Introduction
Timothy Goddard
Good day to you wherever you happen to be. My name is Tim Goddard, VP of Marketing here at Corum. We are very excited to be bringing you part two of our annual report, looking at the impact of PE on tech M&A, as well as a few other things. We have a packed agenda with some of the top buyers in the world represented on the call today and we’re looking forward to hearing from them.
You Only Get One Chance with Buyers: Are You Ready?
Before we dive in, Bruce Milne, our CEO and founder has some thoughts and concerns about what we’re seeing in the marketplace today and the opportunities for owners of technology companies. Bruce?
Bruce Milne
2017 is shaping up to be the best year ever for tech M&A. Indeed we’re seeing a number of preemptive offers. CEOs are selling companies in a panic, calling us and asking what to do now.
First of all, you never want to deal with only one buyer. That’s not how you get optimal value. I put together a quick list here of things you want to think about, a baker’s dozen. The big companies see three to five hundred opportunities a month. They will give you a chance, but only one. So you don’t want to blow it.
1. First is preparation. Are you prepared for partnering discussions? That very first question, improperly answered, may end your chances.
2. Research. Do you know what they need? Why you are superior to competitive options?
3. Trends. How do you map to the disruptive trends that drive tech M&A today? Can you properly position your company as an opportunity? Your executive summary has to persuade within two sentences. It can’t start out as a history lesson or a spec sheet.
4. Buyer contact. Do you know who to contact within the firm? At what level? I will tell you, it’s not the current folks you might be dealing with.
5. Buyer process. Do you understand the buyer’s submission and decision-making process, the bottlenecks and the timelines involved?
6. Other buyers. Do you know the little-known buyers who are paying top dollar today? You see them in our reports every month. They’re the ones driving the value up. Leave them out at your peril.
7. Due diligence. Are you truly ready for due diligence? Or will you step on one of the many due diligence landmines that will blow up your deal or at minimum kill value.
8. Process. Is a process in place to handle all the dialogs with potential partners? Properly-timed discussions to create an auction environment. That’s how you get the value you want and an optimal deal.
9. Financials. Are they ready? Are your past financials clean, at least the past three years? Are you GAP compliant? Do you have solid, three-year dependable projections? You’ll need them.
10. Professionals. Do you have knowledgeable professionals in place, ones who have specifically done tech M&A deals. You don’t want ones that will kill your transaction because of ignorance or ego.
11. Valuation. Do you know how to gain the high ground in valuation discussions, what methods and costs to use?
12. Negotiations. There are a lot to negotiation. Structure, liability, price, employment agreements, non-competes, and you may be negotiating with your future boss.
13. Lastly, work load. Do you have another 60-80 hours at times, per week, to dedicate to the most important transaction of your life? It has to be done right.
If you haven’t been to one of our conferences, I would really encourage you to go, especially our Selling Up Selling Out bootcamp. The better prepared you are to answer these kinds of questions, the greater your chances for success to get that optimal outcome that you want and deserve.
Timothy Goddard
Thank you, Bruce. That’s good advice and in particular, coming up on March 2nd, we have a Selling Up Selling Out conference here in Seattle at our headquarters. If one is not coming up in your area, then we’d love to have you here.
February 2017 Research Report: PEs on the Prowl
Timothy Goddard
Let’s turn now to our Corum Research Report, looking both at PE from the past year and also from the last month. Over to Elon and team.
Elon Gasper
Thanks, Tim. Resuming our Annual Report, private equity acquisitions last year saw remarkable changes: A 39% increase in deal count, plus the prior year’s leaderboard stability seems nearly limited to Vista Equity—one of our panelists today—continuing to hold the top spot, with over a third of this chart turning over. Four firms made the chart for the first time: EQT, H.I.G., Genstar and Providence, with GTCR returning after a year’s absence and Accel-KKR (also on our panel) back for the first time since 2013. Within the ranks, KKR and Thoma Bravo moved into the top three, unseating Insight and ABRY, pushing them into the next three to join TA Associates, yet another of our panelists today.
Two-thirds of the deals were for bolt-ons and tuck-ins, reminding smaller companies that demand for followup acquisitions to grow platforms by filling gaps and patching holes means a broad and carefully-targeted search for PEs with portfolio matches is essential to an optimal M&A process.
For example, early last year Vista bought Denver-based Identity-as-a-Service specialist Ping for $600M, establishing a platform, then a few months later acquired UnboundID, a much smaller firm doing an estimated $15M revenue, adding its Austin staff and Social Login technology to grow Ping. Other examples, Yasmin?
Yasmin Khodamoradi
Similarly, KKR moved the needle by paying $3.3B for Apax-backed enterprise software maker Epicor, and Thoma Bravo spent $544M for healthcare authentication firm Imprivata. We’ll see what they’ll do with these acquisitions later on.
Calling out another platform, Insight picked up New Zealand document sharing SaaS provider Diligent for $624M, at a strategic-style 6.6x revenue, and Idera, backed by TA Associates, bolted on Corum-client Gurock Software, which makes a leading test management SaaS suite.
Elon Gasper
A few weeks ago in the first part of this annual webinar, we dubbed 2016 “the year of the Megadeal”, as those acquisitions at the billion-dollar or higher level set a new annual record of 76 spanning all six of our market sectors, leading us to predict a 2017 “megadeal market echo” of demand for bolt-on, tuck-in and competitive response follow up acquisitions to round out these big transactions, nearly a third of which were executed by PE, again across all six of our market sectors with the highest concentrations in horizontal and vertical.
Yasmin Khodamoradi
Those are comfortable sectors for PEs seeking growth-ready businesses built on scalable SaaS models that are actively defensible by domain expertise.
Our top three PE acquirers were no exception as significant platform plays in Horizontal sub-sectors like Adtech, BI, supply chain, and ERP in addition to vertical deals in government and energy are primed for bolt-on activity over the coming years.
Elon Gasper
And that’s our 2016 PE backdrop. Turning now to 2017, we begin with the public markets, where we’ve seen multiple tracking averages in the US breaking records, including the Nasdaq and the Dow 20,000 mark as it gained 15% since just last June.
This long Bull market is now within weeks of completing its seventh year. On balance we see the underlying trends continuing to support tech M&A with highly favorable conditions for sellers.
Our January Corum Index saw buyers still focused on opportunities to “move the needle” as the megadeals count kept up with 2016’s blistering pace while overall transaction numbers were slightly lower year over year, with megadeal momentum still pinching bandwidth for other deal flow. Private equity continued to take share.
All 5 January megadeals fell into the three markets we’ll cover today. We’ve already described Gartner’s multibillion dollar purchase of CEB in last month’s webinar, so let’s start with a broader look at IT Services. Thomas?
IT Services Software Valuation Metrics
Thomas Wright
IT Services multiples maintained their historic highs, powered largely by the Focused IT Services trend. As the trend advances, it is producing demand for smaller, innovative shops - witnessed by the multitude of acquisitions around the Microsoft ecosystem – Canada’s Microsoft cloud solutions provider with a focus on energy Stratiform was purchased by PCM for $1.3 million. Toronto-based Microsoft systems integrator Navantis was acquired by Colorado-based managed services provider, Datavail. AND San Diego-based ERP and CRM consultancy Tridea Partners was grabbed by Denmark’s Columbus for $6.7 million, for its deep expertise in Microsoft Dynamics.
Indian IT services giant Wipro followed the trend, paying $9M – or 14x EBITDA – for Brazil-based InfoSERVER and its focus on security-based services for the banking and financial industries.
Deep domain-mastery is also in demand when dealing with the government – spurring Harris to sell its IT division and client relationship with NASA to Veritas for $690M.
Not to be left out, Accenture—Corum’s #3 strategic acquirer of 2016—started the year with three focused acquisitions. solid serVision was acquired for its ServiceNow systems integration and aptly-named California-based InvestTech Systems was purchased for its expertise with investment technology. And to solidify the consulting giant’s presence in the IoT ecosystem, they acquired IoT Product design and consultancy Altitude.
Infrastructure Software Valuation Metrics
Elon Gasper
Infrastructure sales ratios have stayed in a tight range over the last 12 months as EBITDA ratios have hit levels not seen since 2014; both remained stable in January.
Application Programming Interfaces—APIs—have grown from a few simple standards into a maturing infrastructure of their own, which means M&A deals to grow key platforms, the latest last month as Oracle bought Apiary, adding its frameworks and governance solutions to build out the Oracle Integration Cloud.
It’s over a year since Hewlett Packard divested its PC, printing, and other non-core tech units to concentrate on high-growth enterprise markets. Now refocused as HPE, the previously slow-moving behemoth just executed a flurry of acquisitions to try to make up ground on the established Cloud giants, starting last month by paying $650M at 6.5x sales for hyper-converged infrastructure specialist SimpliVity, then bolting cloud metering firm Cloud Cruiser onto its data center care portfolio. And just last week, it bought a behavioral analytics provider Niara to integrate into its Aruba subsidiary’s security suite. Clearly HPE feels a need to establish a hybrid cloud line of defense to support its hardware market against the public cloud onslaught; a great example of the kind of set-up you’re waiting for as an entrepreneur, when tech giants respond to disruption with fear and urgency.
Another dramatic example occurred as application performance management outfit AppDynamics saw its IPO canceled at the last minute as it was snapped up by Cisco for $3.7B at a remarkable 17x sales multiple, showing the premium a big company is willing to pay for key market tech when it perceives a pressing strategic need.
Vertical Software Valuation Metrics
Yasmin Khodamoradi
Sales and EBITDA multiples in the Vertical market maintained the high levels achieved last quarter. For the first megadeal in the sector, Francisco Partners-backed CoverMyMeds was bought by health distributor McKesson Corporation for over $1B, strengthening their offerings in the pharma and healthcare verticals.
The automotive theme continues to drive M&A on both sides of the Atlantic, as Berlin-based Autonomous was landed by TomTom to advance its map-based products for self-driving via 3D sensor technology, and Marcou, the owner of ground transportation brands like Boston Coach and Super Shuttle upgraded their tech offerings by purchasing New York-based booking tool GroundLink, and Limo Anywhere, a limousine management platform out of Texas.
In the education market, K-12 assessment supplier QUESTar Assessment was pocketed by Educational Testing Service for about $128M to help narrow the gap between learning and accountability. Software Secure, which offers remote proctoring solutions for higher education, was bought by PSI Services. And, Intellus Learning, which provides educational content management SaaS, was picked up by Macmillan Learning.
In the real estate space, Showing Suite, which provides scheduling and feedback SaaS for real estate agents, was acquired by competitor ShowingTime and Floored, which provides 3D graphics and visualization SaaS, was purchased by CBRE Group to enhance their marketing of properties, complementing their earlier investment in Matterport’s VR 3D mapping tech.
Elon Gasper
Finally, speaking of VR, European giant Schneider Electric took a step into augmented and virtual reality by acquiring Italy’s MWPowerlab, an AR/VR sim training specialist. The deal should enhance Schneider’s operator training and immersive simulation software for enterprises, and pressure other industrial automation players still behind in VR-style simulation capacity, as it’s quickly becoming the new norm.
Fast, fierce and unforgiving change means more M&A, right, Tim?
Timothy Goddard
It seems like it.
Private Equity Roundtable
Now I’m looking forward to speaking with some of the folks that are making that happen, not just some of the largest PE buyers, but some of the largest buyers of tech, the largest buyer of tech, in fact, is who we’re going start off with. Renè Yang at Vista Equity Partners, followed by Michael Libert at TA Associates, and Maurice Hernandez at Accel-KKR.
Let’s start with Renè, who is based in Austin.
Renè Yang
Thanks, Tim. I run a $500M fund within Vista, and while we are a $29B firm, we have a fund that is dedicated entirely to helping software businesses between $10-30M in revenue scale. We often partner with founders and management teams, who have really reached that inflection point in their business, where they are looking for a partner who can provide the operational experience to help them grow. Our portfolios can really leverage all the lessons we have learned working across 200 software companies of all sizes and verticals, and who have faced all sorts of challenges.
We host the Practice Sharing summit, we have written 110 best practice white papers, and we have a team of 90 software operators in our consulting group who can really help our companies tackle challenges.
Given our deep exposure to the software market, I wanted to share a couple of insights. The first is that there really has been a move for investors to focus more on balancing growth and profitability these days. Gone are the days where growing at all cost is the best strategy. These days I think really finding the balance between organic growth and profitability is what gets the highest valuation. And, when it comes to profitability, particularly when it comes to smaller companies that are still trying to build scale, it is much more important to focus on gross margins than it is on EBITDA margins, especially if you are still investing significantly.
So, if I were a CEO, I would really try to prioritize trying to have my business have the highest gross margin possible, because that just means more dollars you can funnel into sales and marketing or product or infrastructure, while still maintaining the option of being profitable in the future. This is truly how you build the foundations for real operating leverage.
The other insight I wanted to share is that these days investors really do come in all sizes, shapes, and forms. It is important to find that right partnership and cultural fit for both your style and needs. I think some CEOs really need a partner who just provides capital and lets the management team run their show. Other CEOs are at the other end of the spectrum. They need a thought partner that can add value and help them grow their business.
I really recommend, before going down the path of taking on capital, spend some time and do some introspective thinking on what type of partnership both you and the business need the most and then take the time, talk to investors, see the difference between them, talk to your peers who have first-hand experience, talk to bankers who have had a lot of exposure to various firms, because you’re not going to have the time to figure it all out in the middle of a transaction. So it is important to really invest the time to figure it out beforehand. I think we all know that ultimately this is a big decision and unless you are selling 100%, you will have to live with your choice for many years down the road.
That’s all I wanted to share for now. I’ll be happy to elaborate on either of these or anything else you are interested in discussing during the Q&A.
Timothy Goddard
Thank you. Please use the Q&A window on the right side of the screen if you do have questions for our panelists.
Now let’s go to Michael Libert from TA Associates in Boston.
Michael Libert
Hi, I’m Mike Libert, I’m a VP at TA Associates. We’re a 49-year-old PE fund investing out of a $7B fund today. We focus on profitable growth businesses, specifically within technology with a big focus on software.
To us, a great business is one that is capital efficient. What I mean by that is that they deliver good returns on their investments, whether that is growth or profitability. I’m a big believer in the rule of 40, which is the sum of your revenue growth and your profit margins. If they can hit 40% or higher, I think that is a good example of a business that is capitalizing pretty effectively on their market opportunity and balancing investments and growth very effectively.
Some of my concerns that I would advise around for the coming year, are we are now entering the eighth or ninth year, depending on how you look at it, of an expansionary economy. I think it’s now the third longest running economic expansion since the great depression. At some point, inevitably, there will be a pullback. My advice would be to think very effectively around what are your key investments for the year, what is it nice to have versus a must have in terms of your priorities, and optimize around those. I do worry that there could be a pullback economically as well as in the market in the coming year or two.
In terms of prices paid in the market today, we are seeing multiples at an all-time high in technology, specifically for scale assets. PE and investing broadly is a threshold business and when I say that I mean that as you get larger, the rarity of that scale increases, the scarcity value increases, and the corresponding multiple goes up. There are a large number of buyers for what we call mid-market companies, I think about those as being $30M of revenue and higher, and that market is larger as you get bigger, so therefore naturally the price goes up as the demand increases.
Below that there is a higher supply of businesses, naturally, the bottom of the pyramid, and a lower pool of potential buyers, because buyers are really looking for scale. One of the things we do believe is that bulking up is a great way to deliver compelling valuations to selling shareholders, and my advice would be thinking about if you can add scale organically, that is certainly valuable, but if you can add scale inorganically by combining with a competitor business or completing an add-on of an adjacent product or business in your market category, that’s a compelling way to increase the multiple and of course building value of your enterprise.
Timothy Goddard
Thank you, Michael.
Now let’s hear from Maurice in Silicon Valley. Maurice, what kind of trends are you seeing in the market today?
Maurice Hernandez
One trend that we are seeing in the overall software market that we think is interesting is that we continue to see companies that are purchasers of software favor solutions that have less overall friction, whether that is in the buying process or with the actual use of the software, and how that translates well for SaaS companies who are able to sell their software with bite-sized implementations compared to historical implementations of large on-premise deployments, and also with SaaS companies who now have more modern GUIs which make it easier for users to use and access a software system and that is playing well for SaaS companies, when really modern SaaS companies are able to win share from larger enterprises and more traditional vendors.
The other trend that we have seen, especially with SaaS, is that more SaaS companies penetrate markets that have historically favored on-premise solutions, and we have seen this now in traditional industries such as the national services and insurance that have really favored keeping their data in house and are now much more willing to leverage the cloud and seeing the benefits of that. We’re also seeing SaaS be more adopted in industries like construction, where ERP was traditionally favored to be on an on-premise basis. We’re seeing the same thing at certain geographies, especially in Europe where they traditionally favored on-premise, now they have a greater appetite toward using SaaS.
One thing that we’re seeing now with investors is that in different cycles investors used to favor growth at all costs, and now we’re seeing investors assign higher values to companies that are able to show both growth as well as profitability. So a combination of both seems to reward companies more so than just growth alone.
In terms of what we are very excited about, and we work with mid-sized technology companies, over the last ten years or so, we’ve been seeing more midsize companies really be excited about a global growth opportunity for this software. What we’re seeing is that entrepreneurs over the last few years have been increasingly more aggressive in terms of chasing that global opportunity and that is where we feel you can really get a company to scale quickly, and that’s what we’re excited about.
Timothy Goddard
Thank you.
Q&A
We’ll now go to Q&A. Feel free to add your own questions as we go.
One of the things that is pretty clearly now a trend, you all hit on it, we have moved away from the era of buying growth only and it really is a mix of both growth and profitability or margins. To that end, Renè, you talked a bit about the question of EBITDA versus growth margins. Michael, I know you have a slightly different take on that. Would you like to give us your thoughts on that question?
Michael Libert
Sure. I think finding growth this far into the economic cycle is very difficult on a sustained basis. If you can continue to deliver organic growth, that’s terrific, but I think about growth not just organically, but complimenting that through add-on acquisitions, and I know Corum has deep domain expertise and a perspective on that.
In terms of the ratio I talked about, that rule of 40, it’s all about are you getting the bang for your buck when you are making an investment? Whether it be in sales and marketing or R&D or management expertise, in terms of the return on that in organic growth or other means, and if you’re not, really being laser focused on improving your profit margins and getting some value for profits, because I think there’s a big premium being paid for that as well today.
Timothy Goddard
Great. Renè, over to you on that question of gross margins. What does a good gross margin look like? In fact we had a question specifically from the audience on that. Say, for a $10M annual revenue SaaS company, what would the ideal margins be there?
Renè Yang
Yeah, sure. So, gross margins are all about unit economics at the end of the day. The higher your unit economics are, the more money you get to spend on other things that don’t have to go into the cost of goods sold, so it’s really hard to get to 35% EBITDA margins in the future if your gross margins are only 50%. It just means you have to be super efficient with development or sales and marketing. So, as software investors, I really view good gross margins as something that is higher than 70%. The nice thing about gross margins is that unless you are super small, whether you are a $10M revenue company or $30M or $300M, getting to 70% or higher gross margins, if you’re a true software business, is pretty achievable. I think anything lower than that would make me ask whether or not there is a high amount of unprofitable services or hardware.
The other thing I would say is that it is also important to make sure you are allocating the right costs into gross margins. When we think about gross margins, it is really on a functional level, and cost of support heads, hosting costs, cost of professional services or implementation people should all go in there. So if I see a company with 90-95% gross margins, it probably signals that they are not actually putting all the right costs in there.
Overall I would just make sure that first you are allocating the right costs into gross margins and then really focus on improving your unit economics to be as high as possible, because I think the higher that number is, it’s how you’re going to create operating leverage over time.
Timothy Goddard
Great.
Maurice a question for you, moving away from the hard number questions, because obviously more goes into it than that. When you first meet with a CEO, what things intrigue you and what things scare you off?
Maurice Hernandez
In terms of what intrigues us as a firm, I always start with what is the story behind you starting this company. That’s what we really get excited about, that’s where we see the passion and where we really understand where this entrepreneur would like to take his company forward.
In terms of what scares us or what we are watching out for, when we are looking at a partnership, and there’s a saying that after you get in bed with a PE firm it’s harder to get out of than a marriage. For us, we really look for someone who can be a very good partner and we assume that the person across the table is looking for the same. What we’re really looking for is someone who we really feel would be very aligned with us. That is the foundation for a successful partnership.
We really encourage the entrepreneurs that manage the teams that we work with, someone else mentioned it, but to really get to know the potential investor in their company and to do their diligence. Because outside from hearing from the investment team themselves, we encourage any potential management team that would be working with us to call our former management teams. And not only for those situations where we’ve had great outcomes, and we’d be more than happy to share that, but also for all the situations where we’ve been in a tough spot. I think that really understanding the level of engagement and alignment is important for a management team and we probably don’t see them do that as much as they should.
Timothy Goddard
We have some more questions coming through. We’re coming up on the half hour, but if you’re able to stick around, we’ll keep going, our panelists have been willing to stay with us for a little longer. If we don’t get to your question we will follow up with you by email.
Michael, when you guys are talking about growth, what are you talking about? Year over year growth? Five year? What kind of growth are you most concerned about?
Michael Libert
Consistency. I think consistency is the most important to us. Volatility is very intimidating for a lot of firms, at least for us. I’d rather see a business that can consistently deliver 10 or 15% year over year growth, year-in year-out, in terms of that predictability. Seeing one great year with 30% growth and the prior 5 years being suboptimal for that, it’s hard for us to believe that is sustainable and we can project and believe that we can sustain it over time.
As a PE investor, we plan to be your partner for 5-7 years and we need to believe that the market opportunity and the business model you have developed can continue to deliver that growth for us as investors as well. That’s why we want to see that consistency, that repeatability, that growth is most important to us.
It’s hard for us to get behind one great customer that has had a terrific year. Concentrations are very difficult for us. Instead of reaching for the sky, as I would say, can you deliver 6-8% every single year instead of trying to have a heroic year after several volatile ones. It’s hard for us to build confidence behind that.
Timothy Goddard
Sure. Renè, what are your thoughts on the question of growth?
Renè Yang
I completely agree with Michael, I think the consistency is really important. In addition, our focus would really be on recurring revenue growth. Often businesses, part of the business is recurring revenue and part is one-time revenue, which is often license or services. I would much rather see consistent recurring revenue growth than continued one-time growth. As we all know, recurring revenue is king, the more recurring revenue you have the less you have to sell new in the following year. Making sure that the recurring revenue stream is healthy, growing, and has good retention is going to be a higher priority for us than growing the one-time revenue.
Timothy Goddard
Makes sense.
Here’s a question, and it’s something that comes up quite a bit. I’ll leave it as a jump ball for whoever has insight for it. When you’re talking about things like gross margins and you are looking at a company that is built on someone else’s platform, where someone else is taking a chunk out of the business, but it also has a large ecosystem that makes it possible, with Force.com, Azure, AWS, etc, how do you look at companies like that. Is that something that sort of scares you away at the beginning, are the metrics different? How do you look at those companies in that situation?
Renè Yang
I can answer that. I would say for those businesses, I don’t view it any different. But that licensing cost that you will have to pay to Force.com or Azure, that just eats into your overall gross margins. As long as your overall gross margins are still above 70%, I think overall we would treat those businesses no different. It is attractive that it is built on a platform and you have exposure to a great ecosystem, but if you’re going to pay 8-15% to some of these platforms, it just means you have to be pretty efficient with the other parts of your business so that it doesn’t eat away at your overall gross margins.
Michael Libert
I agree with that comment. That serves as a channel for your business, and therefore your sales and marketing have to be that much more efficient. If Salesforce is bringing you to market, you need to take advantage of that in terms of the pre-qualified access to those customers in that example. Make sure your sales and marketing costs are leaner because you are paying that big toll, as Renè mentioned, every year. I think if you are efficient around it, it’s still a great business and a great business model and it can help you scale faster, but you have to be more thoughtful about different elements of your expenditures.
Maurice Hernandez
I agree with both of those points. Case in point, Viva Systems, a publicly listed software company has used the Force platform and they have consistently delivered 30% growth and over 30% margins for many years. So companies are able to achieve the same kinds of metrics that companies with proprietary software systems have been able to provide. I would, however, note that many investors would not view them as equal. Rightly or wrongly. I think if you were managing a team with a company using a lot of third party software, I would just be prepared for the questions an investor may ask of you. That is, what is the risk of using third party software? Are there any terms around that agreement? If you are licensing a code base, when will it be renewed? What is the down side with doing that, because there is inherently more risk in having your own proprietary software, to a certain extent.
Timothy Goddard
Great. Thanks so much to our panelists for joining us and giving us some extra time. Thanks for attending and we will now go to our closing.