November 2010 Tech M&A Monthly

November Corum M&A Report

 

“Structuring the Deal” plus Cloud and IBM

 

 

Jon Scott

 

Welcome everyone to the Corum monthly M&A report for November, 2010. This monthly event puts current events and economic news in a context relevant to software and technology executives building their companies and planning for strategic transactions like M&A. Thanks for joining us. In keeping with the international nature of today's topics, I see by the registration list that over 300 executives from around the world are registered for this event.

 

This is the agenda of topics for the next 60 minutes, including a special update on IBM's recent M&A activities.  I'm Jon Scott, deal VP here at Corum, based out of our Seattle headquarters.  Our slate of speakers today includes Bruce Milne, CEO and founder of the Corum Group, who will begin, John Melotte, Corum dealmaker from our office in London, Jeff Brown, a Corum VP from our office in Houston, Tomoki Yosuda, a senior research analyst for Corum, and he'll provide an update on the current M&A market, and then Dougan Milne, Corum's VP of research, will be leading the review of IBM's recent acquisition activity, followed by guest speakers from the 451 Group and several companies that recently sold to IBM.  As usual, we'll wrap up with a Q&A session at the end. 

 

We keep this event to about 60 minutes and you will want to stay tuned for the Q&A session.  As to Q&A logistics, feel free to ask questions at any time, but we'll address them all during the Q&A session. To submit a question, please use the Q&A window on the right side of your screen and make sure to send your questions to all presenters or all panelists. If you select host or any other option, your question will not be seen by us or included in the queue.

 

Today's conference is being recorded and will be rebroadcast this coming Thursday, November 11, and after that the event will be available on the Corum website via the Conferences and Events menu on the left-hand side. Or, you can request for an archive by sending an email to pats@corumgroup.com.  With that, I will turn the floor over to Bruce Milne.  Bruce? 

 

Bruce Milne

 

Thank you, Jon. Good morning, good afternoon and evening, as the case may be. We have folks here in from between 20 and 30 different countries.  Let me get into it right away.  We have a lot of speakers and a lot of ground to cover, jumping back and forth between the US, Europe and Asia.

 

Internationally, the news is basically good, (xxx 4:17) profit's are up, they set a record in North America, clearly there is some recovery there. China's benchmark rates have raised for the first time since 2007, and as you can see from the news there is a lot of dialogue and dispute going on about currency rates. The US wants to devalue and China doesn't want to, and nobody's happy.

 

The European economic outlook improved more than forecast recently, inflation jumped a bit, that means there is activity happening, but the jobless rate, this is a problem, this is at a 12-year high.  German investor confidence fell, but UK manufacturing growth rate accelerated, okay, so we get mixed messages there, things are good, but there are some concerns.

 

In the United States, we grew 2%, but a lot of people aren't happy about that, economic indicators have risen. Fisher, one of the Fed chiefs, said the US economy is nearing “stall speed”.  Two day's later, Dudley said that the US economy is wholly unsatisfactory.  Thanks for the good news, guys. 

 

The US services industry, though, probably grew at a faster pace, and this is yesterday. We get this data right up to an hour before, so we try to give you the latest and most relevant information. The ISM factory index rose to a five-month high, which is good news.

 

But consumer sentiments decreased in October. Some of this stuff is (xxx 5:39), some of it is a leading indicator. Jobless claims in the US are expected to drop to a three-month low, that's good. ADP estimated that there were 43,000 workers added to payrolls. That's great news, but we have what, 8.5 million people unemployed, officially? 

 

Orders for US capital fall, signaling less investment, but then we have companies in the US planning to raise capital spending, according to another survey. Hmm, who do I believe? “Cash Hoards Show Borrowers' Angst Over Economic Growth.” In other words, a lot of companies are sitting on cash, kind of concerned, but maybe with the election, maybe if we see a freeing up of credit, we'll see a lot more investment, at least I think so.

 

Now, I'm kind of lumping finance and real estate together. Speaking of cash, the largest stockpiles, interestingly, are in the big tech companies, Microsoft, Google, Cisco, etc. The biggest? Apple, with $51 billion. The sales of US homes increased again in September. Existing home sales rose 10% over last year, that's all good news. But, you know what, they say there is still as many as 10 million mortgages under water. We have a bottleneck there with some of the problems they've had there with foreclosures. 

 

The DOW is up, hope you have some stocks.  Ebay is planning for $1.5 billion in debt.  We've been talking a lot about this, with interest rates effectively at 0, the effective LIBOR rate now is a quarter of a point. It's so easy for them to raise cash debt, we've seen it with IBM, with Microsoft, we've seen it with eBay, they're foolish if they don't get some debt in place with these rates. But again, US homeownership is at a 10 year low with foreclosures on the rise.

 

Shifting over to the technology sector, it is the same names getting the headlines, Apple opens stores in China to boost sales, they enlist Unisys to help with corporate and government deals. I love that, Unisys, I'll come back to them later on, they are one of the original mainframe computer companies, made up of firms like Burroughs and Univac and others. I used to work for Burroughs and Unisys. It's interesting that Apple is going to these traditional suppliers to help break those deals open. You have to remember they have been dealing with corporate and government for 60 or 70 years. Actually, Burroughs since 1885!

 

Google's China share has fallen to the lowest in three years. Verizon is to sell Samsung's tablet, everyone's getting into these now, last month we talked about RIM.  Then Sprint undercut the iPad, and the Samsung/Verizon tablet and we're getting into price wars already.

 

Oracle, you have to love Larry Ellison, a $2.3 billion humiliation lawsuit to SAP because they downloaded some Oracle code that they shouldn't have.

 

In tech finance, Microsoft is up 51% in profits.  Wow. That tends to quell concern about the Apple worry, their new strategy, etc. They're coming out with a lot of good product, generating a ton of cash. The stock is only up about a buck or so on that news. EMC's third quarter profits climbed 58%, we just had them on here and they'll be back again next year. We love to see that growth in storage demand.  Apple joined the top 5 handset makers worldwide as Nokia slips down. Their market share is falling and they are looking for a strategy and they just changed their CEO. Intel is expanding, they spent $8 billion in factory upgrades. You have to believe that if they are spending money like that, they believe in the future.

 

Steve Jobs said that he is keeping his powder dry for future bets, again, I mentioned they have the largest treasure chest right now at over $50 billion. And Oracle, this is yesterday, acquired Art Technology Group for $1 billion, to add to e-commerce.

 

Let me shift over to London and go to John Melotte. John, you recently did a transaction, tell us about that. 

 

John Melotte

 

Thank you, Bruce, and a welcome from London to everyone listening. Yes, at the beginning of October, 360 Scheduling, based in the UK, become Corum's latest client to successfully sell, in this case to the UK subsidiary of the Swedish company IFS. 360 have great mobile resource management technology, solving the largest and most complex shipping problems, computing optimal solutions in real time. Their latest release is fully implemented in the cloud.

 

Corum's instructions were to find a partner that would best support the existing team as they turned world-beating technology into a world leading solution. IFS is that partner. It's ERP solution has 2000 customers across Europe, the Americas, Africa and, Asia. It has significant capital resources, there is a great cultural fit and a shared vision for the development of mobile resource management.

 

With its sound solution, 360 Scheduling generated a lot of interest from strategic and financial partners. Some of that interest converted into sales opportunities, with the rest, Corum was able to create a competitive global auction that resulted in IFS being seen as the right future partner.  All in all this is a classic Corum sale, completed in just under one year. A great company and an outstanding executive team have been acquired by well-matched strategic buyer. The 360 Scheduling management team is now focused on delivering on the potential of their technology within the supporting IFS group. It was a privilege to work with them and they have my very best wishes as they continue to work to build on what they have already achieved. 

 

Back to you, Bruce.

 

Bruce Milne

 

Thanks, John. Good job on that, I hope we can come back to that cloud strategy they had. It is interesting that we noted earlier in the year that there were a record number of companies going to market, the highest number since the dot com era and right now we have the largest number of companies in LOI since the dot com era, so you're seeing a lot more transactions. Next year, as we normally do, probably in February, we'll have a seller's panel and perhaps have the CEO from 360 Scheduling at that time.  He's a great guy.

 

Let's go from London to Houston with Jeff Brown. One of the things we wanted to talk about, this time, is structure. In each of these monthly webcasts we try to break out one part of the M&A process. This time we chose structure. Jeff, you have a lot of experience with that.

 

Jeff Brown

 

Yes, many first time sellers don't fully realize that there is an aspect of the deal that is even more important than the price, and that's the structure. An essential theme around structure is that the more willing the seller is to take some contingent or time-based payments and share risk with the buyer, the higher the likely price for the transaction will be.

 

Some of the elements that fall under the heading of structure and form the backdrop to the these methods that we see on the screen for closing the valuation gap include: is the buyer purchasing the EBIDTA of the business or the stock? How are the liabilities of the business divided between the buyer and the seller? What protections or indemnities are being provided by the seller to the buyer? Are you getting paid in stock or cash? Are those payments guaranteed? Are they lump sum payments or paid out over time? Lastly, how much of that purchase price is placed in escrow and what are the terms of it being released from escrow?

 

Next we'll see that in this juxtaposition, the buyer and the seller are at odds. As a seller your objective should be to find the deal terms that pay you the highest risk-adjusted price for your business and transfer as much of that risk as you can to the buyer.  After all, if you are no longer in control of the business, why should you carry any risk for the business going forward? Or even hold risk for the prior conduct of the business before you sold it. As the buyer, though, your objective is just the opposite, take control of the business by spending as little as needed and assume as few of the risks as you need to. This might even mean a structure like an exclusive technology license, which works best if this is your objective. This natural conflict between buyer and seller means they butt heads on fundamental issues.

 

This conflict starts long before the deal terms are agreed. It begins with due diligence, with the buyer wanting a comprehensive due diligence exercise to examine every last detail of the business, and the seller wanting to limit diligence to only what is reasonably needed to understand the transaction. The focus on the analysis and detail by the buyer will even be reflected in all aspects of the transaction, including how comprehensive the purchase and sale agreement is.

 

Next, you will see that we have given you an idea of different transaction structures in prior Corum transactions. Here we see five real world examples of deals that Corum has closed, showing the difference in structure in the payments only in those deals. By no means does this represent the full extent of the differences in the structure of these deals. Each of these sellers is generating over $10 million in trailing twelve months revenue (TTR).

 

So we see in A and E that these deals are very similar in payment structure, they are all cash deals, with some form of employment or consulting agreement tied in for the sellers of the business. B, C, and D have some upside risk reward with them, with the buyer's stock and earnout provisions being included in the deal. C is a very interesting deal, it has the highest valuation but note that slightly over 55% of the valuation is in the earnout potential against $115 million valuation.  That is slightly over $65 million of earnout potential in this one. A common denominator amongst all these is escrow and escrow adjustment provisions. Be wary of these, because they can cost you money if the terms of the escrow are not favorable to you.

 

Next, five keys to structure success. First and foremost, know your stakeholders. Understand what your board, your shareholders and your management are looking for here and confirm with your transaction adviser as well. Find unity on your position and assess your options so that you know when you have reached your objectives in the deal.

 

Two, don't let the buyer negotiate serially, and don't you do the same. Get all the issues on the table early and at once. Few of these issues can be dealt with in isolation, so you need to maintain the big picture and keep the tradeoffs and the confessions in balance. 

 

Third, understand your liability and tax situation clearly before you start, know where the “gotchas” are and know where you need to be there.

 

Fourth, be resourceful, creative, and flexible to bridge the gap in valuation. These deals are hard to do, and it takes a great deal of flexibility from the buyer and the seller to get a deal done. 

 

Lastly, of course, get good counsel, both tax and legal, as well as transaction counsel.

 

So, thank you, Bruce.  Back to you.

 

Bruce Milne

 

Thanks, Jeff. It's interesting, that one for $115 million was down in your neck of the woods, I remember that, and normally we wouldn't do that much earnout, but it was a very high price. It's interesting, they actually exceeded the earnout in that case. 

 

Now, let's shift to a cloud update. We had promoted that we'd talk to you about mini-mergers, we're going to have to come back to that, because we felt that what happened in the last couple of days at the Cloud Conference was worth getting an update on. Dougan?

 

Dougan Milne

 

Yeah, thanks. I've just returned from Silicon Valley where this week they hosted the 17^th annual Cloud Expo. In fact, the expo is still running through the end of today, so I didn't get the chance to stay for all of it. It was a very informative conference, definitely geared more towards the infrastructure side of the cloud, and definitely focused more toward the entrepreneurs. They had a lot of boot camps, keynote presentations, panels, forums, etc. A somewhat smaller and more condensed exposition this year. So, not as many application vendors there, but there were a lot of infrastructure players.

 

Obviously the cloud is a topic that has maintained a hype for the better part of the last decade. It will continue to evolve over the coming years, but I thought I would briefly touch on what I felt were some of the main takeaway points that were being discussed at this year's expo.

 

First, and it is important to note that besides all the hype that is mentioned, the cloud has actually gotten off to, I hesitate to say, but kind of a slow start. This isn't to say that all the ideas have not been in place for quite some time, but the primary challenges have been in kind of aligning the application side of the cloud with the infrastructure side of the cloud, and then of course making it attractive to the potential users. The users is the key word here, again despite the hype, the core adoption and certainly the target market for much of what has been evolving over the past several years has been for the enterprise. And really, enterprises have only recently started embracing the cloud after several years of looking at it, testing it, probing, weighing their pros and cons, we're just now starting to see some of the major financial institutions putting parts of their data stacks or application stacks into the cloud. We're just starting to see some of the world's largest industrial firms starting to run parts of their systems and automations through the cloud as well. So this is a trend that will need to build up momentum and it is a trend that I'm sure we will see continue over the next several years.

 

Another interesting piece of the puzzle that frankly puzzled me in a lot of ways is that a lot of the startup cloud application vendors that we saw trying to make it off the ground in the mid-2000s, 2005-2007, those companies touted the pure cloud offering, the elimination of wires, stacks, servers, etc, a lot of them have refined and expanded their model in just the past 18 to 24 months, because they have realized that many of those big enterprise IT admins are very hesitant to push their systems into the cloud, so what many of the vendors are offering now is choice, and it's the choice between a completely cloud-based, hosted model or now offering a small, appliance-based solution that will allow for those enterprises to run their own private cloud. Those appliances, the private clouds, they quell a lot of the enterprise woes about moving large stacks of data and applications, it certainly brings about a better sense of security.

 

You may have heard some of the recent big announcements from the likes of Amazon and Microsoft, Rackspace, etc, regarding pricing and new introductory tiers for computing power and storage, of course. This is sort of a big deal, as important as the large enterprises are, these new pricing tiers are definitely catering toward and focused more on the SMBs. It is incredible when you look at startup cost 15 years ago versus today, you know an entrepreneur with an idea and some pocket change can literally get a company off the ground, utilizing the crowd. Jonathan Spozado, who has now sold two of his companies to Google, when I interviewed him last month at the Growth and Exit Strategy Conference in Seattle, he gave a great little anecdote. “If you can afford to buy a Honda Accord, you can afford to start a software company.” I think that is a great picture of the cloud right there and how it has benefited the startup scheme. 

 

Just lastly here, there are a lot of new entrants on the infrastructure side, but it is still heavily dominated by the giants. Of course Amazon, Rackspace, Microsoft, Azure. Getting into the virtualization side we of course have VMware, and IBM is certainly a big player as well. 

 

That's about all I've got for the quick Cloud Expo update, from there I'm going to turn it over to Tomoki Yasuda, who's going to give us a run through of Corum's monthly statistics. Tomoki, are you there?

 

Tomoki Yasuda

 

Hello, everyone, my name is Tomoki Yasuda, a senior analyst at Corum Group. Long-time listeners know that this is a boilerplate edition of the webinar, and I'm really going to have to fly through these slides, so forgive me if you don't get all the information you'd like.  I will sum it up in a summary blog, so please check that out later this week. 

 

Getting right down to it, October has shown strong gains in the public market, as tech companies all across the board make good gains. As you can see from the slope on the right, this is probably the best (xxx 22:10 sounds like runner runner) month we've had in the past twelve months. As usual we see the S&P tech index performing the highest, followed by the NASDAQ and the Dow Jones.

 

Next is the Corum Index. For the first or second time in the year, we see that deals have not surpassed the previous year's. We are currently seeing about a 14% drop in volume and although this may signal that buyers are cooling down and having a digesting period, I think putting some thought around these that numbers would be beneficial and some points to consider are these:

 

1.      Remember that this time last year is when M&A activity ramped up dramatically and buyers with that pent-up cash reserve and demand were really doing a flurry of acquisitions all at once.

2.      Another reason could be that buyers were waiting on Q3 numbers and earnings reports before going ahead with acquisitions, in the case of the recent Oracle and ATZ deal, I could see that being the case.

These are just some things to keep in mind while looking at these numbers.

 

Moving along, we see there were two megadeals, both by the Carlyle Group, both targets in the telecom and infrastructure space. It is very interesting to see what is happening there right now, and I will go into more detail about that later in the presentation.  The other metric that has gone up a little bit is average deal size, median sale size has gone down, and the rest seem to be relatively close to each other. 

 

In the next few slides I'll cover the six broad markets that Corum covers, again, sorry I'll have to skip a few of these, but please read my summary blog, which will go into more detail about all these sectors, or feel free to reach out to us, I'm always available by email or by phone.

 

With the Horizontal Market, looking at the graph here, we see great gains in October, looking to be around the second highest peak in the year, in terms of EBITDA and the highest multiples this year in terms of sales, trending above 3x.  A deal I'd like to get into here is the acquisition of YouCalc by Success Factors. Success Factors is a public stock company playing in the performance management sector. They targeted YouCalc, is an intelligence vender out of Denmark, that aggregates analytic tools, such as Google analytics, (xxx 24:19 mail chimp?), and Salesforce, and puts it into a simple, visually compelling dashboard.  It really shows a fundamental shift in the use of business intelligence applications in enterprise.  More so that analysts nowadays, the everyday employee needs ways to access information and it makes sense in a really simple way.  We get bombarded with so much information these days that really a tool like this is necessary for the everyday employee.  A big win for Success Factors in my opinion, they really understand their target market, and this will mean more competition for those intelligence vendors.

 

In the Vertical Application market, EBITDA multiples are rising above 10x and sales remain steady around 1.9x.  Unfortunately, this is one of the slides I'm going to have to skip, it focuses on the healthcare sector, but please check out that blog I've been talking about.

 

The Consumer Application market is probably our most dynamic market, going through some obvious peaks and troughs throughout the year, currently sitting at 10x EBITDA, and still around 0.7x sales. The deal spotlight in this sector focuses on the acquisition of iPhone game developer Ngcomo by DeNA, a Japanese internet mobile conglomerate. DeNA is going to pay $300 million in cash and securities with a potential earnout of $100 million for shareholders if they hit certain milestones.  Just some background info, Ngcomo is one of Apple's most successful developers with over 60 million downloads, which is roughly a third of the population of Japan, so that's pretty big. The rationale behind this acquisition is for DeNA to get a foodhold in the US market, and its plan is to use M&A as a vehicle to build the largest social mobile gaming platform in the world.

 

The real key here is use of real-time analytics for social gaming.  That is why they are getting huge multiples. These gaming companies can update their games, which usually have a shelf life of just one or two weeks, and stay very competitive with each other, making really great efficiencies with short shelf life products. It is pertinent because it is amazing the value they are able to extract out of their products, and I believe that as companies other than gaming companies continue to concentrate their business more online, real-time data analysis will likely play a very large role in shaping how key decisions are made. 

 

Next up we have the Infrastructure Market, one of the highlighted deals from the Carlyle Group is here, their acquisition of Syniverse. It is very interesting to see the reactive activity going on in this space.  As people around the world are concentrating more on 3G and mobile broadband, this sector is really going to ramp up in the next few years.  Just some statistics for you guys, according to Instat, mobile carriers are poised to spend nearly $170 billion by 2014 on wireless infrastructure and the average consumption rates are going up 50% every half year.  This is a very compelling stat, and Carlyle is positioning themselves very well with these acquisitions.  I will not be surprised to see some rollups in these companies in the near future. 

 

Next we have the Internet Market slide, and unfortunately this is another one that I will have to skip. In summary, October posted numbers at 14x EBITDA and 2x sales.

 

Lastly, we have IT Services, which has traditionally maintained a very flat valuation, but we see an unprecedented 0.8x sales and EBITDA is still around 6 to 7x.  With that, I'll turn the mic back over. 

 

Bruce Milne

 

Thank you, Tomoki.  We had a couple of questions during this with people asking if they can get these slides.  If you haven't been on before, all the numbers and graphs that we sometimes go through very quickly because we try to keep this under an hour, will be online one week after we rebroadcast this next Thursday.  It's really interesting to see the growth in the mobile sector. We'll be having a separate report on the mobile sector as well as the Chinese gaming players. They are changing the rules. Our friends Carlyle in the private equity space are doing the biggest deals, you know, welcome back to private equity, they are playing a huge role and they have $500 billion in uncommitted funds.  Carlyle, by the way, we've done a number of deals with them and they are one of the few firms that has actually gone fishing with us as a buyer.

 

Now, let me shift over to our key presentation, IBM.  Last month we had the newest giant in the industry, Google, and profiled them, this month it's IBM.  We're going to go through an overview of recent transactions and analyst opinions.  I'll give you a little bit of background on IBM history, Dougan will be talking a little bit about the past year, and then our guest speaker Jonathan will be talking about the future and what it all means to us, and if Big Blue is in your future.

 

IBM is over 100 years old. They started as a tabulating machine company, there were a number of companies that they acquired along the way. Their revenues today are over $100 billion and they have just over 400,000 employees in 200 countries.  What is really interesting is that they are, even now, the second most valuable global brand behind Coca-Cola.  I remember that when I first got into the computer industry I was selling computers for, as I mentioned earlier, Unisys, and my mother always used to say proudly, “My son sells the IBM machines,” and I'd tell her that I sold computers for a competitor. Computers, not IBM machines, that's how strong their brand was.

 

They hold more patents than anyone. If you ever get into this, they are a machine, a huge R&D machine. Their stock is at an all time high.  I have a little bit of it in a managed account and I wish that I had more.

 

IBM has a long history. They are the largest computer company and still are in terms of sales of equipment. The model 360 mainframe in the '60s and '70s was where they were dominating the world, and they were truly dominant. The industry was called IBM and the seven dwarfs. I worked for one of the seven dwarfs.  Ward Carter, the chairman, and I, worked together a long time ago for (xxx 30:57) Corporation and we always said IBM stuff was overpriced and slow and whatever, but they would show up with teams of professionals and Thomas Watson, who built them up and who really invented the large account sale. They would show up in blue suits and only white shirts, they were serious guys doing serious work and they would do a great job and we were envious.  So I was a competitor.

 

Then they got into the PC business in the early 1980s and they really helped to confirm and endorse the whole PC movement when they got in there with the AT.  I was lucky enough to be chosen to be one of their advisory members, I had built the world's largest vertical company as well as one of the largest sellers, then I'd been on Apple and IBM's board and based on that they invited me to be on their advisory board, first for channel distribution and then later for operating systems.

 

Then, things kind of fell apart. The mainframe market share was being eroded, first by main computers, people like Digital and Data General, and then microcomputers. They fell on hard times, going from almost the size they are today, just under 400,000 employees, to just over 200,000 employees at the bottom, during the 1990s. They brought in Lou Gertsner from American Express, greatest turnaround in history. He did something really interesting, he went around and he didn't start talking about what he was going to do, like all the politicians are today, 48 hours after the election. He went around and interviewed the top executives, particularly tech executives, in the world. I remember he visited with Bill Gates out here at Microsoft, about what he should do with IBM, how he should reinvent it. He also did that with some of his key executives.  I remember running a conference at the time where their head of acquisitions was in the audience and I was speaking. This was Selling Up Selling Out, which was then and remains the definitive education on how to prepare, position, value, structure, negotiate, and execute a merger or sale of your company.  He loved the conference. I remember a question came up about what the things are that can kill deals, from a legal perspective.  I said what I always say, which is we can generally frame any legal problem as a business risk, we can haggle it in the structure of the deal in escrow, etc, but there are really two things we worry about. One is control and dispute over IP. Two is antitrust, and that kind of raised his ears up and we talked afterward, because IBM had gone through the worst antitrust suit in history in over a decade with the American government.  We spent some time talking about what I thought they should do. 

 

They are the largest acquirer of technology in history. At that time, they weren't doing much, but they went through this large antitrust suit. Now, today we see Google fighting with China and RIM is having problems in the Arab world and regularly the EU dings somebody to make money, it is like a toll to do business there, a billion here or there for Microsoft and other major players, and we see the same thing in the US.  Everyone is subject to it, it is a way for governments to put a tariff on business and make money.  But back then, there was only one company and IBM was a target for almost a decade of IBM against the US government. Out of that, IBM developed some very clear guidelines. They are black and white, because they felt the pain of this. 

 

If you've ever been through antitrust, because of my role investing and building companies, writing books, and such, I have been an expert witness for a number of years in antitrust cases in the computer industry. I can tell you that there is nothing more debilitating as a manager or an owner of a company to be involved in these things. I was an expert witness and they are so complicated it's hard to find a jury to even understand what the heck you're talking about, and horrifically expensive. You spend millions of dollars on legal fees and that's just your monthly attorney bills. You just don't want to get into them, they're very complex. 

 

Out of this, IBM developed their very black and white policy of not talking about their mergers and strategies without getting approval from them, and I can certainly understand that. I was on their advisory board and couldn't talk about deals we'd done with them, I remember an early project megadeal, we couldn't tombstone it. So it's interesting, I went into profiling IBM, and we know a lot of the companies that have sold over the past year.  We have two of the best presentations from their representatives for you, just wonderful stuff, and very positive about IBM, but unfortunately we weren't able to get them reviewed in time for today's webcast.  We will share that with you as soon as it comes through.

 

But what I can share with you is the benefit of what our surveys to sellers came up with, and that was that IBM tends to move fast. We think of them as big, and because of that maybe lumbering along, but they are not. If they want you, they will move very fast and be very competitive. Their process is probably, from what we can see, the most refined in the industry. You have to remember they have done more acquisitions than anyone and they have refined their process.  The due diligence is probably the most thorough, you'd better be on your best game.  What's interesting though, is how embracing, and literally warm was the word we heard about their culture. They thrive on the inflow of talent and they will support you, they want you to do well with your technology and ideas. They probably have, from what we can see, the best integration. You don't hear a lot of drama in the press about their acquisitions and problems there, and it is because they have learned in 100 years of making deals the right way to do it and I applaud them for that. And I totally understand the confidentiality issue, I've been on their side and the other side and we will have those presentations for you. 

 

One of the things that the CEOs that we talked to collectively came up with is that if you are going to sell to IBM, you'd better be good at what you do. You'd better have strong leadership teams, and you'd better have tight operational models, keep very detailed financials, because IBM is professional, they probably have the largest corporate legal staff of any major company in the world. Invest aggressively in sales and marketing. Be like IBM. Plan early for an exit. These are things we hear from others.

 

We always see these taglines like Just Do It with Nike, the first tagline we all remember is IBM's, back in the '50s to the '70s, which was “Think” and it got you thinking, and they're good at it.  They're a good company, and you'll need good counsel, we heard consistently, get a good lawyer, get a good ibanker who knows how to deal with these guys. 

 

Let me close on this section, because I want to shift gears to our speakers. 

 

This came out yesterday, Dow Chemical's CEO said he admires IBM's M&A Model. “I love the IBM model,” Andrew Liveris told Reuters. “They got to a certain size and from that moment on, they did bolt on technology M&A, which they scaled up around the world.” I think that's a great intro to Dougan, let's hear about some of the bolt on M&A they did this past year.

 

Dougan Milne

 

Great, thank you. I'm going to leave some of the further analysis to John Abbot from the 451 group, who we're happy to have with us. But let's just run through this. IBM is currently sitting in second place for acquisitions in 2010, second only to Google, who has just made an insane amount of acquisitions, something like 25 or we might even be up to 26 at this point. But IBM certainly is not sluggish in any way, having done 15 acquisitions so far this year. Just to point out, if there is a little asterisk beside the total deal amount there, those are estimates of the deal amount. As we've certainly covered here, IBM does not like to talk a lot about, frankly anything, but certainly not about how much they're paying for a company that they are acquiring.

 

But to run down the list to give you some understanding about what each of these companies does, a lot of GRC, that's governance, risk and compliance, we see the first couple here fit under that heading, both with Clarity Systems and PSS Systems. BLADE Networks is a company we got an interview with, but unfortunately, it did not get passed through IBM in time for this webinar today. They do ethernet and blade server switching systems that you'll see in a lot of data centers around the world.

 

Netezza, that was one of the big announced deals back in September, data warehousing and appliances of multiple sorts, including analysis of large volumes of data and I think John Abbott will probably talk about that as well.

 

OpenPages was also in September, another GRC company. Unica is getting a little bit outside of the form here. They are online email marketing, they do campaign creation and management for email marketing, this is a software as a service business, this one fit really well with what IBM announced as Project North Star, kind of encompassing the entire area of web analytics, web deployment and content management.

 

Datacap obviously does data and document capture, as the name would suggest. Storwize does more data storage and compression appliances that are primarily used in large enterprises. BigFix was one of the other interviews that we have but that we aren't able to share with you just yet. They do asset and patch management, OS deployment, security change, a lot of that change management stuff I was talking about, and it also somewhat fits into the GRC category.

 

Again, going back to Project North Star, was the acquisition of Coremetrics. This deal was back in June, they do online marketing campaign analytics, that's another SaaS deal right there.

 

One of the big deals of course, a headline deal because they finally bought them from AT&T, IBM bought Sterling Commerce, who of course do data and application integration, EDI, SEM software and various SaaS. Cast Iron Systems was just before that, back in May. Intellizen was network automation, again related to change management. 

 

Initiate Systems, earlier in the year, in February, they do master data management, MDM, primarily for the government sectors, medical sectors, and other large enterprises. And of course, the first deal of the year, 11 months ago now, National Interest Security, LLC. As you would imagine, they do systems and security integration, IT consulting, primarily based around security and various DPL operations.

 

Now, you don't have to memorize all these deals, because there will be another slide that will give you a bit more detail. I want to go head and introduce John Abbott from the 451 group. John is actually based out of their London headquarters.  If you're not familiar with the 451 group, you probably

should be. A lot of people know the Reuters of the world, they know the Bloombergs, they know Forester and IDC. The 451 Group is very specific to the tech sector, reporting on M&A as well as on a lot of the trends that are now happening in the market. We are a big supporter of theirs as well as a customer of theirs and they have a great amount of analysis and John is one of their chief analysts over there. I'm going to go head and turn the floor over to him. 

 

John Abbott

 

Yes, hello. Thanks very much for inviting me on.  The first slide I have is really just to introduce the 451 Group, although Dougan has already done a good job of that. I'll just point out that we started off as an analyst company covering startups, really, and working out how they would fit into the larger scheme of things, particularly the big companies and their strategies. So we covered the emerging startups and put them into groups in great detail, from 2000 when we really started operations.  Then a few years ago we acquired Tier 1 Research and got into the managed hosting side of analysis, which has proved a really useful thing to do, because the models they come up with are extremely relevant. So we combined that with our own research into things like grids and came up with a big cloud program. We've been tracking 200 or 300 cloud programs for quite some time. Then last year we acquired The Uptime Institute, and that got us into datacenter operations, best practices and puts us in direct contact with some very large users, which has been great.

 

This is just the slide to put the thing in context. IBM's CO said in May that the plan was for them to spend about $20 billion on M&A over the next 5 years and that figure roughly matches the amount that they have spent on M&A over the previous 5 years. Just while this slide is up there I'll point out that the majority of the spending there was focused on 2005-2007, with some really big deals there, Ascential, Filenet, and especially Cognos in 2007, which was $5 billion alone.

 

Things have been ramping up again over the last year.  That brings us to the next slide, a list of IBM's recent M&A activity in the last year. I'm not going to go all through them, I'm really just going to talk about high level trends here before we get into some more future things.  It is worth pointing out that IBM has spent more on startups over the past year than it has on public companies. As Dougan pointed out, they don't like to talk about the values very much, but the ones with the asterixes we have estimated from various sources, usually corroborated very carefully, and if you add it all up, IBM spent around $2 billion, just slightly less than what it spent on public companies like Unica and Netezza, which is pretty interesting.  Overall, IBM is spending less on small technology pickups and concentrating on acquisitions of larger standalone businesses that it can accelerate using their global channels, for instance.

 

HP, similarly, has recently telegraphed to bankers that it doesn't want to get pitched by $5 million startups that want to change the world anymore, hence their bigger deals lately.

 

IBM has also been doing a lot of one to one transactions where it can, especially with the private companies. It is not participating in auctions, we've heard of at least two examples where IBM has approached the target with a huge deal that was too good to turn down and the target company didn't even retain a banker.

 

In modeling out these acquisitions, IBM tends to pay particular attention to pull through sales, like it's $1.4 billion buy of Sterling in May. This obviously bolsters IBM's middleware capabilities, but it also adds a heap of services around those deployments and other offerings recently acquired like Coremetrics and the marketing automation from Unica. These things can be applied widely, so the target revenues at the time of acquisition become fairly irrelevant.

 

I'll move on now to the final slide and talk about some trends that we have seen and predictions.  First of all, industry reaction deals. I think of these, BLADE technology is the most obvious one. It is the middle of a chain from Cisco's entry into service a couple of years ago with the UCS system, BLADE adds some networking intelligence to IBM, which is an area where they have been fairly weak until now.  It is not going directly to Cisco's core territory, but it is moving into the data center and networking side, which is extremely important and top of the rack switches.  Netezza is another industry reaction one, you can see it as a response to Oracle's introduction of the integrated system for analytics and transactions recently as well, and the Sun acquisition. 

 

In general, IBM has been following the storage business pretty closely and its XIV acquisition last year, which is not on the chart, and it anticipated some of what HP and Dell were trying to do this year, but at a reduced cost, in fact, which was good. It had been weak on networking.  BLADE is a start that we are still expecting IBM to look to expand in this area with a more substantial acquisition.  It could be Brigade or Juniper, despite the huge cost those would bring.

 

The next is consolidation and integration, this is continuing that theme, systems architecture is starting to come together, service storage and networking technologies are converging, driven by the widespread adoption of virtualization and the need for increased automation, if you are going to run large scale data centers to host things like could computing.

 

IBM has its own virtualization technology and partners with VMware, Citrix, Red Hat, and with things like the new mainframes that were introduced this year, it's talking about work load optimization, which is moving applications to the most relevant architecture automatically. There is a lot of integration there, and cloud delivery models are becoming important. I actually agree with Dougan's earlier point that hybrid clouds being a very important trend going forward. Cast Iron Systems gives IBM a fairly simple point to point integration product that can be utilized to link up private on premises and public clouds. BLADE again gives them an intelligent networking stack to help integrate the networking side with storage and server management. Storwize, the storage acquisition IBM made earlier this year could well be integrated into some of the appliances, the smart analytics appliance, for example, that IBM is already marketing. Storwize compresses data in real time, it is a little appliance that is in front of the storage that compresses data and makes it easier to manage and makes it so you can store a lot more data in the same space.

 

Another way things are coming together is with frameworks, and a lot of these acquisitions are part of a framework initiative at IBM that can be used across multiple engagement channels and multiple industry areas. Unica is marketing automation, Openpages with its government's risk and compliance software and Sterling Commerce with a lot of B2B stuff, they are all key players here and IBM can apply this to various application areas.

 

Project North Star, which was also mentioned earlier, is all about improving customer web experience by combining and integrating a variety of IBM technologies is key here and Unica, we think, is going to be a key component. (xxx 53:24 sounds like kid fix) will supply a security layer into the fabric of the enterprise across a wide range again. These are some of the motivations that IBM has been using.

 

IBM has been gradually shifting towards applications.  They exited the applications market many years ago, but with Cognos, back in 2007, it started adding more industry specific intelligence.  IBM is upping its vertical market activities, verticals are starting to become mainstream, so in retail, Coremetrics adds a lot to its retail division and Initiate and Datacap both are strong players in healthcare. There is potential to see IBM or others acquiring healthcare specialists in the future.

 

IBM has been talking about smarter planet, that is a way of integrating these various technologies to do interesting things, including lots of services, which is a big message for IBM. 

 

In the last few seconds, what's next? Well, security in the cloud remains a big one, we hear about potential security acquisitions still coming along, data continues to grow, so we are looking at more data management problems, and particularly to try and address service fraud. If you look at Google nowadays, I know you had a session on Google recently, but it is interesting to question how many servers they have now to run their data centers, and they stopped talking about how many they had a few years ago and there are estimates that it is up to three or four million servers there now, and that's a nightmare to manage. Service fraud is a real problem and to find industry standard servers, even the cut down servers, doesn't solve the problem.

 

Other areas we expect IBM to look at are virtualization, getting the input and output consolidated and IBM might buy a small start up or a larger one.  We still, as I said earlier, expect a big network acquisition and the other area that IBM is working on is the coming together of element managers like System Director with the broader systems management which will help with the cloud problem as well.

 

That's really me finished. 

 

Bruce Milne

 

Really quick, John, when you said a possible network acquisition, what did you mean by that?

 

John Abbott

 

Sure.  You know, BLADE gives IBM network switches for blade servers, and top of the rack switches so you can consolidate the connections on a blade and then fan them out. It hasn't got an equivalent of HP's 3com, it's not targeting Cisco directly, Cisco hasn't been that strong in data center switches, although it is moving in that direction and certainly top of the rack switches are more important for Cisco, so that's what I mean. Juniper, which BLADE had some association with is an obvious one, although the BLADE/Juniper deal which I thought was interesting, fell apart before IBM closed the deal.

 

Bruce Milne

 

Thank you very much. We're getting on in time, so we probably only have time for just another question or so, but you're welcome to email anything to us and we're glad to respond.

 

Let's go to Q&A here just briefly.  We have some upcoming events. If you're part of YPO, there will be 600 people on that call, it's a global conference call on tech M&A, Ward Carter is running that. The merge briefings are live regional events, where you get an overview of the marketplace and the process that is currently being used in the industry. The Selling Up Selling Out conference, the one I mentioned earlier, that's the definitive education conference on how merge your company.

 

Miro, are you there in Munich?

 

Miro Parizek

 

Yes, thanks for a moment to be able to talk about the World Financial Symposium, Growth and Exit Strategies for Software and IT Companies. This is the eighth year, it takes place in London, on the East and West Coasts of the United States every year, we just had a great one in Seattle, in fact. It's a very unique event, bringing together the financial community and the players, owners and CEOs of IT and Software companies, talking about all aspects of M&A, public markets, private equity recaps, use of debt, etc, there's a fantastic agenda, I've been chairing this now for five years, it is, I think, the best ever, we have Cisco, Google, Software AG, and ABG on the buyer's panel, for example. Take a look at worldfinancialsymposium.com, see the agenda, look at the speaker's list itself, it's fantastic, and I hope to see you in London on December 7.

 

Bruce Milne

 

I'll be there chairing a session, I think, on the financial panel for the leading ibankers of the world. It looks to be the best attended event ever. This is a great place to get advise and meet with these guys one on one, the networking sessions are wonderful, we hope to see you guys there.

 

Let me turn it over to Jon for a Q&A. 

 

Jon Scott

 

Let me just go back to one point, we'd like to offer you a complimentary pass to any of the Selling Up Selling Out conferences or Merge Briefings that Bruce mentioned a moment ago. On our website, corumgroup.com, you'll find a link to Conferences and Events. You can go there for upcoming events, schedules, and registration information. On registration you can enter a promo code which will waive the registration fees. The promo code today is manovember10. Or you can contact me or any of the Corum deal makers if you would like information on that. Also, before we jump to Q&A, reserve the slot on your calendars for December 2^nd for Corum's next monthly M&A event. That will be at 1 p.m. Eastern time, and it will be an interesting webinar.

 

I want to open up Q&A and we only just have time for a couple of questions. Miro, this one came in from Germany, so I'd like to address it to you. The question is this: We work closely with IBM, so we keep an eye on them. I haven't noticed them doing any acquisitions in Europe, but maybe you have better data on that, what is IBM doing in Europe recently? Miro, do you have thoughts on that?

 

Miro Parizek

 

Interestingly enough, in prep for this session, which focused on IBM, I looked into what they have been doing over the last 100 transactions or so. It's true, they have not been very active in Europe since mid 2007, which was their last acquisition here, a French firm, Ilog, a $340 million acquisition, an optimization and visualization software company. In fact, to date, most of their focus in Europe has been on service-related firms, but they have taken a 2.5 year respite from acquisitions in Europe. That may have been partly due to the financial crisis, shifting focus, so I think that will change going forward, but IBM certainly should open its eyes to software assets in Europe the way Microsoft, Google and Oracle do.

 

Jon Scott

 

Thanks, Miro. John Abbott, here's another question I'd like to address to you. It says: In general, IBM has been focusing on more software acquisitions and away from additions to the global services group. Is this a change in position from the recent past transactions?

 

John Abbott

 

I agree. I think I alluded to IBM building up its software businesses quite aggressively and I think it is getting closer to the application left behind a while ago. They have realized that a lot of the application business is slipping through its fingers because of that and those associated service revenues that are associated with that as well. There are services that are associated with that, but IBM is really intent on increasing its vertical market expertise.

 

Jon Scott

 

I would agree with that, and I would add, too, is that I read an article back in May and Paul Masano was quoted, talking about the fact that the margins in the services side of things are lower and obviously software margins are higher, so I think they have control of the services business and they are jumping over into a higher margin business where they can have less pressure. So I think that is probably part of it, too.

 

I'd like to thank all of the speakers and thank you, our audience for participating today. We went a little bit over schedule, but I think the information was great. I hope you join us in person at an upcoming Corum conference. That concludes the Corum M&A monthly report for November, 2010, thanks again for attending.