The second quarter provided reason for guarded optimism about the nation's economic outlook. The technology sector led a sustained and impressive stock market rally. For the quarter, the S&P 500, NASDAQ and Dow were up 15%, 20% and 12%, respectively. Improved earnings reports, smaller inventory reserves, continued Fed rate cuts and an aggressive fiscal policy were the catalysts many investors needed. Investors also seemed comforted by a more stable geopolitical picture.
Relative to the first quarter, total U.S. M&A activity increased 31% and dollar value was up 38%. M&A activity in the software industry continues to lead all other sectors. According to MergerStat, software accounted for 300 deals in Q2, approximately 15% of all U.S. M&A activity for the quarter.
Acquirers spent $15.4B on software businesses in Q2, more than three times the $4.7B spent in Q1. Note, though, this includes Oracle's $6.2B bid for PeopleSoft, as well as PeopleSoft's $1.4B bid for J.D. Edwards. The median software M&A multiple grew 9% to 1.2x. However, strategic acquisitions continued to yield valuations considerably in excess of the median.
In summary, financial buyers reentered the market seeking sound investment opportunities for realistic prices. Industry consolidation among enterprise players, long predicted, became more of a reality, and strategic buyers seeking competitive differentiation, new markets and accelerated growth shopped aggressively and paid higher multiples. We expect these trends to continue for the remainder of the year and remain confident in our forecast of a 10% increase in software M&A for 2003.
ECONOMY
After 10 very difficult quarters, Q2 provided reason for guarded optimism about the nation's economic outlook. The technology sector led a sustained and impressive stock market rally. Improved earnings reports, smaller inventory reserves, continued Fed rate cuts and an aggressive fiscal policy were the catalysts many investors needed, choosing to ignore several negative indicators including an escalating unemployment rate. Investors also seemed comforted by a more stable geopolitical picture, but major challenges in post-war Iraq, the "road map" in Israel and the Palestinian territory and a new peacekeeper role in Liberia, loom as potential spoilers. Through June 30, the S&P 500, NASDAQ and Dow are up 11%, 20% and 8% respectively (see Figure 1). For the quarter, these same indices are up 15%, 20% and 12%. Relative to October 2002, they've increased 25%, 45% and 23%, respectively.
Figure 1: Q1 2003 Major Market Indices
A significant number of economists are now predicting the U.S. economy will rebound in the second half of the year from a lethargic Gross Domestic Product (GDP) growth rate of 1.4% (see Figure 2) to a far healthier 3% to 3.5% rate, which historically has connoted long-term growth. The Conference Board's leading index of 10 economic indicators, which have traditionally marked turning points in the U.S. economy, increased 1% in May, the biggest increase in 17 months. Specifically, the index recorded improvements in real money supply, consumer confidence, weekly initial claims for unemployment, building permits and manufacturers' new orders for consumer goods and materials.
Figure 2: U.S. Gross Domestic Product (GDP)
In line with the broader market, the average market value of the SEG-SEVENTY, our software industry public company index, climbed 10% during the quarter, following a 14% increase in Q1 (see Figure 3). Interestingly, the median revenue multiple grew 15% to 2.1 times trailing-twelve-month (TTM) revenue, while the median PE fell 16.3% to 28.7x, indicative of earnings growth exceeding market growth. For the SEG-SEVENTY, the median multiple of EBITDA was 18.6x. The average revenue multiple for the portfolio was 2.7x, and the corresponding confidence interval at eighty percent was 2.4x to 3.0x.
The markets disproportionately rewarded the industry's largest players - those public software companies with the greatest revenue and earnings. The median revenue multiple for the 23 companies in the SEG-SEVENTY with revenue between $200M and $1B was 2.2x, but only 1.8x for those with revenue below $200M.
Valuations by software sector continued to vary widely, as they have over the past 10 quarters. Q2 median revenue multiples by sector were:
- Business Intelligence (BI), 2.5x
- CAD/CAE, 2.2x
- Customer Relationship Management (CRM), 1.5x
- Developer Tools (DT), 3.0x
- Enterprise Application Integration (EAI), 2.3x
- Enterprise Resource Planning (ERP), 1.6x
- Information / Data Management (IM), 1.9x
- Security, 2.8x
- Supply Chain Management (SCM), 2.0x
The CRM sector of the SEG-SEVENTY, comprised of 13 companies, saw the largest increase in valuation, growing 40% in Q2. Security software companies grew 15% after declining in Q1. Software companies specializing in developer platforms and productivity tools, such as BEA Systems, Borland and Mercury Interactive, continued to lead in valuation, but declined 4% to 3.0x.
Figure 3: SEG-SEVENTY Median Multiples by Sector
Despite improved earnings and a healthier economic climate, IT spending, an important barometer for sustained tech sector growth, remained lackluster. April and May spending surveys by UBS Securities and Goldman Sachs showed deterioration, with UBS estimating 1% year-over-year growth in IT spending, and Goldman Sachs reducing their estimate from 1% to -3.2%. However, a June report from Goldman Sachs is more optimistic, indicating a rebound in IT spending from -3.2% to -0.4% for the year and 6% growth for 2004. Security and storage management remain high on the priority list (see Figure 4).
Figure 4: CIO Software Spending Priorities
CIOs are insisting on greater ease of application integration and lower cost of ownership. In particular, CIOs are pressing for lower license and maintenance fees which could imperil software company operating margins and profitability, key valuation criteria.
MERGERS & ACQUISITIONS
Software industry M&A activity in the second quarter was driven by three disparate buyer types reflecting very different motives: Larger companies seeking to eliminate competition; private equity firms seeking to take undervalued public companies private; and strategic buyers seeking competitive differentiation, new markets and accelerated growth. These same buyer types and deal motives will undoubtedly characterize software industry M&A in H2.
Industry Consolidation
Industry consolidation took on new meaning in Q2, as Oracle launched its hostile bid for PeopleSoft, closely following PeopleSoft's friendly bid for J.D. Edwards. Increased competition, stagnant Fortune 1000 IT spending and bargain valuations have spurred acquisitions aimed at eliminating competition and aggressively expanding into the mid-market. After a dearth of mega-mergers in the past two years, we expect additional big deals to follow closely on the heels of Oracle/PeopleSoft/JDEC in H2, now that the pot has been stirred. Look for IBM, among others, to react. Some believe Oracle would seek to replace IBM's DB2 at many enterprises which now use the database with their PeopleSoft and J.D. Edwards solutions.
Private Equity Buyouts
Private equity firms continued their shopping spree in Q2, seeking undervalued software companies to take private. While some are turnaround opportunities available at bargain basement prices, others are small, reasonably healthy public companies that are suffering from stagnant growth, Sarbanes-Oxley and the inability to raise additional capital. Most of the latter have solid revenue and decent profitability, but little sex appeal. The plan: take them out of the limelight, reduce overhead, build revenue both organically and through consolidation, then roll them out again when the IPO market returns. In Q2 alone, we identified more that a dozen such acquisitions by private equity buyers, including:
- Battery Ventures / Made2Manage Systems
- Cerberus Capital Management and General Atlantic Partners / Baan
- Gores Technology Group / Resonate
- Platinum Equity Holdings / Tanning Technology
- Saratoga Partners / Divine's Managed Services Unit
- Vector Capital / Corel Corp.
Strategic Acquisitions
Strategic acquisitions continued to be a primary M&A driver in Q2. Buyers primarily sought and bought small/midcap companies, many of them private, with complementary products that could significantly enhance the buyer's offering or reach. Most buyers continued to stick close to home, seeking companies in the same sector. With few exceptions, the acquired companies were typified by solid financials, strong brand identity, a plethora of customers and the potential for providing the buyer with immediate incremental revenue and earnings. Looking forward, principal acquisition targets will continue to be software companies that leverage buyers in the small/medium business market, as well as such key vertical sectors as finance, government, utility and energy. Not surprisingly, strategic valuations led, by far, industry valuations and going private valuations.
Figure 5: U.S. Merger & Acquisition Activity
M&A: The Numbers
Relative to the first quarter, total U.S. M&A activity increased 31% and dollar value was up 38%. At the current run rate, 7,212 deals will close in 2003 for an aggregate of $348B (see Figure 5). M&A activity in the software industry continues to lead all other sectors. Software accounted for 300 deals in Q2, approximately 15% of all U.S. M&A activity for the quarter (see Figure 6).
Figure 6: U.S. Sector-Specific M&A Activity
Acquirers spent $15.4B on software businesses in Q2, more than three times the $4.7B spent in Q1. Note, though, this includes Oracle's $6.2B bid for PeopleSoft, as well as PeopleSoft's $1.4B bid for J.D. Edwards.
The median software M&A multiple grew 9% to 1.2x. However, strategic acquisitions continued to yield valuations considerably in excess of the median. Example transactions include:
- Medical Systems / Triple G Systems Group, 3.1x
- Jupitermedia / ArtToday.com, 2.7x
- Kofax Image Products / Mohomine, 6.0x
- Mercury Interactive / Kintana, 5.1x
- NDC Health Corp. / TechRx, 4.4x
- ScanSoft / SpeechWorks International, 5.0x
- Symantec / Nexland, 2.5x
No surprise, cash remains king. Cash continues to be the preferred acquisition currency, with many buyers still believing their stock is undervalued (see Figure 7). 67% of buyers in Q2 used cash - down from 70% in Q1. 18% of buyers in Q2 paid all stock, and 15% used a combination of the two.
Figure 7: Software M&A - Form of Payment
M&A: Most Active Software Sectors
Systems/app management, ERP, accounting/financial and supply chain management were the most active categories in Q2.
Representative transactions include:
Accounting / Financial Management
- Agile Software Corp. / MS2
- Fidelity National Financial / Hamilton & Sullivan
- Fidelity National Information Solutions / DPN
- Financial Profiles / StatiaFX
- Hyperion Solutions Corp. / The Alcar Group
- Risk Capital Management Partners / AcuRisk
- SAS Institute / OpRisk Analytics
Enterprise Resource Planning- Battery Ventures / Made2Manage Systems
- Cerberus Capital Management and General Atlantic Partners / Baan
- Epicor / Select CompuNet eBusiness Assets
- Oracle Corp. / PeopleSoft· PeopleSoft / J.D. Edwards
- Prophet 21 / Faspac Systems
- Speedware / Enterprise Computer Systems
Security / Firewall- Microsoft Corp./ GeCAD Software
- Network Associates / Entercept Security Technologies
- Network Associates / IntruVert Networks
- SAIC / Predictive Systems' Business Unit
- Symantec Corp. / Nexland
Enterprise Systems Management- BMC Software / Database Guys (DGI)
- Gores Technology Group / Resonate
- IBM / Think Dynamics
- NaviSite / Interliant
- Surgien Networks / ProTier Corp.
- Tarantella / New Moon Systems
Supply Chain Management- Agilisys International / Future Three Software
- Electronics for Imaging / Printcafe Software
- JDA Software Group / Vista Software Solutions
- Manhattan Associates / Select ReturnCentral Assets
- NDC Health Corp. / TechRx
- NxTrend Technology / Dimasys Software
- SSA Global Technologies / Ironside Technologies
Marketing Automation- Google / Applied Semantics
- Interwoven / MediaBin
- Siebel Systems / BoldFish
- Silverpop Systems / Select Avalon Digital Marketing Systems Assets
- Unica / Marketic
Wireless Software- Sun Microsystems / Pixo
- Infowave Software / HiddenMind Technology
- Novarra / Neomar
- Nokia Corp. / Eizel Technologies
M&A: Most Active Buyers
There were few buying sprees in Q2. The most active buyers were:
|
ACD Systems
Deneba Systems, $5.5M
|
Cadence Design Systems
|
SELECT SOFTWARE M&A TRANSACTIONS, Q2 2003
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| ACD Systems (Tsx:ASA) | Deneba Systems | $5,500,000 | $4,600,000 | 1.2x | Cash & Stock |
| SEG's Insight: ACD, a developer of digital imaging and management software, acquires Deneba, a provider of photo editing and desktop publishing applications. Deneba's core products and small file "foot print" complement ACD's products and Web distribution model. Deneba should also aid in diversifying ACD's revenue, likely derived mostly from its ACDSee product. ACD will pay $4.5M in cash and $1M in stock, but seeking to preserve its cash balance, has offered Deneba shareholders a 20% premium on any cash amount under $1.5M taken in ACD stock. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| Battery Ventures | Made2Manage Systems (Nasdaq:MTMS) | $13,516,000EV | $30,100,000 | 0.5x | Cash |
| SEG's Insight: Battery Ventures, a first-tier VC firm, takes private Made2Manage, an ERP provider to small and midsize manufacturers. Here's another example of a struggling, undervalued public company being acquired at a price that looks like a real bargain at a 1.0x multiple, but represents a healthy 40% premium to shareholders. Look for additional acquisitions by Made2Manage now that it has Battery's financial backing and greater flexibility as a private company. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| Cerberus Capital Management / General Atlantic Partners | Baan | $135,000,000 | $265,000,000 | 0.5x | Cash |
| SEG's Insight: Once a real competitor in the ERP space before falling early victim to an accounting scandal and selling to Invnesys for $800M, Baan fell victim again - this time to the stagnant ERP market and depressed corporate IT spending. Private investment firms Cerberus and General Atlantic are the beneficiaries, picking up Baan for a song. The investors will combine Baan with SSA Global, leveraging Baan's strength in open systems and its European focus with SSA's AS/400 strength and North American focus. The combined business will boast $600M in revenue. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| FileNet (Nasdaq:FILE) | Shana Corp. | $8,500,000 | $7,500,000(est.) | 1.1x | Cash |
| SEG's Insight: With $160M of cash on its books, cash-healthy FileNet, a provider of enterprise content and collaboration software, picks up Canadian firm Shana, a privately held e-forms software vendor. A FileNet partner for the last 12 months, Shana complements FileNet's offering and furthers its push to offer customers an end-to-end ECM solution. With 66 employees, Shana's revenue is estimated to be $7.5M. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| Group 1 Software (Nasdaq:GSOF) | Sagent Technology (Nasdaq:SGNT) | $17,000,000 | $37,900,000 | 0.45x | Cash |
| SEG's Insight: After defaulting on a $7M loan in late March, data extraction and analysis provider Sagent threw in the towel. Group 1, a CRM solutions vendor, is the beneficiary. Group 1 pays 0.5 times Sagent's LTM revenue and in return picks up 1,500 global customers, powerful complementary technology and a product it can sell immediately into its installed base of 2,000 customers. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| Hewitt Associates (Nyse:HEW) | Cyborg Systems | $43,000,000 | $40,000,000 | 1.1x | Cash |
| SEG's Insight: Global HR outsourcing and consulting firm Hewitt picks up Cyborg Worlwide, a provider of HR workforce management software. What really attracted Hewitt was Cyborg's lucrative payroll services business, which Hewitt needs to round out its HR outsourcing business. Hewitt also gains access to 750 companies in 10 countries using Cyborg's payroll service. At 1.1x, the multiple is in line with what we expect today from a strategic acquisition of a service provider. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| JDA Software (Nasdaq:JDAS) | Vista Software Solutions | $4,300,000 | $4,300,000 | 1.0x | Cash |
| SEG's Insight: Leading retail industry software provider JDA beefs up its planning, forecasting and supply chain solutions by acquiring the IP assets and staff of Vista Software, a provider of data synchronization and integration solutions linking retailers, distributors and manufacturers. This is an inexpensive acquisition that will enable JDA customers to better manage trade promotions and synchronize data throughout their supply and demand chains. Vista had $1.4M in software revenue. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| Kofax Imaging Products | Mohomine | $9,000,000 | $1,500,000(est.) | 6.0x | Cash |
| SEG's Insight: Kofax, a provider of software and image-processing products for data and document capture, picks up Mohomine, a venture-backed developer of unstructured data capture. Mohomine's patented classification and extraction technologies, which can classify up to 100 documents per second, further Kofax 's pursuit of an end-to-end data capture solution. Kofax paid roughly 6x on LTM revenue between $1M and $2M, a relatively good return for Mohmine's investors who received 80 cents on the dollar. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| MICROS Systems (Nasdaq:MCRS) | Datavantage Corp. | $52,000,000 | $42,000,000 | 1.2x | Cash & Stock |
| SEG's Insight: MICROS, a leader in IT services and solutions to the hospitality industry, acquires Datavantage, a provider of POS software to the likes of Starbucks, IKEA and Staples. MICROS rationalized the acquisition by pointing out hospitality businesses often have retail operations. Fact is, MICROS is bucking the current trend of staying "close to home" by moving into a new and different vertical market that is faring better than travel and hospitality. Saratoga Partners, Datavantage's investors, earned a 43% IRR. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| NaviSite(Nasdaq:NAVI) | Interliant(Nasdaq:INIT) | $7,000,000 | $44,600,000 | 0.2x | Cash |
| SEG's Insight: Navisite, a provider of application management and hosting services, acquires Interliant, a bankrupt competitor focused on corporate messaging and e-mail outsourcing. It's fourth acquisition of a hosting business in recent months, NaviSite is taking advantage of depressed valuations and others' misfortunes. While the market reacted favorably to the acquisition, driving NaviSite's stock price upward 67%, we're a little less enthusiastic. NaviSite has significant debt, a dwindling cash balance and negative operating income. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| Oracle Corp.(Nasdaq:ORCL) | PeopleSoft(Nasdaq:PSFT) | $4,170,000,000EV | $1,930,000,000 | 2.2x | Cash |
| SEG's Insight: On the heels of the PeopleSoft/J.D. Edwards announcement, Oracle responded promptly by tendering a hostile bid for PeopleSoft in the amount of $5.1B, or $16 per share. Viewed by many as a grossly inadequate offer, PeopleSoft's stock price was bid up from $15 to $18 in anticipation of a higher offer by Oracle or a white knight. Less than two weeks later, Oracle revised its bid upward 22% to $19.50 per share, but many obstacles remain. Oracle, which has historically abstained from acquisitions, was sufficiently threatened by the prospect of a PeopleSoft/Edwards merger to act as spoiler offering most of its $6B of cash. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| PeopleSoft(Nasdaq:PSFT) | J.D. Edwards (Nasdaq:JDEC) | $1,350,000,000EV | $886,000,000 | 1.5x | Cash & Stock |
| SEG's Insight: Kicking off what was a very exciting week for software M&A, PeopleSoft announced it would acquire J.D. Edwards. With Edwards, PeopleSoft will greatly strengthen its position in the mid-market, as well as its presence in manufacturing and other key vertical industries such as real estate and construction. Though Edwards' revenue declined 11% from its 2000 high, it has done reasonably well in the current economy. We're a bit surprised at the price, which equates to a modest 1.5x multiple and only a 19% premium to Edwards' shareholders. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| Saratoga Partners(NASDAQ: FILE) | Divine's Managed Services Unit | $28,000,000 | $60,000,000 | 0.5x | Cash |
| SEG's Insight: Fallout from the Divine debacle continues with the U.S. Bankruptcy Court's approved sale of Divine's managed services unit to Saratoga Partners, a New York private equity firm. Saratoga is one of the few private equity firms that saw opportunity in the current market and jumped headlong into the fray. This is Saratoga's third acquisition since February and follows on the heels of its recent sale of Datavantage to MICROS Systems. The managed services unit was built through Divine's acquisition of Data Return, Intira and Host One. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| ScanSoft (Nasdaq:SSFT) | SpeechWorks Int'l (Nasdaq: SPWX) | $133,756,000EV | $36,000,000 | 3.7x | Stock |
| SEG's Insight: ScanSoft, a leading developer of digital imaging software, continues to redefine itself by picking up publicly traded SpeechWorks, a speech recognition and text-to-speech vendor. This is ScanSoft's third acquisition in this sector. ScanSoft clearly considers SpeechWorks to be highly strategic, considering the 63% premium it paid for a company that has historically lost significant amounts of cash. ScanSoft expects the deal to be 5% accretive after eliminating $27M through headcount cuts and office consolidations. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| SERENA Software (Nasdaq:SRNA) | TeamShare | $18,000,000 | $12,500,000(est.) | 1.4x | Cash |
| SEG's Insight: Serena, a provider of software solutions used to manage enterprise application code and Web content changes, picks-up TeamShare, a "SoftLetter 100" provider of developer-oriented collaboration and workflow management tools. TeamShare's product, which is already integrated with Serena's, provides a highly complementary product extension for Serena. Revenue is estimated to be $12.5M. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| SSA Global Technologies | Elevon (Nasdaq: ELVN) | $20,280,000 | $33,000,000 | 0.6x | Cash |
| SEG's Insight: Serena, a provider of software solutions used to manage enterprise application code and Web content changes, picks-up TeamShare, a "SoftLetter 100" provider of developer-oriented collaboration and workflow management tools. TeamShare's product, which is already integrated with Serena's, provides a highly complementary product extension for Serena. Revenue is estimated to be $12.5M. | |||||
| Buyer | Seller | Price | Revenue | Multiple | Currency |
| Symantec Corp. (Nasdaq:SYMC) | Nexland(OTC:XLND) | $20,100,000EV | $7,740,000 | 2.6x | Cash |
| SEG's Insight: Symantec continues to reposition as a security software provider by acquiring Nexland, a small public company whose patent-pending security applications and appliances enable secure virtual private networking between corporate and remote offices. Here's another example of a strategic partnership evolving into an acquisition with a decent multiple. After backing out Nexland's cash and adding debt, Symantec paid $20.1M. Nexland's compound annual revenue growth rate exceeded 129% over the last two years. | |||||
EV: Enterprise value = Purchase price, plus debt, minus cash & equivalents
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.