September 2012 Tech M&A Monthly

September Tech M&A Monthly

Intro and Spotlight Reports

Bruce Milne

Welcome to the September Tech M&A Monthly with our new thirty-minute format. I’m Bruce Milne, your host today, founder of Corum. Our schedule is jam packed, we’ll have a field report on casual games, an upcoming market spotlight, and from Europe an electronic media report just in from Amsterdam. We’ll review the Corum Index, deals and valuations from our research department, and we have a seller presentation from Chris Mattieu of Nodestar, and a buyer presentation from Austin Scee of Versata.

Let’s go straight to our field report from Jim Perkins.

Jim Perkins

Thanks, Bruce.

Our recent World Financial Symposium Casual Gaming Market Spotlight featured some the best and brightest leaders in the industry. Michael Pachter of Wedbush Securities revealed his thoughts on online casino gaming and gambling. He controversially gave the traditional casino companies the edge in this space, citing customer retention and incentive programs, brand loyalty, and particularly currency security as the main issues. I’d emphasize the need for these traditional casino firms to improve their online customer experience and gameplay quality. All this will lead to many more acquisitions in online casino gaming, as competitors.

Kent Wakeford of Kabam gave us an inside view of how they make acquisitions, with a specific focus on massively multiplayer social games.

Daniel Bernstein insightfully separated the development of new games on smartphones vs. tablets.

Looking forward, Corum sees strong M&A value for game content studios. The trend into late 2012 and 2013 will also see the rise in importance and value in online gaming platforms, customer retention technologies, and currency security.

Back to you, Bruce.

Bruce Milne

That was quite the panel you had there. I love the names of some of these companies. Now let’s move to Jon Scott, our expert in Europe, who is in Amsterdam. He has a special spotlight on Enterprise Mobility.

Jon Scott

Thanks, Bruce.

I cover the security segment for Corum, and the revolution in mobile consumer devices and applications is posing significant challenges to enterprises as end user expectations shoot by these advances, and run into corporate concerns about security, management, and policy.

Every year at the RSA security conference, I come across emerging software companies that are helping to solve these problems and are proving to be attractive targets for enterprise software giants. They race to keep up with the racing technology landscape.

In the market spotlight webcast from the World Financial Symposium on October 9, you’ll heard from industry leaders about valuation trends, recent transactions, and opportunities for software companies to profit in the current market. I hope you can join us then.

Bruce Milne

We look forward to that. By the way, we have a special report that was on our agenda, but because of the timing, we have moved that to next month’s webinar. It is a quarterly report which is a full hour.

Now let’s go to a special report from Europe, we have Nat Burgess, CEO of Corum, Mark Johnson from our Stockholm office, and Elon Gasper, VP and director of research. Here’s Elon.

Elon Gasper

I’m at a research center in Ukraine where I’m meeting with our team and others from Corum who have flown here to work on client engagement and implement our plans to enrich the research portions of our tech M&A webinar and other Corum events.

Earlier this week I was in Amsterdam for the IBC electronic media conference, with over 50,000 attendees there was a record crowd, there were hundreds of exhibits, and the tremendous disruptive impact on this field was evident to everyone. It is clear now that calling tablets and mobile phones second screens is an obsolete term. Consumers simple expect all their movies, shows, and other video to appear at will on any screen they access. The low barriers for entry for software companies and the subsequent labyrinth of businesses has generated a complex but transient business ecosystem that we expect to give way to broader and more stable solutions.

Expect to see a wave of consolidation sweep through this field soon as the larger companies choose partners based on technology, team expertise, and the market positions that were staked out by visionary, well-executed plans now maturing. We’re assembling a full report on this fast-moving sector for an upcoming market spotlight. Back to you, Bruce.

Bruce Milne

Thanks, Elon. I think it’s clear from these updates that all of our deal makers are leading executives are also leading experts in their own fields, having built and sold their own companies. Jim, for example, sold his company which made the largest-selling product of the time, Duke Nukem; Jon sold two companies; Elon is one of the leading entrepreneurs and visionaries in the multimedia field.

Corum Index and Research Report

Now let’s move ahead. We have a special report coming in a minute, but first let’s hear from the Corum research group on what’s happening in deals and valuations. Alina?

Alina Soltys

Thanks Bruce. I’m joined on today’s webinar with Corum’s analysts Amber and Jason. We’ll move straight into a quick public market update.

The second half has been doing surprisingly well, but the new numbers in just this week show a drop in Chinese imports as well as the Fed’s deliberation on additional stimulus is expected to be announced today. The Fed’s move has been weighing on the markets over the last few weeks as they have already built into the price some help that is expected to come.

If we move on to the Software M&A front, Corum tracks and reports on a few key metrics monthly, found in the Corum Index.

First, some billion-dollar deals. The largest deal here was Carlyle acquiring Getty Images for $3.3B.

IBM is the latest giant to jump on the Human Capital Management bandwagon, acquiring the publicly-listed Kenexa for $1.3B, which came in at 4.1x revenue for this SaaS company. This comes after similar acquisitions in the last year by SAP and Oracle as they reached out for two other public companies: SuccessFactors and Taleo.

Amber Stoner

And just reaching the billion dollar deal mark is another private equity firm making a large acquisition in Thoma Bravo’s purchase of Deltek for an enterprise value of $1.1B at 3.2x revenue contributing to the increase in private equity deal value despite the decrease in number of private equity deals this month.

Jason Steblay

VC-backed exits also plummeted from 76 in July to just 46 in August. Although it’s just one month, and it’s hard to extract any trends given the high volatility we saw last year at this time, it is possible that the poor performance of many recent high-profile IPOs are beginning to spook PE and VC investors. Too soon to say, but going forward we’ll keep an eye on these numbers at Corum.

As we move into the six sectors, Amber is up first with Horizontal.

Amber Stoner

Thanks, Jason. The horizontal sector is still running an exceptional sales multiple, still the highest among our six sectors, increasing to 2.8x this month.

One of the more intriguing August deals in the space was the merger of CDC Software and Consona. The companies merged as a portfolio company of Vista Equity and have renamed themselves Aptean. The combined company increases its exposure in well-defined vertical markets by combining complementary solutions in key applications areas, including CRM, ERP, and SCM.

It will be interesting to see how Aptean moves forward with its products; especially in the CRM space as following the acquisition the company now has three CRM software applications in Onyx, Saratoga, and Pivotal. Could Aptean move forward with a cloud-based CRM solution, building off of Onyx as the only cloud deliverable offering in the portfolio? We’ll have to wait and see, but regardless we expect Aptean to continue building through acquisition as both of its predecessors did before the merger.

Any big consolidation plays in the vertical space Jason?

Jason Steblay

No major consolidations, Amber, but Autodesk has continued its acquisition streak. In August it picked up PLM solution provider INforbix for an undisclosed amount. Compared to July’s purchase of SocialCam, AutoDesk appears to be returning to its roots a little bit. InforBix will add powerful search, indexing, personalization and data visualization technology to the Autodesk PLM platform. Building a robust PLM Platform is a logical horizontal move for Autodesk as it tries to offer its existing design users more cloud based, value added services.

Overall, multiples in the vertical market have held relatively steady since June, but healthcare related IT M&A has really begun to heat up, as Corum will discuss in detail during the October Market Spotlight report. Alina, are you seeing a little more volatility in infrastructure market?

Alina Soltys

The Infrastructure space has bounced around over this summer ending up in EBITDA multiples but down in revenue multiples - which can be ascribed to normal market volatility. The next company in our deal spotlight has had quite an eventful history of its own.

UC4 has been in private equity hands since 2006 when Carlyle first picked it up; then it grew through a couple of acquisitions, including a company Corum Represented in the sale to UC4 called AppWorx and has now sold it off to a Nordic PE firm called EQT for $270M, or 3.3x revenue. UC4 had experienced good traction in the last year in its IT services and management automation platform -- really one of the more unique products to create one consolidated view of all IT processes across physical, cloud, &virtual environments.

And speaking of virtual environments, the internet being the largest virtual environment out there. Amber what have you been tracking there this month?

Amber Stoner

Well, the Internet sector experienced a slight drop in sales multiples in August, although not enough to worry as the sector is still up from Q2 and trading at a healthy 2x sales.

Despite that drop in public valuations we’re still seeing deals done at higher valuations, like Ask.com’s acquisition of About.com for $300M in late August, a 3x revenue valuation. In what appears to be a complementary and synergistic merger, the combination of About.com’s more than 900 topic sites with Ask.com’s 100 million global users will allow Ask to better satisfy users with answers from millions of About.com articles, while also providing significant, additional traffic to About.com’s guide pages.

Google also made a complementary acquisition in August, buying the Frommer’s travel-guide business from John Wiley & Sons for an unofficial $25M. This deal follows Google’s acquisition of Zagat Survey in 2011. Google has said that the Frommer’s brand will be melded with the Zagat brand. While Google says it made the acquisition to attract more advertising dollars tied to online-travel bookings and local-business information, Frommer’s data about local businesses worldwide could also boost the Google+ business listings and Google Maps, creating a more integrated and visual travel/tourism search experience for consumers.

Speaking of consumers, Jason, you’ve seen some interesting deals in the consumer space, right?

Jason Steblay

Over the last few months there have been a lot of interesting gaming deals with mixed results which has been driving some of the volatility we’ve seen in the consumer market. However, the electronic payments industry began to generate a lot of M&A activity in August and if this summer is any indication, consumers will soon have many more options to pay for their morning espressos or just about whatever else they buy. In August alone, we counted five deals involving electronic payments of some kind, not including Starbucks big investment in mobile startup Square. To name just one, BrainTree—whose technology powers over 3,000 e-commerce sites like LivingSocial and Uber—acquired fellow payments start-up Venmo for $26 million. According to a New York Times Report, BrainTree expects Venmo’s technology will help it prepare for the impending wave of mobile commerce.

We do expect the next 18 months to bring the largest growth and actual establishment of the e-payments space across the broad smartphone user base, exciting times ahead.

Alina Soltys

This excitement has carried into IT Services as well deals that are more revealing than the usual of changing market conditions. August saw the consolidation of 2 of China’s largest IT Services providers: HiSoft acquired VanceInfo in a 1:1 stock swap worth $437M.

Trading as high as 1.9x revenue, VanceInfo closed at 1.0x revenue, much lower than the early year premiums Asian firms were receiving. .

As local labor costs are rapidly increasing, Chinese companies can no longer compete on price alone, rather this is driving consolidation in the industry to provide higher level business services and the cashflow to do large implementations. This is certainly expected to continue in the next 18-24 months as others seek to gain operational efficiencies and broaden their product bases.

That wraps up this month’s research report, back to you Bruce.

Bruce Milne

Thank you very much. Before we shift topics, I’ll make a few comments. We’re still seeing a bit of an effect from Facebook, some fallout from the IPO, but I can tell you that the activity in the M&A market, particularly privately-held firms like those we represent, have been very active. You’ll probably see more announcements on deals done by us next month than in any month in our history.

A note of congratulations to UC4, the heart of their company was two acquisitions we did with them, Carlyle, who was involved in that, you’ll see them and firms like IBM and Google at our annual report at the end of the year. Congratulations also to VanceInfo with their acquisition by hiSoft to become China’s largest IT services company. As some of you may know, VanceInfo is on Corum’s World Technology Counsel advisory board.

Guest Speakers

Let’s move on to our special guest, Chris Mattieu. Chris recently sold his company Nodestar to AppFog. Congratulations to you, too, Chris.

Chris Mattieu

Thank you very much, Bruce. Nodester was the second company of mine that I’ve had acquired over the last two years. It was basically an open-source cloud-based platform as a service for Node.JS. If anyone has been tracking that, it’s one of the hottest developer frameworks to hit the market. It is the engine behind all of the new real-time web applications being developed today.

It started off really as just a project of mine to scratch an itch I had for needing a platform to host my Node.JS applications. It was all open source, as I mentioned earlier. I think that fueled the fire on the press. It was picked up by Mashable, Hacker News, and ReadWriteWeb within the first week of me open sourcing the project. At that point we realized that it really needed to be a service. People were clamoring, asking for hosted apps on Nodester. So we picked up a few sponsors that paid all of our hosting fees, did that for about a year. This was a 24/7 operation, we weren’t ready to charge for services, the platform was still growing with lots of community contributors and developers from all over the world helping build the project up.

At the same time, I accepted an executive position for Bechtel, a hundred-year old, $30B company. I was getting tired of the 24/7 requirements for the company, at the same time, new competitors were coming into the space, including Red Hat, Microsoft, and Google. I realized the timing was right to exit while we had such a nice brand built up and a good following.

I had a conversation with a buddy of mine, the founder of Mindshare PR in San Francisco, and I asked him for help. We worked out a simple commission deal with them and within two weeks she had put me in touch with six companies that were interested in having discussions about Nodester, possibly acquisitions. We were very transparent with all of them. We didn’t have NDAs with them originally, so we said, “listen, here’s all of the people at the table that we’re talking to.”

I was really concerned as to what we could get out of the company as a price tag because we had no revenue, all of the application was open source, which was also part of what made it so popular, and after talking to a few folks, some of our competitors were just looking to buy our customer list, email addresses, kind of low ball figures on those numbers.

AppFog stepped in, we had a really good vibe with those guys, they’re an up and coming company, I think they have $10 million in funding, they were very interested in growing the Nodester community, using it as a lead generation tool into their platform as a service play and really they offered a buy it now price that we negotiated for us to stop talking with the other six companies, within about a week. We closed within thirty days of due diligence and it has been a smooth transition period. Cash and stock deal, great guys to work with, definitely a platform as a service company to watch. Very excited about that closure in my life and I’m starting on a new project idea.

Bruce Milne

That’s great. I want to hear down the road about your next big thing.

People ask us all the time what the smallest firm we can sell and we say that we’re back in the days where just a good idea sometimes sells. It doesn’t have to be a big up and running company.

We have another presenter. What do you do when you’re not a candidate for traditional M&A? I know that applies to a lot of you online here. Well, one of the companies that will buy companies like yours is a firm like Versata. Austin, tell us about your model there. Austin Scee is the general manager for Versata.

Austin Scee

Yeah, I’m the head of corporate development for Versata. I ran a company for them previously and was a general manager/CEO. Prior to that, I spent five or six years in PE, and eighteen years looking at software companies in different capacities.

What I will say is that you can think of Versata as a buyer of last resort. I know that sounds a little harsh, but that is what we do. We buy very quickly, we do very light due diligence, move quick, pay cash with 100% certainty. There are a couple of other strategies like that out there, but instead of getting into that, what I’d really like to do is tell you how to avoid being in a position where a one-time revenue exit is what you’re looking at.

I’ll do that by sharing what our playbook is. It’s not for you to replicate, practically speaking that’s not easy, but it is quite simple. The first thing in a software business that we look at is pricing. I’ll tell you that in the years I spent in PE, every time I asked someone who owned or ran a software business how they priced their product, the answers ranged from the market besides formity to I have this spreadsheet, when really the only answer is I raise prices until my customer retention reaches a point that is unsatisfactory. That really is my best advice for software companies that are in a position where it is difficult to be profitable or as profitable as you want to be, where a $20-30M revenue business may not be possible, it may be possible to reset prices and customer expectations and raise prices. Our experience is that it doesn’t always work, but it works a lot more often than people think and that’s because primarily as a software CEO and a business owner, you listen to your sales people and they have different incentives than the shareholders and you get caught in that challenge. First thing, look seriously about raising prices, take that risk, many times it works.

The second thing, the businesses that we acquire, that we run, are businesses that don’t have the capability of growing 20-30% a year. Some of them are trying to do that, and so they find that their customer acquisition costs are very high and their return on investment is not high enough to justify the investment. We focus on operating efficiencies and we source our talent globally and we eliminate almost every office lease, people work from home, people take on multiple tasks, and we get lots of operating efficiency that way. I’ll tell you that for many $5-10M software companies, it’s very possible to run at 40-50% EBITDA margins and keep your customers very happy.

I’ll end there.

Bruce Milne

That was great stuff. That’s one of the first things that we see when representing privately-held firms is that in almost all cases they are underpricing or not charging enough for maintenance, red carpet service, whatever, and generally the buyers represent brand name distribution and can raise those prices fairly significantly and move into the profit zone.

Q&A

There was a question that came up during the session. We were asked, “Could you please comment on big data M&A globally and in Asia in particular?” Alina, you want to take that?

Alina Soltys

Let me take the Asia question. Typically Asian firms, especially Chinese ones, have been backed by heavy private equity companies that insist on IPO exits. This works for the companies that have the investment from the top tier PE firms that use their connection within the government to push the company to the front of that IPO line.

M&A exits lately have been seen more as a Western strategy and the next strategic decision and of course, as with other Western influences, this is starting to influence Chinese firms, and more of them are looking into doing the typical M&A route versus the IPO route. And of course the rest of Asia, including India and Singapore, have been doing M&A more consistently. It’ll be exciting to see Chinese firms participating in M&A as a more influential strategy.

Bruce Milne

We’ll have an update on China, we have an advisory board there, plus a special associate who works with us in China. The changing market they have, they saw a crash in their market. Some of these companies were valued at over 6x multiples, when the ones in the US were 0.5x multiples, and that has all changed fairly dramatically.

We had another question about PEs for hosting cloud providers. Alina?

Alina Soltys

Just a quick comment. We haven’t seen PE really go into hosting as cloud providers. They may be backing other companies that are doing the acquisitions, but there is an interesting trend with telecoms, operators like Verizon doing the Terramark deal last year, and that makes a lot of sense for those telecom companies. They service a lot of business services for large customers with internet provision and telephony solutions. The cloud and hosting just makes sense for those upselling opportunities. There are a lot of margins built in with the hosting versus the traditional telephone services that are there. It also expands their revenue base. That’s why we saw Verizon do that large deal last year with Terramark and a few others as well.

So PE may start coming into the picture, but right now it’s those strategic M&A deals that are taking the stage.

Bruce Milne

Thank you, Alina. We also had a question about valuations in general. Actually we’re seeing valuations hold up. The market in the privately-held firms, smaller companies as you saw from Chris’ talk, are holding up very well and we’ll be doing a special report profiling a number of deals next month as well as some other reports.

Thank you.