November Tech M&A Monthly: Special Election Report

Introduction and Overview

Bruce Milne

Good day to our attendees from 36 countries around the world. I’m your moderator, Bruce Milne, Corum founder. Our agenda today is about the election and its impact. We’ll start off with an overview of specific markets that are going to be affected by the changes, and then we’ll go to our research reports, and then a special field report from Europe by Miro Parizek and our special guest from Finland.

Let’s go right to our post-election outlook. Japan and Europe are slowing, but still going much faster than the West. The US is doing…okay. Just okay. Up about 1.5 to 2 % real growth. It looks like those numbers are real, and that’s going to give us confidence. There is renewed focus on Latin America, I think that was one of the biggest benefits of this election campaign, we kept hearing about Latin America and it got a lot of people focusing on it. In fact on December 6, Corum will be doing a Latin America Spanish broadcast to 32 nations around the world.

The big issue coming up is the fiscal cliff, we have higher taxes, fewer deductions and spending cuts. Overall, about $600 billion involved, and they haven’t addressed if they’re going to try to address it with a lame duck congress.

By the way, speaking of that fiscal cliff, January first, as a reminder to those of you who are CEOs or who own your own businesses, as you do your estate planning, you have your total personal gift limit going from $5 million to $1 million. I hope you’re aware of that, it’s time to make a quick call to your attorney. We had a special report on this in February. Ping us and we’ll make sure you can see that broadcast.

The dollar remains strong in the short term, but watch out for inflation. Bipartisanship, I hope it doesn’t continue. Here’s what I do hope for: some horse trading. My predictions for that, Clinton-era taxes will be put back in, both for cap gains and for ordinary income. In exchange for repatriation window, meaning companies can bring back their foreign capital, about $3 trillion sitting outside the US, they can’t invest in US stock, real estate, etc, I’m hoping that the government allows that money back, let’s say at a 15% dividend. Maybe an ease up on drilling and coal, but that may just be me dreaming to get gas prices down. Less draconian estate taxes in the short term, more investment tax credits and retraining, and of course both sides will declare that they won.

In terms of tech M&A specifically, my prediction is that the repatriation will free up around $200B among the strategic companies for M&A directed at US companies. This will create a tsunami of M&A activity. The confirmed growth will create confidence that will expand M&A, which had kind of been in a hold mode during the election season. Crowd funding, part of the jobs act, will start to get more traction, and we’ll see M&A toward the end of the year from that. Traditional firms will continue to make tech bets. You saw our report on deals with did with Bosch and Brother last year, where they essentially made technology acquisitions to re-invest in themselves, to move forward in a stronger way. You may have seen that Panasonic recently took a hit on their stock, and in response they said they will be making more technology investments.

The looming dollar inflation will boost foreign acquisitions, and there will be some specific markets that will do better than others.

US Election Impact

Now, let’s get some details on the markets that will be affected by the election. We’ll catch up with Elon Gasper in Cincinnati, Ohio. Elon is our director of research and he’ll be joined by Jason Steblay.

Elon Gasper

Thanks, Bruce, for the high level overview. Turning to some more specific areas of interest to software execs, one additional effect that we should note is the continuity of IT in government itself, and the implications for software companies that do business with the feds.

One person that has a lot of influence in this arena, is the US CIO, Steven VanRoekel, a former Microsoft exec, Bill Gates protégé and well-respected techie. It is expected VanRoekel will stay on now, and finish the ambitious tasks he started in the Government for the 21st Century program, including an aggressive cloud-based mobile IT, a BYOD toolkit, mobile security standards from NIST, and what he calls a “Federal Web Space” that will enable citizen access to services “anywhere, anytime, on any device.”

With these campaigns likely to continue, Obama’s re-election is a sign that government investment in these areas will drive further mobile/cloud adoption by the giant government customer; growth that will surely support more M&A by encouraging contractors to pick up innovative companies in the mobile-cloud space. Moreover, buyers will see this technical commitment and continuity as a reason to move ahead in consolidating the business to government space and in the compliance market, as we’ll mention later.

Jason Steblay

One other general factor to consider is Obama’s signature accomplishment in the entrepreneurial arena, the JOBS act, will now go into effect next year unimpeded, making it much easier for small companies and buyers to raise money from accredited investors and the public, with deregulation of angel investing, an IPO onramp for the newly defined emerging growth companies, and even equity crowdsourcing alternatives for startups. We covered this historic change it depth back in May, and the basic impact on software execs and M&A remains as we projected then: more access to capital, more buyers, more alternatives for innovative companies to support valuation.

Elon Gasper

Moving on to major sector impacts, the greatest is likely to be in the healthcare IT and software space. With Obamacare repeal off the table, the remaining challenge will be funding. Such budgetary problems, whether real or last-ditch political attempts by the House, may slow entitlement changes at the consumer level, but they are less likely to effect the implementation of the regulatory changes and incentives which have already accelerated consolidation in this space, led by electronic health records, decision support tools, and practice management software.

We think this M&A wave will continue in a vast context of mass mergers and takeover deals in the health insurance sector as the structural aspects of Obama’s healthcare overhaul progresses. Deals like the $6B Aetna-Coventry acquisition earlier this year, WellPoint’s $4 billion takeover of Americagroup in July and Cigna Corp’s buyout of HealthSprings in October 2011, that will continue apace, and the software health IT industry will be swept along in this strong current.

With change this big, surprising entrants and strategies may emerge from the buyside, as we already witnessed with SAIC’s recent acquisition of MaxIT, a leading healthcare consulting firm. Just like we’ve seen in other sectors, massive change makes a fully developed and executed global search even more important in obtaining an optimal outcome for the software company seller.

Jason Steblay

Speaking of global, in perhaps the most global industries of all, Obama’s energy policies seem to be having some latent effects on M&A. Globally in 2011, KPMG counted a total of 591 renewable energy deals valued at more the $51B and acquisitions in 2012 are close to matching that pace. Remember, $90 billion of Mr. Obama’s much maligned and much applauded stimulus bill was dedicated to stimulating companies green energy. A few may have flamed out in spectacular fashion, but the program may have done wonders in advancing innovation in the industry, a key driver of M&A.

While it will be impossible for Obama to get any such spending program across the Congress a second time, we are anticipating strong deal flow and valuations for the next few years.

Elsewhere, the continuation of Obama’s environmental policies may have the effect of stimulating innovation in coal, automobile manufacturing, and natural gas as companies in those industries strive to meet high efficiency standards. However, the proposed elimination of $4B in annual tax breaks to the oil and gas industries may have a chilling effect on some M&A.
For more in depth reporting on the state of M&A in the energy sector, tune in to our market spotlight webinar later this month.

Elon Gasper

One area we won’t be expecting cutbacks in is the growth of federal regulations. There are more than 4,000 federal rules in the pipeline, and that doesn't include the regulatory costs from Obamacare and Dodd-Frank, both of which still require vast amounts of rules to be written. Clearly this will all be positive for valuations and support consolidation in the Compliance sector. With government regulation increasing and the companies that manage it for businesses will have enhanced visibility which will encourage buyers to extend their own horizons. The more intricate the texture of the controlling authority, the better for governance risk and compliance companies, their valuations and the outlook for their M&A.

Another particular area of impact could be gaming and online gambling. With Senator Kyl, the high-profile internet gambling opponent, now retiring, many expect a partial federal legalization of internet gambling, driving M&A in the sector to even giddier heights of consolidation as the big players place their bets and go for the jackpot. But much hinges on the powerful Nevada senators: Majority Leader Harry Reid is fiercely protective of his state’s market share in gambling and could pose a formidable obstacle on the Senate floor.

Jason Steblay

Turning to defense, Obama’s campaign called for a smaller, smarter army. Overall, this means some sharp reductions for defense spending and his budget calls for reducing it to less than 3% of the economy by 2017, its smallest share since just before World War II. However, the little he plans on spending on defense, he wants to spend in some pretty interesting places.

One such area is cybersecurity, which he called ''one of the most serious economic and national security challenges we face'' this summer. That inclination will be born out in items such as his July call for a unified standard that would set minimum cybersecurity requirements for critical infrastructure companies such as those in telecommunications, transportation, banking and finance industries. Security companies will likely benefit as buyers move into action, on the enhanced predictability Obama’s team’s continuity provides, and the confluence of defense with industrial cybersecurity measures.

These shifting priorities in defense have already driven some significant M&A activity which has consistently returned high valuations. A recent PWC report found that between 2008 and 2011, over $22B was spent on cybersecurity transactions, including Dell’s acquisition of SecureWorks and Intel’s pick up McAfee in 2011. Going forward, we expect companies with technologies that address these “new reality threats” to receive higher valuations, but traditional government contractors may see their valuations threatened by spending cutbacks.

Elon Gasper

So that’s what we see as the dust settles, from general effects to some specific software sectors. Now, looking ahead to the next election, we think the primary issues at stake in 2016 for software M&A will be…just kidding! Over to you, Bruce.

Bruce Milne

Yes, let’s put the election away, it’s been stressful enough. I think I slept well for the first time in about a month.

Corum Research Report

For our next report we’ll be joined by Amber Stoner, senior analyst. Back to you for our regular monthly research report.

Elon Gasper

Thanks, Bruce. Following up last month’s quarterly webcast, we begin with the public markets which have climbed down from their mountainous heights of a couple months ago, but are still showing fine gains over the last couple quarters in all three key major indices we track. We predicted this would be a banner year for M&A due to the US recovery, cheap debt, disruptive technology, and record cash for acquisitions, and as you heard, we don’t see the election results disrupting that now. Amber, what does the Corum index say now?

Amber Stoner

Well, Elon, there were fewer total transactions this month than there were this time last year, likely due to the election, as Bruce mentioned, while the number of mega deals remained fairly consistent. However, the largest deal size jumped considerably with SoftBank’s $20.1B investment in Sprint Nextel, to go along with its $1.8B acquisition of rival eAccess to increase SoftBank’s market share, beating rival KDDI, with whom SoftBank is competing for iPhone users with the launch of the iPhone5 last month.

Jason, any interesting trends in private equity?

Jason Steblay

One maybe trend, the number of PE deals fell significantly from 22 in October of 2011 to just 12 last month. The overall value of PE deals, despite the lower activity, was likely buoyed by Bain Capital’s billion-dollar deal for Atento however. It’s possible, the PEs were holding back deals to see if they could get more favorable tax treatment in 2013 in light of Tuesday’s election as a Romney White House would have likely tried to reduce the capital gains rate, but that’s all just speculation. We’ll keep an eye on this to see if it’s a new trend, or more likely just a blip.

Elon Gasper

Now we’ll look at the six parts of the market from the seller’s perspective, in our new streamlined format. We’ll still use the more detailed charts at the quarterly, but this for an update, first Horizontal.

Amber Stoner

October was a relatively quiet month in the horizontal software market, multiples didn’t move far from where they closed the third quarter, and the heavy SaaS influence remained, continuing to return the highest valuations for sellers among our six sectors.

In one of the more intriguing October deals, ExactTarget, the email marketing software provider, picked up Pardot, the Atlanta-based marketing automation company for $95 million. Pardot, with its certified Salesforce, Netsuite, Dynamics and Sugar integrations will help move ExactTarget into the CRM space and enable it to offer more value added B2B marketing services such as lead scoring.

ExactTarget also completed another, smaller, acquisition for iGoDigital in a deal valued at about $21 million. The twin acquisitions signal that the recently public ExactTarget intends to use its fresh cash to aggressively target the rapidly growing marketing automation market, which IDC expects to reach $4.8 billion by 2015.

Going forward, the growing opportunity in cross channel marketing and management will encourage consolidation as the larger vendors including IBM, Oracle, SAP, and Microsoft, search for innovative young companies that will extend their own offerings in this space.

Turning to another constantly consolidating space, Elon how are valuations holding up in the Vertical Market?

Elon Gasper

Much like the horizontal sector, valuations in the vertical market held mostly steady during October, although there was a slight dip in the EBITDA multiple. As Amber noted, consolidation plays are still the status quo, however the ongoing transition to SaaS business models among Vertical application providers has also helped to bolster valuations here.

Foodlink’s October acquisition of TrueTrac is emblematic of both trends. The combined company will form the first end-to-end, from field to consumer, network of produce traceability for the food industry. With the acquisition, the Foodlink platform can now connect information in the field, such as product harvest date, temperature and lot number with sales-order information between supplier companies and retail buyers. Along with the vertical integration inherent in the deal, TrueTrac’s business model also brings a SaaS element to Foodlink.

October also brought with it activity in the Energy sector, which we will cover in detail during a special world financial symposium’s market spotlight webinar later this month. The healthcare sector also continued its tear that we described in our quarterly report with some Canadian electronic health record providers and other sellers swept up in October as part of its historic consolidation wave.

Speaking of historic consolidation waves, Jason you’re tracking a company in the consumer market on seemingly historic acquisition spree too?

Jason Steblay

That’s right, but first in the consumer application sector as a whole, the rapid pace of consolidation in the video game sub sector continued to buoy valuations in the broader market.

Focusing in on the digital content sub-sector though, Disney agreed to acquire Lucasfilm, the creator of Star Wars, for $4 billion in October. The deal follows Disney’s strategy of gobbling up other mega studios, like Pixar and Marvel to name a few, to expand its digital content empire.

Will the new consolidated studio have the bargaining power to extract better terms from Netflix, iTunes, and Amazon for its films, or possibly build out its own robust delivery service? We’ll have to wait and see, but it is getting more common for content providers to team up to fight the leverage of the content distributors. We just have to look at last week’s merger of Random House and Penguin book publishers for further evidence of the trend.

Amber Stoner

Speaking of recent trends, in the infrastructure market, the acquisition of virtualization and network management companies accelerated in October. We counted at least four such transactions during the month which may have helped steady enterprise value over sales multiples.

The largest of which was Riverbed Technology’s billion dollar acquisition of OPNET; the acquisition will allow Riverbed to extend its network performance management business into the multi-billion dollar application performance management market. With migration to hybrid cloud and software-defined networking underway, apps are now of increased importance. For Riverbed to continue its goal to be an IT performance company, it needs a leading APM offering, and it gets that with OPNET’s APMXpert.

Also in October, NetGain Technologies acquired Lexington-based IntraSource to extend its customer base and expand its technology portfolio; demonstrating NetGain’s commitment to growth and being a regional leader in the managed IT services and solutions industry. NetGain also recently expanded into other cities in the region, including Cincinnati, OH; that’s where you are now, right, Elon?

Elon Gasper

That’s right, but I’m going to focus on Internet companies that can be anywhere. In the Internet Market segment, an ongoing trend is the acquisition of Directory companies. Four of whom built online directories in a variety of areas; then harvested that value by finding buyers who are aggregating those fields during the month of October.

First, there was Yelp’s $50M acquisition of Germany’s Qype. Both operate online searchable business directories that allow visitors to rate and review businesses. By acquiring Qype, Yelp is expanding its international presence, particularly in Germany and the UK, where Qype brings Yelp more than 2 million reviews and 15 million unique visitors per month in those geographies.

In the second transaction, two pro-entrepreneur directories, StartupDigest and Startup Weekend tied the knot in October. StartupDigest’s newsletter and online resources will complement Startup weekend’s physical events. Interestingly, the non-profit Kauffman Foundation will be the combined entity’s parent company.

Elsewhere, myZone Media, Inc., the aggregator of community, entertainment and nightlife websites for large urban areas added Clubvibes to its family of websites.

And Colorado online directory provider and local interest magazine publisher, Pelican Publications, acquired thesmartbook.com, a home and garden directory that electronically distributes coupons to its customers in the Denver area.

Finally, one more for extra credit: The prototype internet directory Yahoo! just made its first acquisition since Melissa Mayer took the helm and just after her first child was born with Stamped. Congrats seem due, don’t you think, Jason?

Jason Steblay

Yes, congratulations, of course! But that doesn’t apply to the IT Services index which continues its sluggish performance once again returning the lowest multiples of our six sectors. Nevertheless, these types of valuations do provide fodder for continuous M&A as we saw a good number of smaller deals during October.

One of the more significant deals however was Advent International’s acquisition of KMD, Denmark's largest IT services provider for $437M. KMD reportedly distributes Danish public sector salaries and welfare benefits equivalent to about 25% of the country’s GDP. Given the ongoing fiscal crisis in continental Europe its possible Advent was able to achieve some significant discounts as a British buyer.

Elon Gasper

And that’s our update on October. Back to you, Bruce.

Bruce Milne

Thank you. It’s interesting closing out on Advent. Tom Lauer runs that, and they’re probably the biggest PE firm doing specifically international deals, especially in Latin America, and they’re going to be playing a bigger role. Interesting also to see the power of the Japanese Yen with SoftBank buying Sprint Nextel, which drove my stock straight up. Lots of international deals there.

Europe Spotlight

That leads us to our next report on the international front, going to Nice, France, to check in with Miro Parizek, Corum’s managing director, who has a brief report for us, and will introduce our guest speaker.

Miro Parizek

Thanks Bruce.

My field report from Europe will touch upon 3 points today: Eurozone debt and economic growth; Tech M&A here; and our relevant experience here.

First, last night at around midnight, after tough negotiations and a vote, they passed another austerity package in Greece. This was despite significant protests in the streets. This was as I expected and I don’t think this protest-approve new austerity package-protest-approve new austerity package pattern in Greece will change any time soon, so get used to it and don’t panic. No need to sell your shares when another headline regarding Italy, Spain or Greece pops up on your home web page. European leaders are committed to maintain the Euro regardless of the cost, and it makes sense ultimately, so it will not fail.

As to tech M&A in Europe, it has remained robust and has grown steadily, as in the US, since the trough in 2009. For instance, so far this year, we have tracked 34 $1B+ deals worldwide, and 10 of those have involved a European buyer and/or seller. We have tracked 900 deals so far this year involving European companies, or roughly 30% of all tech M&A around the planet. So despite woes regarding the European economies, technology companies based here are very active buying abroad as well as attractive targets for international acquirers. This is underscored by the fact that half the Euro deals involve a non-European party.

After our European field report from early Q3 where we announced the closing of the Esterel transaction, where we sold to Ansys for $53M and the previous quarter’s activities involving our Korean and New Zealand based clients sold to North American acquirers, as well as an Eastern European transaction, we are pleased to announce the closing of yet another transaction in Scandinavian.

This is the result of our commitment to the region reflected in the opening last year of our office in Stockholm.

Today, I am pleased to have here as a guest a major shareholder and chairman of our client Fastrax, Pekka Ruusunen, to talk about his experience with the company and the recent sale process.

Pekka is a serial entrepreneur, IT investor and advisor to some of Finland's most innovative technology companies. He was instrumental in Fastrax's recent development and in its transaction with U-blox. Pekka, please tell us a bit about yourself, Fastrax and what you discovered while selling the company.

Pekka Ruusunen

Thank you, Miro, and hi everybody. I’m calling in from Helsinki, Finland.

I have been an entrepreneur in the IT sector for more than 20 years. My last software company ended in 2006 when I sold a telecom software company to Ericsson. For six years, then, I’ve been an advisor to entrepreneurs in growth companies.

My role is to get involved for two or three years before exit. In the latest case, Fastrax, the deal closed October 29, this year. It illustrates well how I prepare companies for exit. Fastrax focused on receiving modules of global navigation satellite systems, like GPS. The investor of Fastrax asked me to join in June, 2009, having two roles, Chairman of the Board, and management advisor. At that time, Fastrax was not in good shape, it was about to go belly up. There was more debt on the balance sheet than the company’s annual revenue. Only existing R&D capitalization kept the balance book alive.

Furthermore, for a period of one year, the company had not been able to pay the mandatory insurance payment, causing further difficulty when the company could not pay the invoices for suppliers on due dates. They were unable to make a credit arrangement with the bank, as the risk was considered too high.

The founders and other management had practically no active deals in the company. They all had different priorities and practically no chance to get money with any exit. This made it hard to sell the company at that phase.

So what actions could we take to turn the company around and make it an active acquisition target? We realized that the only solution from a buyer’s point of view, was to make a management buyout with low valuation and they asked me to be the key person to do that.

Management, including myself, bought out the investors, and then put further money into the company to keep it alive. A clever way of accomplishing this, was that management and other shareholders opted to take lower salaries for six months. On the balance sheet, the equity was negative. However, there was a two-million Euro equity load that we used as cap equity to turn the balance positive again.

One other issue was a track and trade business unit where we were competing with our own customers for business. That unit had to be divested and that took about one year. However, it meant another important improvement to the balance sheet and finally the company had clear focus.

The final exit process started with Fastrax was approached by a public North American company. We decided that we needed a professional advisor to make sure that the shareholders would get the best possible bargain price. Out of three candidates, I chose Corum based on their diverse experiences, and Miro was the man.

The whole process took about eight months. We started by giving Corum information for them to make an exit summary of Fastrax. Then, together we prepared a long list of buyer candidates. The shopping phase took about two months and we ended up having three public companies in an auction situation, one from North America, and two from Europe. The initial bids were low level, as expected, but then Miro started the race. Gradually, after seven or eight rounds, we had a price tag that was acceptable to our shareholders. Finally, on October 29, we closed the deal with U-blox for 13M Euro, closed to $17M US.

Bruce Milne

Congratulations, thanks so much for choosing us, and I hope you can join us for our annual celebration trip for companies who have just sold.

It’s often important to not miss the window of opportunity for a sale, companies should be able to look at an exit because of that.

We’re going to close now. Join us on December 20 for our best of 2012, and our global annual forecast. Last year more than 1000 attendees joined us for speakers from Google, IBM, Salesforce.com, and many others. Thank you.