Introduction

 

Bruce Milne

 

Good day, I’m Bruce Milne, CEO of the Corum Group, host of today’s Tech M&A Monthly; we’re your sponsor.

 

We have a jammed agenda today, with research and a special report on how to do a valuation, but let’s start off with something that has been sweeping the industry, and that is the headlines on non-tech buyers. This month, 451 Group noted activity by non-tech buyers. We’ve actually been seeing that for quite some time. A lot of them are international. These non-tech buyers can be somewhere in your food chain, they can be a customer or a supplier such as the one in the far bottom right there, Blue Cross. Or they can be somebody international you have never heard of, like Le You there in the top left. They’re a major Chinese chicken parts company which paid over $120M for one of our clients. They could be a giant, like Brother, in Japan, the world’s largest maker of sewing machines, beating everyone, or the $50B private company Bosch outbidding Google for an IoT company. Or Hitachi or Glastron, or one of New York’s most active banks, BBBA.

 

The point is there are a lot of non-tech buyers and most of them are international, by the way, so be sure to include them in your global search.

 

So let’s get started and go straight to our Corum Research Report, with Elon Gasper and Yasmin Khodamoradi.

 

Corum Research Report – Highly Active PEs

 

Elon Gasper

 

Thanks, Bruce. We begin with the public markets which continued soaring on the rising updraft of cash being created by central banks like confetti in a cyclone. With cheap money and easy financing for buyers needing growth, it’s a seller’s market and prospective sellers should be taking advantage of this bounceback from the correction of a year ago; consider at least calibrating the value of your company and potentially reaping the other rewards of a process while buyers are so receptive. We don’t know how long this bull will last but with relatively few corrections in his run to date, his next move is unlikely to be up.   

 

The megadeals boom again headlined our Corum Index, which also caught a considerable increase in PE-backed deals, both more than doubling as buyers thought big, reaching for move-the-needle opportunities at home and abroad over smaller and younger firms. Among those megadeals:

 

·         Texas-based managed cloud services company Rackspace went to public PE firm Apollo Global for $4.3B, at just over 2 times revenue.

·         Dentsu Aegis continued its shopping spree with a reported billion and a half dollar acquisition of DC-area marketing solutions firm Merkle.

·         Top translation specialist LanguageLine and its cloud-based platform joined French call center giant Teleperformance for $1.5B in new debt, and mentioned it might buy more.

·         Vertical sector smart meter maker Sensus was snapped up by Xylem for $1.7B; the water tech company plans to spend more than $3B on M&A.

Plus two yesterday in Infrastructure:

·         First, Intel’s security unit returning to its original name McAfee as a few billion from private equity firm TPG re-establishes one of the world’s largest pure-play cybersecurity companies.

·         And second, an even larger deal, HPE offloading a software arm to Micro Focus, vaulting that British firm into the top tier of European tech.

 

Note that tuck-in acquisitions often follow these mega deals, so keeping abreast of the possibilities is an important M&A best practice.

 

We have further news and analysis for 3 of Corum’s six markets today, starting with Horizontal Applications. Yasmin?

 

Horizontal Software Valuation Metrics

 

Yasmin Khodamoradi

 

Horizontal sales multiples hit their highest levels this year with EBITDA slightly leaning back, reflecting the sector’s solid M&A flow.

 

Genesys put its $900M investment from Hellman & Friedman to work, picking up unified communications SaaS provider Interactive Intelligence for 1.4B at over 3x revenue.

 

Greentree International, a multisector ERP player from New Zealand, was purchased by Bain Capital-owned MYOB for over $20M, to enhance its opportunities in the mid-market.

 

Innotas, a project & portfolio management SaaS vendor, was bolted on to Insight Venture Partner’s Planview for $80M and 5x revenue; another example of a PE extending into the mid-market tier.

Meanwhile, horizontal AI applications were in high demand as Salesforce pocketed two such companies for over half a billion dollars. The purchase of Quip’s word processing app and BeyondCore’s enterprise analytics SaaS should help augment Salesforce’s Analytics Cloud with AI.

 

At the same time, Orbitera, which provides a platform for commerce in cloud applications, was sold to Google for a reported $100M to fuel the web giant’s ambitions of competing with AWS and Microsoft Azure. Giants playing catch up is another factor driving today’s seller’s market.

 

What’s going on in the Consumer sector?

 

Consumer Software Valuation Metrics

 

Elon Gasper

 

Sales and EBITDA multiples in the consumer sector both climbed along with the general markets and consumer spending, as gaming sector consolidation took a turn a bit counter the overall trend with interest extending to smaller players and supporting tech such as:

 

·         An MMO gaming add-on hub based in Atlanta, Curse, acquired by the Twitch subsidiary of Amazon, as the Seattle giant extends its gaming infrastructure.

·         And here in Seattle, livestreaming service Beam Interactive was collimated into Microsoft’s Xbox team.

·         Salt Lake City’s Sandboxr was sold to WhiteClouds to bring their 3D printing platform into the videogame market.

·         DEQ Systems, supplying table games to casinos worldwide, was dealt to Scientific Games for about $20M to expand its portfolio and player base.

·         Finland mobile video game developer Kopla was bought by its German partner Flaregames.

·         Finally, LA VR content creator Surreal was wrapped up by media company STX, deploying part of a cash infusion from Chinese giant Tencent.

 

Next, bring us up to date on August’s Infrastructure market, Yasmin?

 

Infrastructure Software Valuation Metrics

 

Yasmin Khodamoradi

 

Infrastructure sales multiples seemed stalled as investors seek the next big thing in AI, cloud, IoT and security.

 

Apple joined the AI race once again, grabbing Seattle-based Turi for a reported $200M. Turi’s platform for developing machine learning applications will help Apple build on its existing AI infrastructure.

 

Intel also made an AI deal, snapping up San Diego-based deep learning developer Nervana Systems for over $400M, in a bid to unseat Nvidia as a leader in deep learning hardware.

 

The demand for security, especially identity access and management software is rising as well, with Tampa-based Sypris Electronics selling its cybersecurity unit for $42M to Analog Devices, which like many has its eyes on securing the internet of things, including Clavister, which acquired its partner PhenixID for about $7M.

 

And 2FA was snatched by fellow Texan Identity Automation adding to its Identity and Access Management portfolio.

 

Elon Gasper

 

Finally, one more from this week, as in line with many of our top ten trends such as AI Enablement, IoT Software, Positioning Intelligence and especially Enmeshed Systems: image processing specialist Movidius, the computer vision expert behind Google’s Tango, was grabbed by Intel as the chip giant embraces the low-power, parallelized capabilities needed for its RealSense line to do things like help drones avoid obstacles and enable motion capture and 3D object scanning.

 

And that’s our report. For next month’s quarterly we’ll fan out to all our 6 markets and 30 sector survey of activity and valuations, on October 13th. Back to you, Bruce.

 

Bruce Milne

 

What’s that last one? Helping drones avoid crashing?

 

Elon Gasper

 

They are swarming around.

 

Bruce Milne

 

My son needs that. We’re on our third drone. Lots of green there. It’s very impressive. All the usual buyers, plus some ones that haven’t been active and oh my gosh, the money being spent by the PE guys.

 

What’s also interesting is you have, what was it, 123% increase in the PE firms selling from last year. Now remember, those guys are smart, money, so if we’re worried about being in the top, we should be looking at what they’re doing, because they obviously sell at the top. Good stuff. Thank you Elon and Yasmin.

 

12 Steps to a Successful Valuation

 

Now we have a special presentation for you today. Twelve steps to a successful valuation. We have gotten lots of questions recently about valuations and what is happening in the current environment. Structure and negotiation are obviously important, but how do you get a maximum valuation?

 

We at the Corum Group have developed a very interesting infrastructure, quite different from everyone else in the industry. We not only reach out to sellers, as you all know, because you’re on this webcast today, but to a lot of buyers as well and many of you are on the webcast as well. We have very interesting and unique infrastructure. We are one of the world’s leading research firms. We have three research operations around the world and we are opening a fourth in Asia. We do lots of publications: Our annual report, the Top Ten Disruptive Trends, and many others. We’re the world’s leading educator, we do up to 200 events around the world. This week alone we’re in three or four different locations.

 

But what a lot of people don’t realize is that we are also the world’s leading experts in valuation. All of this obviously leads to transactions. We’re going to talk about valuations today. A lot of you don’t realize that for the last seventeen years, we have been the author of choice for valuations on software companies by Wiley Company. Now, Wiley is the largest publisher of books for business training, as well as MBA level courses in this financial material. We’ve been very proud of our association with them since 1999.

 

Today we’re going to be talking about some of the lessons that we’ve been teaching in these publications, as well as in our live events like this one and our Selling Up, Selling Out conferences.

 

So let’s take a look at what we’re going to be talking about today.

 

Valuation. First off you need to understand the purpose for this. People speak about valuations as if it’s a singular activity, kind of the same for everything, which it absolutely is not. You have to understand that there are valuations for estate tax issues, there are valuations for a divorce, and what’s acceptable for divorce court is different. If you’re raising bank financing that’s a different kind of valuation. If you’re setting up ESOP, buy-sell agreements, negotiating with venture investors or just for your own curiosity.

 

The valuations that we’re going to be talking about today are for strategic sale for a buyer that will be bidding in an auction environment. In that case the actual process takes precedent in terms of creating value.

 

There are ten ways to value a company:

 

·         Sales multiples

·         Earnings multiples

·         Comparable M&A

·         DCF

·         Replacement cost

·         Dollars per RND developer

·         IRR

·         Liquidation value

·         Book value

·         Internal transaction price

 

We’re only going to be talking about the first five. A lot of these others are very common and in fact the most common ways to value traditional companies. The software companies have a completely different set of metrics in terms of how they are valued, because at the increments, it’s almost all profit.

 

So we’re going to talk about the 12 steps involved in putting together a successful valuation.

 

Firstly, why do you do a valuation? You want to start with a SWOT analysis before you do anything else. Then you want to set it up, creating a company and market overview. Then we need numbers, pull some financials. Then we have to understand the valuation methodology, explain the methods that we are using. What peer groups are involved?

 

Then you have to find your comparables. DCF, using discounted cash flow, and if you do, what discount rate applies? If necessary, do you need to do replacement value? How do you weigh these and when do you present the valuation?

 

Let’s kick off with Rob Schram here at HQ with why you do a valuation. Rob?

 

Rob Schram

 

As a seller preparing for M&A, it’s best to determine your desired outcome and work back from there.  What do you want to achieve by way of deal structure, the transition to new ownership, your future participation, etc?   And of course, how will your company be valued, and are those numbers acceptable?

 

Ultimately the deal value is determined by what qualified, interested buyers are willing to pay, and a broad market engagement ensures that you’re leveraging the right candidates.  Naturally, both sides of an M&A deal will have different ideas about the worth of a target company, so determining your valuation range in advance provides a defensible foundation for proceeding, as well as a framework for setting the expectations of your ownership team.

 

In the following segments you’ll hear about a variety of methods for determining and optimizing your enterprise value.

 

Bruce Milne

 

As a reminder here, we’re talking about valuations that are very much created by the process, creating an auction environment to get to a maximum price, as referenced in this visual.

 

Now let’s go to Rob Griggs on performing a SWOT analysis.

 

Rob Griggs

 

Having a current and updated SWOT analysis greatly enhances your valuation!

 

To really know your Strengths, Weaknesses, Opportunities and Threats is paramount to demonstrating to your acquirer that you know your technology roadmap, your situational analysis, your marketplace, your competitors, your risks, and most importantly how to adjust and leverage the strengths and mitigate or turn weaknesses into non-risks!

 

Knowing and presenting your SWOTs is absolutely a credibility factor for strategic and financial buyers.  This allows you as the seller to be confident in achieving the highest valuation possible.

 

Since every great company I’ve ever worked with maintains a SWOT analysis, this means if you want to be a great company, and achieve the highest valuation, it is time to get busy!

 

Bruce Milne

 

Thanks, Rob. Now we’ll here from Steve Jones on how to create a company market overview.

 

Steve Jones

 

In presenting your valuation, before turning right to the numbers, introduce your company, its market and value proposition, the opportunity, and risks.

 

You should include a summary of the business, its history and technology, along with its unique position in the market.  Also identify other markets where your product or services can apply.

 

This information is based on a few sources: the original executive summary you prepared, the competitive research, plus feedback you've received in dialogue with potential buyers. They will confirm why you're valuable to them, which will help improve value.

 

Along with an accurate view of your market, there should be explicit definition of your business and revenue model, with some reference to other similar companies that might make logical comparables.

 

You will also need to address business or technology risks to lend some legitimacy to the work you are doing. This will affect the discount rate you choose in your computation, which we’ll cover in another segment.

 

Bruce Mline

 

Speaking of income statements, let’s take a look at the numbers. How do you develop a pro-forma financial that all this is based on? Let’s go to Allan Wilson.

 

Allan Wilson

 

A pro-forma earnings statement is a standard accepted financial model used in the valuation process of any business. A pro-forma financial statement has hypothetical amounts, or estimates, built into the data to give a picture of a company’s profits, if certain nonrecurring items were excluded. Pro-forma earnings are not computed using standard GAAP and usually leave out one-time expenses that are not part of normal company operations, such as advisory board expenses that will not continue to be paid post acquisition. Such expenses can be rightly viewed as not contributing to the company’s go-forward representative valuation. A pro-forma financial statement can exclude anything a company believes obscures the accuracy of its financial outlook.

 

Bruce Milne

 

Thanks, Allan.

 

Now let’s try to understand how you apply a valuation methods once you have your pro-forma financials in place.

 

Peter Prince

 

Considering a company's valuation is not an exact science, with a large number of methods available. In simple terms, multiples of both sales and EBITDA are the most commonly used in conjunction with a company's Enterprise Value (EV). Two other methods that can also be used are the Discounted Cash Flow (DCF) method and the Comparable method, where one company can be compared to a similar company that has been sold in the recent past. It is a prudent point to use the numbers aligned with publicly quoted companies as these are easily available in terms of performance and shares price.

 

In some cases, you may also look at Replacement Value: the cost it would take to replicate the product and company. It should always be remembered that none of these methods provide an exact valuation and all of them should be used to at least offer a range within which to work.

 

Bruce Milne

 

Great. That was Peter Prince from the UK. Now to New York and Ivan Ruzic, talking about peer groups, which were just referenced.

 

Ivan Ruzic

 

When it comes to establishing a range of valuations for a transaction, one of the first places that almost everyone starts is with an analysis of public company financials. This is because public data is readily available and also serves as an objective and very public measure of value.

 

The analysis involves a comparison of operating metrics, such as enterprise value to sales, and enterprise value to EBITDA for a peer group; that is to say, a comparable universe to that of the transaction.

 

If there is an art to this, it is in establishing that peer group, which can be based on any number of criteria, such as business focus, company size, or growth characteristics, to name a few.

 

Remember that any valuation based on public companies is no more than just a guide. It doesn’t reflect a potential buyer premiums for strategic value or change of control, nor does it reflect any appropriate discounts. After all, public companies are more highly valued than private ones.

 

This is one of the places where experience really counts and a seasoned analyst is worth his or her weight in salt.

 

Bruce Milne

 

Good stuff, thank you Ivan. Now, once you know your peer group, you have to understand what comparables there are, and that’s not quite as easy. So let’s go to the west coast and Peri Pierone.

 

Peri Pierone 

 

One important approach used in determining valuation of a subject company is analyzing comparable transactions. Most of us know how residential real estate values are driven by comps, and the same principles apply to tech companies. Key criteria for finding good comps include acquisitions of companies that have like business models, ones that are in the same industry, companies that have similar profiles for growth and profitability.

 

Comparative analysis is somewhat perishable. Clearly we prefer recent transactions over older ones. Since many M&A deals are private, finding the right set of comps can be challenging, and is one reason why you want to work with a firm that has extensive research capabilities.

 

Bruce Milne

 

Good, thank you. We talked earlier in the introduction about non-technology firms buying. I can tell you one thing they demand in all valuations is discounted cash flow. Let’s take a look at that with Dan Bernstein.

 

Dan Bernstein

 

The DCF, or Discounted Cash Flow valuation method is the most universally used method by all buyers, tech and otherwise, because it tries to capture the value of your revenues going into the future. And remember, buyers of technology in particular are buying the future, so this has a direct impact on the offer they will put forth.

 

A discount rate is taken to your cash flow for your future three years’ projections, with a terminal value applied for all subsequent years to estimate the possible free cash collected by your business. Smaller, but high-growth, profitable software companies, benefit from a DCF-based valuation. Especially as other methods may not yet apply.

 

Bruce Milne

 

Great, thanks Dan. Several of our speakers have talked about the discount rate and how difficult that is to determine. So let’s hear from an expert on this topic, Steve Hassett.

 

Steve Hassett

 

The cost of capital or discount rate is important.  Its proper calculation dictates the result of a DCF analysis—or in English—how much a buyer will think your company is worth.  It’s highly technical and requires expert analysis. Books have been written on calculating the cost of capital.  I should know, since I wrote one. 

 

In its simplest form it can be thought of in three components.  The risk fee rate, which includes inflation, which is what return would an investor expect for an investment for risk.  Plus a premium for incurring risk, which in itself has components to capture risk related to size, industry and specific to your company. 

 

For the risks associated with growing technology companies the cost of capital will typically range from 15%-20% or more.   It’s important and if the buyer wants to debate it, you need an expert on your side to win the debate.

 

Bruce Milne

 

Yes, you need an expert on your side and you need to take the high ground when you do a valuation.

 

One of the methods that is employed less, but it can be the most important method, is replacement value. Let’s go to Canada and hear from Dave Levine.

 

Dave Levine

 

The classic build versus buy analysis is the foundation of a replacement cost valuation method. The fully burdened costs per person or contractor, the number of full time employees and contractors required, and the number of years in development will go into building this analysis. Not to be overlooked, the time to market factor will be defined with underlying assumptions. With this information, an acquirer will calculate their ability to build it themselves.

 

This method may be useful as a seller where other valuation methods don’t fairly value the investment put into a company, such as raw startups and legacy companies that don’t get high multiples but often have extraordinary investment in technology and expertise through generations

 

Bruce Milne

 

Great, thanks Dave. So now that you have all these valuation methods, how do you blend them together, how do you weigh them? Let’s hear from Jon Scott.

 

Jon Scott

 

A weighted valuation provides a good way to balance the three main approaches we’ve just discussed: Discounted Cash Flow, Public Company Multiples and Comparable Transactions. 

 

The valuation methods can be weighted evenly or you can move the weightings to support your strategy or the dynamics of your market.  For example, if you are a SaaS software company and your focus is on customer acquisition and top-line growth and not on generating high EBITDA multiples, you may want to raise your weightings on comparable transactions and reduce weightings on the DCF method.  The main thing about adjusting your weightings is it provides you with different scenarios to study and build your case before presenting a valuation model to an interested buyer.

 

Bruce Milne

 

Good, thanks Jon. Now the last question is on timing and when you present a valuation. For more on that we’ll hear from our Executive VP, Jim Perkins.

 

Jim Perkins

 

As a seller, when should you present your valuation to buyers?  The answer: as late as possible.  Maybe never!  The marketplace will determine your most valuable attributes. Why short sell yourself when buyers are willing to pay more than you think your worth? 

 

During a properly managed M&A process, buyers will likely disclose their preferred valuation methods, comparables, structures, and reasoning for each, and you can use all of these to craft your valuation if you present it later.  Buyers are often looking for growth in revenues and profits; they are buying your future. Creating an auction environment will increase the value of your company with multiple buyers.  Present your valuation as late as possible, or maybe not at all.

 

Bruce Milne

 

Thanks, Jim, great stuff.

 

We’ll be happy to send you this material, but if you’re really interested, we recommend you go to Selling Up, Selling Out. This is the bootcamp that not only covers valuations, but preparation, structure, negotiation, how you do these transactions. This has been ongoing every week since September of 1990. This is the gold standard in the industry that both buyers and sellers attend.

 

Q&A

 

We have just a couple of minutes for questions. One which came in right away is, “We have a software company to sell. We have an interested buyer, but are wondering how to seek other buyers.” That’s a great question. We’re seeing about 70% of the companies we talk to these days have been approached. That doesn’t mean it’s the right party, and as we’ve seen in our statistics, you’re going to sell more often to someone else and it improves your price dramatically—about 48%—if you go through a full process.

 

When we have an interested party like this and we don’t want to mess that up, you go into the process, do a valuation, share the results of that with the potential suitor as soon as you can. But that takes a little while, because you’re going to have to do all the legwork we talked about today. That’s not easy, that’s serious work on a serious topic. So you do that, and at the same time you’re moving into the marketplace to calibrate interest from other parties.

 

I think we have another one here. “Are there thoughts to be shared on valuations of small technology firms and ITVARS?” We’re seeing a lot of activity in this area. We have a process called “hiatus” where we take a company on hiatus if they don’t get the offer they want or they get feedback from the marketplace. We just had two firms on hiatus, and one was an IT firm that got an offer while they were on hiatus. So, a year or a year and a half ago, the market was saying, “Not now,” and suddenly everything changed.

 

“Do brokers sell themselves or would you recommend someone else?” We’re the leading seller of software companies in history. We don’t recommend someone else. Our process is quite unique. The things we talked about, the eight steps, we use a formal approach, there are only former CEOs in the process.

 

We had a comment here on the SaaS model. This model is clearly going to be necessary, if you aren’t already moving to it, that’s one of the questions that the buyers are going to have to answer. We’ve had several reports on this.

 

“How long does it take to evaluate a small software company?” You have to go through all the steps that we talked about, but I’ll be glad to offer any of our analysts to chat with you and give you some idea about what you might be worth in the marketplace today.

 

Boy, lots of questions here, but unfortunately we’re right at the end. Elon, do you see one there?

 

Elon Gasper

 

We’ll get back to the folks we haven’t addressed by email.

 

Bruce Milne

 

We’re right at the end of our time, but we do have one question here that I can answer quickly. “How is debt considered?”

 

In the buying of companies there is a lot of cash, both with PE and we’re seeing some of the strategic companies get debt to buy. But if you have debt, you have to subtract that from the valuation; that’s how you would do that, but we didn’t get into the details.

 

Thanks for joining us and now we’ll go to our closing.