It’s like 2003 again in the private equity technology world – and it’s a good thing. The last great wave of technology M&A activity began in late 2003 and came to a crashing end in December 2008. The U.S. was just beginning to come out of the September 11th inspired recession and valuations for enterprise technology companies were in the doldrums. The industry still had not recovered from the Dotcom implosion in 2000. Yet starting in 2003 aggressive technology centric private equity firms like Golden Gate Capital, Francisco Partners, JMI Equity, etc. started buying up software companies (disclosure: I was a corporate development executive for a Golden Gate Capital portfolio company from 2005 through 2007).
While the valuations for the acquired companies may have been distressed, the core businesses tended to be very solid. Typical valuations metrics were Enterprise Value / Revenue <1.5x and Enterprise Value/EBITDA <3x. Typically, these deals were done primarily with cash and limited debt. From 2005 through late 2007 the technology private equity market grew almost exponentially due to the large amount of ‘covenant-lite’ debt that was available to fund deals. A good example of this was Silver Lake Partner’s take private of Serena Software in 2006. Silver lake financed a third of the deal with cash, and the other two-thirds with a variety of debt instruments. Silver Lake paid about 4.7x EV/Revenue and 11.7x EV/EBITDA for Serena Software. In 2007 it was not uncommon to see 8 to 12 private equity firms looking at the same deal and bidding prices up.
Starting in mid-2008, the debt markets for technology private equity deals began to dry up as the sub-prime mortgage market crashed. By December there was no debt to be had. A classic example of this was JDA Software’s abandonment of their planned acquisition of i2. JDA announced the deal in August, but by November it was pressuring i2 “negotiate a reduced purchase price given that the available credit terms to JDA would result in unacceptable risks and costs to the combined company.” Basically, JDA’s bankers, Credit Suisse and Wachovia simply would not finance the deal on terms acceptable to JDA at the original price. Rather than live with onerous terms, JDA let the original commitment letters expire and they paid i2 a $20 million breakup fee. The JDA/i2 deal signaled the end of the debt fueled hyper growth of private equity technology deals.
In the past three months, however, it has been interesting to see a few deals close that resemble the early days of tech private equity boom. These deals include Symphony Technology’s acquisition of MSC Software, Vista Equity Partners Acquisition of SumTotal, Infor’s acquisition of SoftBrands, and finally IBM’s recently announced acquisition of SPSS. The first three deals are classic tech private equity deals, while the fourth one is example of what a strategic acquirer is paying for an existing tech property with a strong franchise. Take a look at the following table that summarizes some of the key deal stats:
Each of the private equity deals had something in common as well as some unique characteristics. All of the PE deals were valued at a discount to revenue – in other words the acquirers were buying each business for less than one times their trailing twelve months revenue. In each company there were material profit improvement opportunities available simply through the elimination of public company costs and other standard restructuring tactics like the consolidation of finance, administration, and HR.
Symphony Software – MSC Software Deal
The Symphony-MSC Software deal has a complex structure. Symphony is joined in the deal by Elliott Management. Elliott is an activist hedge fund that takes significant positions in target companies. Elliott owns about 13% of MSC Software. In the deal Elliott is contributing their stock and an additional $48 million in convertible notes. There are no financial covenants associated with the Elliott note, but there is a $48 million liquidation preference. Wells Fargo Foothill and CapitalSource are contributing $45 million and $20 million in debt financing and Symphony Technology is contributing the rest and guaranteeing the debt. As an aside MSC Software will be outsourcing their R&D work to Symphony’s India-based outsourcing company, Symphony Technologies. The only material covenant for the WFF & CaptialSource debt appears to be a $32 million EBITDA covenant or a 2x Debt/EBITDA multiple, which should be a slam dunk to achieve through elimination of public company costs, outsourcing to Symphony Services, and other typical restructuring activities. Once the proxy is filed on the deal there should be a few other interesting tidbits to emerge.
Update. Since this post was published in early August 2009, a bidding war has broken out. On September 19th MSC announced that they had received a superior offer from a private equity firm. According to Orange County Business Online Symphony & Elliott’s rivals in the deal are Golden Gate Capital and Vector Captial. Since mid-September the bid has been increased seven times and Symphony has matched it each time. On September 29th Symphony submitted another bud at $8.40/share and substantially increased the breakup fees to alomost $40 million. Currently, the shareholder vote is scheduled for October 8th.
Also, in early September MSC settled a class action suit brought by a number of investors after the announcement of the initial deal with Symphony. Like in the Softbrands deal described below, the suit was settled when MSC amended their proxy statement with significant additional details regarding the bidding process and J.P. Morgan Chase’s fairness opinion. One of the interesting elements of the fairness opinion was the peer comparables JPMC used to justify the original proce from Symphony. Here’s an extract of the complete filing which you can find here.
At a 10.35x EV/EBITDA multiple the current MSC deal is well priced in today’s market. The incremental cost of the acquisition in comparison to the original bid may require additional cost cuts at MSC.
Vista Equity Partners / SumTotal Deal
What was interesting about the SumTotal deal was that it was a battle between two private equity firms, Accel-KKR and Vista Equity Partners. The discussions began in March 2008 when Vista contacted SumTotal’s management to engage in some general discussions. Then in April, Accel-KKR approached SumTotal with an eye towards entering into acquisition discussions. These discussions continued throughout the summer and in August things had developed to the point where Accel-KKR was considering a bid between $7-$8/share. During that timeframe SumTotal’s stock was trading between $4/share. Accel-KKR wanted SumTotal to go exclusive with them, but SumTotal deferred. Concurrent with all of this was the meltdown of the financial markets in the fall of 2008. By October, SumTotal’s CEO had announced his plans to retire and the SumTotal Board decided not to proceed with a sale of the company, hire a new CEO, and returned to their ‘strategic plan.’
In mid-October, Vista filed a 13-D where they reported their beneficial interest in 11.4% of SumTotal’s stock. SumTotal announced it had hired a new CEO to start November 1st, and they also decided to re-engage RBC as an investment banker.
Over the next six months Accel-KKR & Vista battled back and forth to win the SumTotal deal. In late April, Accel-KKR had finally come to terms with the SumTotal board and agreed to a deal valued at $3.80/share with no financing contingencies. The deal also had a ‘go shop’ provision which SumTotal immediately began to exercise. 12 parties were contacted, including 4 strategic buyers. At the end of the day Vista proposed $4.85/share and won the deal. 478 days after they had started discussions with SumTotal. You can check out the entire timeline in SumTotal’s proxy filing here.
Golden Gate Capital & Infor / SoftBrands Deal
SoftBrands has been a provider of enterprise software for the manufacturing and hospitality industries. It’s never exactly been a darling of Wall Street and its stock has traded from a high of $2.36 share all the way down to $0.46/share earlier this year. In September 2008, SoftBrands board began an exploration of ‘strategic alternatives and hired Piper Jafffray to advise them. In late 2008 they were approached by a potential buyer interested in their manufacturing business. By the end of January they had four other potential bidders. In early February Infor expressed an interest in a strategic transaction. By March, the Board’s Special Committee had decided to solicit offers for the entire Softbrands business and not just the hospitality business. A total of 8 potential acquirers got into the deal. Golden Gate bid $1/share for the entire business and got SoftBrands to agree to exclusivity. After diligence was completed, Golden Gate dropped the price to $0.88/share, but subsequently was talked up to $0.92/share to close the deal. The $0.92 represented a 100% premium over SoftBrands stock price at the time.
One of the interesting turns of the SoftBrands deal was that some unhappy shareholders sued SoftBrands in Delaware Chancery Court over the deal. “On July 16, 2009, a purported class action lawsuit was filed in the Court of Chancery of the State of Delaware (the “Court”) by stockholders alleging, among other things, that the SoftBrands board of directors breached their fiduciary duties in connection with the proposed Merger, and requesting injunctive relief, attorneys’ fees and other remedies.” On July 30th, SoftBrands filed an 8-K announcing the tentative settlement of the litigation as well as the release of additional information to SoftBrands shareholders. The additional information included SoftBrands’ internal financial projections for their business in 2010 and 2011 (hint, a miracle was going to occur in mid-2010 when organic growth magically returned to the SoftBrands business) as well as details about Piper Jaffray’s fairness opinion. Take a look at the following table of comparable transactions:
What’s a little more interesting is to extract the Infor / Golden Gate Capital historical transactions and compare them against the SoftBrands deal:
Net net, in 2009 Golden Gate/Infor is valuing SoftBrands at about half of the value it paid for major transactions in the past.
Doing highly accretive take-private deals at low valuations with primarily cash and a little debt were the hallmarks of how the technology private equity wave got started in 2004. It’s good to see the industry returning to these tried and true practices.
The next challenge for the private equity world will be how to ignite some organic growth on the properties they have acquired. The ingredients and conditions to launch capital light software or SaaS startups have never been better. Open Source software has replaced the need for expensive infrastructure software like database management systems, web application servers, content management systems, etc. There rarely has been a time in the market when so many qualified software professionals (engineers, marketeers, sales people, customer service, and even accountants) have been available. Finally, cloud-based data center solutions are cheap, reliable, and pervasive. Additionally, the wave of social technologies has introduced one of those rare inflection moments in the tech marketplace – just as relational database management systems did in the 1980s, client-server technologies did in the 1990’s, and the Internet did in the early years of this century. Perhaps in addition to the undisputed skills of financial and operational engineering, today’s technology private equity firms can find a way to invest some of the new cash flow created by today’s M&A deals to spur organic growth and eventually drive more valuable IPO or acquisition exits.