By Ken Bender, Managing Director, and Allen Cinzori, Vice President - Software Equity Group, LLC
A comprehensive review and analysis of the past quarter's software industry mergers and acquisitions, this report analyzes changing market valuations of public software companies as a group, as well as by product category. The Report also includes detailed data and in-depth analysis of M&A transactions during the quarter, including changes in the most active software product categories, continued improvement in M&A valuations, further transition in deal structure and form of payment, and shifts in buyer priorities and thinking. Also listed are Q1's most active buyers and insight into some of Q1's most interesting and instructive deals.
ECONOMY
By almost every measure, the U.S. economy continued to improve in the first quarter. Gross Domestic Product rose at a 4.2% annual rate, up from the 4.1% pace in 4Q03 (Figure 1). However, the growth rate was lower than the 5% rate some economists had expected. According to the Wall Street Journal, economists now predict the economy will grow 4% or more in 2004 and Q1's GDP report supported those expectations.
The Conference Board's composite index of leading economic indicators, a key short term forecast, improved again in March by 0.3%. During the same period, coincident indicators increased 0.2% and lagging indicators fell by 0.1%.
Consumer confidence remained strong through the close of the quarter. Growing concerns about Iraq and skyrocketing gasoline prices did not negate the positive effects of low mortgage rates and vehicle manufacturer discounts.
Although March also saw a long-awaited improvement in employment, with non-farm employees increasing by 308,000, the unemployment rate held steady at about 5.7%. While the media has identified outsourcing as the primary culprit, most economists disagree. Only 16% of 55 economists surveyed by The Wall Street Journal identified outsourcing as a significant factor. While an estimated total of 58.6 million layoffs took place in the U.S. between 2001 and 2003, only 690,000 jobs were lost through relocation to overseas markets.
PUBLIC MARKETS
The stock market charted an uneven course in the first three months of 2004, but gave up little ground. Early Q1 saw the Dow, Nasdaq and S&P 500 increase as much as 3.2%, 7.3% and 4.5%, respectively over their January 1 opening, but drop as low as (1.6%), (5.2%) and (3.5%) during a major sell-off (Figure 2). Some last minute buying at the end of the quarter stabilized these same indices, resulting in close of quarter percent changes of (0.5%), (0.6%) and 1.6%. Nevertheless the Dow, Nasdaq and S&P 500 closed up 30%, 49% and 33%, respectively, from the end of 1Q03.
As of January, our public software company index known as the SEG-70 (comprised of 70 companies in nine major software product categories) has been expanded to 108 companies in 17 principal categories (the SEG-100) to enable more detailed tracking of industry performance and trends. New product categories include:
- Enterprise System Management
- Financial Software
- Healthcare Software
- Internet Tools/Utilities
- Manufacturing Software
- Middleware
- Operating Systems
SEG-100 valuations improved markedly in the first quarter. The Median EV/Revenue ratio for the SEG-100, a key indicator, reached 3.0x, while median EV/EBITDA and EV/Earnings for those companies posting profits increased to 22.4x and 34.3x (Figure 3). The median current ratio, measured as current assets divided by current liabilities, an indication of a company's liquidity, was a healthy 2.1.
The escalating market caps and higher EV/Earnings ratio are partially attributable to improved financial performance. Aided by stronger demand and continued cost-cutting efforts, median annual revenue of the SEG-100 rose 8.3% between 1Q04 and 1Q03 (Figure 4), while median earnings grew an impressive 56.3% over the same period (Figure 5).
Continuing the trend we first observed in 3Q03, U.S. markets in 1Q04 continued to favor those software companies with the largest revenues (Figure 6). As a measure of market value, the 21 companies in the SEG-100 with revenue greater than $1 billion averaged a 4.5x EV/Revenue multiple, as compared to a 2.5x multiple for companies with revenue less than $1 billion. Expectedly, those public software companies posting profits in Q1 were rewarded with a 3.3x revenue multiple valuation, as contrasted with non-profitable companies which had a median 2.6x multiple.
Market valuations for public software companies also varied widely by target market and product category. Valuations for most categories peaked in January, but ended the quarter relatively unchanged. The SEG-100 median revenue multiples by principal product category for Q1 are enumerated in Figure 7.
Publicly traded operating system software developers, led by Microsoft, boasted the highest valuation among all categories at 6.9x trailing revenue, (Figure 8). Storage Management software developers posted a 1Q04 revenue multiple of 6.4x and a median year-over-year revenue growth rate of 17.5%, along with year-over-year earnings growth of 388.6%. The manufacturing vertical showed impressive 37.4% year-over-year revenue growth, but that did little to improve valuation. Manufacturing posted a revenue multiple of 2.0x, second lowest among all SEG-100 product categories. Customer relationship management (CRM) and supply chain management (SCM) were the laggards in terms of year-over-year revenue growth, posting losses of 10.1% and 6.7%, respectively.
MERGERS & ACQUISITIONS: THE TRENDS
In order to discern trends in merger and acquisition activity, it is essential to understand changes in buyer thinking. Precisely what motivated the buyer to acquire this particular company; to spend cash, dilute equity, allocate precious resources and assume sometimes formidable risks? What were the deal drivers in Q1, how were they different from 2003 and how did they impact valuations and purchase prices?
An improved economy, respectable revenue growth, solid earnings and soaring public market valuations spurred a growing number of public and venture-backed private companies to pursue acquisitions in the first quarter of 2004. In our view, however, the uptick in M&A activity and M&A valuations is most attributable to projected increases in corporate IT spending. In the software industry, stronger demand by enterprise customers translates quickly to fierce competition among software providers. In virtually every enterprise software product category, larger companies turned to strategic acquisitions to competitively differentiate their offerings. As a result, both software industry M&A activity and median valuations increased again in 1Q04.
Despite the higher price tags, buyers were undeterred, showing a resolve not seen since the bubble days. The number of transactions with multiples of 5 times trailing twelve months (TTM) or higher climbed sharply. Even a few private equity firms chose to compete aggressively with strategic buyers for best-of-breed technologies. And while no one is quite ready to declare a new bull market in M&A, there are indications we're moving in that direction.
PRODUCT EXTENSION
A deal-by-deal analysis of some 182 transactions we analyzed in 1Q04 reveals 63% of the buyers, primarily public software companies, sought to enhance their current product suite by acquiring small and mid-cap companies targeting the same markets with highly complementary, best-of-breed, market proven products and technology (Figure 9). The objective was to better satisfy market requirements and thereby differentiate from the competition and create new sources of revenue. Examples abound, including Verity's acquisition of both Cardiff Software and NativeMinds to provide a more comprehensive, single source, user friendly solution (see deal write-ups that follow). Hewlett Packard made three acquisitions in Q1 (Novadigm, Consera, and Trulogica) to extend the capabilities of its OpenView suite. JDA Software, a leading retail enterprise software provider, acquired Timera, a developer of workforce management solutions to bring a broader complement of products to its target market. Intellisync acquired Search Software, whose software manages personal identity data in enterprises and network databases. These product extension buys were roughly the same percentage of 1Q04 total transactions as in 4Q03.
NEW MARKETS
Last quarter we noted a surprising number of buyers who had ventured far from home, acquiring software companies in new product categories and new markets in an effort to accelerate growth. The trend slowed in the first quarter of 2004, with buyers acquiring new product categories and markets, comprised of some 15% of all software M&A transactions, compared to approximately 25% in 4Q03. New market buyers in Q1 included corporate computer system reseller Agilysys which acquired Inter-American Data (IAD), a software provider serving the gaming and casino market. Captiva Software, a provider of input management solutions, acquired ADP Context, developer of automated health care claims processing software. Convergys, a Cincinnati Bell spin-off that's now a $2.3B global provider of outsourced customer billing and HR services, acquired DigitalThink, a provider of e-learning to the Fortune 1000.
VERTICAL MARKETS
Vertical market software company acquisitions comprised about 8% of M&A transactions in Q1, led by five deals in the healthcare sector. Healthcare software company acquirers were among the few remaining bargain hunters, seeking to capitalize on valuations which remain depressed due to stagnant healthcare IT spending and escalating industry cost pressures. Q1 also saw software acquisitions in the manufacturing, legal, education and energy sectors. Q1 saw a growing number of mobile content delivery and wireless software transactions, particularly in vertical markets. Look for a growing number of mobile content and wireless software transactions during the remainder of the year.
TRENDS FORECAST
While software industry M&A activity in the first quarter was nearly identical to 2003's average, we anticipate merger and acquisition activity to ramp in the remaining three quarters, exceeding 2003's total (1,325 transactions) by about 12%. Principal acquisition targets will continue to be best-of-breed software companies which functionally enhance the offerings of larger public companies or which extend them into new product categories and geographical markets; software companies which extend leverage buyers in the small/medium business market; and software companies in key vertical sectors such as healthcare, government, defense and finance.
MERGERS AND ACQUISITIONS: THE NUMBERS
The momentum of 2003's U.S. merger and acquisition activity continued to build in the first quarter of 2004. Domestic M&A activity across all industry sectors in Q1 2004 totaled 2,218 deals with an aggregate purchase price of $297 billion (Figure 10). While the total number of deals in Q1 declined 8% from Q4 2003, total M&A dollars for the first quarter is up 140% from Q4 2003, already 56% of 2003's total.
Software mergers and acquisitions continued to lead all other industry sectors with 387 deals, up slightly from deal totals in Q3 and Q4 of 2003 (Figure 11). In terms of M&A dollars spent, the $12.6 billion spent on software company acquisitions in Q1 was up 7.7% from Q4 2003 and 4.1% from Q3 2003 (Figure 12). Internet tools/utilities transactions were partly responsible for the surge in M&A spending. Ask Jeeves / Interactive Search Holdings, Yahoo / Kelkoo, InfoSpace / Switchboard and Convergys / DigitalThink each had large price tags reflecting hefty multiples (See deal write-ups). Two mega-deals, Juniper / Netscreen and (Bain Capital, Silverlake, Wargurg Pincus) / UGS PLM totaled $5.5 billion and represented 44% of total U.S. software M&A dollars paid in Q1.
For the fifth consecutive quarter, median valuations for software company exits continued their quarter over quarter increase (Figure 13). The median software company M&A valuation (based on equity purchase price), reached 2.3 times trailing-twelve-months (TTM) revenue in 1Q04, more than two times the median M&A valuation of 1Q03 and better than 4Q03's 2.1x median valuation.
Although cash remains the preferred form of payment for software M&A, stock is comprising a growing component of the deal consideration (Figure 14). With stock prices higher, larger public companies no longer consider their stock too deflated in value to use as currency. Smaller public companies, with higher stock prices but little cash remaining on their balance sheets, also convinced more sellers to accept stock. As a result, 51% of buyers in Q1 2004 used cash - down from 68% in Q1 2003 but on par with last quarter. 22% of buyers in Q1 2004 paid all stock (vs. 21% in Q1 2003) and 27% used a combination of cash and stock (vs. 11% in Q1 2003).
MERGERS AND ACQUISITIONS: Most Active Buyers
Multi-transaction buyers proliferated in the first quarter of 2004. It was not unusual to see the same buyer roll-up a competitor in one deal and strategically enhance its product line in another. Some of the quarter's most active buyers:
Agilisys International
|
Kintera, Inc.
|
MERGERS AND ACQUISITIONS: SELECT 2003 SOFTWARE M&A TRANSACTIONS
Buyer: Agilysys (Nasdaq: AGYS)
Seller: Inter-American Data
Price: $36,500,000
Revenue: $40,000,000
Mult.: 0.91x
Currency: Cash
Category: Hotel/Casino Vertical
SEG's Insight:
Agilysys, a distributor and reseller of enterprise computer systems, acquires Inter-American Data (IAD), a provider of property and materials management software to casinos and major resorts. Seeking to redefine itself due to shrinking hardware margins and a TTM revenue decline of 50%, this is Agilysys' second acquisition in five months of a vertical market solution provider. There is some synergy, though, as Agilysys is an IBM Premier Business Partner, and IAD's solutions run on IBM platforms. With $319 million in cash remaining, look for additional Agilysys software acquisitions in the coming months.
----------------------------------------------------
Buyer: Ask Jeeves (Nasdaq: ASKJ)
Seller: Interactive Search Holdings
Price: $342,603,000
Revenue: $100,000,000
Mult.:3.4x
Currency: Cash, Stock
Category: Internet Search
SEG's Insight:
Consolidation continues amoung search engine providers, as Ask Jeeves acquires competing internet search company Interactive Search Holdings (ISH), the owner of the Excite, iWon, and MySearch websites. Investors responded favorably to this deal. Originally worth $328 million when tendered, valuation grew to more then $420 million after Ask Jeeves shares jumped 40% on deal day to $29.01 - a 877% increase since the beginning of 2003. Ask Jeeves, which lost $699 million during its first six years in business but is now profitable, raised the $115 million cash purchase price by issuing zero coupon convertible subordinated notes back in June. Ask Jeeves reported revenue of $107 million and an operating profit of $25 million while ISH had revenues of $140 million and profit of $35 million. The acquisition doubles Ask Jeeves market share to 7% and gives them an annual search inventory equal to 21 days worth of Google's traffic.
----------------------------------------------------
Buyer: Avocent (Nasdaq: AVCT)
Seller: OSA Technologies
Price: $100,000,000
Revenue: $6,250,000(Estimate)
Mult.:16.0x
Currency: Cash, Stock
Category: Firmware
SEG's Insight:
Avocent, supplier of KVM (keyboard, video and mouse) switching and connectivity solutions, expands into a new market by acquiring OSA Technologies, provider of embedded firmware and software to manage servers, blades, networks and storage devices. The $100 million purchase price ($52 million cash and $48 million stock) represents a hefty premium over OSA's revenue (estimated at less than $10 million), but will extend Avocent into a new, higher end/higher margin market. OSA, with offices in Shanghai and Taipei, also offers Avocent more exposure to Asian markets. OSA has received more than $19 million in equity financing from the likes of Dell, Intel Capital, VC's and Taiwan Manufacturers.
----------------------------------------------------
Buyer: Bain Capital, Silver Lake Partners, Warburg Pincus
Seller: UGS PLM Solutions
Price: $2,050,000,000
Revenue: $897,000,000
Mult.:2.3x
Currency: Cash
Category: Product Design Management
SEG's Insight:
In a quest for cash to offset its $5 billion in debt, Electronic Data Systems' (EDS) sells its product design management-software unit, UGS PLM Solutions, to private buyout firms Bain Capital, Silver Lake Partners and Warburg Pincus. Each will reportedly invest $350 million cash and take an equal stake. Citigroup Global Markets Inc., J.P. Morgan Chase & Co. and Morgan Stanley have agreed to provide roughly $1.2 billion in senior bank debt and high yield bonds. The $2.05 billion price amounts to 2.3x UGS' $897 million trailing revenue in 2003, and 10.2x current EBITDA (roughly $200 million). UGS' 42,000 customers and 8% annual revenue growth brought an array of interested parties to the table. The UGS deal is the largest technology private equity investment since the $2 billion purchase of Seagate Technology Inc.'s disk-drive business in 2000.
----------------------------------------------------
Buyer: Convergys (NYSE: CVG)
Seller: DigitalThink (Nasdaq: DTHK)
Price: $105,000,000EV
Revenue: $42,100,000
Mult.:2.9x
Currency: Cash, Stock
Category: Online Education
SEG's Insight:
Convergys, a Cincinnati Bell spinoff that is now a $2.3 billion global provider of outsourced customer billing and HR services, acquires DigitalThink, a provider of e-learning to the Fortune 1000. After issuing first quarter earnings targets that fell below some analysts' projections causing its share price to drop 5.8%, Convergys is betting DigitalThink will help it retain customers and aggressively expand its HR outsourcing business. The $120 million purchase price represents a 30% premium to DigitalThink's closing price immediately before the deal was announced. The timing was right for DigitalThink, which lost more then $10 million on $45 million in TTM revenue, as well as one of its biggest clients, EDS. Investors agreed, driving DigitalThink's share price up 51% on deal day.
----------------------------------------------------
Buyer: FindWhat.com (Nasdaq: FWHT)
Seller: Comet Systems
Price: $18,580,000EV
Revenue: $8,500,000
Mult.:2.2x EV
Currency: Cash,Stock
Category: Internet Tools/Utilities
SEG's Insight:
FindWhat.com, a provider of marketing and e-commerce services, including online marketplaces, acquires Comet Systems, a developer of free download consumer software and a fee-based desktop search engine. FindWhat, which derives most of its revenue from a keyword-targeted internet advertisement service, hopes its advertisers will pay more in order to gain access to the 100 million who have downloaded Comet's pop-up blocker and surf privacy software. Comet stockholders will receive $8.5 million in cash (equal to Comet's 2003 net revenue) plus $15 million in FindWhat stock and up to $10 million in cash based on 2004 and 2005 operating performance.
----------------------------------------------------
Buyer: Hewlett Packard (NYSE: HPQ)
Seller: Novadigm, Inc. (NASDAQ: NVDM)
Price: $94,834,000 EV
Revenue: $58,300,000
Mult.:1.6x
Currency: Cash
Category: Enterprise system management
SEG's Insight:
Hewlett-Packard Co. continues to aggressively expand its OpenView software suite by acquiring Novadigm Inc., a leading provider of automated IT configuration and change management software. Simultaneously, HP picked up Consera Software, a provider of software that enables IT resources to be mapped to business services. Last fall, HP acquired Talking Blocks for services management, Baltimore Technologies' Select Access business for identity management, and Persist Technologies for information lifecycle management. Novadigm saw its revenue decrease 11% the last fiscal year. HP agreed to pay $6.10 in cash for each share of Novadigm stock. The day after this deal was announced, Novadigm's stock shot up 27% shortly after the opening bell.
----------------------------------------------------
Buyer: InfoSpace (Nasdaq: INSP)
Seller: Switchboard (Nasdaq: SWBD)
Price: $104,150,000EV
Revenue: $15,190,000
Mult.:10.5x
Currency: Cash
Category: Internet Tools/Utilities
SEG's Insight:
In a drive to increase its share of the $450 million online local directory market, Internet and wireless solution provider Infospace acquires Switchboard, a provider of online business directories advertising products. InfoSpace expects Switchboard to add $10 million to $12 million in revenue and between $4 million to $5 million in search and directory income during the second half of 2004. Local search has become a hot area for Internet companies, with Google and Yahoo each introducing new tools in the past month. With revenue of $15 million, the $160 million all cash price represented a 28% premium over a very healthy market cap of $147 million, and was received favorably by investors. Switchboard's price leaped 28% on deal day, while Infospace's price jumped 14%.
----------------------------------------------------
Buyer: Juniper Networks (Nasdaq: JNPR)
Seller: NetScreen Technologies (Nasdaq: NSCN)
Price: $3,436,781,000EV
Revenue: $275,290,000
Mult.:12.5x
Currency: Stock
Category: Security
SEG's Insight:
Juniper Networks, the second largest internet router manufacturer, acquires internet security solution provider NetScreen Technologies in a deal valued at $3.8 billion. Noting the hefty 56% premium, the market drove down Juniper's share price 11% on deal day, slicing more then $456 million in deal value. That same day NetScreen's share price increased 36% to an all time closing high. The amount Juniper is paying is nearly $1 billion more then Juniper's total cumulative revenue last year. Why the big multiple? First, Juniper has focused primarily on the telecom market and now needs NetScreen to compete against bellwether Cisco in the lucrative government sector. Second, NetScreen has performed admirably, even in a tough economy, by boosting sales to $245 million last year, up 77% from 2002. This acquisition puts pressure on the other major firewall/VPN provider, Check Point, to partner with a hardware provider. Check Point now becomes the only major player entirely focused on network security. For the time being, Juniper and NetScreen will remain separate businesses, although eventually NetScreen's security will be embedded in Juniper's routers.
----------------------------------------------------
Buyer: Serena Software (Nasdaq: SRNA)
Seller: Merant Plc (Nasdaq: MRNT)
Price: $309,300,000EV
Revenue: $128,300,000
Mult.:2.41x
Currency: Cash,Stock
Category: Change Management
SEG's Insight:
Serena Software's acquisition of competing Enterprise Change Management (ECM) software provider Merant creates the second largest provider (23% market share) in this space behind IBM's Rational Software division (30% market share). The combined company will have estimated annual revenue of $225 million, 15,000 customers, and 46 of the 50 largest multinational companies. Serena, sells ECM software mostly for mainframes, has a market cap of about $803 million, while Merant, whose software is deployed on distributed systems, has a market cap of about $300 million. Serena's 2003 revenues were 27% lower then Merant's, but Serena achieved much higher revenue and profitability per employee leading to the higher market valuation and an opportunity to improve Merant's performance. For Merant shareholders, the deal equates to a 25% premium above Merant's closing price on the day of the announcement, not bad considering Merant has racked up losses aggregating $140 million on revenue of $483 million over the last three fiscal years and saw its revenue fall 32%.
----------------------------------------------------
Buyer: Verity (Nasdaq: OPSW)
Seller: Cardiff Software
Price: $50,000,000EV
Revenue: $26,300,000
Mult.:1.9x
Currency: Cash
Category: Content management
SEG's Insight:
Verity, a provider of enterprise search, classification and personalization software, acquires Cardiff Software, a developer of document-capture and e-forms processing software. The deal, which takes the last independent e-forms software developer off the market for $50 million all cash, extends Verity into a new area of information management. Verity will now be able to capture data from documents and forms and move the unstructured information through business processes, which then can be searched and analyzed by Verity's suite of tools. With Cardiff competitors (Accellio, Shana, and Caere) in the e-forms space all being acquired by larger companies, and with Microsoft and Adobe systems elbowing their way into the space, the time was right for Cardiff to exit.
----------------------------------------------------
Buyer: VerticalNet (NYSE: VERT)
Seller: Tigris Corp.
Price: $9,279,690
Revenue: $10,000,000
Mult.:0.93x
Currency: Stock,Cash
Category: Supply Chain Management
SEG's Insight:
Verticalnet, a strategic sourcing and supply chain application vendor, acquires Tigris Corp., a sourcing and supply chain consultancy. Most appealing to VerticalNet was Tigris's data intensive, tools-based approach to spend analysis, which Aberdeen Group claims could save enterprises $260 billion annually. The acquisition, which will double VerticalNet's TTM revenue comes none too soon. VerticalNet's revenue declined 65% to $9.6 million in its last fiscal year. With only $4.2 million in cash on hand, the company resorted to a net $6.2 million private placement less then two weeks before this deal was announced.
----------------------------------------------------
Buyer: Yahoo (Nasdaq: YHOO)
Seller: Kelkoo SA
Price: $576,000,000
Revenue: $50,000,000
Mult.:11.5x
Currency: Cash
Category: Internet Tools/Utilities
SEG's Insight:
Yahoo expands both its geographical reach and search-related marketing services by acquiring Kelkoo SA, a major European comparison shopping site. Founded in France in 1999, Kelkoo grew through a series of rapid acquisitions in the U.K., Spain and Norway, and now operates in 9 European countries with 32 million unique users monthly. While the $578 million all-cash purchase price (41 times 2003 cash flow and 11 times last year's sales) leaves some observers breathless, at least a few analysts believe Kelkoo's revenue and cash flow will double in 2004. They also see the acquisition as necessary for Yahoo to fend off fierce competition from rivals Google and Microsoft. The Kelkoo deal follows Yahoo's December 2002 acquisition of search engine provider Inktomi for $235 million, and its July 15, 2003 acquisition of Overture Services, a leader in paid-search listings, for a whopping $1.6 billion.
----------------------------------------------------
EV: Enterprise value
This report was prepared by Software Equity Group, L.L.C. (SEG), a mergers and acquisitions advisory firm serving the software, life science and technology sectors. SEG is solely responsible for its content. This material is based on data obtained from sources we deem to be reliable; it is not guaranteed as to its accuracy and does not purport to be complete. This information is not to be used as the primary basis of investment decisions. For more, please visit www.softwareequity.com, or phone (858) 509-2800.
