Introduction
Nat Burgess
Welcome to this month’s tech M&A monthly. We have a monthly report where we go through M&A trends and software industry trends, and we’re very pleased to have additional content today focused on private equity, an update on deal activity, deal volume, most active investors, and then, as a special treat, we have four seasoned PE pros who are out actively doing deals, investing in and buying companies that may look a lot like yours. So stay tuned for that panel discussion later in this session.
Upcoming Events: World Financial Symposium
I wanted to highlight a couple of upcoming events, and this is, frankly, going to echo some of the research report that we’ll hear shortly. Pay close attention to where the PE firms are investing, where they’re putting their money, where they’re placing their bets, and what you’ll find is that there is a lot of attention and a lot of energy around media technology and data security technology in particular. Those are two of the highest volume areas. It so happens that we’re working with our partner, the World Financial Symposium to put on market spotlight events, focusing on those areas. We have Media Technology on March 16 and Data Security on March 23. Prior to that we’re also working with the WFS on connected cars and auto tech, that’s Feb 23, and Tech Patents and Exit Strategies on March 1. Those events and more details can be found at wfs.com.
Corum Research Report
Returning to our core agenda, we’re going to go through Corum’s monthly research report, talk about trends and activities in the market, and then we’ll turn it over to our PE panel in about ten minutes. With that, let’s turn to Elon Gasper, Corum’s VP of research.
Elon Gasper
Thanks, Nat. PE-backed tech deals last year continued to see increases in the sizes of megadeals and number of investments.
On our PE buyer leaderboard, Vista took over the top spot, trading places with Insight, with ABRY again rounding out the top 3. Among their transactions were car insurance software maker Solera, taken private by Vista for almost $4 billion at 5x revenue; SCM vendor E2Open, bought out by Insight for $273M; and procurement specialist CompuSearch, wrapped up by ABRY for $350M.
The next 3 leaderboard places also contain the same buyers as the prior year, as Thoma, TA and KKR kept active with deals such as service management specialist Xtraction Solutions, another 5x purchase, added by Thoma Bravo to its portfolio company Landesk to help it focus on BI offerings.
And those three are followed by Marlin, returning to the chart after a year’s absence, announcing its purchase of telecom lifecycle management provider Asentinel, then bolting on Corum client eMobus to it late last year. That’s standard practice for PEs, to acquire one firm then fill gaps and extend market share by adding a smaller company or two. In Marlin’s case that helped almost double its announced deals year over year, a stand-out gain among an otherwise quite stable top tier.
Given the hundreds of significant PE buyers we track in our Corum database, it’s remarkable to see how little turnover there is in this top layer. These firms have developed professional organizations and working models that span operations from origination through execution and integration, enabling nearly every one of them to have scaled up deal numbers as the market boomed and cash was readily accessible during these last few years. Can you dissect some of the sector distribution for us, Yasmin?
Yasmin Khodamoradi
PEs powered nearly a quarter of last year’s milestone 59 megadeals. Those transactions fell mainly into the high volume Infrastructure and Vertical markets, though they accounted for 3 of the 4 Horizontal megadeals.
Looking downmarket and deeper into sectors, a number of areas showed increased activity last year, led by the relatively narrow Media Tech segment, which more than doubled, particularly in the areas of content creation, management, and delivery, illustrated by acquisitions of companies like Moovly, Masstech, and ATX Networks.
This was followed by the much broader Security sector, with anti-fraud, anti-malware and network security sub-sectors demonstrating rising appeal to PE buyers like Marlin, CVC and Apax.
Elon Gasper
And that’s our 2015 PE backdrop. Turning now to our first 2016 update, the January public markets gave back the gains of the last 5 months, with last month’s losses capped by this month’s return to 2014 levels for both tech and broader indices, as Internet tech led high-flyers back down to more earthly levels, erasing much of the gap that’d grown last year between tech and traditionals.
Despite that and future uncertainties, we find reasons to remain composed amid this market downturn and its public company value rationalizations and unicorns losing their horns: from a long-term view, valuations remain well above average; and from our vantage point at Corum, workhorse companies—going concerns with revenue, growth and sustainable models—continue to generate buyer interest, field LOIs and progress through due diligence.
LinkedIn and others saw the froth blown off their value ratios for one of the same reasons M&A continues: big companies, and PEs building them, need growth. And they are sitting on record amounts of cash. That and most of these other factors are very different than last decade; execs at software companies with growth and strategic fit may even find more urgency among acquirers now.
Yasmin Khodamoradi
Our Corum Index reflects an energetic start to the tech M&A year, with a 3% increase in total January tech transactions, 6 megadeals across 5 of our market sectors and double digit growth in PE deals and VC-backed exits.
Next, to update three sectors’ January activity, can you start us off with IT Services, Artem?
IT Services Software Valuation Metrics
Artem Mamaiev
IT Services valuations remain at historic highs even after a half-point correction in EBITDA ratio.
The market saw a consolidation of the defense sector, with Lockheed Martin merging its government IT Services unit with Leidos in a complicated, stock-shuffling $5 billion transaction to create the largest US government IT outfit.
In the UK, City Lifeline, a provider of colocation and hosted services, was snapped up by Redcentric for almost $7M and 7.7x EBITDA multiple, and Ancar B, a colocation and virtualization services vendor, found a home with Pinnacle for almost $5M at 5.5x EBITDA.
Elsewhere, in IT Services for insurance, New Jersey-based MF eXchange was acquired by Thomas Cook through its Indian subsidiary Quess. The deal equips Quess with IT expertise in the property and casualty insurance field.
Finally, 4iSoft, an insurance IT consultancy from Chicago, was grabbed by Symphony Technology to be bolted onto insurance risk management SaaS, Ventiv.
What’s happening in the Vertical space, Yasmin?
Vertical Software Valuation Metrics
Yasmin Khodamoradi
Vertical sector sales multiples are on the wane, reverting back to levels seen last fall while EBITDA multiples remained steady.
Salt Lake City’s Orange Legal was sold to Xact Data Discovery, backed by Clearview Capital, which should help Xact shore up its e-discovery and forensic data management services for law firms. Another e-discovery services provider, Virginia-based LDiscovery was acquired by the Carlyle Group and Revolution Growth.
In the automotive space, Wilson Software, was “parked” by Montreal’s Valsoft Corporation to build more comprehensive solutions for car dealerships worldwide.
And LoJack, the venerable maker of vehicle tracking and anti-theft solutions, sold up to CalAmp for $134M, to help the wireless software vendor build on its connected car technology. We will hear directly from CalAmp in our Connected Car Market Spotlight webcast on February 23rd at wfs.com
The industrial simulation industry has consolidated in the last month as Siemens spent nearly $1B at 5x sales for New-York based CD-adapco, which provides automotive engine simulation software used in Formula One Racing.
Finally, in the UK, KBC Advanced Technologies, which provides simulation software for the energy market, was bought out by AspenTech for $230M.
Internet Software Valuation Metrics
Elon Gasper
Internet market values led the way down in January, though EBITDA multiples still remained the highest among our sectors. Among transactions we saw a group of old-school content deals coming out of the UK, including law news site Legal Week, bought by ALM Media, after picking up China Law & Practice last year, leaving it poised for further progress in the international arena.
Again in the UK, provider of credit fund analysis Creditflux was picked up by BC Partners-backed Mergermarket to improve its real-time data provision. And London’s CoinDesk bitcoin reporting site was bought by Digital Currency Group to build on DCG’s portfolio of bitcoin and blockchain ventures.
Finally, Connectifier, a pioneering AI-powered search engine for recruiters, was acquired in a deal announced a week ago. The fast-growing company’s database of hundreds of millions of job candidates, culled by its machine learning platform from social media and other sources, aligns with one of our Top Trends, AI Enablement. These disruptive trends continue to drive M&A by big companies despite—or because of—their latest stock price challenges.
Oh, the acquirer? LinkedIn. That makes this a timely case underlining ongoing tech M&A motivation, wouldn’t you agree, Nat?
Nat Burgess
Absolutely. So if the platforms for hiring and training and retaining employees are still red hot, that tells us that maybe despite the roller coaster ride we’re having in the markets, there is still some fundamental momentum in the tech sector. Okay, thanks for the update.
Private Equity Roundtable
Now we’re going to move on to our panel. I’m really excited to have four very experienced, very distinguished PE investors with us today. We have time for a good discussion and also for Q&A. So bear in mind that on your screen, you have a window for putting in questions. As we proceed with our discussion, make sure you get those questions up in the queue, we’ll try to save time at the end to address them. If we’re unable to get to all the questions, we’ll respond via email.
We’re going to go around the table here and do some introductions, give each of the panelists a minute or so to tell us about themselves and the firms they are representing; then we’ll go into our Q&A. I’d like to start with our guest Joe Manning from the Riverside Company.
Joe Manning
Hi, good afternoon. I’m Joe Manning a principle at Riverside, based in our Cleveland, Ohio office, and I’m the head of our software and IT specialization. I currently serve on the board of four of our portfolio companies, three of which are high growth SaaS businesses, three of which are high-growth SaaS businesses. Riverside is a very active investor in the SaaS and software sector, particularly at the lower end of the middle market. In the last five years we’ve done over 20 acquisitions of SaaS businesses. The vast majority of deals we do are at enterprise values under $200M. Sometimes as low as $2M. I’ve been with Riverside now for about 10 years.
Nat Burgess
Thanks for the introduction, Joe. I think we’ve worked on three different transactions with Riverside now, and what’s been interesting is that some of the best people we know in the market have gone to work for you and we’ve had a chance to work with some of those individuals on transactions as well. Congratulations on the progress and the market share that you guys have established in SaaS companies.
We’ll come back to that topic shortly.
Next up I’d like to welcome Rob Palumbo, from Accel-KKR. Rob, can you introduce yourself please?
Rob Palumbo
Sure. Hello everybody, this is Rob Plaumbo. I’m with Accel-KKR. I’ve actually been with the company since inception, nearly 15 years ago. Accel-KKR is an exclusively software-focused PE firm. We’re based in Menlo Park with offices in Atlanta and London. We invest in businesses anywhere from $10-150M in revenues. Over the course of the firm’s history we’ve made approximately 100 investments across North America and Europe. Our latest fund is $1.5B and again that remains focused on software and tech-enabled services.
Nat Burgess
Thanks for that Rob. We’ve definitely been impressed over the years with how deep you and your team go into these sectors. When you get involved in HR platforms or content management, we always have pretty productive discussions as you build out the companies in your focus areas. We’re glad to have you with us today.
Next I’d like to welcome Pete Freeman. We first go to know Pete over at General Catalyst, but why don’t you give us an overview on what you’re doing and what Build Group are doing?
Pete Freeman
Sure. Thanks a lot, Nat, appreciate you having me on the call. Build Group is a relatively upstart in terms of other members of the panel. I’ve spent about 14 years in PE, started with TA Associates, and ran the enterprise software practice at General Catalyst. We started Build Group about 9 months ago. Our focus, as an Austin-based firm is middle market business software companies, similar sizes to some of the other panelists, that are $5M to $25M in revenue. Our approach is different in that we’ll only make probably two investments a year and we’re funded by a group of high net worth individuals that have no need for short term liquidity. Our objective is to find companies that have a long way to grow. We can compound in for a long period of time. I would say my team is entirely made of operators. Several were senior leaders at Rack Space and have various skills in business development, marketing, and finance, and that’s our focus.
Nat Burgess
Thanks, Pete. I think if you go to the Build Group website, you’ll see that focus. Our experience working with Pete at General Catalyst was that they had a keen idea of who the right people were to run businesses, and we came very close on one deal where they had identified a very strong CEO and ultimately it went to a different investor. But I think that operator/builder ethos is very clear on the website and in the company.
Finally, I’d like to welcome Geoffrey Baird, who is representing Tailwind Capital today. Geoffrey , why don’t you give us a brief introduction.
Geoffrey Baird
Thank you very much. Good afternoon, everyone. I’ve actually spent 30 years running technology companies both in the US and the UK, both startups and venture-backed and PE-backed firms. In the last year, I joined Tailwind Capital, which is a 15-year-old NYC headquartered middle market PE firm. I’m working as an operating executive, so my goal is to work with the companies that we invest in and work with the CEOs in building and developing the technology solutions and products. We’re very much a growth investor. We have very similar arrangements to the others, from $50M-300M valuation range, but we put relatively low leverage on the firms and work in actually looking to grow and invest EBITDA in helping businesses grow. We’re very interested in a number of different trends happening in the marketplace, particularly in the whole cloud transition, and how the mid market has a real role in providing technology services into that space. We pose this on B2B and services rather than technology creators. We’re looking for people who have deep customer relationships and then help manage them delivering technology from various Silicon Valley companies into the marketplace.
Nat Burgess
For our audience today, which is several hundred software company CEOs, there’s a connective thread here between our panelists, which is they’re not investing in public companies and hoping that things work out. They are rolling up their sleeves and working to build the technology companies of tomorrow.
I’d like to take this discussion in that direction. My first question is to Joe. Joe you mentioned the number of SaaS investments that you’ve made and the importance of the SaaS model to your investment strategy. It seems like everyone is a SaaS company or at least putting up the window dressing to look like a SaaS company. We’re seeing a lot of creative accounting and presentation of financials, recharacterization of recurring maintenance revenue… so I’d like to know, from your perspective, what is a SaaS business, what makes them valuable, how do you figure out if they truly have the revenue model that you’re looking for?
Joe Manning
Great question. Because you’re right, we’re getting in marketing material every week and any company that has some kind of software component now calls themselves a SaaS business. Understandably so, because the SaaS multiples are so high.
I think the PE and VC community is now very well-versed on these business models. So for a business owner, it’s a good thing if they’re not a true SaaS business to develop that actionable roadmap and timeline on how to get there.
We look at there being two issues to evaluate in a SaaS business. One is does it have a SaaS revenue model? That first issue is typically the quickest and easiest to evaluate. That typically means a pricing model that is centered on recurring revenue, opposed to one-time license fees or lumpy professional services revenue, which is typically low margin.
If you check the box on that SaaS revenue model, then you need to move along. Do you have a true SaaS technology architecture? This is quite important, as it gets to the heart of the scalability of the business. SaaS technology architecture means is it multi-tenant, are there multiple customers in the same database? Is there a single instance and code base? Are all clients utilizing the same product? Is the product accessed over the web without needing installation on the customer service or desktop?
Nat Burgess
I think those are all valuable filters, since a lot of our audience today are actually premise software companies that are considering transitioning to SaaS. I’d like to pose a question to Rob next. Similar question, but if you’re looking at two companies, one of them has successfully transitioned to SaaS and is commanding a very high valuation, the other is a successful legacy premise software company that has an opportunity but maybe not the expertise to transition to SaaS, which is more interesting to you and what are some of the fundamental things that you focus on as you assess whether they are interesting to you?
Rob Palumbo
Sure. That’s an interesting question. Any answer would have a lot of qualifications and it depends related to it. The reason I say that is, as people have alluded to, the values ascribed to pure SaaS businesses are generally higher, for a whole host of reasons, most of which are probably obvious to the listeners. We wouldn’t necessarily view one as better than the other, other than to say a lot of our businesses are making that transition and there is a lot of value creation that can be done in making that transition. It’s not as simple as simply a technology rewrite or rebuild, but how do you introduce the product, how do you price it, how do you sunset the old product?
We actually have a consulting group, several members of which joined us at Bannon Consulting and worked at Ariba where they made that transition. There are a lot of important business decisions that go along with the technology. If we were looking at a SaaS business versus a legacy business, we would be thinking about the disparity between the values of the two businesses, simply by virtue of the way they deliver a product. Most certainly the SaaS business is going to be more highly valued. The question for us becomes how much value can we help create with our partner company in helping them to make that transition. And are we the management team effectively getting paid to do that? If that is not the way the business was started, it’s very doable, we’ve done it with a number of companies in our portfolio, but there’s more to it than that, it’s not just simply rewriting technology and helping work through that process is part of what a good PE firm should do.
Nat Burgess
That’s a really important point. It’s hard to make this transition, you need different people and a different go to market strategy. Having people who have done is successfully is probably the only way to ensure success.
Pete, I’m going to turn this over to you now with a related question. You mentioned you have high net worth individuals backing you. You have a long term horizon. How do you think about your investments in terms of a time line and in terms of liquidity? For the sake of argument, let’s say that most PE firms have limited partners that want to see a return in 5-10 years at most with a rolling series of companies they invest it. You have a slightly different perspective. How do you create a return for your investors?
Pete Freeman
I think in our case we looked at firms like Berkshire Hathaway and my partner’s company Rack Space is the seminal case study that has built our investment philosophy. But it comes back to growth. If you are in companies that can grow at 20, 25, 30%, in five years you can grow substantially. In ten years you can grow by multiples of that. By leveraging individuals who are really focused on longer time horizons, we have the luxury—and to be fully transparent about how most of the PE world thinks—how can I make 3-5x my money in 3-5 years, and make enough of those investments so that my overall funds, when all the economics are considered, generate a 2.5x multiple. We look at that and we say, how can we generate returns for our investors of 1500 to 2000 basis points above lower risk equity indices for long periods of time. That’s how you create really compelling returns for shareholders over time.
Nat Burgess
Interesting. That definitely does open up the horizon. Going over to Geoffrey now, just to warn you, I am going to ask the White Space market opportunity question. You have a degree in cybernetics and math, you’ve worked in telecom, you’ve worked in mobile, you have an engineering background and an operating background, so what are some of the areas in which you see great growth opportunities for CEOs in today’s markets, areas in which you would invest.
Geoffrey Baird
There are two areas there. One is the area in which I would invest and the other is areas in which I see great growth, but they are not always the same. I invest in areas where I see an opportunity to make money, which doesn’t necessarily have to be tripling the marketplace.
Over the last four years, the easy answer is the Internet of Things and I think there is a great opportunity there. At the moment it’s in a huge hype position at the peak of the Gartner inflated hype curve. But I think the core concept of what miniaturization of technology, what battery technology and what the pervasive connectivity we have can change in business process, particularly in B2B, is huge. Obviously there’s a huge consumer area there that I’m not investing in because it’s a consumer space. In the actual application, in that area, I think it’s great. We’re looking very much at the industrial side of that, in terms of how industrial manufacturing processes can be evolved and change there. I think from a mid-market perspective, in that play, obviously there’s the actual technology, the innovation, if you create something new, which is going to only be a select number of players, but in the actual service space and the market that is actually going to deliver that to customers, companies that already have strong relationships in those sectors have a real opportunity to source technology from a variety of established and startup companies and build and integrate new services for them. I like that a lot.
As a quick aside, I actually think that the mobility space has still got a huge role to play in changing business process. I think the enterprises are going to leverage much more of the active economy which is developing out of the consumer space, that still has a long way to go in the commercial markets.
Nat Burgess
I think that really helps frame it up. The IoT focus, the industrial focus, frankly, we’re excited as well. We’ve done deals with Bosch and PTC and Ansus and we’re continuing to see a lot of exciting opportunities there. However, a lot of our work is in the vertical markets, traditional enterprise software, and a lot of our audience today is in the vertical markets, as evidenced by a question that just came in from one of our participants today, which is “What vertical markets do you see as potential acquisition targets for 2018-2019.” Obviously, who knows? But that beign said, we have three panelists with deep experience in the vertical markets. Why don’t we start with you, Rob? If we’re thinking about traditional markets like health, financial services, etc, what are you excited about today?
Rob Palumbo
Fundamentally, the vertical markets are where we focus. What we continue to see and I’ll address a couple of them, is a lot of software that is still being developed that is doing very basic and fundamental automation of work flow in replacing home systems or Excel spreadsheets, and as long as we’ve been doing this, this trend has not abated at all.
Where do we see those opportunities, where are we seeing them? A lot of interesting spaces: healthcare, energy, a huge one for us is human resources and frankly that’s been a big one because it’s been safe bet that if corporations are looking to streamline their organizations, but unfortunately a lot of times HR has been a function that has been neglected. That’s been a good space for us. Everything around the employee. Look, we continue to see good opportunities in retail and government as well. The main expertise that a vertically focused software company can bring to bear is what we do is the biggest moat around that business and the most interesting differentiator, vis a vis the big software companies like Oracle and Microsoft in terms of how they compete. We believe it will continue to be a great go to market strategy for the foreseeable future.
Nat Burgess
That is helpful. We’ve had another question that I think is an interesting one. All of you have talked about the importance of partnering with companies and really helping to bring in the right consultants and other people to instill growth. That being said, what are the merits of doing a majority control investment versus a minority investment. I’d like to get a short response starting with Joe.
Joe Manning
Well, a lot of times that decision is the business owner’s personal financial risk versus reward tolerance. So in most instances, if we see someone choosing one or the other, it’s that the owner wants more personal liquidity, so their doing a majority sale so they get more cash right now, but they’re still retaining some upside versus a roll-over ownership. The minority share still has a good risk tolerance and want to get a smaller cash out now and bring in a partner that can help accelerate the growth. In both instances they’re bringing out a partner for strategic, financial and operational support. Then how much cash you get now versus ownership, a lot of times it’s the personal owner’s decision.
Nat Burgess
Yes. Rob, what about you? Is it a red flag when someone wants all cash now?
Rob Palumbo
It’s not a red flag. The other considerations we see between minority and majority deals is governance, which is to say in a majority deal their partner has effective control with respect to decision making. That’s the governance answer. The practical answer is I think it is often important for a business owner to focus on it, but in practicality it often doesn’t work that way. What I mean by that is a part of equity partner is dependent upon a need for the management team to be there and be motivated and they’re say in running that business is of paramount importance. So the worry about losing quote-unquote control is not an impractical matter quite as substantial as they may think. Nonetheless, it’s a very important consideration for a lot of the business owners we talk to.
Nat Burgess
Peter, I’d like to go to you next with a related question on what makes a deal attractive to you and what the red flags might be. What are some of the thresholds that you think about and with your investment charter that limit you in terms of how big someone needs to be for them to be an appropriate partner for you as a platform investment.
Pete Freeman
We can actually be very flexible and creative. I’ll give you an example, we just made an investment in a vertical stack business in Toronto that’s $3M IRR. Our target is much larger than that. What we liked about the business was that it had a phenomenal team. It’s a multi-facet SaaS, low cost, really easy to use intuitive solution that is disrupting legacy players in a multi-billion dollar market. You don’t see a lot of billion dollar software markets that lack a SaaS disruptor. In that case we said, “it’s a $3 million business, buy it’s growing at 200% a year. We love the team. Here’s a chance to own a piece of the company and work with them to take a meaningful share of that market.”
We’ll make smaller investments, our goal would be to get a minimum of $10M into an investment platform over time. Another thing I would add to the earlier question is that since we are targeting long holds, we do focus on how much liquidity the active management team is going to take. Enough to pay off their mortgage, send their kids to college, which is a good thing, so they don’t have to hold onto their business with white knuckles and they can afford to take risk over a long period of time. But if they’re selling the majority of their stake, that’s something that we would pay close attention to.
Nat Burgess
That makes a lot of sense. We have time for one more question. This one is going to Geoffrey. The question is, “In a first meeting with a CEO, what are the things that get you intrigued; what are the things that scare you off?”
Geoffrey Baird
I think the first one is always the quality of the team and the CEO. We’re looking for the passion, obviously, but also the knowledge and role that the CEO is playing in terms of whether they’re the lead salesperson or they have a team that is well structured. We’re looking at deals where we’re looking at a minimum of $5M EBITDA, so we’re looking at businesses that are already getting going. We look to see that they’ve put some structure into it, some understanding of how to run this business. Clearly we’ve been looking for a business that has potential to grow and actually demonstrate track record of growth. A red flag in a meeting are things where it’s either the numbers are up and down, the numbers aren’t explainable at a high level, the ability to clearly explain what the company does… I don’t know how many times I’ve been in meetings where I’m still not sure what they do. The clarity of what they do and the business problem they solve and why customers buy them, I think that’s really important and really valuable for us.
Putting all those together and asking if this business has a meaningful opportunity in the marketplace, we like the idea of looking for long term relationships and the adding in of a customer base, a good brand, a good additional customer base, those would be the core ones. Those are the ones we look for first.
Nat Burgess
That makes sense. I’d just like to echo the clarity point. Obviously we work with a lot of privately-held companies, and there’s often an “aha” moment where you start looking at how the customer is using the product and what they value. Then you realize there’s more value there than they realize if you can package it and express it adequately. That’s an exciting revelation.
Geoffrey Baird
I’ll add one thing. I’ve been in that position and actually invested in companies where I’ve seen them not articulate it well, but with our understanding of what is there, by working with the CEO, we know we can unearth another growth opportunity.
Nat Burgess
I’d like to thank our PE panel, Joe, Rob, Pete, Geoffrey, we really appreciate you taking time out to join us today. I know it had a lot of value for our guests. Thank you very much.