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A Tempest in a Chinese Teapot. The Non-Merger of CDC Software & Chordiant

January 13th, 2010 | No Comments | Posted in Financial Literacy, Private Equity, Venture Capital

The latest M&A transaction in the enterprise software space went from boom to bust in less than 5 days.  On Wednesday, January 6th, CDC Software (CDCS) made an unsolicited offer to buy Chordiant Software (CHRD) for $3.46/share or about $105 million.  CDC Software is a $200 million provider of enterprise-class ERP and CRM solutions.  CDC Software is part of the CDC Corporation (CHINA) that also includes CDC Global Services focused on IT consulting services, and outsourced R&D and application development,  CDC Games focused on online games, and China.com, Inc. (HKGEM:8006) focused on portals for the greater China markets.  Chordiant is a $77 million provider of front office CRM and contact center solutions.  On Friday, January 8th, Chordiant rejected CDC Software’s offer since it “significantly undervalues Chordiant and is not in the best interests of Chordiant’s shareholders.”  On Monday, January 11th, CDC Software announced their intention to sell the 392,762 shares of Chordiant they had acquired in the run up to their unsolicited proposal.

CDC Software’s unsolicited offer represented a 21% premium to Chordiant’s stock price over the preceding 30 days – a premium that CDC cited as above the median 19% premium paid in the enterprise software space in the past few months.  CDC Software offered two options to Chordiant’s shareholders – 40% of the consideration in cash and 60% in CDCS stock, or 50% cash and 50% CDCS stock.  On the surface, it looks like a low-ball bid – with Chordiant having $49 million+ in cashon their balance sheet, CDCS is basically offering to buy CHRD with their own cash and some CDC stock, as shown in the following table:

This is not the first unsolicited offer CDC Software has made.  You might remember CDC’s attempt to acquire CRM provider Onyx Software in 2006.  In the end, Onyx went with a deal from Made2Manage Systems, a portfolio company of Battery Ventures and Thoma Cressey Equity Partners.  The deal chronology is pretty interesting and you can read the whole chapter and verse here in an abstract from the proxy filed along with the deal.  Onyx ended up going with M2M primarily because of the all cash offer versus CDC’s cash and stock offer and a pattern of ‘inconsistent statements’ and behavior from CDC throughout the process.  While the shortcomings cited by Onyx in 2006 may have been true, since that time CDCS has established their credibility as an effective acquirer and they have grown the value of their equity consistently.  The CDCS’ deal for Chordiant has a few similar undertones, the fact that CDCS walked away from the deal less than a week after starting it shows that things have changed in the past four years.

When you peek behind the numbers a bit, you will see that the CDCS offer is pretty much in line with the overall market.  To begin with, let’s contrast the financial fundamentals of the two companies:

CDCS’s revenues have been basically flat until 2009 while Chordiant’s have been in decline for a number of years.  While CDCS profits have grown significantly over the past three years, Chordiant’s EBITDA continues to decline.  Chordiant is suffering the same fate as a lot of mid to late stage enterprise technology companies – their ability to materially grow revenues in their core market has evaporated and regardless of how much money they invest in execution, they still can’t stop declining revenues.  They are also sitting on a huge pile of cash that they have been unable to deploy to drive organic or inorganic growth.  Chordiant took a stab at acquiring their smaller competitor Kana Software in December by trying to interrupt their deal with Accel-KKR, but failed to get the Kana board to take them seriously.

As the following table indicates, the Street considers CDCS to be more valuable than Chordiant:

What is more interesting is that CDCS’ offer is very much in line with how the market values CRM, marketing, and sales companies in January 2010.  The Software Equity Group publishes monthly, quarterly, and annual analyses of enterprise software M&A and valuation trends.  In their January Flash report, they reported the following metrics for their CRM, sales, and marketing category:

While the Chordiant Board may not like it, the market considers unprofitable late stage CRM companies with a history of declining revenues and an inability to deploy large piles of cash to drive growth not to be that valuable.  Most strategists and bankers would agree that Chordiant needs to combine with a larger company that can leverage economies of scale to lower costs and a large, pre-conditioned customer base to cross-sell their offerings to, which is pretty much what CDCS is proposing to do.

It is hard for a management team and a board to decide to sell, and to sell at what might be considered to be a discount.  In the case of CDCS and Chordiant, the initial offer was just enough of a premium to get over the typical Revlon Rule-like fiduciary responsibility requirements.  Just this week alone, three other enterprise software companies agreed to acquisitions where VC and private equity investors barely broke even, much less made significant money on the transactions.  These deals included Progress’s acquisition of Savvion ($49 million in consideration versus $52 million in VC funding), CA’s acquisition of Oblicore (estimated $25 million consideration against $20 million in invested capital), and Lawson’s acquisition of HealthVision ($160 million in consideration versus $136.7 million in invested capital.  The investors did get a 3.5x return on their investment due to their creative use of leverage — check out this WSJ piece on the transaction).  Tech companies go through a predictable lifecycle – they are born, go through adolescence, become mature, and then eventually reach retirement age.  While I am not advocating ‘death panels’ for technology companies, I wish they were clearer standards that boards and management teams could use to honestly assess their options when revenue growth is no longer a viable option for the business.

A challenge investors in companies like Chordiant face is determining how to effectively value the upside potential offered by a cash and stock deal, like the one offered by CDCS.  At the end of a conference call conducted by CDCS on Friday January 8th there was an interesting Q&A exchange between CDCS’ CEO Peter Yip and a Chordiant investor.  At one point in the discussion, the Chordiant investor remarked:

“You’re trying to get me – convince me to sell to you. So I’m saying to you, great. I agree with you. You can run it better than them because you have run your company better.  But if you’re going to pay me, you need to pay me what the company’s worth because you and I both know that it’s very, very cheap here and that we are at an historical bottom in a cycle.”

The investor felt that the price should reflect the value CDC Software would create in the combined company after the restructuring and integration.  He wanted to be paid now for the value CDC Software would create in the future – value that Chordiant has not been able to generate on their own account.  Perhaps investors will come to realize that taking a bet on an acquirer’s stock will yield a significantly better return than letting a management team that has not produced continue to struggle on until their asset becomes worthless.

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