Sensitive ‘barbarians’?

Contact: Brenon Daly

Although private equity (PE) is often portrayed as heartless and hardened dealmakers, it turns out the group is actually quite sensitive. We don’t necessarily mean emotionally sensitive but rather economically sensitive. This hyperactive group of acquirers is far more attuned to interest rates, credit availability and other economic factors than rival corporate buyers. What happens outside buyout firms goes a long way toward shaping what goes on inside.

We’re seeing that right now in the tech M&A market. The just-enacted sweeping overhaul to the US tax code has changed some of the key calculations that buyout shops have to make before they can put their unprecedented pile of cash to work in tech deals. Under the new tax regime, PE firms are facing higher costs and potentially longer holding periods – both of which would weigh on returns. (Buyout shops are getting hit with numerous changes, the most significant of which is that they are now only able to deduct a portion of the interest payments for the debt they use to acquire companies.)

The tax changes, which were negotiated and passed in the final few months of last year, knocked PE almost completely out of the market during that time. Through the first three quarters of 2017, buyout shops were clipping along at an average of about $10bn in spending each month, according to 451 Research’s M&A KnowledgeBase. However, spending plummeted to just $7bn for the entire fourth quarter. The aggregate value of deals in December – the month when the new tax code was approved – didn’t even reach a half-billion dollars, the lowest monthly total since early 2014.

Of course, this is only the most-recent case of macroeconomic conditions shaping PE activity. A far more vivid example of that came a decade ago, when the mortgage crisis effectively killed the first wave of tech buyouts. As we noted last summer on that unhappy anniversary, the last four crisis-shadowed months of 2007 accounted for just $7bn of the then-record $106bn in PE spending that year. The PE industry took until 2015 to reclaim the level of spending it put up in 2007, according to the M&A KnowledgeBase.

No one is suggesting the changes from the tax code will be anywhere as severe as the disappearance of credit, which is what we saw in the recession a decade ago. This time it’s more of a recalibration than a retreat.

What to look for in tech M&A in 2018

Contact: Brenon Daly

As we look back on 2017 and ahead to 2018, 451 Research has published its annual forecast for tech M&A, highlighting the trends that we expect to shape deal flow and the markets that we think will see much of the activity. The 2018 Tech M&A Outlook – Introduction serves as an overview of the broad M&A market, setting the stage for the upcoming publication of our comprehensive report that features analysis and predictions for eight specific IT markets on what deals are likely in 2018.

The full report, which we think of as an ‘M&A playbook’ for the enterprise IT market, has insightful forecasts for activity in application software, information security, mobility and other key sectors. The 80-plus-page 2018 Tech M&A Outlook report will be published at the end of January. It will be available at no additional cost for subscribers to 451 Research’s M&A KnowledgeBase Professional and Premium products, and will be available for purchase for 451 Research clients and others that don’t subscribe to our M&A KnowledgeBase products. (If you’re interested in purchasing the full 80-plus-page report, contact your account manager or click here.)

In the meantime, our introduction provides insights on some of the overall dealmaking trends that are also likely to shape activity and valuations in sector-specific transactions. Key highlights in our overview of the broader M&A market include:

  • After tech M&A spending in both 2015 and 2016 topped a half-trillion dollars, what happened that knocked the value of deals in 2017 down to just $325bn?
  • Many of the tech industry’s biggest buyers printed only half as many deals as they have in recent years. Is that the new pace of M&A at these serial acquirers, or will they rev up again in 2018?
  • The pending tax overhaul will likely add billions of dollars to the treasuries at major tech vendors. Why don’t we think that will necessarily lead to more M&A? If they don’t spend it on deals, what are tech companies going to do with the windfall?
  • Which tech markets are expected to see the biggest flow of M&A dollars in the coming year? Enterprise security tops the forecast once again, but what about emerging cross-sector themes such as machine learning and the Internet of Things?
  • How did private equity (PE) move from operating on the fringes of the tech industry to become the buyer of record? PE firms accounted for an unprecedented one out of every four tech transactions last year. Why do we think their share of the market will only increase?
  • VC portfolios are stuffed, as the number of exits in 2017 slumped to its lowest level since the recession. What challenges loom for startups and the broader entrepreneurial community without the return of billions of dollars from those investments?
  • For startups, will venture capital be flowing freely in 2018? Or will the polarized VC market (fewer rounds, but bigger rounds) continue this year?
  • Despite nearly ideal stock market conditions, why don’t we expect much acceleration in the tech IPO market in 2018? What needs to happen – to both supply and demand – for the number of new offerings to take off?

For answers to these questions – as well as other factors that will influence dealmaking in 2018 – see our just-published 2018 Tech M&A Outlook – Introduction.

Thoma Bravo goes fishing, lands a Barracuda

Contact: Brenon Daly

After four underwhelming years as a public company, Barracuda Networks will step off the NYSE in a $1.6bn take-private with Thoma Bravo. The all-cash transaction, which is expected to close within three months, is one of those rare deals that appears to fit both the buyer and the seller in equal measure. With $17bn sloshing around, private equity firm Thoma Bravo needs to put money to work and has made the information security market a favorite shopping ground, having previously taken four infosec vendors private.

For Barracuda, the proposed leveraged buyout (LBO) wraps a period of not truly finding a home on Wall Street. As a public company, Barracuda posted just one-third the return of the Nasdaq Composite over the same period. The $27.55 per share that Thoma Bravo is paying represents the highest price for Barracuda stock in two and a half years. At one point in 2015, shares of Barracuda changed hands above $40.

Part of the reason why Barracuda fell out of favor with investors is the company’s ongoing transition from an on-premises business to more of a cloud focus. The so-called ‘legacy’ revenue – much of which is tied to appliances – has been shrinking every quarter, but still represents roughly one-third of sales. Deemphasizing that business has boosted Barracuda’s operating margins, but has slowed overall revenue growth to the single digits. Going private to complete the transition to a higher-margin software business, while continuing to throw off $10-20m of free cash flow each quarter, makes sense for Barracuda.

On the other side, Thoma Bravo pays essentially a market multiple for a company that has figured out a way to turn a profit selling into the underserved SMB market. (The enterprise value of Thoma Bravo’s bid stands at $1.48bn, or 4x trailing 12-month sales at Barracuda. That roughly matches the 4.4x TTM sales/EV multiple that Thoma Bravo paid in its most recent infosec LBO, Imprivata.) Further, Thoma Bravo has some growth opportunities once it adds Barracuda to its portfolio, both in terms of products (for instance, the target’s managed security service) and markets (Barracuda still generates 70% of its revenue in the US).

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

Webinar: PE activity and outlook

Forget Oracle, IBM, or any of the other big-name, publicly traded acquirers that – until now – have always set the tone in the tech M&A market. If a tech deal printed in 2017, the buyer is more likely to be a private equity firm than any of the well-known serial acquirers on the US stock market. This is the first time in the history of the multibillion-dollar tech M&A market that financial acquirers have been busier than these strategic acquirers.

To understand how the ever-growing influence of buyout shops is reshaping both M&A and the tech industry, join 451 Research for an hour-long webinar on Thursday, September 7, 2017, starting at 1:00pm ET. Registration is available here: https://www.brighttalk.com/webcast/10363/274289.

Meet the new buyer of your tech company

Contact: Brenon Daly

For all the dramatic impact that private equity (PE) firms have had in snapping up huge chunks of the tech landscape, most of Silicon Valley actually knows very little about these buyout shops. (Not for nothing is the industry called private equity.) The little that is known about them probably dates back to Barbarians at the Gate, when the firms mostly operated with a strip-and-flip strategy. That’s not really the approach these new power brokers are bringing to their current tech investments.

In the rebooted strategy for hardware and software vendors, many of the buyout shops have swung their focus from costs to growth. Sure, PE firms still prize cash flow, but in many cases they will be looking as closely at the trend line for MRR as they do EBITDA generation. It’s an approach that has helped fuel five straight years of increasing tech deals by buyout shops, rising to the point now where financial acquirers are putting up more prints than the longtime leaders of the tech M&A market, strategic buyers.

Between direct acquisitions and deals done by portfolio companies, PE firms are on pace to purchase roughly 900 tech companies in 2017, which would work out to roughly one of every four tech transactions announced this year. That’s about twice the share of the tech M&A market that buyout shops have held even as recently as two years ago. More than any other buying group, PE firms are setting the tone in the market right now.

For a closer look at the stunning rise of PE buyers in the tech market, 451 Research is publishing a special two-part report on the trend, ‘Preeminent PE: The New Masters of the Tech Universe.’ The first part of the report takes a look at how financial acquirers sprinted ahead of strategic buyers, and how the current PE boom is different from the previous PE boom before the credit crisis. The second part turns to the strategy and valuations of tech deals done by buyout shops.

Although both of these reports will only be available to 451 Research subscribers, everyone is invited to join 451 Research for a webinar on the activity and outlook for PE firms in tech M&A on Thursday, September 7 at 1:00pm EST. Registration can be found here.

An unhappy anniversary for buyout shops

Contact: Brenon Daly

A decade ago, the financial world started its most recent journey toward ruin. Although the total collapse wouldn’t come for another year, the first tremors of the global financial crisis were felt in August 2007. At the time, few observers could have imagined that a bunch of bad bets made on shady mortgages could reduce some of the world’s biggest banks to heaps of rubble.

For some financial institutions, the destruction was self-inflicted. But others were simply collateral damage, counterparties to risky trades that they may not have fully understood but took on nonetheless. Whatever the cause, the result, which was just starting to be realized 10 years ago, was that everyone was in over their head.

As banks went into survival mode, the financial system dried up. Lenders, already worried about the bad debt on their books, stopped extending loans. It became a credit crisis, with whole chunks of the economy grinding to a halt. There was also a dramatic – if underappreciated – impact on the tech M&A market: the crisis effectively ended the first buyout boom.

Private equity (PE) firms were just hitting their stride when the crisis took away the currency that made their deals work: debt. Don’t forget that just months before August 2007, PE shops had announced mega-deals for First Data ($29bn) and Alltel ($27.5bn). Both of those acquisitions were $10bn bigger than any tech transaction ever announced by a financial acquirer up to that point.

Those deals turned out to be the high-water marks for PE at the time, with the water receding unexpectedly quickly. Of the 10 largest PE transactions listed in 451 Research’s M&A KnowledgeBase for 2007, only one of them came after August. More broadly, the last four crisis-shadowed months of 2007 accounted for just $7bn of the then-record $106bn in PE spending that year.

The late-2007 collapse in sponsor spending continued through 2008-09, as the recession broadened and deepened. The value of PE deals in both of those years dropped more than 80% compared with 2007, according to the M&A KnowledgeBase. The PE industry’s recovery from the credit crisis would take a long time, much longer than the relatively quick bounce-back in the equity markets, for instance. Overall spending by buyout firms wouldn’t hit 2007 levels again until 2015.

For more on the impact of PE activity in the tech market, be sure to join 451 Research for a special webinar on Thursday, September 7 at 1:00pm ET. Registration is free and available by clicking here.

In tech M&A, PE takes prominence

Contact: Brenon Daly

For the first time in tech M&A, financial acquirers are doing more deals than publicly traded strategic buyers. That’s a sharp reversal from years past, when private equity (PE) firms represented only bit players in the market, operating well outside the focus areas of US-listed acquirers. Even as recently as three years ago, US publicly traded companies were announcing more than twice as many transactions as PE shops.

So far in 2017, financial buyers (both through stand-alone purchases and deals done by their portfolio companies) have announced 511 tech transactions, slightly ahead of the 506 deals announced by tech vendors on the Nasdaq and NYSE, according to 451 Research’s M&A KnowledgeBase. Even more telling is the current trajectory of the two groups. PE firms, which have increased the number of acquisitions every single year for the past half-decade, are on pace to smash the full-year record of 680 PE transactions announced last year. Meanwhile, US-listed acquirers are almost certain to see a second consecutive decline in M&A activity, with the full-year 2017 number tracking to almost 20% below the totals of 2014 and 2015.

The dramatic shift in the tech industry’s buyers of record has been brought about by changes in both acquiring groups. PE shops have never held more capital than they currently hold, which means they need to find markets where they can put that to work. (The tech industry, which is aging but still growing, offers bountiful shopping opportunities.) Cash-rich buyout firms, which are built to transact, have simply taken the playbook they have used on their shopping trips through other markets such as manufacturing and retail, among others, and applied it to the technology industry.

In contrast to the ever-increasing number of PE shops and their ever-increasing buying power, the number of tech companies on the Nasdaq and NYSE has been dropping for years. (Indeed, the overall number of US traded companies has been declining for years, with some estimates putting the current count of listings at just half the number it was 20 years ago.) For instance, some 38 tech vendors have already been erased from the two US stock exchanges so far in 2017, according to the M&A KnowledgeBase.

Yet even those companies that still trade on the exchanges aren’t doing deals at the same rate they once did. In years past, some of the big-cap buyers — the ones that used to set the tone in the tech M&A market — would announce a deal every month or so. Now, public companies have slowed their pace, and PE firms have simply sprinted around them in the market.

Consider this tally, drawn from the M&A KnowledgeBase, of activity last month by the two respective groups. On the lengthy list of tech giants that didn’t put up a single print at all in July: Oracle, Microsoft, IBM, Hewlett Packard Enterprise, Salesforce and SAP. Meanwhile, financial acquirers went on a shopping spree. H.I.G. Capital, Francisco Partners, Clearlake Capital and Thoma Bravo (among other PE shops) all inked at least two prints last month.

PE shops make the market for tech M&A in July

Contact: Brenon Daly

Spending on tech deals in July hit its second-highest monthly total so far this year, driven by the widespread dealmaking of private equity (PE) firms. Buyout shops figured into eight of last month’s 10 largest acquisitions, either as a seller or a buyer. The big-dollar prints by financial acquirers in July continue the recent surge of unprecedented activity by PE firms, which have largely displaced corporate buyers as the ‘market makers’ for tech M&A.

Overall, the value of tech transactions announced around the globe in July hit $28.9bn, roughly one-quarter more than the average month in the first half of the year, according to 451 Research’s M&A KnowledgeBase. Our research shows that PE firms accounted for some 40 cents of every dollar spent on tech deals last month — two to three times higher than the market share financial buyers held in recent years. Further, unlike the previous PE boom in the middle of the past decade that was dominated by single blockbuster transactions, the current record activity is coming from virtually all deal types.

Just in July, we saw financial acquirers announce transactions ranging from multibillion-dollar take-privates (the KKR-backed purchase of WebMD) to ‘synergy-based’ midmarket consolidation (Francisco Partners’ Procera Networks won a bidding war with another buyout shop to land Sandvine) to early-stage technology tuck-ins (Vista Equity Partners’ TIBCO scooping up one-year-old nanoscale.io). Overall, according to the M&A KnowledgeBase, PE firms announced a staggering 77 deals last month. That brought the year-to-date total to 511 PE transactions in the first seven months of 2017 — setting this year on pace to smash the full-year record of 680 PE deals recorded last year.

More broadly, last month featured a fair amount of old-line M&A, whether it was buyout firms trading companies among themselves (Syncsort) or mature tech industries consolidating (Mitel Networks reaching for ShoreTel or serial acquirer OpenText picking up Guidance Software, for instance). Those drivers put pressure on valuations paid at the top end of the market last month. According to the M&A KnowledgeBase, acquirers in July’s 15 largest deals paid just 2.4x trailing sales. Not one of last month’s 15 blockbusters got a double-digit valuation, although subscription-based ERP software startup Intacct came very close. For comparison, fully five of the 15 largest transactions in the first six months of 2017 went off at double-digit valuations.

For PE, secondaries become primary

Contact: Brenon Daly

In many ways, the tech buyout barons have themselves to thank for the record run of private equity (PE) activity so far in 2017. The number of so-called ‘secondary transactions,’ in which financial acquirers sell their portfolio companies to fellow financial buyers, has increased for three consecutive years, according to 451 Research’s M&A KnowledgeBase. The pace of PE-to-PE deals has accelerated even more this year, with an unprecedented 64 secondary transactions already in 2017 — more than twice the average number in the comparable period over the past half-decade.

The fact that secondaries have become primary for PE shops represents a fairly noteworthy change in both the buyout shops and their backers, the big-money limited partners (LPs) of the funds. In years past, LPs have frowned on the practice because, in some cases, they might be investors in both the PE funds that are doing the buying as well as the ones doing the selling, which doesn’t really reduce their risk in that particular holding — nor do they truly exit that investment. The practice has been criticized by some for being little more than buyout shops trading paper among themselves.

For that reason and others, our M&A KnowledgeBase indicates that the number of PE-to-PE deals in the first half of the years from 2002-10, when the tech PE industry was relatively immature, averaged only in the mid-single digits. In others words, PE shops are currently doing 10 times more secondary transactions than they did in the first decade of the millennium. Recent tech deals that have seen financial buyers on both sides include Insight Venture Partners’ sale of SmartBear Software to Francisco Partners after a decade of ownership, TA Associates’ sale of Idera to HGGC, and Summit Partners’ sale of most of Continuum Managed Services to Thoma Bravo.

These types of transactions appear likely to remain the exit of choice for PE shops, as both the number of funds and the dollars available to them continue to surge to new highs. The increasing buying power of buyout firms stands in contrast to the diminished exits provided elsewhere for portfolio holdings. The tech IPO market has never provided much liquidity to PE shops. (For instance, neither Thoma Bravo nor Vista Equity Partners has seen any of their tech holdings make it public.) Meanwhile, corporate acquirers — the chief rival to financial buyers — have dialed back their overall M&A programs, and in some cases have found themselves outbid or outsprinted in PE-owned deals by ultra-aggressive buyout shops.

Private equity’s latest venture 

Contact: Scott Denne

The bulging coffers of buyout funds are delivering a record amount of exits to venture capitalists, providing some measure of relief as strategic acquirers scale back dealmaking and the IPO market remains a selective venue. Yet relying on a different category of buyers could have venture investors rethinking how to value the products – startups – they sell to them.

So far this year, private equity (PE) firms have spent $4.8bn on 40 companies that have taken venture money. That nearly matches last year’s record dollar total ($5.2bn), according to 451 Research’s M&A KnowledgeBase, and is on track to pass the number of such deals in 2016.

Returns from both PE shops and strategic acquirers range from prodigious to paltry, although usually at vastly different multiples on the high end of the market. Take the two largest VC exits this year, Cisco’s $3.7bn acquisition of AppDynamics and PetSmart owner BC Partners’ purchase of Chewy for an estimated $3.4bn. Both delivered outsized returns, but Chewy went off at nearly 4x trailing revenue, which is above market for an e-commerce transaction although not in the same neighborhood as the 17.4x AppDynamics garnered.

In AppDynamics, Cisco is gambling that the application performance management vendor will mature into that lofty price. PE firms are less inclined to make such a wager. While PE shops are buying venture-backed companies – they account for a record 14% of venture exits so far this year – they’re looking for proof, not potential. Those tougher standards could start to trickle down to valuations in venture fundings as PE firms determine a larger share of the outcomes.

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