January 24, 2014

Technological currents continue to drive M&A strategy. Some of the themes Cheverny is paying particular attention to include:

Security – in the network, the mobile world and the data centre. Between widespread electronic espionage emanatING from China to the revelations of Mr Edward Snowden, network and data security grabbed more than a normal share of headlines. This had a consequent effect in M&A markets, wherein corporations sought to bolster portfolios (examples include the Mandiant deal discussed in an earlier blog post, IBM’s almost $1 billion purchase of Trusteer as well as Cisco’s $2.7 billion – and 10x sales – purchase of SourceFire) whilst simultaneously looking to distance themselves from being seen to be too tied to the U.S. government (and, more importantly, the NSA). IBM’s sale of its x86 server business to Lenovo falls into the latter camp. The sector also attracted substantial equity investments: towards the end of the third quarter Palantir raised almost $200 million on a valuation believed to be $6 billion. Private equity has also focused on the sector, bringing funding for take-private transactions such as Websense (Vitsa Equity Partners paid $900 million for this company, which had been listed on the bourse for over a decade). Blue Coat was taken private by Thoma Bravo and OTPP/Teachers Private Capital and subsequently funded as an acquisition platform (the Netronome deal being a case in point).

The Cloud and SaaS are continuing to upend traditional models in software and hardware. Maintenance and support revenues represent a third or more of turnover at many software firms. Cloud-based SaaS (software as a service) does not merely end the traditional software license+maintenance model, it also means that the purchase of the servers to run the applications will shift to the SaaS operator or the cloud provider supporting the SaaS company. These are significant issues for traditional software and hardware vendors. In this context the IBM/Lenovo deal (below) or Oracle’s outlay of $2 billion on SaaS and subscription-based software companies (BigMachines and Responsys being two noteworthy examples) seem entirely logical.

One company’s dross, another’s gold? At the time of writing IBM had posted six consecutive quarters of flagging revenue numbers. Senior management responded by slashing bonuses. Having made major investments to purchase companies in growth areas (see our earlier blog post on SoftLayer) IBM also turned to M&A to address those segments where revenue was declining: today saw announcement of the $2.3 billion sale of the x86 server business to Lenovo. A substantial portion of this unit’s sales had been generated in China; in the wake of the revelations about the U.S. N.S.A. (above) IBM’s sales in this market had sagged 20% or more. Lenovo believes that being a Chinese-owned player will address these concerns. Microsoft’s purchase of Nokia’s handset/smartphone business is another example of the thesis that a new owner can add substantial value. Microsoft (which is posting stronger sales than many had anticipated on the back of cloud-related products and its Xbox console) hopes to use the $5 billion Nokia purchase to provide impetus for its mobile operating system platform. Yet given that Nokia’s handset market share continues to slide it may be that Microsoft has to undertake additional deals in this area (Blackberry?).

A busy M&A docket does not provide immunity from difficulty Over the years 2002 to 2012, storied Silicon Valley powerhouse HP spent almost $50 billion on over five dozen acquisitions. It did so under several CEOs. 2013 proved to be a year of indigestion, as a new-ish CEO failed to make any significant acquisitions and concentrated instead on bringing an unwieldy strategy and capital allocation structure under control.

Valuations have not budged overmuch On average, technology M&A deals outside of the micro-cap zone have remained in the 3-3.4x sales band that has prevailed since the financial crisis (wherein the two year average fell to ~2.5x sales). Average multiples have yet to regain the pre-crisis levels of 3.5x or higher. Naturally these blended numbers tend to mask the sky-high valuations paid for security firms (10x sales) or social media plays as well as the lower price/sales for more prosaic or dated technology revenue streams. What is clear is the growing importance of private equity, which now accounts for approximately a quarter of technology M&A. (In Canadian data centre/hosting markets, for example, the last few years have seen private equity buyers purchase everything from Q9 (and then sell it to a consortium of larger private equity firms working in tandem with BCE) to iWeb (subsequently sold to Internap).

Graph 1 - Blog 24 January 2014

Graph 2 - Blog 24 January 2014

Graph 3 - Blog 24 January 2014

Data: 451 Research, Capital IQ