September M&A Webinar
Market Volatility, Asia, and Deal Structure
Intro and Market Overview
Ward Carter
I'm Ward Carter, chairman of the Corum Group and I'm speaking from our headquarters here in the Seattle area. You are part of a group of hundreds of software and technology executives from over 20 countries who have registered for this event today.
Here is our agenda for the next 60 minutes. We'll start with our Market Overview, we'll compare and contrast 2008 with 2011, and hear about some software M&A deals we recently closed. Our research department will cover the Corum Index and recent market trends and M&A activity. Given the current volatile market, we'll examine ten questions that every tech executive should be asking, followed by a special field report on Asia. We'll close with comments from four very interesting industry guest speakers that we will introduce later. At the end we'll open the floor to Q&A.
Our slate of speakers today includes a number of faces I think you will recognize, including our founder and CEO, Bruce Milne, Nat Burgess, our president, four of Corum's regional directors and dealmakers who will give field reports, including two new faces, Mark Johnson and Rob Schram, followed by Tomoki and Alina from our research department.
The four guests that we have today including John, Jeff, Arvind and Jeffrey, and we'll introduce them during the course of the presentation.
Now I'll turn the floor over to Corum's founder and CEO, Bruce Milne.
Bruce Milne
Thanks, Ward. We have a lot of news to cover, probably more headlines than any month I can recall. We'll go straight to the ones from Asia.
Bad debt at Chinese banks is growing. There is quite a bit of debate about that. Chinese investments are rising, and we'll hear more about that from Jeff Wu later. Wal-Mart and Ikea are the leading retailers buying land in China. The Yuan just had its biggest leap in three years and may that herald stimulus for global recovery. We'll come back to currencies in just a few minutes.
Malaysia's economic expansion is slowing, we just saw the same headline for Indonesia. This last headline was from yesterday, Japan's growth is less that forecast due to global slowdown. Of course, they are still suffering fallout from the earthquakes and the nuclear disaster. They had three quarters of lower than contracted growth.
On the European front, UK retail sales have risen less than forecast. Similarly, European growth missed the forecast, and German's economy almost stalled in Q2. The French economy's growth has sputtered to a halt, and Europe is proposing financial transaction tax. Pay attention to that, because what that says is that they will impose a tax on stocks that you buy and sell. That could also effect transactions on non-public companies, which can effect you. The US is looking into the same tax. European consumer confidence has dropped, I saw this morning's headlines that both the EU and separately the UK manufacturing numbers came in below expectations.
Moving to the US, consumer confidence fell to a two-year low, and consumer prices have risen more than forecast. How could you have lower confidence and growth, but higher prices? This is because of the dollar, which just doesn't buy as much.
The US lost its AAA credit rating via S&P, we saw this huge debate where they talked about default getting us put in the same category as Greece or Portugal, or whatever, and this caused a lot of concerns, the stock market went down, and we'll talk more about that. They have now replaced the head of S&P!
Orders for durable goods in the US rose 4%, and then orders to US factories rose by the most we've seen in four months for autos and planes. This was July. This morning's headline, which we didn't have time to include here, is that US manufacturing output is again less than forecast.
Gross said that the US and Europe may face recessions, that was on Monday. Productivity has fallen in the US for the second quarter in a row as labor costs rise. Jobless claims have topped the forecast. I thought this was an interesting one, the announced US job cuts rose 47% in August from a year ago, according to a Challenger report. So, we're actually having more job cuts now than we did a year ago.
In real estate, because if it doesn't recover we're in for a rough time, foreclosures made up 31% of home sales in the second quarter. That's bad news because of all the foreclosures, but at least it is good news that we are working through them. New home sales are falling, 2011 could be the worst year yet, home prices declined 5.9% in the second quarter, this is from a year earlier.
July new home sales fell to a five-month low, existing home sales in the US fell in July. Home prices in the US did show signs of stabilizing in some areas, and in certain categories we're actually seeing the market bottom out. Housing starts dropped in July. Early mortgage delinquencies have risen to the highest in years, so we're back to people not being able to pay their mortgage. Mortgage rates declined to a nine-month low, and they're actually nearing an all-time historic low. US home values have undergone the smallest drop in four years according to Zillow, which is an indicator that we are bottoming out. Maybe it's time to buy.
In the finance, commodities and currencies sector, the S&P 500 had its worst slump since the 2008 bear market. Those of you who held stocks know the sinking feeling you get when it goes down by the numbers it dropped by. Almost 1800 points unimpeded. Insiders bought stocks at the highest rate since 2009, which is good. They believe in their stock, that it's going to go back up. Two-year notes sold at a record low auction yield. US two-year notes' yield fell on a record Fed move. The European bank stress hit levels unseen since the Lehman collapse. The point is that there is a thing that I've talked about before, there is an accord and the banks and the countries are annoying it right now.
Rousseff urged Brazilians to keep spending as stocks plunged, so we're seeing the same thing in Latin America as well.
Gold went parabolic then into the biggest slump in 18 months, back up. The Yuan is at the highest rate to the dollar in 17 years. The Swiss ponder a battle over the runaway Franc, it was back up this morning. The problem is that you could buy, say, 10 years ago, in 2002, the Swiss Franc was 1.82 to the dollar. Now it's 1.30 the other way around. It's more than doubled. The Mexican peso is weak and the lowest since December on the US' downgrade.
This is interesting, Honda may expand overseas to avoid the Yen effect. In other words, the Yen is so strong—at one point it was about 360 to the dollar, now it's about 85 to the dollar—they believe it is beneficial to go overseas. I just saw the same thing for Fiat, they are thinking about coming to the US because it is cheaper to produce here than in Italy!
Google and Microsoft have gone public with patents, all kinds of stuff there. Facebook is seeking acquisitions to fend off Google, Motorola's value to Google is found in 18 patents, and we'll hear more about that. That was a landmark deal with Google buying Motorola. Kodak, this is interesting, one of the darlings when I was a stockbroker in the '60s, they're going to be worth five times as much in a breakup, with $3 billion in patents.
The Android patent problems are getting worse as Motorola considers collecting royalties. That will be fun to see.
The Justice Department moved to block the AT&T/T-Mobile deal. Sprint's stock soared. Apple was sued by HTC over patents, of course there are others, too. The Google competitor is not a partner with Samsung and others. One of the problems is that if you buy someone like Motorola, you're not in competition with some of the people who were your partners before. RIM is in no man's land from the Google deal. Google's premium for Motorola is 17,000 patents! Apple stopped sales of Samsung tablet in parts of the EU.
In technology in general, Google agreed to pay $500 million in a drug-advertising settlement. Google+ may pass Twitter and LinkedIn with 1/5 of all US adults online.
Apple's Steve Jobs resigned as CEO, he will be succeeded by Tim Cook. This is a huge situation. He's built an extraordinary company there, the most valuable company in the world right now.
The HP breakup looms on the cheapest tech valuation. The biggest news there is that HP is getting out of the PC business. We'll have a lot more on that in our next month's webinar.
VeriFone's Bergeron stated that he might spend $1 billion annually on acquisitions. I love this last headline that came in this morning. “Forget Apple, Amazon is taking over the world.” Amazon will be our profile next month.
Taxes, we don't usually talk about this, but I had to put it in. We think as we've talked about in the past with things like patents and currencies, we think taxes will start to effect you in coming years. We'll talk more about that later.
Congress has established a bipartisan board for debt reduction, after all the drama and scare about defaults and the stock market crashing, they set up a board on how to reduce debt and how to get additional taxes. Warren Buffet said to stop coddling billionaires, the problem is that Congress has trouble differentiating between billionaires from business owners.
We're going to come back to this. We think more taxes are in our future, especially regarding transactions.
2008 versus 2011
I had a lot of calls last month. When stock markets go down like that, a lot of people worry, they worry about their own portfolios and about their single biggest asset: their company. We gave a talk in December of 2008, and the headline was, “Worried about your company's future? You should be.” We had 600 companies sign up for that webcast. I thought it would be interesting to compare 2008 to today. Back then, this was an interesting cartoon about the things that were causing the problems and we had those derivatives and lenders and all that. Let's take a look at the realities then versus the realities now.
This slide is straight from 2008. The consumers were MIA, unlike in past declines, because at those times we had recessions that we came out of, but this one seemed deeper because the consumer just seemed out of it. The financial systems were wounded, remember we were going through serious hits and government bailouts. Stocks were decimated, we saw the best buying opportunity of our lives with US stocks crashing to dramatic lows. Currencies were in disarray with wild fluctuations, and there was more bad news ahead. This was from not quite three years ago.
Now from this year, consumer sentiment has dropped, financial systems are still weak, countries have ignored the Basel Accord, stocks are fluctuating at the same pace, I mean look at the four days of 400 point moves in the Dow. We had record down days. Currencies are still in disarray, extending to gold, and assets are still deflating.
So there are a lot of similarities. There are a few other things, too. Jobs have not recovered. We talk about the 9.1 or 9.2% jobless rate, and part of the problem is those people are self-employed. Domestic workers are not there. The real rate of joblessness is about 16%. Sovereign debt is now a huge issue, it wasn't really on the horizon before. Whole countries that could go under. We have an inflation risk in Asia, there is still no credit, but with all the cash out there, all my friends who are in the trade, they can't borrow money.
There are some positive things though, and that is some of the worst financial systems have been weeded out. There is light at the end of the tunnel for the mortgage mess, and business is running, although slowly. There is plenty of cash if we can just figure out a way to channel it into small businesses, that will be a game changer. I hope that they allow money to be repatriated back into the US from foreign funds, because that could pump $1-2 trillion back into the economy.
Asset values seem to have bottomed out, which is a good thing.
I pulled this slide up from two years ago. The reason it is important is that everyone is wondering why this is happen. The reason is simple, we're not hitting the numbers. If you look at the growth numbers, these are from Morgan Stanley two years ago at our annual report going into 2010, look at the US. They expected the US to be growing at 3.6% this year, Europe at 1.5% and Japan at 1.2%. The US is currently at 1-1.2%, less than a third. The Eurozone stalled, and Japan has contracted the last three quarters. That's the problem in a nutshell. If you don't have the growth, you don't have the jobs, you don't have recovery and real estate, you don't have the tax rules being met. Emerging markets have slowed down as well.
The point is that we've had a good 10 days or so in the market, but investors should not put down the Dramamine yet, because how the market goes does affect M&A. Although tech is very resilient. We'll talk next month about why tech is going to motor right through no matter what happens.
M&A Field Reports
Let's move to a field report. We talk about deal structures. Let's talk about three deals that just happened, starting with Frank Berger in Germany. Despite the economic concerns, deals are doing well. We’ve had a number of recent transactions and have a large backlog of companies in LOI, closing this fall. What’s interesting about some of the transactions is not only the structure, but the buyers – some you’ve never heard of, and some surprises, non-tech companies that you’d never expect were getting into software big time. Let’s go to Germany and Frank, regional director there, to hear about one such transaction just announced.
Frank Berger
Thanks, Bruce. I am happy to talk briefly about my recent transaction, the sale of Inubit to Bosch. Inubit AG is a 100-person firm based in Berlin—a leading supplier of software solutions for business process management or BPM for various industries.
The Robert Bosch Group is a leading global supplier of technology and services in the areas of automotive, industrial technology, and consumer goods. At $50 billion in revenue and 300,000 employees, they are one of the most renowned private German industrial firms.
Though 125 years old this year, the Bosch Group is an extremely future-oriented company. They see the growing importance of software and the internet for their own business model and founded their own software organization a few months ago, called “Bosch Software Innovations GmbH”. As part of this organization, Inubit will play a key role: They will not only keep developing and marketing their products and solutions for business customers, but also provide vital basic components for creating systems and services platforms for what is known as “the internet of things and services”.
This term refers to the next generation of the internet, in which more and more devices and systems other than computers will be capable of sending and receiving data automatically via the internet. This will give rise to completely new services, which will change people’s everyday lives. Because the transaction is still subject to approval by the antitrust authorities, closing will take place in a couple months.
I am proud of this transaction, especially that I had the pleasure of leading from initial contact to signing of the purchase contract. And I'm happy about the valuation we achieved. Let me assure you: It’s a super time for M&A here in Europe. I am optimistic that two more of my projects will be closed this year.
Back to you Bruce.
Bruce Milne
That's great, Frank. Now, let's go West over the Atlantic to Bruce Lazenby in Ottawa, who was involved in selling a a smaller family-owned business, like many of yours. Bruce?
Bruce Lazenby
Greeting's from Canada's capital.
My deal was with PrimaSoft, a mature company, like many others, that grew out of a husband and wife consultancy, in this case in the access to information field. A few years ago they made the final transition from being a consultancy to being a software company by hiring an experienced CEO and stepping away from the day-to-day operations. A smart move, as we know that software revenue is more highly valued that services revenue.
This structure could have gone for a long time, as they were collecting dividends from the company, but could it really? We know that competition lurks around every corner and that markets come and go. Rather than relying on the whims of the market, where they could potentially wipe out a good chunk of their retirement, the shareholders decided to be proactive and seek an acquirer so they could convert this asset to cash.
They engaged Corum, we did a global search, and ultimate CSDC Systems out of Toronto made the winning bid. This was a great win-win. The shareholders are private, so they were able to lock in the value of their retirement in cash, PrivaSoft now has a new life as a larger company with more reach and more resources.
I think the moral of the story here is if you have a good part of your retirement tied up in your tech company, you owe it to yourself and to your family to at least give a serious test of the market to make sure you can capture the value of the company now, especially while the markets are strong.
Thank you.
Bruce Milne
Thanks, Bruce, good point. Now let's bring the discussion back to HQ, Nat, you had a recent transaction.
Nat Burgess
That's right, Bruce. This was an exciting one. Brent Farmer is a very innovative, brilliant guy who has also become a very good friend, because this is the second transaction that we have done with him. The new one is the sale of his company, Interactive Softworks to USAN.
There are three things I want highlight here. First is that this is a company that was healthy, profitable and growing, a leader in its space. It didn't have to sell, but Brent was clever enough to see that he needed to diversify and that with a larger partner he could put his technology on a global scale. He achieved both those goals working with us.
The second thing I want to highlight is there is a bigger trend going on around interactive marketing, customer engagement, and we're seeing that in large deals, like Francisco Partners buying WebTrends' email division, but this creates opportunity for the little guys too, as long as they are positioned properly, as long as they run a good process, they get to take advantage of these trends as well.
Finally, how many of you are aware of USAN? They're a great company, I have tremendous respect for these guys, but they are small, based in the Southeast, they are private, and it is not an obvious company for interactive software to sell to. And that is true for all three of the transactions we are highlighting today.
Back to you, Bruce.
Bruce Milne
Good point. We wanted to go to the field and see what is happening with deal structures, and what we found is that they are all for cash. There is a lot of cash in the system. With that we're also seeing a broader range of companies buying in this space.
Corum Index
Let's move to the Corum Index, the M&A update from our research department with Tomoki and Alina.
Tomoki Yasuda
I'll be kicking off research portion with a weekly view of the market. Despite the volatility and shocks we have encountered in the past few weeks, we ended August on a more positive note with a sharp rebound in stocks. Currently we're seeing a bit of a mix in tech as investors react to regulators impeding the AT&T/T-Mobile deal.
Our next slide should be familiar to our regular audience, and to our new visitors, the Corum Index represents a table of the metrics that we keep on the M&A market. Comparing numbers from August to a year ago, M&A in general is up by a wide margin, almost a 40% increase in deals. We've also had a lot of notable megadeals, which are deals over $1 billion, this month, they are definitely deals that will change the tech landscape in the future.
Alina Soltys
That's right, Tomoki, the largest tech deal that we saw in the last year was actually Google picking up Motorola mobility for $12.5 billion. This deal was significant for Google in two ways. First of all: Patents. We've been talking about them over the last few months, and with all the patent wars going on this is a great way for Google to shore up their defenses against the likes of Apple and Microsoft. They acquired 17,000 issued patents from Motorola, with another 7500 pending. Secondly, Google now owns the entire production line for Android devices, kind of going the way that Apple went of directly tying the software to the hardware, which will significantly improve performance.
They are not shutting down partnerships with the likes of HTC, but I'm sure their partners are a little nervous with the new threat from the inside.
Tomoki Yasuda
And you know what, Alina, what's funny with that is we're seeing the opposite trend with HP, who has completely overhauled their strategy, acquiring autonomy and spinning off its PC business. I want our listeners to think about that for a minute. The leading PC maker in the world has exited the game. I'm not sure how they will weather the storm, but I'm capable of seeing what they're capable of with WebOS permeating throughout the market via the Touchpad. I'll be looking forward to the new innovations they take on their business.
Now I'd like to shift gears and dive into our six software markets. Alina?
Alina Soltys
For our Horizontal category, the overall market took a beating and so we see the drop off in the monthly statistic, but we're still up on both multiples from a year ago. The deal I want to highlight here is Plimus being acquired by Great Hill Partners, a PE firm that focuses on tech company investments. This acquisition actually fits into their sweet spot of internet companies at the intersection of ecommerce, marketing, and online retailing.
Plimus was acquired for $115 million, and that includes a growing base of over 6500 small and medium sized business that are being served on a SaaS model based in the cloud. This is a reoccurring theme that we are going to touch on later on. What Plimus does is provide ecommerce tools for sellers that focus on selling digital goods and services online. It also has a very strong payment processing solution. The ecommerce giant that we all know, Amazon, has actually been having a renaissance of its own. With the introduction of the Kindle platform, they are not attacking the electronic textbook space, which as an industry, has been long overdue for some change.
Tomoki Yasuda
We're definitely on the cusp of a digital revolution in the education space. Amazon's decision to provide textbooks via Kindle has made some splash in the news, but there was actually some activity before that. For example, NewsCorp acquired Wireless Generation, a provider of digital K-12 learning tools, and now the acquisition of Renaissance Learning, a progress monitoring software vendor in the education space by PLATO, an education curriculum planning software provider. PLATO itself was acquired by Thoma Bravo in 2010 and they are definitely seeing a great opportunity right now to do both on acquisitions. I definitely think education will be one of the key sectors that will be gaining a lot of attention because, essentially the way students digest education materials has traditionally been the same for the better part of a century: we just read books. With the advent of tech, we could start seeing more diverse ways for students to learn, with innovations through games or social applications.
Alina Soltys
So, our next category focuses on providing those to-die-for entertainment and educational apps that we can't live without, whether it be on the Kindle or on Amazon's new tablet. The revenue multiple here continues to hover around 2x in the consumer space, it is up from a year ago. We've seen the gaming sector explode in acquisitions recently and larger developers are buying smaller shops that produce hits. We've seen this from the very top of the pyramid with Zynga acquiring 10 companies this year, so far, and the smaller guys, who are still large studios and development shops following suit. Acquisitions are a sure way to boost growth by easily gaining additional players who can cross-pollinate among products.
The deal spotlight here is Glu Mobile, which is a social gaming company focused on mobile and tablet platforms. They announced the acquisition of Blammo and Griptonite on the same day. Blammo is a premium casual game developer founded earlier this year, and they developed two titles for Glu before being acquired for $4.5 million with an additional earnout potential of $15 million. For a company no older than eight months, they showed up on Glu's radar after producing several top ten hits.
Griptonite is a development shop with 200 people based just 10 minutes from us in Kirkland, Washington. They have been around since 2000, producing games for all the major platforms, which means they have made a lot of investment in people, with specific development knowledge for each platform.
Tomoki Yasuda
I'm glad you brought up that point. While the mobile space is seeing a lot of dynamic shifts, we're on the edge of another huge development that could erase the need for app developers to be platform-specific. What I'm talking about is the advent of HTML 5. Take, for example, this deal with Sprout, a company that offers an easy-to-use platform for building HTML 5-based ads, which was acquired by mobile app network InMobi. Their timing is pretty impeccable, actually. Steve Jobs just made a blog post addressing how advertisers' only way to connect with people in the Apple ecosystem is through HTML 5 and not flash. This is also a double-edged sword for Apple, who praise the qualities of HTML 5, but who should also be very afraid of its capabilities. The new iteration of HTML can essentially let developers create an app-like experience within the web browser, which makes it a game changer.
This opens a window for developers to become more platform-agnostic and presents a chance for them to infiltrate Apple's walled garden without paying the 30% tax on their native apps. How will Apple respond? Will developers be able to pull off a more comprehensive browser-based app better than the native one? We don't know yet, but it is definitely something I'm paying attention to.
Another company that I have been paying close attention to is Verizon, who just acquired startup CloudSwitch for an undisclosed sum. The interesting part about this deal is that Verizon bet big on building out its cloud portfolio with the acquisition of TeraMark earlier this year. Essentially the carriers just don't want to become marginalized as a dumb pipe, so they are looking into upselling their existing customers by providing business services, in this case cloud services.
Now, what CloudSwitch does is allow companies to migrate their systems toward cloud computing and appliance-based software. It essentially makes a seamless transition to the cloud without rewriting code, which is very attractive for companies that have established IT systems and practices. This will provide a gateway for Verizon to consistently upsell other services to other companies that transition to the cloud. A smart play by Verizon and one that has clear strategic synergies.
Alina Soltys
And Verizon is truly taking a visionary role here. They are going beyond their co-location hosting acquisition which was already pretty visionary for a telco, but now they are actually creating a whole ecosystem around it, as Tomoki noted.
We've seen a record amount of cloud hosting deals this year, starting with the two largest, as mentioned. The telcos are aggressively expanding into hosting and picking up these prime assets at pretty prime valuations. Winstream this month joined the group, picking up PAETEC for $191 million. This was a bit more of a modest valuation than those seen elsewhere. Mostly this was due to the fact that PAETEC has had pretty flat, organic growth. They have relied solely on acquisitions to keep growing, and they have done 5 in the past twelve months.
Some of these tech companies that we have mentioned have risen in the last decade, like Plimus or SalesForce, who push everything to the cloud. They have been helped tremendously by these co-location hosting providers. Without their plumbing, none of this would be possible and the cloud revolution that we're in would have been a distant dream without these guys.
That wraps up the Corum Research report for August. Back to you, Bruce.
Bruce Milne
Thank you for that report. I look forward to the Corum Report on all the sectors next month.
Ten Questions You Need to Ask
We have another exciting segment next, but we'll be brief because we want to get to our speakers. With all the drama we had in the last month, we have a lot of questions from people that we have been dealing with over the years, many of which are listening in today. We put together 10 questions that from our advisory board that we think each of you must be asking. Nat?
Nat Burgess
Thanks, Bruce. Most of our audience, every month, are CEOs. We talk about tech trends, we talk about strategy, but I want to address some questions directly to you as CEOs, as you think about your own balance sheet and your own future.
Let's talk through these.
1. Do you believe that the current economic environment is likely to drive valuation multiples up or down?
Simple question. Is Facebook worth $100 billion? We saw what happened with Zynga. What's going to happen in the next few years? Valuations have ticked up since 2008, there is a lot of cash available now, but if you look at the data points that Bruce covered early in the day, you'll see red flags on the horizon.
2. Is it more likely or less likely that your company will do better than planned in the uncertainty ahead?
Remember, the turbulence that we face affects your customers as well as you and so we think back to 2008 when Cisco stopped forecasting their own financials because they just could not predict customer demand. Again we see red flags on the horizon, so this is more than just a question of how strongly you feel about your capabilities to manage through turbulent times. What about your customers and market demand?
3. There are massive tax shortfalls and the recent showdown did not solve this problem. Do you think that income taxes are going to be raised again?
4. What is the chance that the capital gains tax may as much as double over the next 36 months?
We've been talking about this for a while now. We talked about it back in 2008. It has taken longer than we anticipated. Other things we forecasted have happened, the patent challenges for small companies, we'd been talking about that for years, that is very real now. Warren Buffet came out recently and said that personally he'd be fine with long term capital gains at the same levels of ordinary income tax. Well, Warren, when you make billions every year, that may be okay. But if you're the CEO of a company and you're investing profits every year to build equity value, and you only get to sell that company once, you may not be so comfortable with higher taxes.
5. Do you think that the debated financial transaction tax will affect you?
Do you have a 401k account? Do you have a brokerage account, a treasury account in your company? The answer is simple: Yes.
6. With the projected dollar devaluation, will a delayed sale give you more or less in terms of global purchasing power?
This goes back to the question of when do you want to be liquid? The answer is you want to be liquid at a time when you can acquire assets at historically low prices and you can take advantage of currency arbitrage opportunities.
7. Are hard assets more likely to rise faster in value than soft assets over the past 60 months?
We were just comparing notes here before the webinar. If you bought a gold rolex three or four years ago, guess what? It's actually worth 40% more today than when you bought it new! That's interesting. Privately held tech companies are nearing record highs in valuations and meanwhile asset values in areas like real estate are nearing all time lows. Arbitrage is simple.
8. Do you and your family have the wherewithal to motor through a potential recession that could delay an exit three to five years?
There are signs that we are at or near a peak in M&A and historically we have cycled through three-to-five year recovery periods to get back on top. When we're working with clients in those troughs, it's not enough to wait, you have to innovate aggressively. You have to tiptoe through the patent minefield, you have to fight just to stay even.
9. Personally, do you have energy to go several more rounds knowing that the competition might get a lucky knockout punch in?
10. Finally, fighting through the trough takes energy. It takes its toll. Meanwhile, let's all remember that M&A is about changing your life. What is your dream?
Bruce Milne
What is your dream? We have two more segments here.
Field Report: Asia
Now, let’s head east to Asia, specifically India and China, to see how they are fairing in all of this turmoil. We have four presentations, two by our own staff to give us an update on each country, and speakers on the ground in each country to give us their impressions.
First let’s start with India, a country we have done a number of transactions in.
It’s my pleasure to introduce Mark Johnson, Corum's newest regional director for the Nordic region. Mark is a veteran of the tech industry as an M&A advisor, former CEO, venture capitalist, and naval officer, having graduated from Annapolis. He did his graduate work in Sweden, where he continued his semi-pro cycling training. We asked Mark to join us today to talk about the India market as he has extensive experience in Asia. Mark, thank you for joining us.
Mark Johnson
When we think of the Indian subcontinent and its boom tech sector, we all think of 1 billion+ population with over half in poverty, a vast division between rich and poor with a rising middle class, a massive IT services industry fueled by excellent technical universities, low cost of living and salary levels, and working knowledge of the English language. These facts are all still true and the services industry is still driving growth in the tech space. However, anecdotally we are seeing evidence of consumer and enterprise software innovation expanding beyond India.
Concerning India's trends and growth, we'll first focus on the consumer himself. India has a population of 1.2 billion, with over 100 million internet users, growing at 25% per year. Internet consumption patterns differ in that users primarily go online for purposes of entertainment from either cafes or mobile handsets, rather than from personal computers.
There are 790 million mobile subscribers in India, growing at a rate of 20 million per month. While Nokia's market share has been taking a beating across its traditional markets, it still has 59% market share in India! The value today of the ecommerce industry is $10 billion and growing phenomenally at a rate of 60%.
A quick look at the IT outsourcing industry shows that it tops the charts and is today double that of China, at a value of $76 billion. While growth is slowing down, it is expected to have a value of $225 billion by 2020.
The IT industry is still dominated by an oligopoly of three players, Tata, Infosys, and Wipro, representing 80% of the market cap of all Indian public IT companies.
Finally, Indian deal activity has been ongoing but flat over the past two years. Two interesting cross-border examples that have occurred over the past few months include Wipro acquiring SAIC, an oil and gas IT practice for $150 million, and Cognisant acquiring CoreLogic for $50 million.
Thank you, and back to you, Bruce.
Bruce Milne
Thank you, Mark. For our follow up field report, let’s turn to our friend, Arvind Kajaria, managing director of Intrasoft based in Calcutta, India. Due to the extraordinary distances and time zones involved, his segment was recorded this morning while the rest of us slept.
Thank you, Arvind.
Arvind Kajaria
Hi everybody, this if Arvind, and I run Intrasoft Techngologies from Mumbai, India. We've been involved in some outsourced backended work and most of our work revolves around internet technologies.
I've been asked to speak about the ongoing prospects of the M&A market. I think India is at a crossroads, a very important crossroads. I think what has happened in the past 15 years, we've seen phenomenal growth, mainly the top three companies, Infosys, Wipro and TCS have been receiving large volumes and quantity orders from the overseas markets, especially the US, and this has caused a whole new segment of IT professionals to be created in our country. This has propelled the economy because this has created demand in housing and auto, etc, and this has been great for everyone, but it has created its own problems as well. The problem is mainly of talent shortage.
As more and more work gets oursourced, it is becoming increasingly difficult, even for these three companies to become larger than they already and it is almost getting impossible for a mid-size company to get larger and for the smaller ones to survive unless they are proprietary-driven.
I think from an M&A perspective it is a very good situation to be in if you have a strong company, if you are in a niche market, because I find the bigger guys with money at their disposal will find it very challenging to hire people in the quantities that they are used to hiring. For example, regularly TCS, etc, have been growing by adding about 100,000 people to the work force every year. They continue to do so, but it is at a much higher price and since the supply side is short the employees are more demanding and much more choosy than they were before.
Right now, however, because of the Wall Street sentiments, it has effected our financial markets as well. As things improve and luckily we have not been as effected as some of the Western countries, and I see them improving in the next six to nine months, people with deep pockets and money to spend and ambition to grow, they will have no alternative but to acquire companies, not only for niche products, but also for the kind of man power they have at their disposal.
A case in point would be Satim, which had some promoter-driven problems, had about 10,000 people working for them, and one of the companies that bid for them were the Tech Mahindra people, and if you read the reports you'll recognize that one of the main reasons why they acquired the company was because of these people, you just catapult yourself into the big league as far as HR goes.
That is my feel on it. I think it is a great time to be in, there is enough floating around, private money as well as public money, and the market still has yet to grow, there is a lot of value to be added as far as resources out of India go. I'm very bullish on M&A activity for the reasons noted. Thank you very much.
Bruce Milne
That's great, we're really grateful for Arvind joining us. Now we'll come home to Rob Schram for our segment on China. Rob just joined us at our headquarters here in Bothell. He is a veteran of the tech industry, having been a founder, CEO and CTO, and he's also sold several companies and engaged in two IPOs. Most recently he was CEO of Evergreen Fuel. Rob, tell us what is happening in China.
Rob Schram
Thanks, Bruce. Here are some of the positive and negative trends we are seeing in China.
On the positive side is China's impressive economic growth. Their GDP will be close to $7 trillion this year, up from $4.5 trillion as recently as 2008. The consensus on China's growth rate is in the range of 8.5-9.7% year over year. Even though their economy is decelerating in pace with the rest of the world, their net velocity is still exceptional.
Also, China's economy is increasingly self-sustaining. Their economic growth is intimately coupled with demand from large consumer nations, but China's own demand has quickly become an important driver of growth in the rest of Asia. The reduced reliance on external demand is a stabilizing influence.
As you can see from the two charts, China claims the highest global year over year GDP growth rates as well as the third best GDP worldwide.
As shown on the next slide, additional positive indicators are rapid development of internet, telecomm and related technologies. China boasts the world's largest number of internet users, more than 500 million, and we are seeing increasingly rapid development of internet businesses in China as their digital economy evolves.
Furthermore underpinning the growth of China's digital technology is an internet infrastructure that still only reaches 40% of the population, which totals approximately 1.35 billion now. China had 457 million users online at the end of 2010 and they are adding about 6 million users per month. By comparison, the US internet population is approximately 240 million, so China's 40% penetration is already more than double US usage. Analysts predict that these numbers may double within the next two years.
We also see continued development in the Chinese telecomm market, which with nearly 1 billion users is the largest in the world in terms of subscribers and second only to Japan in the Asia-Pacific region in terms of revenue. The mobile sector is still expanding about 15% per annum and non-voice and value-added service revenues comprise at least 50% of the total in software-service offerings. Important among these are a number of hot software stocks in the Chinese gaming sector. The chart shows China ranked worldwide in internet penetration and it gives a graphic illustration of the regressive adoption of the internet in Asia and the world. As you'll notice, China represents 50% of the Asian market, which is 44% of the world market. That is an impressive base with a lot of room to move.
This final slide shows some negative effects, where we see the global downturn and tight money affecting small to medium enterprises. This is key because China's SMB sector generates two-thirds of industrial output, pays half the tax revenue, and employs 8 out of 10 Chinese workers.
The central bank has raised interest rates 5 times and raised bank reserve rates 9 times since last October. State-owned enterprises can use their connections to local banks and government to assure financing, but a significant portion of China's SMBs don't have adequate liquidity and are experiencing share declines in revenue brought on by canceled orders and investment plans.
20% of SMBs in China, approximately two million companies, are now producing at half capacity and risking bankruptcy.
In addition, initially hot internet stocks are in general decline, as are Chinese IT service companies. The chart here shows a representative sampling in this sector.
Thanks, and now I'll turn it over to Bruce.
Bruce Milne
Thanks Rob. Now to get a field report on the ground in China we turn to our friend Jeff Wu of VanceInfo, a leading IT outsourcing company, where he is chief globalization officer. Jeff, are you in Beijing?
Jeff Wu
I was in Beijing yesterday, but I just flew in to San Francisco.
Just to echo Rob's observation, leaving Beijing where all these exciting things are going on and coming to the US, it gives me peace of mind. Two years ago, our stock was in the $4 range and then in a year and a half we got to the $40 range. I think that was largely due to China's economy. We were able to gain more growth in the Chinese market and all these improvements were recognized by Wall Street.
Moving forward, I think for VanceInfo, which is a China-based IT services provider, and also an offshore in China, we are aiming to go global and my role is to get us to the global stage. I'm also looking at all the US-based strategic investments, M&A included.
We are also trying to make all these efforts in these different areas. Also, as you can see in the past few months, the IT services in China got hammered, we were all effected. With the strong support of the Chinese market and with VanceInfo's strength as an acquirer I'm sure we can bounce back again.
Back to you.
Bruce Milne
Thanks, Jeff. With the Yuan at a 17-year high against the dollar I suspect that we will see you guys doing some acquisitions of US companies, at least we hope so.
Seller's Panel
Wrapping up the hour, we have two presenters, Jeffrey Smith and John Heyman. First is Jeff Smith, CEO of Flight Landata, who just sold to KEYW. Jeff is a true industry veteran, and he is also a venture capitalist with First Boston. Jeffrey, are you there?
Jeffrey Smith
I am here. Thanks for the introduction. It is Next Boston, but close enough. Good afternoon.
As you said, until three weeks ago I was CEO of Flight Landata and I am currently the managing partner of Next Boston, LLC, an investment management company based in Milan and Boston.
In the last two-and-a-half years we've had a unique view into the small defense contractor environment and since last year we engaged in a significant effort to achieve value for shareholders through the sale of the company which we have just achieved successfully to KEYW from Hanover, Maryland, for a headline number of $30 million in a cash structure with quite a significant positive adjustment upward.
Flight Landata is a defense contractor who specializes in sophisticated deployed airborne remote sensing solutions for the US Department of Defense. There is a 20-year history of sensor development, with EO sensors first successfully deployed in war zones in 2004. The company's recent growth and sale comes from a shift from a contractor-owned/contractor-operated service model, providing planes, pilots, site management, sensor operators, mechanics, absolutely everything required for operating in an extremely austere environment, in a war zone effectively. Taking a technical sale and converting it into a reoccurring integrated services model, which was quite fundamental in the sale of the company.
Corum has asked me to quickly speak on timing issues and I'm going to touch base on a few key points in trying to reduce the timing of a sale and trying to get the situation off the ground here as fast as possible. Fundamentally we were thrilled with the results. There is money available in the defense sector for great companies, but the timing and risk variability is extremely high at the moment, as we experienced through our transaction cycle.
We tried to break the timing of the sale into three basic sections: Prep, about three months in total; the actual sale process of about six months; and the deal conclusion at about three months for a total of about a year.
These are absolutely not the shortest time we've ever worked on, but they are practical minimums. Basically we've done 25 deals as principals in 18 countries over the past 30 years, lead primarily by my partners and I and what I would like to do is highlight a few issues that have minimized time to deal and have basically helped us to avoid disasters.
The most critical element that we have seen is right from the beginning getting shareholder, board of director and board of developer buy in. Not only for their understanding and support, but in this extremely volatile period to get them to really settle on a realistic expectation for final value and timing. They are going to get less, in our view right now, in the defense sector, and it will take longer than they have come to expect. Preparation is absolutely critical.
In this process we had two bankers and three law firms present to the board and key shareholders before we even started the process.
The second thing we would highlight, certainly as part of this process, is taking the time to identify the right bankers. We started looking at 30 firms, interviewed 10 intensively, asked for 5 formal proposals before getting down to our final banker and it was an excellent process to get the board prepared, getting valuation expectations established, and coming up with the right team.
Critical for our disaster avoidance course also is the establishment as CEOs using a chairman through the process, or at minimum a lead director to manage the shareholders and directors. This is the only way this will get done. You are doing three jobs, selling a company, running your company, and in the end you are managing shareholders and directors, which is often one step too far.
In the sale process, to highlight the volatility, it is critical to understand the situation that your potential targets are in. Over half of the firms that we initially approached were involved in a transaction of their own, either as a buyer or a seller, and were simply unavailable to evaluate the FLD opportunity. This has nothing to do with the quality of anything on the table, it is a reality of the defense industry at the moment.
Flexibility, and I'll conclude on this, we targeted an initial 14 firms trying to keep to a very narrow focus. At the end we contacted over three times that many companies to get to the right partner. In the end, KEYW turned out to be a superior match for everyone involved, there was no process at all, there was an immediate move to an exclusive transaction with no real competitive process and no auction, to the benefit of everyone. Flexibility, timing, preparation for a lengthy process, these are all critical, as well as finding an investment banker who can manage you through this space is fundamental.
We found this to still be a rich environment, valuation were healthy, interest was high, but variability was certainly the greatest that I've ever faced and I certainly encourage everyone to not only take the macro advice that Corum has offered here but also some of this micro deal advice into account when calculating timing. Things are tough and getting started early is fundamental.
Thanks very much, Bruce, and I'll turn it back to you.
Bruce Milne
Thanks, Jeff, great stuff, you were in a tough sector and you got it done. Your comments echo exactly what we teach these days.
We're running a little bit over, but this is wonderful information. I'd like to introduce one of the true leaders of our industry, John Heyman, CEO of Radiant. He took his company through an IPO, a lot of acquisitions, and then finally a sale to NCR for over $1 billion. Congratulations to him and thanks for joining us.
John Heyman
Thank you and let me just compliment all the presenters and speakers today for their wise advice around the trends going on out there. I think the 10 questions to ask are very on point.
My background is we built Radiant over the past 20 years or so from a company with really almost no revenues to one approaching almost $400 million and we closed the sale to NCR for roughly $1.2 billion last week. It is a great deal for our company and our shareholders, and I think it's also a great deal for NCR.
Let me just quickly try to boil this down. My guess that most people on the webinar have not actually sold a company before. You've been building your company and now selling it comes down to three things that I'll draw the analogy that these steps are like building the company. First you have to build something of value, then you have to market it, and then you have to close the deal.
I think now is a great time, if you've built something of value, buyers will come, especially the strategic ones who are flush with cash and who are looking for predictable businesses that are growing, that can expand their earnings, and perhaps their multiples, and create more bandwidth in their teams.
I think that is what we presented to NCR, that's why we were paid over 20x EBITDA, and I think as you think about the potential buyers out there who are looking to your company like your buyers are looking to your products in terms of getting value, the more you can add to your story and their story around growth, predictability, margin expansion, etc, that will create more value to you.
Second, you need to market your business. So many of us are wrapped up in building our companies and marketing to our customers and building our capabilities inside our employee groups, but now is a great time to be out there speaking with your competitors, thinking about who are the most likely buyers, who has the most to gain, talk to investment bankers, PE firms, talk to other participants in the industry, because everyone right now is looking for ways to grow inorganically, because organic growth is very tough to come by.
Three, be in position so that when you have identified a buyer, be ready to close the transaction. Buyers and the boards of buyers are looking for clean businesses. If your business isn't clean today, take care of it. Build quality revenue streams. Build high visibility. Once you get a price you're interested in, you don't want to get into a rigorous due diligence process and lose momentum. If people think your numbers aren't clean, if people feel that your forecasts are not based on a good foundation, you start to lose momentum, and you may lose the sale, so spend time preparing your company for this process. The due diligence process is a rigorous one, you have probably not been through many processes like it, and just be prepared, because you will be completely undressed through the process. Surround yourself with great advisers, surround yourselves with M&A attorneys and a good banker. This is an intense process and it has to be managed.
My final quote is on timing. We debated if this was or was not the time to sell the company. The 10 great questions to ask yourself are excellent, but when we went public 15 or so years ago, we barely got out in a small window and the it closed on tech for about a year. I think given the volatility in the markets right now, if you're thinking about selling your business at any time over the next two or three years, go ahead and get prepared today for this. You want to be able to take advantage of windows. We announced our deal around July 9th and closed it last week. I think had we waited on that deal, even just another 30 days, it may not have happened given the shakiness in the markets. That is not because NCR would not have wanted to buy or we wouldn't have wanted to sell, it is just that the markets were not right and so I highly advise staying very flexible and responsive to the market in getting your company prepared.
Again, I'd like to echo all the great advice that has been shared today by Corum and their advisers.
Bruce Milne
Thank you very much to both John and Jeff for their spot on advice. We're running a little bit over. Going to the next slide here before questions, we have a new merge briefing, the one here, which is exactly on target to the issues discussed. The current environment, the diligence required, and all the steps in the process and how much effort it takes. This is a brand new conference and we did the beta of it in Portland last week, it will be rolled out in New York, San Diego, Helsinki, Tel Aviv, Paris and London over the next month.
Those who get the best education have the best chances at getting a deal done, as you heard from our two last speakers. I'd encourage you to attend one of these events or our definitive merger education, Selling Up Selling Out.
I'll personally be in Tel Aviv, Paris, London, and possibly be in San Diego. With that we'll open it up to questions. We're actually a couple of minutes over, next month we'll be doing Amazon, Japan, undervalued tech, and 10 reasons why buyers are buying now, some of which we touched on today. I know we're over, but we had one question that resonates, Ward are buyers still buying now?
Ward Carter
Good question. Frankly we're seeing a huge amount of activity. We've had a record number of new clients recently, we have several deals closing this week, and as you've seen from the update we had earlier from research, there are a record number of closings. We are guardedly optimistic, we are seeing a lot of positive activity, there is a lot of cash out there, and I think Jeff mentioned that a lot of companies are recognizing that they can't just manage their growth organically, they need to go inorganic, which means taking some cash and spend it wisely to acquire key strategic targets. That is where we are seeing a lot of activity within our client base, Bruce.
Bruce Milne
There is a strategic imperative of a lot of cash, the dollar is down, it is cheaper to buy American companies, there are so many reasons, and we'll talk a lot about those next month.
I want to thank everyone for joining us today, this is one of the best seller's panels we've done and well worth running over time.