Cloudflare looks to stoke a flickering IPO market

by Scott Denne

Cloudflare, a network control specialist that unveiled its IPO prospectus this week, will need an enthusiastic reception to get over an already-rich private valuation and an uncomfortable comp. Through 2019, Wall Street has greeted new offerings from enterprise technology vendors with enthusiasm, extending double-digit valuations on the opening days of all new issues. And while there still seems to be plenty of appetite, the enthusiasm has tapered a bit with recent declines in the equity markets.

As Cloudflare looks to debut, it boasts 48% year-over-year topline growth through the first half of the year. And like all startups, that growth comes at a cost. In cranking out $234m in trailing revenue, the company chalked up a $91m loss, with few signs that it will be approaching profitability anytime soon. Unusually, it’s a surge in Cloudflare’s G&A expenses, not only sales and marketing costs, that’s eating away at profitability. In the first half, its G&A expenses were roughly equal to its R&D costs, each of which is about half of the $67m it spent on sales and marketing.

As we noted in a recent report on B2B tech IPOs, all recent issues have come to market with valuations north of 10x trailing revenue. And although most still trade well into double digits, the market has cooled a bit. Of the eight such offerings this year, five are down 10% or more from their opening prices. Even so, the valuations are still generous. Take Slack, for example. It’s down about 20% from its first day and trades at 38x trailing revenue.

For Cloudflare, though, the least generous valuation from this year’s crop belongs to a fellow networking services firm. Fastly, Cloudflare’s competitor in the CDN sector, is one of the few that trades with a multiple that’s in single digits after a 35% decline since its opening day in May. While Fastly trades at 7.5x, Cloudflare will need to get above 12x to top the valuation from its series D round. Despite a 5% dip in the S&P 500 this month, it should still get there. Cloudflare is about 40% larger than its rival, growing 10 percentage points faster and targeting a larger slice of the networking market.

B2B tech IPO activity

Filling up on restaurant tech

by Michael Hill

Point-of-sale (POS) vendors have built up an appetite for restaurant technology as the number of tech acquisitions they’ve made in that vertical has jumped since the start of the year. The uptick in these segment-specific deals arises from the food and hospitality industry’s penchant for embracing digital commerce innovation combined with weak overall demand for POS systems and software.

According to 451 Researchs M&A KnowledgeBase, POS companies have inked seven restaurant tech purchases since the start of the year, almost as many as the eight they printed in 2018. Many of the acquisitions so far have been done to consolidate in the restaurant sector, while others were made to extend the buyers’ POS software suites into adjacent categories.

For example, restaurant POS startup Toast, which has amassed nearly $250m in funding since 2016, recently reached for StratEx, a provider of automated HR management software to restaurants that covers onboarding, payroll, benefits administration, scheduling, attendance and applicant tracking. As we noted in earlier coverage of Toast, the past few years have shown the food service segment to be among the earliest to embrace digital commerce innovations.

Restaurants have more advanced POS needs than the average retail business, demanding capabilities such as table management and online ordering, in addition to payment processing and customer management. And restaurants often spend more on POS systems than any other tech purchase, so nesting multiple applications inside these mission-critical systems offers a path to market for other restaurant-focused software products. HR management software such as StratEx’s aligns with restaurant POS, as that system doubles as a punch clock at most restaurants.

Other recent transactions appear to follow a similar recipe: start with POS and mix in other back-office applications. Take Lavu’s pickup of accounts payable specialist Sourcery Technologies earlier this month. With that move, the buyer is aiming to upsell restaurants with POS software that unifies restaurant sales with vendor management.

Part of the motivation for the string of deals in this space could be the modest growth for the overall POS market, which our surveys show is expected to be relatively flat in the coming months. According to 451 Research’s most recent Voice of the Enterprise: Customer Experience & Commerce, Organizational Dynamics & Budgets survey, only 42% of respondents said they expect their organization to maintain or increase its budget for POS software in the next quarter, the lowest reading for any of the nine software categories covered in the survey.

Annual acquisitions of restaurant technology vendors by POS providers

A dip in divests

by Scott Denne

A string of notable divestitures in recent weeks gives the impression that shedding business units has become more popular among large tech vendors. Instead, the opposite is true. Public companies are finding new homes for old assets at a historically low pace amid a rising stock market and rosy sales outlook.

Since the start of the month, there have been three high-profile divestitures:

Square shed its food delivery business, Caviar, in a sale to DoorDash that returned nearly 10x what the mobile point-of-sale provider paid for the business five years earlier.

Symantec sold its enterprise security business, nearly half of its revenue, for $10.7bn to Broadcom in the largest information security deal in history. (Subscribers to 451 Research’s Market Insight service can access a full report on that deal here.)

Most recently, Verizon unwound Yahoo’s $1bn acquisition of Tumblr, selling the business to Automattic, reportedly for a token amount of cash.

While such exits make headlines, they’re not part of a surge in divestitures. According to 451 Researchs M&A KnowledgeBase, companies that trade on the two major US exchanges have sold just 51 business units since the start of the year, meaning that 2019 could be the first year since the dot-com bubble with fewer than 100 such deals.

The number of transactions is low, but more of the targets are commanding premium valuations. Our data shows that the median multiple in the sale of a business unit from a Nasdaq- or NYSE-traded firm stands at 2.5x trailing revenue through 2019, which is more than a turn higher than the median multiple on such deals through the rest of this decade. And in only one year did the annual median top 2x – it was 2.1x in 2016.

Many companies might not be considering reorganizational moves with the stock market running high through most of this year – despite some recent turbulence, the S&P 500 is up 16% since the start of the year. There’s also optimism about future sales. According to 451 Research’s most recent Voice of the Enterprise: Macroeconomic Outlook, 72% of businesses expect their Q3 sales pipeline to be at or above plan. Yet our data suggests that vendors should be exploring sales of underperforming assets while the terms are generous.

Sales of tech assets from NYSE– and Nasdaq-traded companies

Going it alone

by Brenon Daly, Liam Eagle

 

After bulking up in recent years in part to fend off the ever-expanding influence of the cloud suppliers, web hosting and managed service providers are now going it alone. For the most part, they’ve closed the M&A playbook, or at the very least, dramatically scaled back their acquisition ambitions. Deal spending this year is likely to slump to its lowest annual level since the recession a decade ago.

Based on the M&A pace through the first seven months of 2019, full-year spending on acquisitions in the hosting/managed services market is tracking to about $3bn, according to 451 Research’s M&A KnowledgeBase. Assuming the back half of 2019 plays out the way the year has gone so far, the value of announced transactions in the sector would be less than one-third the annual spending in any of the previous four years.

There are several reasons for the decline, including a few drivers that may be gone and not coming back. For starters, some of the biggest deals done by hosting and managed service providers in recent years were straightforward consolidations. Hosting companies were looking at their peers as a way to grab as much infrastructure (and as many customers) as possible and then wring out operational efficiencies.

However, with the rise of the cloud hyperscalers – providers that, collectively, spend billions of dollars a year on building and maintaining their clouds, and still have tens of billions of dollars in their treasuries – infrastructure became something of a commodity. For hosting firms, that has meant it’s no longer economical to acquire rivals to pile up infrastructure. Instead of buying, they are renting. Virtually all managed hosting vendors offer front-end management of cloud infrastructure from hyperscalers.

This shift in strategy isn’t only being driven from the supply side, however. A recent 451 Research survey of more than 700 IT buyers and users found that pricing was the key determinant of whether organizations used managed services. Slightly more than six out of 10 respondents (62%) told our Voiceof the Enterprise: Cloud, Hosting and Managed Services survey that lower costs were the main business case for managed services. That handily topped the half-dozen or so other benefits, which were all in the 40% range and below.

Figure 1: Hosted/managed services acquisition activity

A rare trip into rarified air

by Brenon Daly

Symantec’s blockbuster $10.7bn divestiture of its enterprise security business to Broadcom marks a rare trip into rarified air for the information security (infosec) M&A market. Through the first seven-plus months of 2019, 451 Researchs M&A KnowledgeBase shows not a single deal in the segment valued at more than $1bn.

Obviously, the unusual carve-up of Big Yellow blows past that threshold. But setting aside this transaction, which we would very much describe as a one-time deal, a couple of trends are playing out in the infosec market that may make it tough to see many more of those three-comma deals coming for the rest of 2019. We suspect that this year’s total will end up looking up at the three separate billion-dollar transactions we tallied last year.

Helping to keep a lid on deals at the top end of the infosec sector right now are factors including:

Several of the industry’s largest vendors appear unlikely to pursue big-ticket transactions. In some cases, that’s due to internal upheaval (e.g., Symantec, which has announced five billion-dollar acquisitions in the past 15 years). In other cases, it’s due to a likely period of digestion (e.g., Palo Alto Networks, which has dropped $1.6bn in a half-dozen high-valuation deals over the past 18 months).

After only recently starting to print big purchases, private equity firms have slowed their activity at the top end of the market. That move down-market comes after buyout shops have been behind significant infosec take-privates in the past two years, including Barracuda and Imperva.

And most notably, VC dollars have replaced M&A dollars in the ‘unicorn universe.’ In just the past four months, Auth0, SentinelOne, Cybereason and Sumo Logic have all landed funding rounds that value the infosec startups at more than $1bn, according to the premium version of 451 Research’s Private Company Database.

As long as startups only have to give up a portion of their equity to VCs (rather than full ownership to an acquirer), funding will likely be the option of choice for popular infosec startups. Of course, taking money now at such an elevated level assumes that billion-dollar buyers will return at some point to provide big exits. That may well be the case, but it’s a pretty high-stakes gamble nonetheless.

Broadcom broadens into security

by Brenon Daly

What began last summer as a head-scratching novelty has now become a consistent strategy at chipmaker-turned-software vendor Broadcom. A year after the semiconductor giant inked the second-largest software acquisition in history, Broadcom has made a big splash in information security (infosec), paying $10.7bn for Symantec’s enterprise security business.

Although the transaction is ‘just’ an asset purchase, it nonetheless stands as the largest infosec acquisition in history, according to 451 Research’s M&A KnowledgeBase. Another way to look at it: Broadcom’s massive bet on Symantec basically equals a full year’s worth of M&A spending for the entire infosec market. (The M&A KnowledgeBase shows annual spending across the infosec sector over the past two decades has ranged widely from $2bn to $28bn, depending on blockbuster deals.)

By virtually any measure, Broadcom is paying up for Symantec’s castoff business. Divestitures, particularly those involving low- or no-growth businesses, invariably garner a discount to broad-market M&A multiples. Depending on the segment and the assets, divestitures can get done at 1-2x sales, or half the prevailing prices in outright acquisitions.

At a purchase price of more than $10bn, Broadcom is valuing the enterprise security division at 4.5x sales. (In the most-recent fiscal year, Symantec’s enterprise group posted sales of $2.4bn, a level that hasn’t really changed in three years.) That’s even slightly richer than the 4.3x that Broadcom paid in its landmark acquisition last summer of CA Technologies.

The most-significant portion of Symantec falling into the portfolio of a financially minded consolidator comes after a prolonged slump at Big Yellow, which has served – not entirely fairly – as a company caught on the wrong side of disruption. As one indicator, consider that its stock price has basically been stuck in place for the past half-decade. During that same period, other business-focused security vendors have emerged and created somewhere in the neighborhood of $100bn – or 10x the terminal value of Symantec’s enterprise business – in both the public and private markets. We’ll have a full report on this transaction for subscribers to 451 Research’s Market Insight service later today.

A rare services deal from Salesforce

by Scott Denne

 

Salesforce accelerates its 10-figure acquisitions, making its third such deal in 18 months. The $1.35bn purchase of ClickSoftware is notable not only because, coming just days after the close of its $15.1bn reach for Tableau, it represents an uptick in billion-dollar transactions from the CRM giant, but also because it marks a new phase its Salesforce’s M&A strategy – paying $1bn for a bolt-on acquisition.

In its five previous $1bn-plus purchases, Salesforce launched new lines of business, beginning with its entry into marketing software when it bought ExactTarget back in 2013. More recently, it got into data integration with MuleSoft ($6.6bn) and drastically reshaped its BI portfolio with Tableau. In reaching for ClickSoftware, a developer of field services management applications, Salesforce adds to its already sizeable Service Cloud offerings.

Only twice in any of its previous 57 acquisitions this decade has Salesforce added to its Service Cloud. The reason: it hasn’t needed to. Service Cloud generates about $3.6bn in revenue, making it the second-largest of Salesforce’s product groups, just behind its $4bn Sales Cloud, which it will likely catch, as the former grew 27% and the latter 13% year over year in the last quarter.

Salesforce M&A

Microsoft jumps into retail media

by Scott Denne

The sudden surge of Amazon’s advertising business has sparked acquisitions of software companies that help retailers become publishers. Microsoft is the latest entrant with the purchase of PromoteIQ, a maker of software that enables retailers to run product ads. As audience monetization becomes a feature of more e-commerce businesses, more deals could come.

For Microsoft, the pickup of PromoteIQ (formerly known as Spotfront) has overlap with its search advertising business. Product ads, often delivered alongside e-commerce search results, are essentially an evolution of paid search advertising. The target’s software provides retailers with workflows and controls to manage their sponsored product listings.

Amazon, more than any other company, has realized the potential for retailers to monetize their apps and websites through sponsored products. As we noted in a recent report, the online retail giant’s advertising business has tripled in less than two years to about $10bn in annual revenue. Despite that growth, the category is nascent enough that there’s not yet a widely accepted name for it. PromoteIQ refers to it as ‘vendor marketing,’ while Criteo and Triad, two of its larger rivals, call it ‘retail media.’

Given the early stages of the market, there are few sizeable players remaining for would-be buyers. Several midsized firms such as Adzerk, Crealytics, Koddi, Playwire and SYNQY offer retail media products. Another vendor, OwnerIQ, enables retailers to monetize purchase intent data gleaned from shoppers on their sites. As Amazon’s advertising revenue continues to balloon, targets in this space could get a look from acquirers in search (Google, Pinterest), e-commerce software (BigCommerce, Shopify) and retail-focused advertising (Quotient, Valassis).

Conversation pieces

by Scott Denne

As machine learning permeates the tech stack, spoken and written queries are displacing type and click, leaving companies – from enterprise software developers to consumer electronics manufacturers – to bolt natural-language interfaces onto their products. That has led to a sharp rise in acquisitions of firms developing conversational artificial intelligence (AI), a trend that’s likely to extend through this year.

Today, two such deals were announced, highlighting the range of applications for such technology. In one, Cisco’s Webex nabbed Voicea for the target’s ability to turn recorded meetings into notes and summaries. In the other, Vonage picked up Over.ai to bolster its call-center products with advanced interactive voice response. The scarcity of natural-language-processing expertise, mixed with the broad applicability of the tech, has fueled a surge of M&A.

According to 451 Researchs M&A KnowledgeBase, 23 vendors developing chatbots or other conversational AI capabilities were acquired last year, up from 15 in 2017. So far in 2019, there have been about three such transactions per month. Based on our estimates, most of the disclosed deal values have printed below $30m, with several below $10m. Still, for conversational AI specialists, exiting sooner could be more profitable than waiting.

Although there’s widespread demand for conversational capabilities, few companies are likely to ink multiple purchases and the buyer universe will begin to dry up. And there may be a limited opportunity to build a large independent company in this market as most businesses look to their existing software providers for machine learning capabilities. In 451 Researchs Voice of the Enterprise: AI & Machine Learning report, a plurality of organizations (38%) told us they’ll leverage machine learning by acquiring software with the technology already baked in.

What might have been (and what may still be) for Symantec

by Brenon Daly

If not for a last-minute snag in talks to sell itself, Symantec would be headed to this week’s Black Hat not as the single-largest vendor in the information security (infosec) market, but as a subsidiary. Negotiations with chip giant Broadcom reportedly broke down over price (what else?), meaning Big Yellow will be unattached and unchaperoned as the hacker’s ball opens in the desert. We wonder, though, how many more industry confabs will Symantec be attending in its current standing?

A public company for 30 years, Symantec generates almost $5bn of sales each year. Part of the difficulty for Symantec right now is embedded in those two facts about the company. Symantec isn’t moving any closer to the $5bn. In fact, in its most-recent fiscal year it actually slipped further away, as Big Yellow got a little smaller in 2018. Declining revenue doesn’t do much for Wall Street investors.

That’s particularly true in infosec, where budgets across the board are fat and getting fatter. A stunning 87% of IT professionals told 451 Research’s Voice of the Enterprise (VotE): Information Security, Budgets & Outlook 2019 that their companies will have more money to spend on security this year than they did last year. On average, respondents to our VotE survey said their security budgets are up 22%, an enviable bump compared with GDP-like growth rates for overall IT budgets.

And yet, Symantec hasn’t been able to enjoy much of the bountiful budgets. That led to the abrupt departure of the company’s chief executive earlier this year, with an interim CEO still leading the industry giant. Symantec’s new chief, who cut his teeth in the semiconductor industry, has a reputation as a straight-talking operator, and he serves a board of directors that tips far more toward finance than technology. Fully half of Symantec’s 12 board members, including virtually all of the directors added in the previous three years, are out-and-out financial professionals.

Given the composition of Symantec’s board and executives, reports of a sale to a financially focused operator such as Broadcom shouldn’t have surprised anyone. (At least not after the chipmaker-turned-enterprise-software-provider shelled out $19bn for CA Technologies, a diversified software vendor that nonetheless shares a similar financial profile and vintage as Symantec.) Although Broadcom wasn’t able to consolidate the infosec giant, the reported negotiations did give a useful glimpse into the most likely outcome for Symantec: a full sale to a financial firm.

The company currently garners an enterprise value of about $16bn, or roughly 3.3 trailing sales. Even with an acquisition premium, Symantec’s LBO valuation would likely be slightly below the prevailing multiple of 4.1x trailing sales in take-privates announced so far this year on US exchanges, according to 451 Researchs M&A KnowledgeBase. Looking specifically at the infosec market, our data shows buyout firm Thoma Bravo has paid 4-5.5x trailing sales in its three purchases of publicly traded security companies in the past three years.

Source: 451 Research’s Voice of the Enterprise: Macroeconomic outlook – Business Trends Q2 2019