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 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

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.

Sunny weather for hybrid cloud deals

by Scott Denne, James Curtis, Steven Hill

To stay relevant during a massive shift toward the use of public clouds, makers of on-premises IT hardware and software need products that help customers develop, run and manage their infrastructure on multi-cloud and hybrid cloud environments. The hunt for those products has been a catalyst for recent acquisitions, including, most notably, IBM’s $34bn pickup of Red Hat. Two other deals that match that theme were struck today, one by Hewlett Packard Enterprise and one by Red Hat, while it awaits the close of its sale to IBM.

The transactions cover different segments of IT – Red Hat purchased storage software, while HPE bought a data platform. Yet both illustrate that helping clients navigate mixed cloud environments has become a strategic priority for legacy IT technology firms. In its deal, Red Hat reached for NooBaa, a provider of object-storage management software for data that resides across multiple clouds.

In the other transaction, HPE nabbed BlueData, a maker of virtualization software for data workloads. That acquisition gives HPE software to bundle with its HPC systems, enabling it to offer both on-premises hardware and the software to run elastic data workloads across a hybrid environment. It’s a move HPE needed to make as more data and analytics tasks are transitioning from on-premises infrastructure at a faster pace than other IT workloads.

According to 451 Research’s Voice of the Enterprise: Cloud, Hosting and Managed Services, Workloads and Key Projects, 19% of organizations will use public cloud offerings as their primary IT environment by 2020, compared with 11% who did so this year. Data workloads are moving to the cloud even faster, with 27% saying that a public cloud (such as AWS or Azure) will be the primary environment for data processing, analytics and business intelligence, compared with 12% this year.

Cloud migration acceleration

by Mark Fontecchio

Businesses providing migration, integration and other IT services for the three most popular IaaS players – Amazon, Microsoft and Google – are being bought at a record pace. Enterprises are migrating IT workloads off-premises at an increasing pace, and cloud migration and integration service providers must keep up. In addition to expanding internally, some cloud vendors are leaning on inorganic growth to add expertise and fill customer needs.

According to 451 Research’s M&A KnowledgeBase, purchases of service providers around those three IaaS players are being inked at a record pace, with nine already this year. That equals the volume for all of 2017 and surpasses the full annual total for any year before that. Notable deals this year include Cloudreach’s acquisition of Relus Cloud last week and Hitachi’s pickup of AWS integrator REAN Cloud, which itself bought AWS integrator 47Lining last year. For Cloudreach, acquiring Relus Cloud added expertise from a company that got its start in 2013 as a consulting services firm focused solely on AWS adoption and migration. Relus Cloud subsequently garnered a reputation as an expert in cloud data analysis products such as Amazon’s Hadoop-based Elastic MapReduce and Redshift data warehouse.

Considering the rate at which companies are migrating off-premises, we expect these types of transactions to continue. Businesses’ primary IT environments are on the move. According to a Voice of the Enterprise survey, the share of organizations employing off-premises IT infrastructure as their primary environment is set to jump to 66% by 2020 from 48% this year. And that shift is most pronounced among the largest companies. Among enterprises with at least 10,000 employees, just 11% use IaaS or PaaS as their primary environment, although 28% expect to move their environment to the cloud in two years.

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

Avaya’s M&A future looks cloudy 

Contact:Scott Denne, Keith Dawson

Barely a month after emerging from Chapter 11, Avaya has returned to the M&A market with the purchase of Spoken Communications in what could be the first of several acquisitions as the company aims to transition its business into a cloud-delivery model. A recently restructured debt load gives Avaya an extra $300m in annual cash flow to put toward M&A, product development and other strategic initiatives to reverse a years-long decline in revenue.

Spoken doesn’t get Avaya into a lot of new product categories. Most of the call-center software that the target sells, Avaya already offers in some form, including interactive voice response and automated call distribution. Instead, Spoken brings a cloud-deployment model with lower costs and the potential for embedded intelligence. The deal, Avaya’s first since mid-2015, follows the creation of a dedicated cloud business unit last month.

With Spoken, it has a meaningful product to place into that unit and a platform for further acquisitions that could include forays into fraud detection and conversational artificial intelligence (i.e., chat bots). The deal helps shore up its contact-center business – the more stable portion of Avaya. Revenue in Avaya’s contact-center business – $1.2bn last fiscal year – has been basically flat for the past three years. Unified communications, on the other hand, has been eviscerated, having dropped by almost one-third over the past three years.

We’d expect Avaya to seek a similar cloud platform purchase for that unified communications business, as it’s in danger of continuing a rapid descent as organizations shift their internal communications to SaaS and other cloud models. According to 451 Research’s Voice of the Enterprise: Cloud Transformation, Workloads and Key Projects, 76% of email and collaborative workloads will reside in the cloud by 2019, up from 55% last year.

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

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.

A private equity play in the public market

Contact: Brenon Daly

In a roundabout way, private equity’s influence on the technology landscape has also spilled over to Wall Street. So far this year, one of the highest-returning tech stocks is Upland Software, a software vendor that has borrowed a page directly out of the buyout playbook. Shares of Upland – a rollup that has done a half-dozen acquisitions since the start of last year – have soared an astounding 150% already in 2017.

Investors haven’t always been bullish on Upland. Following the Austin, Texas-based company’s small-cap IPO in late 2014, shares broke issue and spent all of 2015 and 2016 in the single digits. For the past four months, however, shares have changed hands above $20 each.

Upland’s rise on Wall Street this year essentially parallels the recent rise of financial acquirers in the broader tech market – 2017 marks the first year in history that PE firms will announce more tech transactions than US public companies. As recently as 2014, companies listed on the Nasdaq and NYSE announced twice as many tech deals as their rival PE shops. (For more on the stunning reversal between the two buying groups, which has swung billions of dollars on spending between them, see part 1 and part 2 of our special report on PE and tech M&A.)

Although Upland is clearly a strategic acquirer in both its origins and its strategy, it is probably more accurately viewed as a publicly traded PE-style consolidator. The company has its roots in ESW Capital, a longtime software buyer known for its platforms such as Versata, GFI and, most recently, Jive Software. Upland was formed in 2012 and, according to 451 Research’s M&A KnowledgeBase, has inked 15 acquisitions to support its three main businesses: project management, workflow automation and digital engagement.

Selling into those relatively well-established IT markets means that Upland, which is on pace to put up about $100m in revenue in 2017, bumps into some of the largest software providers, notably Microsoft and Oracle. To help it compete with those giants, Upland has gone after small companies, with purchase sizes ranging from $6-26m.

However, the company has given itself much more currency to go out shopping. Early this summer – with its stock riding high – it raised $43m in a secondary sale, along with setting up a $200m credit facility. Given Upland’s focus on quickly integrating its targets, it’s unlikely that it would look to consolidate a sprawling software vendor. But it certainly has the financial means to maintain or even accelerate its rollup of small pieces of the very fragmented enterprise software market.

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

NetApp taps Greenqloud for hybrid storage push

Contact: Scott Denne

NetApp’s reach for Greenqloud marks its third deal of 2017 as the storage vendor climbs its way out of a rocky couple of years. With the purchase of the cloud management provider, NetApp turns 2017 into a busy – although thrifty – year for M&A.

According to 451 Research’s M&A KnowledgeBase, NetApp has never before bought more than two companies in a single year. The price it’s paying for Greenqloud hasn’t been disclosed, but the target has a modest headcount and raised little funding. In its other two transactions this year – Immersive Partner Solutions and Plexistor – NetApp shelled out less than $30m in cash (total). None of the three warranted a press release – instead they were announced via quarterly earnings calls.

After five years of revenue declines, NetApp’s sales are beginning to level off. In its last quarter (the first of its fiscal year), revenue rose 2% to $1.3bn and its profit increased by 2x. Part of its strategy for getting back to growth and improving margins has been a focus on flash storage with its last major acquisition, SolidFire ($870m).

Another part of the company’s strategy, unusual among storage OEMs, is its expansion of hybrid cloud storage capabilities. NetApp’s desire to push its cloud connections forward drove both today’s deal and its pickup in May of Immersive Partner Solutions, which makes hybrid cloud monitoring software. Greenqloud brings NetApp a team that’s been offering public cloud management since 2010, and its Qstack product gives NetApp the technology architecture to expand its delivery of cloud services.

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