent results
are weak, it would be of most interest to us right now, but fundamentally we
are optimistic about our approach. 

Ward Carter

Thanks, David.  David Reuter, would you like to add to that?

David Reuter

The only other addition that I
would put forward is that I think the activity level in the last year or year
and a half has been more a function of the number of opportunities that are out
in the market.  I really have found that,
in general, companies have retracted from doing things, whether that is being
bought or sold, or doing transactions where it is required to raise capital, it
seems like a lot of companies have moved towards the side lines, I'm not
exactly sure why.  I can guess that they
are probably expecting lower values and they are seeing downward performances
in their business, numerically or just sort of efficiency wise, and hoping that
it will rebound in the near term.  But I
really think that the capital is out there and that deals can get done, it's
just a question of when the companies want to pull the trigger on the
transaction. 

As far as the spaces go, I would
agree with the other comments.  I don't
like using the term recurring revenue because everybody then starts to find a
way to describe their business as recurring revenue when they're really not,
but I would say that having revenue visibility, having a stable customer base,
strong competitive differentiation with a meaningful value proposition, which
are really always the things that we are looking for, which are still very
important, and businesses that have those characteristics are going to get
funded at reasonable levels this year or next. 

Ward Carter

Okay, very good, David.  You know, I'm sure our audience is really
interested in looking at and better understanding how a PE fund would evaluate
investments and can you give me some idea of maybe two or three things that,
when you look at a business, might cause you concern and cause you to back
away, and maybe as a follow up to that, what are things that you look for that
give you comfort and that you would try to specifically target in looking at
investments.  I know that recurring
revenue was certainly one of them and maybe there are others as well.  Things that spell danger as well as things
that give you comfort.  David Golob,
could you take that one first?

David Golob

Yeah.  I think I would partition the response into
two components, one is process-wise and the other is on the fundamentals of the
business.  Process-wise, I think the
things that really cause us to pull away are: (1) when we're getting the rush
job, when there's a sense of urgency that we don't understand.  That just leads to a feeling that there is
something else that we don't understand and that gives pause.  We tend to be relatively uninterested in
transactions where we have to make a decision extremely quickly, unless it is
very clear why there is a high level of urgency, for example, a company that is
on the brink of bankruptcy, or what have you. 

Related to that, I think there is
a signaling question that arises in terms of a proposed transaction structure
where, if somebody, for example, is telling you that they believe that the
fundamentals of the company are very strong and they want to keep running the
company forever, but they actually want to sell 90% of their stock in the
transaction in which you are buying, that kind of signals, regardless of how
good the business looks or, you know, how straight the face of the speaker is,
we tend to look at what people are doing with their money and their time as
opposed to what they are saying, when the two are not in harmony, in terms of
the message that they send. 
Process-wise, those are some issues. 

The flipside of that is we backed a
company a couple of years ago in the internet advertising space where many,
many competitors had been selling their businesses at high prices, and the
founders had been running this company for 10 years, they had not taken a dime
out, they raised $50 million from us, they could have easily said, we each want
to put $10 million in our pockets, because our company is performing and we are
giving up a piece of our business to you guys and best market, and they did not
sell a single share.  All the money went
onto the balance sheet, because they wanted a partner taking this company to
the next level.  That is a tremendous
vote of confidence, frankly, by the team and the company has continued to
perform and we've been thrilled and they're going to make far more money by
staying in the business than they would have by selling.  So, we love it when we see that kind of
signaling. 

In terms of the fundamentals of
the business, I would say the answers are probably pretty straightforward and
consistent from all of us.  The
difference might be, and I'll let the others answer the question in more
detail, but for us, we will invest in businesses that look horrible in terms of
cyclicality, capital intensity, lack of visibility, unprofitability, as long as
we believe that there is a fair investment opportunity that is presented
through a combination of price and structure. 
So, we're not necessarily only attracted to businesses that look good,
it's really just a function of understanding what the opportunity is and maybe
figure you're being compensated for the risk you're taking. 

Ward Carter

Great.  David Reuter, anything to add to that?

David Reuter

Yeah, I would say that for us, the
most critical element that we're looking for affirmatively is going to be
quality of management.  That doesn't mean
one person in the company or two people in the company, we want to see a
consistent approach to building culture, building a pipeline of talent that is
being developed and really an ability to see a track record in either that
company or in a prior situation, so that we believe the management team will be
able to continue to achieve the goals and expectations that they and a new
investor would set out.  That, I think,
is absolutely critical and I think something that is oftentimes understated
when you are speaking with someone and they gloss over the team in a way that
says they have everything set up but in reality they are definitely under
qualified.  I think that is an area that
we often see being under invested in that is crucial to success. 

Other areas that I think are
important to really frame out are having market growth.  I think it's difficult to get excited about
companies that are simply fighting among a saturated market for market share
with other players and having a growing market is something that will position
you for success and allow multiple companies to be successful in a space. 

As far as the negatives, I don't
have anything to add to the hotspots to stay away from.  I really look at the companies from a much
more affirmative way and really trying to see if we can find all of the
critical elements that we definitely start with, with the management team, the
business model, and the market. 

Ward Carter

Thank you.  Michael, further comments on that question?

Michael Wand

I would basically agree with
everything my co-commentators have said. 
With respect to the process, I would think that one other element which
is maybe important for us is due diligence access.  I think we would not like situations where we
feel, going back a little bit to what David said earlier about process
management as well, where you sense that you are not getting the access in
order to really make up your mind and being able to go also into the second
tier management layer and so forth. 

With respect to the business side, one of the things that could set off a red
flag is customer dependency.  We
sometimes see companies that generate, I don't know, 40% or 50% of their
revenues from one customer, and while that can be actually a relatively healthy
business at that state, there is logically a very strongly embedded risk, as is
in very heavily regulated industries where you are ultimately not in control if
politicians or regulators are changing the environment for a company and that
makes us nervous as well.

Ward Carter

Okay, great, thank you very
much. 

I have one question from the
audience that I would like to pose at this point.  David Reuter, maybe you could take a swing at
this one.  The question is, “Will PE
firms consider creating an exit for old, tired shareholders, essentially
recapping the business?  Shareholders who
are not able to add any value to the business and simply want out?” 

David Reuter

Absolutely.  We have done this and we continue to do this
in cases where that makes sense.  It is a
very logical reason to get a PE investor involved.  I think one of the sort of confusing elements
that we confront when a company is looking to do this is that in a lot of cases
a typical PE deal is going to involve some kind of structured security and in a
lot of cases the ”old tired” shareholders you describe are going to be in the
common or less structured security and oftentimes it is disruptive to the other
shareholders that are not selling, why that would change, so sometimes that is
something they need some education on, that it is important to understand why
this is changing when the transaction would occur, but it is absolutely
something that is interesting to us and, I think, pretty common in the space,
so I would definitely encourage people to look into PE for that purpose. 

Ward Carter

Michael or David, other thoughts on
that? 

Michael Wand

As long as the company isn't
tired. 

David Reuter

We'll even be happy to recap out
young, tired shareholders. 

David Golob

And we'll recap out tired companies. 

Ward Carter

I would presume it is fairly
important for there to be a reasonable level of profitability, though for these
types of recaps.  Is that a correct
assumption?

David Reuter

It's not black and white, unfortunately.  I don't have a way to say exactly yes and, if
so, what amount.  What I think is
important is being able to demonstrate a profit model.  In some cases, you'll see businesses that
have a unit profit model established, but they've decided to invest in their
growth.  So, I know for us at LLR, we
won't shy away from companies that have a level of unprofitability that is
reasonable and justified in their investment in the future.  We tend to stay away from companies that have
large cash burdens on a perpetual basis and really haven't figured out their
own model, which shows a level of immaturity to the product or service they are
focused on.  But, if you have been able
to demonstrate unit profitability and you have decided to expand and take
advantage of certain market opportunities, I don't necessarily see that as a
negative.  It might mean you're worth
less, a lot of times companies that have no profit think they should be worth
the same as revenue multiple as a company that is very profitable, and I have a
hard time seeing that linkage, but I think if you approach it from a reasonable
fashion there are definitely deals to be done for the unprofitable
company. 

Ward Carter

Okay, excellent, thanks.  Switching gears just a little bit here, the
word “structure” has been used in a number of these responses and we've talked
about flexibility of structure and I'm just curious, first off we have an
environment where there is less bank debt available, are there other ways that
PE firms can use the leverage, the equity they put in place.  Are sellers willing to take notes or are you
considering earn-outs or other types of contingencies?  Maybe you could just spend some time talking
about typical, customary or preferred deal structure.  David Golob, could you take that one for me?

David Golob

Sure.  I think that occasionally a variety of
different forms of either alternative structure or deferred consideration can
be effective in bridging a gap either in value expectations or maybe more
importantly, in bridging a gap in terms of how people weigh the probability of
various potential outcomes in terms of future company performance.  The easiest and cleanest example of this is
when you have an entrepreneurial management team that is very, very confident
in strong, continued performance in a company and you have an investor who just
wants to make sure they get their money back and make a little bit of money and
is willing to disproportionately see the upside and go to the management time
as long as they can get some increased security interest in the return of the
capital and a modest return above that. 
Those kind of structures, whether they are liquidation preferences or
participation features or so forth, can sometimes be valuable, but you really
have to, in my opinion, view them as things that you anticipate fading over
time, because at the end of the day, if you don't earn your way through them,
they become the starting point for a negotiation and depending on who is on the
other side of the table and what level of ethics and integrity they have and
what kind of view they have about the meaning and value of a contractual
relationship.  It can be worth a lot less
than a legal reading of documents might suggest. 

In terms of earn-outs and seller
paper and so forth, I think our general view is that deferred notes and seller
paper are instruments that are very valuable as financing tools, especially
when the debt environment is not as healthy as it could be, so you feel like
your company is undercapitalized from a leverage perspective on the way
in.  I'd say we have a bias against
earn-outs and more towards deferred consideration because the earn-outs just
create incentive conflicts and they are also subject to all kinds of potential
gaming.  And as a result, they can lead
to mistrust and dysfunctional decision making in terms of people taking out a
calculator before they decide to book a deal or push it into the next year and
that sort of thing.  So, we try to keep
things simple, but at the same time, there are some people who just have
fundamentally different views of the risks associated with achieving a plan,
and in those cases, structure can be helpful for bridging those differences in
opinion. 

Ward Carter

Sure, okay.  David Reuter, any further thoughts on that?

David Reuter

I think that was very well
stated. 

Ward Carter

Okay.  Michael?

Michael Wand

Agreed.  Next question.

 Ward Carter

Okay, good.  One thought, we mentioned the role of
financing and hear a lot about a lack of financing for deals and David Golob
just mentioned that it is harder to get financing.  Is that really playing and having a strong
influence in how you structure deals at this point and do you see it improving
or are banks actually starting to lend on these types of deals again.  Michael, if you could tackle that one?

Michael Wand

To be honest, I have to say that
it hasn't been that bad.  I don't know
specifically about the U.S. environment, being here in Europe, and if you maybe
exclude the UK, which clearly had a severe bank lending crisis, I would say
that in the rest of Europe being able to raise some senior debt from banks if
you wanted to or needed to for a transaction, was actually possible.  In many cases, what we have done also, and we
honestly have to say that we are not playing in the large bank loan area, but
it's often in the area between €20 million and €50 million of debt.  Which you often get from a local bank or a
second tier bank in the specific country. 
They have been very open for business all the way through the financial
crisis.  If, for whatever reason, this is
not possible, you have to be a bit more creative about your deal structure and
as was mentioned before, vendor notes or ultimately having to maybe at least temporarily
finance it with some more equity and recap later.  Those are measures you can take.  But I would say, at least for our business,
which is certainly different from the larger LBOs, we did not have difficulties
in finding debt in the way I described earlier for our transactions across Europe.

David Reuter

I would echo that.  Banks have definitely put their reasonable
hats on, but they are in market and they are lending.  I would tell you that the old deals that were
very light on covenants and very high on multiples, 5x, 6x, even higher in some
cases, against EBITDA, are not happening, but if you're looking for a facility
that is in the 2x to 3x EBITDA range I do think that senior lenders are willing
to put that forth.  What I will tell you
is that in addition to the multiples dropping down to more reasonable levels,
we've also seen pricing increase both on closing fees and on rates. 

The other thing that I've found
has happened that I found interesting in a couple of deals that I worked on in
the past year is that banks are getting more rigorous in their due
diligence.  Historically I felt like
banks were much more focused on the financial plan and really validating the
numbers and building covenants around the numbers, whereas today they've been much
more engaged, almost to the point of feeling like they're buying equity in
terms of the level of questioning and other people they are bringing into the
situation to understand elements of the IT and technology companies, regulatory
aspects, market aspects, competition, so they're underwriting seems to be more
rigorous, which I think is okay.  A
couple of these deals it has been a little bit overboard, in my opinion, but
that hopefully helps them make better loans. 

Ward Carter

Okay, good.  If there are no more thoughts on that, I do
have a quick question with a very specific industry focus.  I'm not sure if any of our panelists know the
market, but I'd like to ask at least. 
What to the panelists think about the M&A prospects for the EDA
industry, that is the Electronic Design Automation space, in particular in the
subsector of tools for semiconductor packaging. 
Any experience there on the part of the panelists?

David Golob

The landmark deal, there have been
a couple of big deals in the EDA space and the big strategic question that hangs
over the industry is whether PLM really represents a logical extension of EDA
or not and I think that is kind of to be determined.  But, EDA is a segment that has very high
profitability and very limited growth and ultimately the end market most
interested in semiconductors which is not a high growth segment in aggregate,
but is extremely cyclical, so I don't think it is a particularly great area for
buy outs, just because it is fairly narrow, it has limited aggregate growth and
ultimately the valuations there, over time, have been un-gratifying.  But, you know, occasionally something does
get done from time to time. 

Ward Carter

Okay, good insight, thanks for
that, David.

Okay, we appreciate the questions
we've had from the audience and we are moving up on the hour here, so we're
going to conclude.  I'd like to express
my particular appreciation to Michael, David, and David for their time and
their very insightful comments today.  I
hope the attendees found it equally of value. 
I'd like to turn it over now to Mark Reed for some closing
comments. 

Mark Reed

Before we wrap up here, I would
like to bring a couple of things to the attention of our audience.  We'd love to have you join us in person at
one of our conferences, which go into a lot more detail about software M&A,
specifics about markets and process, etc. 
Each year, around the world, we host or sponsor educational events for
software entrepreneurs.  One of which is
the Merge Briefing, which is a very focused, 90-minute event that brings software
entrepreneurs current information about the M&A marketplace.  For a more in-depth look at planning and
executing a successful liquidity event, I would highly recommend Corum's
Selling Up-Selling Out conference.  This
is really an intensive how-to that gives a full road map to prepare for and
execute a successful M&A transaction. 
It runs half a day and we conduct it around the world twenty or thirty
times a year. 

I would like to offer all of our
audience members today a complimentary pass to either or both of those.  You can find information about either of them
on our website under the conferences and events link.  If you go there and register you will have
the opportunity to enter a promo code and the code that you will enter for
today's audience which will waive the fees for those events is “march flash”,
not case sensitive.  Or you can contact
me, Mark Reed, or any of the Corum deal makers.

Thanks again, I would like to give
a special thanks to our speakers, we appreciate your insights very much, thank
you to our audience members, especially to those who are attending at terrible
times of day or night, and I really do hope you can join us at a Corum conference
in the future and that does conclude our M&A flash report for March
2010.  Thank you.