A bullish bet in a bearish market

by Brenon Daly

The recent rout of technology stocks didn’t actually provide much of a discount in Big Blue’s big bet on Red Hat. In the largest-ever software acquisition, IBM is valuing the open source software provider at its highest price since its dot-com-era IPO. Essentially, Big Blue had to make up Red Hat’s recent stock decline with a very generous premium. (Subscribers to 451 Research can look for our full analysis of the transaction and its implications on our website later today.)

Ahead of the announcement, shares of Red Hat had shed about one-quarter of their value just since mid-September. The stock bottomed out last week at about $117, its lowest level in a year. Under terms, IBM is paying $190 for each Red Hat share, which works out to a premium of more than 60% from the prior close. That’s about twice as rich as the typical premium in a significant software acquisition.

However, looking at the terminal value of a company relative to the market value of a company doesn’t make too much sense unless we also factor in the state of the overall market. Stock prices change every day, particularly for high-beta stocks like Red Hat. It just so happens that in recent sessions on Wall Street, virtually all of the changes have been marked in red.

In the case of Red Hat, it was riding high last summer, with shares peaking at about $177. At that level, IBM is paying a scant 7% premium on Red Hat’s market value. (That fact hasn’t been lost on plaintiff lawyers, who have already revved up their strike-suit machine to target this deal.)

Rather than comparing how IBM is valuing the company to how public market investors value the company, it’s more useful to look at how IBM is valuing Red Hat’s actual business. And by that measure, this is a pricey pairing.

IBM, which trades at less than 2x trailing sales, is valuing Red Hat at more than 10x trailing sales. That’s substantially higher than the average multiple of 6.6x trailing sales for the 10 largest software acquisitions recorded in 451 Research’s M&A KnowledgeBase.

HR software in demand

by Scott Denne

A tight job market is opening exit opportunities for HR software companies. The record-low unemployment rate – it recently dipped below 4% for the first time in more than a decade – has increased interest in owning software developers that help businesses find, retain and train increasingly scarce employees, pushing such acquisitions to a remarkable level.

In the latest example, Cornerstone OnDemand has reached for Workpop, a provider of software for hiring hourly and seasonal workers, as part of the buyer’s revamp of its recruiting suite. As we noted at the time of that company’s last acquisition – back in 2014 – Cornerstone OnDemand hasn’t been much of a buyer, although in making a purchase now, it’s joining a parade of dealmakers scooping up HR software targets.

According to 451 Research’s M&A KnowledgeBase, acquirers have hooked 70 HR software targets, more than any other full year in this decade. Still, in terms of deal value, 2018 isn’t likely to be a record. The year’s total stands at $2.35bn, while two earlier years (2012 and 2014) saw more than $5bn in HR software transactions.

While 2012 and 2014 each had a pair of $1bn-plus deals by Oracle, IBM, SAP and Charthouse Capital, this year’s boom has benefited midmarket targets as we’ve recorded 13 acquisitions valued at $100-500m, two more than any other full year. Although the jobs picture helps juice this market, much of the increase comes through the same trends that bolster the overall software M&A market – increasing activity from private equity firms and a surge in strategic buyers. The former category has already purchased more HR software businesses this year than ever before, while corporate acquirers are heading toward record territory.

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Zendesk focuses on sales with latest purchase

by Scott Denne

With its latest acquisition, Zendesk concentrates on its march toward $1bn in revenue with an asset that could help it bolster its enterprise sales. The helpdesk software provider adds sales force automation software to its suite with the purchase of FutureSimple (which does business as Base) and obtains a product that addresses the priorities of the largest businesses.

Terms of the deal weren’t disclosed, but there’s reason to believe that Base marks Zendesk’s largest acquisition yet. Zendesk had only inked three transactions before today – two that cost it about $15m each and one, BIME Analytics, that cost $45m. Base, by comparison, raised at least $52m in venture funding, according to 451 Research’s M&A KnowledgeBase, and has about 150 employees, compared with BIME’s 40.

The pickup of Base continues Zendesk’s expansion into other corners of customer engagement, beyond its roots as a helpdesk software developer. As we noted in our report on its purchase of marketing software vendor Outbound, Zendesk needs a broader suite to reach its goal of $1bn in annual revenue in 2020. It finished last year with $430m, a 38% jump from the year before, a growth rate that leaves little room for deceleration if Zendesk is to hit its target.

Although historically targeting smaller businesses, Zendesk hopes to entice more large enterprises to use its applications to get to that goal. By nabbing pipeline management, lead-scoring and other sales automation capabilities, Zendesk injects itself into a top priority for large enterprises. According to 451 Research’s most recent VoCUL: Corporate Mobility and Digital Transformation Survey, 22% of businesses with more than $1bn in annual revenue reported that sales organizations will have the highest budget for software compared with other lines of business: only IT (51%) and Zendesk’s core market of customer service (31%) ranked higher.

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Software’s new characters 

Contact: Scott Denne

After a record-breaking performance for the software M&A market in 2016, the original cast bowed out as the understudies took the stage. Last year witnessed both strategic and financial acquirers making grand debuts in the application software market, while the most frequent and fulsome buyers of years past largely sat on the sidelines, resting from an unusually active 2016.

Spending on application software targets fell by one-third last year to $41.1bn from 2016’s highest-ever total amid a distinct lack of big-ticket deals. In total, there were 988 acquisitions of software companies, just 30 fewer than the year before. Only eight software targets attracted prices north of $1bn, compared with 14 in 2016, with last year’s tally representing the lowest total since 2009, according to 451 Research’s M&A KnowledgeBase.

As much as the numbers, the buyers were changed from earlier years. Although Oracle finished the year with the $1.2bn acquisition of construction software vendor Aconex, its $1.8bn in software M&A spending in 2017 represented a significant decline from the $10.8bn it spent a year earlier. Others were even less active. Salesforce didn’t print a single software deal last year, after spending $4bn in 2016. At the same time, IBM only did a pair of modest tuck-ins, nothing approaching the scale of its $2.6bn purchase of Truven Health Analytics in 2016.

Half of the companies that paid more than $1bn for an application software target in 2017 hadn’t inked a single software deal in any previous year this decade. Express Scripts came back to the market with a pair of transactions, including the year’s second-largest application software acquisition (eviCore Healthcare for $3.6bn), marking its first tech deals since 2009. Some new PE buyers also entered the software M&A market, including Partners Group, which made its first software transaction by paying $1.4bn for Civica – four times more than it had spent on any tech deal.

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Oracle raises its construction cloud with $1.2bn deal 

Contact: Scott Denne

Oracle has stepped off the M&A sidelines with the $1.2bn acquisition of construction software company Aconex, ending its longest dry spell since 2004. In buying Aconex, Oracle doubles what it has spent building its construction and engineering software business, zeroing in on a vertical that’s ripe for cloud applications.

Aconex brings to Oracle collaboration software for construction projects that will become part of a unit that already includes project portfolio management and payment management software that it gained from its purchases of Primavera Software and Textura – a pair of deals that cost it just over $1bn, according to 451 Research’s M&A KnowledgeBase.

 

Today’s transaction values Aconex at 9.4x trailing revenue, nearly two turns higher than where Textura landed. The difference is likely attributable to Aconex’s broader portfolio, along with its accelerating international sales. At the time of its 2014 IPO, the target’s sales in its home market – Australia and New Zealand – made up half of its business. That has now shrunk to less than one-third of revenue amid several years of topline growth above 20%.

Oracle has built several vertical-specific businesses, although it has inked more acquisitions in support of its construction division than other verticals. Unlike energy, restaurants and retail, most of the work in construction happens outside an office, store or other fixed location, so the expansion of cloud and mobile technologies brings with it new applications, not just the replacement of old ones. The downside to the business is that much construction software is bought on a per-project basis, rather than an enterprise license. Aconex has pushed against that barrier, as its subscription revenue now accounts for 46% of sales, up from 34% three years ago.

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Small software buys big, but…

Contact: Brenon Daly

The little brothers of the software industry have stepped in front of their bigger brothers in the M&A market. Medium-sized public software companies have been inking uncharacteristically large acquisitions this year, even as the well-known vendors have been fairly reserved. And while these midmarket software firms have been big spenders recently, the deals are often missing a zero or even two compared with prices the industry bellwethers have paid in years past for some of their purchases. That has helped knock overall software M&A spending to its lowest level in four years, according to 451 Research’s M&A KnowledgeBase.

As an example of the shift in buyers, consider Oracle. The software giant has averaged at least one transaction valued at more than $1bn each year over the past decade, according to the M&A KnowledgeBase. Yet this year, it hasn’t gotten anywhere close to doing a 10-digit deal, and, in fact, hasn’t announced any acquisitions since April. On the other side, several software companies that have only a fraction of the size and resources of Oracle have thrown around a lot more money on recent transactions than they ever have before. A few prints captured over the past few months in the M&A KnowledgeBase clearly show the trend of M&A inflation among the midmarket software buyers:

-At $275m in cash and stock, Guidewire Software’s reach for Cyence in October is $100m more than the SaaS provider has ever spent on any other transaction.
-Both of the largest purchases by security software vendor Proofpoint have come in the past month. Its $60m pickup of Weblife.io in late November and $110m acquisition of Cloudmark in early November compare with an average price tag of just $20m on its previous 12 deals done as a public company from 2013-16.
-Doubling the highest amount it has ever paid in a transaction, serial acquirer CallidusCloud spent $26m for Learning Seat earlier this month.
-In a pair of deals announced earlier this year, RealPage dropped more than a quarter-billion dollars on both of its targets, after not spending more than $100m on any of its previous two dozen acquisitions.
-Upland Software announced in mid-November the purchase of Qvidian for $50m, which is twice as much as the software consolidator has spent on any of its other nine acquisitions since coming public in November 2014.

These deals by midmarket software vendors (as well as other similarly sized buyers) go some distance toward making up for the missing big names. Yet they won’t fully cover the shortfall this year. Partially due to this change in acquirers, spending on software M&A in 2017 is tracking roughly one-third lower than it has been over the previous three years, according to the M&A KnowledgeBase.

​​​​​​​ CallidusCloud’s pocket-sized pickups 

Contact: Scott Denne

CallidusCloud shells out $26m for Learning Seat, the most it’s ever paid in a single deal. That it’s hitting a new record on such a modest purchase shows that CallidusCloud, which embarked on a steady diet of snack-sized M&A at the start of the decade, has stayed disciplined in its acquisition strategy. Today’s transaction also illuminates a modest increase in appetite – both in deal value and volume – as the sales software vendor has reaped results from previous buys.

The company has now printed four deals this year, its busiest since 2011, when it inked five. But that year CallidusCloud was just setting out on its current M&A strategy of making tuck-ins and low-priced extensions to its core sales performance management software offerings. According to 451 Research’s M&A KnowledgeBase, the company bought only three businesses before 2011. Now, its strategy has proven results and its purchases are more ambitious, if still small. In 2011, only two of its transactions crested $5m – this year, all of them did.

Today’s acquisition adds content for CallidusCloud’s sales training products, a unit established by the $3m pickup of Litmos in 2011. Last quarter, Litmos (and associated training offerings) was its second-largest contributor to revenue. As that division’s contribution has grown, so has its position in the company’s M&A efforts – four of its last seven deals (including today’s) bolstered its training business.

CallidusCloud began its M&A adventure in 2010 amid crumbling revenue. Last year, it put up 16% growth, its SaaS sales jumped 25% and its stock rose about 7x. Of course, that’s not all due to the addition of learning management content and software. The company has enhanced its ability to sell multiple products across sales performance, enablement and execution. Last quarter, nearly half of its bookings came via multiproduct deals, compared with just 20% four years ago.

That’s a heartening development for many of the sales-enablement startups struggling to find an exit. CallidusCloud is among the most frequent acquirers of such companies and the exit environment for those firms, as we detailed in a previous report, reflects CallidusCloud’s own proclivities. With few exceptions, exits for sales-enablement startups have been sparse and small.

For more real-time information on tech M&A, follow us on Twitter @451TechMnA.

Synchronoss’ planned ‘pivot’ turns into a face-plant

Contact: Brenon Daly

With its attempt at a pivot having turned into face-plant, Synchronoss will unwind its massive, bet-the-company acquisition of Intralinks by divesting the collaboration software vendor to private equity (PE) firm Siris Capital Group. The buyout shop will pay about $1bn for Intralinks, which Synchronoss acquired last December for $821m.

It was a pairing that faced skepticism from the very start, because the business models and client base for the two companies had virtually nothing in common. The combination also ladled a hefty amount of debt onto Synchronoss, which then compounded problems around servicing that debt by having to restate its financials due to accounting errors. Shares of Synchronoss have lost two-thirds of their value since the acquisition announcement.

As Synchronoss stock cratered, Siris Capital began buying equity, ultimately becoming the company’s largest shareholder. Siris used that position to agitate during the company’s review of ‘strategic alternatives’ announced in early July. Not unexpectedly for the beleaguered company, the process proved fitful. Siris Capital initially offered to acquire all of Synchronoss but then pulled its bid as the company, which was advised by Goldman Sachs & Co and PJT Partners, continued to look for another buyer.

Instead of an outright acquisition of Synchronoss, Siris will carve out the Intralinks division and add that to its portfolio. The transaction is expected to close in mid-November. Further, the buyout firm will invest $185m into the remaining Synchronoss business, which will continue trading on the Nasdaq.

With the divestiture, 17-year-old Synchronoss effectively abandons its attempt to become a broad provider of enterprise software, and retreats back to servicing its long-standing client base of communications and media companies. The move is a reminder that software can be hard. Just ask Dell Technologies and Lexmark. Both of those tech companies also retreated from their M&A-driven effort to become software vendors, divesting their software portfolio to PE shops in billion-dollar deals over the past year.

A pause in Big Software’s ‘SaaS grab’

Contact: Brenon Daly

After years of trying to leap directly to the cloud through blockbuster acquisitions, major software vendors have been taking a more step-by-step approach lately. That’s shown up clearly in the M&A bills for two of the biggest shops from the previous era trying to make the transition to Software 2.0: Oracle and SAP.

Since the start of the current decade, the duo has done 11 SaaS purchases valued at more than $1bn, according to 451 Research’s M&A KnowledgeBase. However, not one of those deals has come in the past 14 months, as the two companies have largely focused on the implications of their earlier ‘SaaS grab.’

During their previous shopping spree for subscription-based software providers, Oracle and SAP collectively bought their way into virtually every significant market for enterprise applications: ERP, expense management, marketing automation, HR management, CRM, supply chain management and elsewhere. All of the transactions appeared designed to simply get the middle-aged companies bulk in cloud revenue, with Oracle and SAP paying up for the privilege. In almost half of their SaaS acquisitions, Oracle and SAP paid double-digit multiples, handing out valuations for subscription-based firms that were twice as rich as their own.

In addition to the comparatively high upfront cost of the SaaS targets, old-line software companies face particular challenges on integrating SaaS vendors as part of a larger, multiyear shift to subscription delivery models. Like a transplanted organ in the human body, the changes caused by an acquired company inside the host company tend to show up throughout the organization, with software engineers re-platforming some of the previously stand-alone technology and sales reps having their compensation plans completely overhauled.

The disruption inherent in bringing together two fundamentally incompatible software business models shows up even though the acquired SaaS providers typically measure their sales in the hundreds of millions of dollars, while SAP and Oracle both measure their sales in the tens of billions of dollars.

For instance, SAP is currently posting declining margins, an unusual position for a mature software vendor that would typically look to run more – not less – financially efficient. But, as the 45-year-old software giant has clearly communicated, the temporary margin compression is a short-term cost the company has to absorb as it transitions from a provider of on-premises software to the cloud.

Of course, the transition by software suppliers such as Oracle and SAP – painful and expensive though it may be – simply reflects the increasing appetite for SaaS among software buyers. In a series of surveys of several hundred IT decision-makers, 451 Research’s Voice of the Enterprise found that 15% of application workloads are running as SaaS right now. More importantly, the respondents forecast that level will top 21% of workloads by 2019, with all of the growth coming at the expense of legacy non-cloud environments. That’s a shift that will likely swing tens of billions of dollars of software spending in the coming years, and could very well have a similar impact on the market capitalization of the software vendors themselves.

Another ‘down round’ IPO?

Contact: Brenon Daly

Another unicorn is set to gallop onto Wall Street, as MongoDB has put in its IPO paperwork. The open source NoSQL database provider plans to raise $100m in the offering, on top of the $311m it drew in from private-market investors over the past decade. As has been the case in other recent tech offerings, however, some of those later investors in MongoDB may well find that the IPO represents a ‘down round’ of funding.

Any discount for MongoDB likely won’t be as steep as the discount Wall Street put on the previous data platform provider to come public, Cloudera. Investors currently value the Hadoop pioneer at $2.2bn, slightly more than half its peak valuation as a private company. For its part, MongoDB, which last sold stock at $16.72, has more than 100 million shares outstanding, giving it a valuation of roughly $1.7bn.

While not directly comparable, Cloudera and MongoDB do share some traits that lend themselves to comparison. Both companies have their roots in open source software, and wrap some services around their licenses. (That said, MongoDB has gross margins more in line with a true software vendor than Cloudera. So far this year, it has been running at 71% gross margins, compared with just 46% for Cloudera.) Further, both companies are growing at about 50%, even though Cloudera is more than twice the size of MongoDB.

Assuming Wall Street looks at Cloudera for some direction on valuing MongoDB, shares of the NoSQL database provider appear set to hit the public market marked down from the private market. Cloudera is valued at slightly more than six times its projected revenue of $360m for the current fiscal year. Putting that multiple on the projected revenue of roughly $150m for MongoDB in its current fiscal year would pencil out to a market cap of about $920m. Given its cleaner business model and less red ink, MongoDB probably deserves a premium to Cloudera. While MongoDB certainly may top the $1bn valuation on its debut, reclaiming the previous peak price seems a bit out of reach.

For more real-time information on tech M&A, follow us on Twitter @451TechMnA.