Venture exits abound but shrink

by Scott Denne

Although unlikely to match last year’s record haul in dollar terms, the liquidity in this year’s VC exit market is more evenly distributed. Through the first half of 2019, more venture-backed companies are on pace to exit than in any year since 2016, shaking off a years-long decline in exit volume. At the same time, blockbuster deals are trending down as many of the venture community’s most reliable buyers have stayed out of the market and some of the most promising vendors opt for public listings.

According to 451 Research’s M&A KnowledgeBase, 359 venture-funded companies were acquired through the first half of 2019, a pace that’s up 15% from last year, which was the lightest year for venture exits, by volume, since 2010. So far, sales of VC-backed tech vendors fetched just $18.9bn, compared with $85.6bn in all of 2019. Although exits are set to pull in less than last year, sales of companies from venture portfolios, if the current pace holds, would generate more than all but two years in the current decade.

Even as more deals print, the typical value of those transactions holds steady from last year’s level. The median deal value of a 2019 venture exit (via M&A) stands at $100m through the first half of the year, slightly down from where it finished last year, and far higher than all other years this decade. It’s a decline in big-ticket acquisitions that’s weighing on this year’s total deal value. So far, only two venture-backed vendors have sold for more than $1bn, compared with 13 in all of last year. Put another way, if past is precedent and 2019 ends with a total of four $1bn VC company sales, there will have been as many $1bn-plus exits in 2019 as there were $5bn-plus exits a year earlier.

Still, it’s not likely that acquirers have lost interest in inking substantial purchases of VC-backed targets. After all, the rise in the stock market through this year has bolstered valuations of many would-be buyers and should make them more willing to do big prints. Instead, venture-backed startups have more exit options and are getting more expensive. The multiple Google paid in its $2.6bn pickup of Looker speaks to that (subscribers of the M&A KnowledgeBase can see that multiple here). Instead of selling, many of the most attractive targets are eyeing the public markets, where, as we discussed in a recent report, many new issuers are fetching multiples north of 40x trailing revenue.

No hard turns for application software market

by Scott Denne

Both strategic acquirers and sponsors have increased their purchases of application software vendors as the market for those targets accelerates beyond last year’s record. As those buyers stayed active, the largest deals grew larger and multiples continued to climb. Rising valuations for growth companies in the public markets – both new offeringsand already-public businesses – have pushed up pricing for software targets and could help propel deal sizes through the rest of the year.

According to 451 Research’s M&A KnowledgeBase, 632 application software providers have been acquired for a combined value of $59.2bn, on pace to top last year’s record haul in both value and volume. In our analysis of last year’s activity (published as part of 451 Research’s Tech M&A Outlook 2019), we noted that 2018 marked the first year that acquisitions of application software vendors crossed 1,100 as both strategic buyers and private equity firms accelerated their purchases.

The same trend has driven this year’s market as well. Both categories of acquirers are up from last year’s pace. Yet the number of big-ticket transactions is down a bit. While 29 application software providers sold for $1bn or more in 2018, only nine have done so this year. But those that have crossed the 10-figure mark have done so in a big way. Since the bursting of the dot-com bubble, only four such targets have sold for more than $10bn and two of them (Tableau Software and Ultimate Software) did so this year.

To be clear, the relative decline in the number of big-ticket acquisitions hasn’t pulled down the total deal value. If the current pace of deal value were to hold through the end of the year, it would finish more than one-quarter higher than last year, which smashed the previous record by nearly 50%. Put another way, at the midpoint of 2019, the total value of application software transactions is higher than all but two full years, our data shows.

Although fewer software vendors have sold for north of $1bn, those that have are fetching higher prices. According to the M&A KnowledgeBase, the median multiple for those deals this year stands at 8.1x trailing revenue, nearly a full turn above last year’s total. That rise comes amid a 22% year-to-date increase in the Nasdaq index and a welcoming environment for new tech listings, including software companies like Slack and Zoom Video, which commanded 62x and 41x multiples at the midpoint of the year, following their recent public market debuts. Such a compelling alternative exit could continue to boost acquisition prices.

Will not mixing blue and red yield green?

by Brenon Daly

IBM has wrapped up the single most significant reshaping of its 108-year history. Now comes the hard part.

After more than eight months of review by regulatory officials around the globe, Big Blue officially owns Red Hat. The $33bn deal stands as the largest software acquisition in history – almost twice the size of the second-largest deal in the space, according to 451 Researchs M&A KnowledgeBase. Corporate deal-makers that we surveyed in December 2018 voted IBM-Red Hat the most significant acquisition of 2018, a year that featured an unprecedented 100-plus tech transactions valued at more than $1bn.

Beyond the sheer scale of the blockbuster deal, the combination promises an outsized impact on IT departments as it pairs IBM’s extensive commercial relationships with many of the largest companies with Red Hat’s close association with many of the most popular technology trends. Most notably, Red Hat – a company that generates some $3bn in sales and is still growing at a solid mid-teens percentage pace – has developed key pieces of open source software for cloud computing (Red Hat Enterprise Linux), OpenStack and containers (OpenShift).

Now that it owns Red Hat, IBM faces a tricky balancing act in getting the hoped-for returns from the massive combination. (Like most large-cap tech acquirers, Big Blue has a decidedly mixed record in M&A. It is in the process of unwinding many of its purchases of business applications, while another relevant acquisition – IBM’s billion-dollar-plus purchase of SoftLayer – has underdelivered.) IBM’s challenges with Red Hat are even sharper than its other acquired proprietary software vendors because Red Hat, an open source software stalwart, had vast technology partnerships, including some with vendors that compete directly with IBM.

Conscious of that, IBM has pledged to preserve Red Hat’s historic neutrality in the cloud wars. (Don’t look for any ‘blue-washing’ of Red Hat now that the deal is closed.) The degree to which IBM follows through on running Red Hat as a stand-alone platform for the increasingly hybrid-cloud world will go a long way toward determining the returns on the deal.

Big Blue should know that the odds are only a slightly in favor of it pulling that off, at least in the view of the one group that matters more than any others: customers. In a novel survey shortly after the deal was announced last fall, 451 Research’s Voice of the Enterprise spoke to several hundred IT executives to get their perspectives on IBM’s plan to purchase Red Hat. The headline finding had a plurality of respondents (40%) indicating they are ‘neutral’ on the deal. Of the remaining portion of IT folks, however, only a handful of respondents said they were more bullish (31%) than bearish (29%) on IBM-Red Hat.

PE, not just VC, joins the IPO parade

by Brenon Daly

The tech IPO parade continues, but with a twist. Rather than having its journey to Wall Street backed by truckloads of venture dollars, the first enterprise-focused company in the second half of 2019 to put in its S-1 is coming from a buyout portfolio. Dynatrace is a private equity-backed spinoff, not a VC-backed startup.

The planned offering by Dynatrace would be the latest move in a rather unconventional journey to the public market by the application performance monitoring (APM) vendor. Founded far from Silicon Valley, Dynatrace got its start in the sleepy Austrian town of Linz in 2005, taking in only $22m in funding before exiting to Compuware in July 2011 for $256m, or 10x invested capital.

Compuware itself was taken private by buyout firm Thoma Bravo three years later for $2.5bn, which, at the time, represented Thoma’s largest single transaction. Shortly after, Thoma spun off Dynatrace from its one-time parent and consolidated its new stand-alone APM holding (Dynatrace) with an existing one (Keynote Systems, which Thoma took private for $395m in June 2013).

After all that addition and subtraction, Dynatrace now looks to debut on Wall Street. That’s a trick that rival AppDynamics wasn’t able to pull off because Cisco Systems snapped the venture-backed company out of registration. Assuming Dynatrace does make it public, it would mark the first IPO in the fast-growing sector since New Relic went public in December 2014. (New Relic currently sports a $5bn+ market cap.)

But it certainly won’t be the last. Dynatrace’s sometime rival Datadog, which has raised $148m in venture backing, is thought to be eyeing an IPO of its own. (Subscribers to the Premium edition of the 451 Research M&A KnowledgeBase can see our full profile of Datadog, including our proprietary estimates for revenue for the past two years.) Meanwhile, subscribers to 451 Research’s Market Insight service can look for our full report on Dynatrace’s proposed offering on our site later today.

PE slows its roll

by Brenon Daly

Buyout shops aren’t buying like they have been. After seven consecutive years of increasing the number of tech acquisitions they announce annually, private equity (PE) firms are on pace for a slight decline in 2019. The slowdown comes as the formidable buyers also start to scale back their purchases, shopping much more in the midmarket than in the billion-dollar range.

As we noted in our full report on tech M&A in Q2, we recorded an uncharacteristic drop in the number of announced deals in the April-June period by buyout shops, which had been the sole ‘growth market’ in tech M&A recently. PE firms have doubled their number of tech transactions in the past five years, but in Q2, they posted a second consecutive year-over-year quarterly decline in deal volume, according to 451 Research’s M&A KnowledgeBase.

To be sure, we don’t want to overstate the slight decline in PE activity. Based on midyear projections, between direct investments and bolt-on acquisitions by portfolio companies, deal volume for financial acquirers looks likely to drop about 6% in 2019, compared with 2018. Buyout shops still account for about one of every three tech acquisitions, our data indicates.

Within that slight decline in the number of prints, however, is a much more significant shift in where they are looking. PE firms are moving down-market in 2019, no longer looking to bag elephants. (Our Q2 report examines this trend in much more detail, as well as compares acquisition activity by financial buyers with their strategic rivals.)

Assuming the first-half pace holds, buyout shops are on pace to ink one-third fewer billion-dollar deals in 2019 than they did in 2018. So far this year, the M&A KnowledgeBase has recorded just 11 purchases by financial acquirers valued at more than $1bn. That’s the fewest big prints for PE firms in the first half of any year since 2015, when PE held just a mid-teens percentage share of the tech M&A market, or merely half its current level.

Machine learning curve

by Scott Denne

As the first half of the year comes to a close, the accelerating pace of machine learning (ML) M&A continues. But what’s changing is the rationale behind many of those acquisitions. Buyers are less interested in picking up ML teams and tech to build broad capabilities. Instead, they’re gravitating toward targets that have specific expertise or technologies to fill product gaps.

Each year since 2013, when 19 companies developing ML technologies or products were acquired, the number of such deals has risen by about 50% annually. According to 451 Research’s M&A KnowledgeBase, 124 vendors developing ML technology have been purchased so far in 2019, compared with 159 in all of 2018, on pace for a 55% rise. Yet buying machine learning for machine learning’s sake has declined.

Take the example of Salesforce. By our count, it acquired nine ML providers between 2014 and 2016 as it built Einstein, a platform to incorporate ML across its software portfolio. It has grown more selective since, nabbing just two such companies in the two and a half years that followed. Similarly, from 2014 to 2016, IBM purchased eight ML vendors to bolster its Watson brand, although none since.

More commonly, acquirers are turning to ML to solve particular problems. In marketing and advertising tech, for example, there have been a streak of acquisitions of firms that use ML to track audiences across multiple marketing channels. LinkedIn snared Drawbridge to improve its ability to match mobile and web users to a single profile and AdRoll reached for X-ID to do the same as audiences move between mobile web and mobile apps.

Most recently, LiveRamp paid $150m for Data Plus Math to build audience profiles across different video-streaming devices (laptops, mobile, connected TV, etc.) That deal, which brought a team of 25 to LiveRamp, demonstrates that buyers, although they may be more discriminating about the technology, are still paying a premium for ML providers. According to the M&A KnowledgeBase, machine learning targets (many of which are pre-revenue or early-revenue businesses) often fetch $1-2m per employee, compared with about $500,000 for a typical tech transaction.

A summer holiday for tech M&A

by Brenon Daly

The summer holiday came early to the tech M&A market. Dealmakers around the globe announced nearly 15% fewer tech and telecom acquisitions in Q2 than in recent quarters, according to 451 Research’s M&A KnowledgeBase. And they didn’t spend much on the deals that they did get done. Our data shows the aggregate value of tech transactions announced in the April-June period slumped to the lowest quarterly level in a year and a half.

Altogether, the M&A KnowledgeBase shows Q2 spending of $113bn on just 815 tech deals. The slump in Q2 activity comes as strategic acquirers continue their extended hiatus in the market they once dominated. (According to our research, the number of tech transactions announced by corporate buyers has dropped almost uninterruptedly since mid-2015.) In the first six months of this year, for instance, tech bellwethers such as Oracle and IBM, which had averaged roughly one acquisition per month in their M&A heyday, have each put up just one print.

But now, add to that an uncharacteristic slowdown in Q2 tech deals by the other main buying group, private equity (PE) firms, which had been the sole ‘growth market’ in tech M&A recently. Buyout shops have doubled their number of tech acquisitions in the past five years, but in Q2, they posted a second consecutive quarterly decline in deal volume. Spending fell even sharper, with the value of PE deals in Q2 coming in at just half the level of the year-ago quarter.

451 Research will publish a full report early next week on Q2 M&A activity, including a look at prevailing pricing, active markets and the significant changes in how and where PE firms are shopping in tech.

Quality, not quantity, in the IPO market

by Brenon Daly

With Medallia’s paperwork closing out tech IPO activity for the first half of 2019, it’s worth taking a look back at the new listings so far this year. 451 Research will have a full report next week on the unusual flow in the IPO market, but our quick take is that Wall Street got back to business (as it were) with tech IPOs, and that the focus has been on quality, not necessarily quantity.

Not a single B2B tech company went public in Q1, a rare quarterly shutout for startups in a segment that typically finds a warm welcome on Wall Street. The slow start to this year for enterprise tech IPOs left the total number of completed offerings at just six for the first half of 2019, down from 10 offerings in the first half of 2018.

To be clear, we are tallying only B2B tech vendors listing on the two major US exchanges, so our count excludes this year’s IPOs by Pinterest and Uber, for instance. We would note, however, that these consumer tech names, unlike their enterprise brethren, received a rather bearish reception on Wall Street. The high-profile offerings of both Lyft and Uber are currently underwater.

More significant than the number of enterprise tech startups coming public this year, however, is the stunning market value they are creating. Collectively, the six B2B companies that debuted in 2019 are valued at over $60bn, as of the end of Q2. For comparison, the 10 enterprise tech vendors that went public in the first half of 2018 created slightly more than $40bn of market value at the end of Q2 2018.

451 Research will have an in-depth report early next week on the stunningly rich valautions being awarded across the board to IPOs so far this year, as well as which startups from our coverage areas might be looking to cash in on Wall Street’s lucrative interest in enterprise tech right now.

Dual tracks: A singular path to infosec riches

by Brenon Daly

Fittingly enough, there are two main types of ‘dual tracks.’ In most cases, dual track refers to a company simultaneously pursuing both the two exits available to startups, M&A and IPO. By keeping one foot on both roads to an exit, an in-demand startup can cultivate new sources of capital on Wall Street while, at the same time, pressuring any acquirer to effectively outbid the public market. Assuming the laws of economics hold, when supply remains constant, any additional demand invariably boosts pricing.

There is also a smaller-scale version of that process, which happens at a level below Wall Street. In a ‘dual track lite,’ a startup also explores an outright sale and a capital raise at the same time. But in this case, the funding comes once again from private-market sources, such as VCs, rather than the public market.

Of course, to be able to effectively – and profitably – dual-track, a startup needs strong interest from the demand side, from both potential backers and potential buyers. And right now, no other segment of the enterprise IT market has more dollars available from both investors and acquirers than the information security (infosec) market.

When it comes to M&A, the 451 Research M&A KnowledgeBase shows acquirers pay two to three times higher valuations in infosec deals than they do in the overall broad market. (Since 2017, our data shows the prevailing multiple in infosec transaction at nearly 6x trailing sales.) And for those security startups pursuing the other track (funding), there is an unprecedented amount of money available from VCs. In just the past month, for instance, we’ve seen big-money fundings for infosec startups, including:

$120m for SentinelOne. (Subscribers to the premium of 451 Research’s M&A KnowledgeBase can see our proprietary estimates for SentinelOne revenue from 2016-19.)

$100m for Auth0. (Subscribers to the premium of 451 Research’s M&A KnowledgeBase can see our proprietary estimates for Auth0 revenue from 2016-18.)

$100m for Vectra Networks. (Subscribers to the premium of 451 Research’s M&A KnowledgeBase can see our proprietary estimates for Vectra revenue from 2016-19.)

But this flood of VC money has skewed the dual track, highlighting just how inflated funding valuations have gotten recently. Consider the two different outcomes, separated by less than three years, for a pair of rival firms. At the end of May, Dashlane raised $110m. We would note that’s exactly the same amount of money that rival password manager LastPass got when it sold the whole company to LogMeIn in October 2015. All in, Dashlane’s funding valuation was roughly 5x richer than the terminal value of LastPass, according to our understanding.

Medallia heads toward NYSE listing

by Scott Denne

Medallia is looking to become the latest software vendor to test Wall Street’s appetite for new enterprise tech offerings as it unveils its IPO prospectus. The experience management software provider, however, lacks the growth of recent debutants and isn’t likely to come to market with the kind of extravagant multiple that many of the year’s offerings have fetched.

The customer and employee experience software developer’s sales rose 20% to $314m in its most recent fiscal year. Its topline expansion accelerated to 32% in the last quarter, yet that’s still behind the numbers put up by many other enterprise companies to enter the public markets this year. CrowdStrikePagerDutySlack and Zoom Video, for example, are all growing around or above 50% annually and boast valuations ranging from 20-70x trailing revenue.

Medallia isn’t likely to garner a price in that range when it comes public. Still, the offering will likely push its valuation well past the $2.4bn it commanded in a February fundraising. Its main competitor, Qualtrics, sold to SAP for $8bn – or 21.5x – on the eve of its own IPO. Medallia is likely to fall short of that multiple when it begins trading on the NYSE, although it could fetch a premium if it follows Qualtrics’ lead and sells the whole business.

As we’ve noted in the past, there are many potential acquirers, such as Adobe or Salesforce, of customer experience management vendors and a paucity of potential targets with Medallia’s scale. Would-be buyers may have difficultly finding other targets with the breadth of Medallia’s experience management and analytics software. Wall Street investors, on the other hand, have many options for investing in faster-growing software providers.