M&A Myths, Misconceptions and Misinformation

Introduction  

Nat Burgess

Good day! I’m Nat Burgess the moderator for today’s event. I’m very happy to be presenting today and I’ll be joined by several of our senior staff who will be reporting on recent events both in our practice and in tech M&A in general. I have a deal that I’ve been managing based in London that will be announced tomorrow, we’ve had recent closings in France and Finland, and we’ll be talking about some of the dynamics in those deals today. We’ll also be talking about recent conferences and some of the reasons why we’re having record attendance, both in sellers and buyers, which we think will lead to record deal flow in coming quarters. We’re also going to cover one of our Top Ten Tech Trends, Information Security, in the context of a transaction we just closed with a very innovative company in France, and then we’re going to go to Corum’s Research Group to talk through the trends in M&A. As we reach the end of today’s event, we’re also going to talk about misconceptions and misinformation in the tech M&A market. This will be an exciting segment and I encourage you to stay tuned through the full 30 minutes, because there are always 100 reasons why you shouldn’t do something, and we’re builders, we look for opportunities to create value, and when you’re in a historic market window, as we are today, we need to get past the myths and misinformation and figure out how to build value together.  

WFS London Report

With that, I’d like to turn it over to our first presenter, Jon Scott.  

Jon Scott

Thanks, Nat. I had the honor of again sharing the 11th annual World Financial Symposium’s London Growth and Exit conference on June 3rd. Corum has been a platinum sponsor of this conference since its inception. The WFS is an international organization dedicated to educating technology leaders. This was an excellent conference, and like today’s webinar, we had more than a hundred people in attendance, as well as delegates and speakers from seventeen countries. The conference was attended by founders, CEOs, CFOs, VCs, private equity firms, buyers, and also recent sellers, all focused on software and technology. It included 10 presentation panels on growth and exit subjects. I liked the presentation by the London Stock Exchange on IPOs and SAP and Autodesk had corporate development executives who spoke on what they look for in an acquisition candidate. That panel was so well-received that it went over the schedule to answer all the audience’s questions.

I presented Corum’s Top Ten Disruptive Tech Trends, which generated some interesting discussions during the network breaks, the lunch, and the cocktail reception afterward. A final highlight was the mock term sheet negotiation, carried out by two partners from Olswang, one of the event co-sponsors, and also a well-known London-based technology law firm. The WFS growth and exit conference is a great one-day event. It is held annually in London, Silicon Valley, New York, and Seattle. For more information, visit wfs.com. Back to you, Nat. 

Nat Burgess

Thanks, Jon. Exciting times around the world for tech M&A.  

Field Report, DRB Systems

If we go back 15 years, we used to find all of our buyers on the NASDAQ. We lost close to 1000 companies over the last ten years, and now about half of our volume is actually with the PE community. One of our most effective deal makers in that context has been our chairman, Ward Carter. He’s here now to give us an update on a recent transaction that he closed with a PE buyer. Ward?  

Ward Carter

I’m pleased to report on a transaction just recently announced, where Corum client DRB Systems obtained a strategic investment from Prairie Capital, a leading PE firm based in Chicago. DRB Systems, founded in 1984 and based in Akron, Ohio, is the leading provider of software and hardware to the conveyorized car wash industry, including point of sale software, loyalty/promotion modules, and control solutions. Over the course of the company’s thirty-year history, its products have been installed in all 50 states, and users of its technology solutions have cared for over three billion cars. These are highly sophisticated systems used by what most would think of as the ”big” car washes which offer a full range of services. As with so many of our clients, we looked very broadly at both strategic acquirers as well as private equity firms that could provide shareholder liquidity as well as strategic growth options. In our search, it was obvious there were many players who could step up with the right financial terms, but few who could provide the right culture and people fit to meet the criteria of this closely held and founder-led business.  We were very pleased to see this deal come together with Prairie and know the partnership with DRB Systems will be fruitful for all involved. One of the reasons this was such a great deal to work on is that DRB Systems is the unquestioned leader in the car wash space. Their partnership with Prairie is a great example of the kind of value that building a successful, market-leading technology company can create, especially when paired with the right partner.  

Nat Burgess

One of the most exciting things about today’s market is that we’re seeing consolidation everywhere. A few years ago during the downturn, it was just in a few bubbles of activity, now it’s across the board from very narrow vertical markets, such as car wash management systems, up to big horizontal opportunities like information security.  

Top Ten Tech Trend: Information Security

To report on a transaction that he just closed in Europe in the Information Security sector, let’s invite Jon back.

Jon Scott

Thanks again, Nat. IT security has been a vital topic for a long time, but the huge increase in technological advancements and the easy exchange of information has resulted in a cascade of security-related events that have driven security to a new place of importance. We all see news stories every day of the risk to our data: the recent Heartbleed vulnerability, Edward Snowden stealing data about the NSA, the Target department store credit card breach and ongoing privacy issues with Facebook and other social media sites. This is impacting both consumers and the enterprise—the desire to secure important information, whether corporate secrets or our Amazon password, is top of mind today like it’s never been. Tools for improved anonymization, privacy, encryption, and authentication are in demand. One of the most important recent revelations in this space was that the announcement that the NSA had paid RSA $10 million to build a back door into their encryption. RSA encryption technology is the de facto industry standard for financial services. It is almost a certainty that all of us on this call today have our personal information is secured somewhere by RSA. Suddenly, having a single point of failure seems extremely troublesome. An established standard is also a higher value target for hackers because a single breach can grant access to thousands or even millions of data stores. Additionally, a single move—like RSA providing back door access to the NSA—can call the entire infrastructure into question.  Events like this mean more opportunities for new software players to take market share in what until recently, had appeared to be a maturing and established market. We also see more ammunition for proponents of point solutions, rather than monolithic single-vendor contracts, and this is opening up opportunities for smaller companies with innovative solutions to diversify the ecosystem, ultimately making everything more secure. An example of smaller security software players growing up is the recent merger between European security leaders DenyAll and our client, Paris-based Bee Ware. This brings together two pioneers in web application firewalls, who together have gained the trust of customers in Europe, North Africa, the Middle East, and Southeast Asia through innovation and expertise. With a broader portfolio and investment capability, the new DenyAll will deliver next-generation application security to more customers worldwide, in the cloud, and through its partner network. Back to you, Nat.  

Nat Burgess

Thanks, Jon. This is important both in information security, but also for all of our clients who tend to be emerging software companies. You need to think not only of what your client is buying but what you’re giving the opportunity not to buy. No one wants to be dependent on a single solution to be held hostage by a vendor. Back when Oracle consolidated, we had conversations with government agencies and large enterprises that didn’t want to have a single vendor, they wanted alternatives, and you’re out there building those alternatives.

Monthly Research Report

We’re going next to Corum’s Research Group for our monthly research report, and with that I’ll hand things over to Elon Gasper.  

Elon Gasper

Thanks, Nat. The public markets have continued their Q2 rebound, with record highs in the Dow and the tech sector remains vibrant. Tech M&A continues to fulfill our prediction of a good year for sellers. We’ll take a timely look at the risks beyond that in our in-depth second half analysis in our mid-year coverage next month; for now, sellers have a chance to calibrate company value here while we’re at this apparent peak. Our Corum Index shows Tech M&A percentage volume year over year grew by double digits, which included Apple’s first megadeal ever, for streaming music and headphones house Beats and its team of savvy LA entrepreneurs, showing how important design language and insight into glamour has become to consumer tech (a timely acquisition in light of Amazon’s announcement this morning of its new music streaming service). Over at the fulfillment end of the pipe, retail integrated payment software provider Vantiv spent a $1.7 billion seven to buy Mercury Payment Systems, commanding multiples that illustrate the value of two of our ten trends: omnichannel marketing and digital currency flow. Now we proceed to our Market sectors and our Top Ten trend theme for this month, the changing nature of Information Security. Amber?

Infrastructure Software Valuations

Amber Stoner

Security has been an ongoing trend in the Infrastructure space throughout 2014, with a number of buyers making moves over the last month to strengthen their security capabilities. Just last week, Intel-backed Hadoop software vendor Cloudera acquired Texas-based data security solutions company Gazzang, specializing in securing big data and key management software, bringing Cloudera a foundation for a unified Hadoop protection strategy. FireEye continued its post-IPO spending, buying network forensics solutions firm nPulse Technologies for $60M, at an 8.6x multiple, to go along with its network threat detection and the endpoint forensics it picked up with Mandiant earlier this year. Cisco grabbed NY-based security company ThreatGRID, a dynamic malware analysis, and threat intelligence technology provider, building upon its 2013 acquisition of Sourcefire. Thoma Bravo-backed LANDESK Software spent an estimated $15M, a 15x revenue multiple, to get Israeli security startup LetMobile, adding data-loss prevention for email capabilities to LANDesk’s existing mobile device management product suite. And tech giant GE acquired Vancouver-based cybersecurity firm Wurldtech which provides security solutions for industrial sites like power grids and oil refineries, as well as individual assets like medical devices and smart meters. What’s going on in the Internet space, Elon?  

Internet Software Valuations  

Elon Gasper

Valuations continue to be relatively high despite recent pullbacks among bubblier speculative players without proven monetization. M&A competition between the large internet companies continued last month as Google purchased 6 companies, including Adometry, a Texan online ad attribution firm, for $150 million; and paid $130 million for Divide’s BYOD management software employing secure containers to keep corporate and personal data separate. And speaking of BYOD, we note the IPO today of MobileIron, which has about 10% of the still-fractured market; we expect more consolidation in this hot sector. Another big buyer last month was TripAdvisor, which added three companies to its portfolio in May: a New England-based vacation home rentals website, London’s Tripbod, that connects travelers to local experts, and a European restaurant reservation service LaFourchette. Six for Google, three for TripAdvisor, we’ll tally the mid-year leaderboard next month.

IT Services Software Valuations

Amber Stoner

In the IT Services sector, sales multiples remain near two-year highs, with a slight drop in EBITDA multiples since Q1. With security, an ongoing trend in tech M&A, companies in the IT Services space with a focus on security are desirable targets for acquisition. For example, F5 Networks acquired Defense.Net, a provider of cloud-based security services designed to protect data centers and internet applications. Defense.Net’s DDoS services fill a gap in F5’s existing on-premise DDoS product portfolio enabling a move into the growing cloud-based application and desktop security markets. Endgame Systems, a provider of Security Intelligence and Analytics services to the commercial sector and federal government, bought Onyxware Corporation, which provides mobile device-focused security software development and prototype design services aimed at BYOD security for government markets, strengthening Endgame’s connections with the government sector and improve its security offerings. Finally, how does the Consumer sector look?

Consumer Software Valuations

Elon Gasper

Multiples there have been buoyed by both subsectors, with the games sector grabbing for growth, while digital media buyers value profits, with some exceptions, notably, in sellers addressing consumer health and fitness. For example, last month  we saw HealthcareMagic and its Ask A Doctor consumer-physician online exchange get Ebix, the old Delphi Information, to shell out $6 million down and over twice that in earnout for that Bangalore company; and Caring.com, which caters to consumers needing eldercare, bought for $54 million by Bankrate; that value apparently supported by the cross selling potential of 2 million visitors per month and a $2.6 million dollar first quarter this year, with growth projected for the remainder.

That is our quick update, next month we’ll catch up on all our 6 markets and their 26 sectors in our 2014 midyear review—and look ahead—back to you, Nat.

M&A Myths, Misperceptions and Misinformation

Nat Burgess

Let’s move on to the myths. I love this conversation, this dialogue, because so often we’ll hear from a CEO who says, “Oh, I didn’t want to go to market and become stale, so I just executed well and we were approached by a guy we already knew, they liked our profitability, and they put a good valuation on us. We didn’t use an intermediary, we just played golf and wrote the number on a napkin and closed a few days later.” So that’s how you sell a company, right? Wrong. Let’s go to our experts, who have managed over 300 transactions, and look at the truth or lack thereof in these myths and misconceptions. We’ll start with our CEO, Bruce Milne.

Build It, They Will Come

Bruce Milne

Recently at a local tech M&A panel, I heard a fellow investment banker say, “Good companies are bought, not sold.” He went on to explain that you should just hang out with the companies that could be potential partners, let them get to know you, and when the timing was right, your phone would ring with an offer, one you could quickly calibrate with other competitors. I literally cried out, “nonsense!” and this panelist quickly admitted he was not from the transaction side of the investment banking house, nor had he ever built, let alone sold, his own software or IT related tech company, he was just a finance guy. This whole logic says if you build it, they will come. But those of us who are entrepreneurs know that this does not work. You need marketing and sales. The trouble is, the believers of this myth are waiting for the phone to ring! And they’re missing the best tech M&A of a lifetime, but they need to get out there. The problem is, if the phone does ring, all too often that caller is a bottomfeeder dialing for deals trying to lock you up. There are several problems with the logic of waiting for the buyer to call you and leaving the timing and pricing up to them, not taking control of your own destiny.

First of all, it presupposes that you know, at the beginning of your company’s life cycle, who might be your eventual buyer. The world is just too big, there are too many buyers out there. Secondly, it presupposes that you know at what level you’re going to hang out with them. Who do you see at Google, how do you get to know them? Is it on the R&D side or the marketing side? One of the problems is that at that level of the company, they don’t think strategically, they’re at the make versus buy analysis point, and that doesn’t lead to big deals. The point is that the world is far bigger than you can imagine in terms of buyers now. Non-technology buyers, strategic buyers, foreign buyers, financial buyers. 25% of the companies that we sell have never heard of their buyer!

A second major fallacy of the logic of waiting for the right buyers to just call you is that you’re supposed to then call other competitive bidders and get other offers from them to help ramp the price up. We agree with that logic, but there’s a flaw in the approach. That is that these buyers because of the new laws on criminal liability, like Sarbannes-Oxley, can’t respond that quickly. It’s very hard to say to someone giving you an offer to sit tight for a couple of months until you can drum up a competitive bid. The reality is that they can’t. There may have been a time, but not anymore. So you have to be careful about trying to go along with this idea that you wait for an offer and then call out for some competitive offers. That’s not how it works in this market.

In summary, it’s exciting when someone makes that call, you worked hard to build that company, and it’s gratifying to have someone interested in your company. It’s a courtship. It’s confirmation that you’ve done something right, that all your work has led to something valuable that someone else might want. But the reality is that those first callers are often times someone trying to buy you on the cheap, and that’s not really what you want. You really want to control your own destiny. You want to make sure that you are the one that controls the process. It takes some time. Often more than four months just to go through enough due diligence to make an offer, and you have to respect that. What I want you to get out of this is: control your own destiny. If you do a full professional global search, what you’ll find is simple. 75% of the time, there is someone else out there willing to pay more than the first offer you might have gotten. If you calibrate these offers and create an auction environment, the average deal improves by 48%!  

Nat Burgess

Thanks, Bruce. Now let’s go to our second myth. You may believe that you already know your buyer, and maybe you do, but maybe you don’t. Let’s go Corum senior VP Rob Schram for more on this one.

Narrow Down, Attach To A Few Specific A-List Buyers

Rob Schram

Thanks, Nat. A prevalent theme that underpins the 100 M&A conferences that Corum puts on every year is, to begin with the end in mind. In that sense, it’s a good idea to grow your company with specific buyer targets in view, but don’t let yourself get too attached to just a handful of buyers. The tech sector is highly dynamic and it’s a mistake to set your sights too narrowly. Our buyer research teams speak in terms of the buyer universe, and as Bruce just mentioned, that’s a literal reality in today’s market. Buyers are everywhere: strategic, PE groups with large portfolio holdings, and non-tech buyers as well, all with exceptional amounts of cash. When it comes time to sell your company, you always benefit from buyer competition. The A-list of most probable buyers will include your buyer most of the time, but the operative phrase there is A-list. In addition, our experience shows that about 35% of the initial interest and 25% of the ultimate buyers come off the B list. It’s less intuitive, but these are excellent buyer candidates, confident that your company is the perfect missing piece of their puzzle, and they will outbid everyone else to acquire you.

You need to refine your market trajectory, not only with respect to industry competitors, but by assessing your technology roadmap, financials, customer base, brand, channels, and so on, through the lens of the buyer community. This is an effective way to keep on track for the highest valuations, and to pivot when required by market dynamics. Often times we see companies that get particularly attached to a large customer, envisioning that an acquisition is inevitable, and sometimes that is what happens. However, it’s never advantageous to negotiate in a vacuum, and if the acquirer realizes that they don’t have any competition, then you’ve lost your leverage. Plus, allowing too high a level of intimacy may preclude taking a broad market approach. The chemistry may be excellent, the revenue significant, but be careful to keep your market options open. At the conclusion of a professional global M&A process, following multiple conversations, Webex sessions, visits from qualified buyers, submission of LOIs, selection of most favorable candidates, the conclusion of due diligence, signature, and closing, at that point, you’ll know your buyer.

Nat Burgess

And you may even be a little worn out, but with the right help, you can get the deal done. Now, we all have friends who operate outside of tech and they periodically ask us, “What on earth is going on with these tech valuations?” Where companies like Amazon, that have never really made money holding extremely high valuations, M&A events that aren’t really explained by profitability. Let’s go to Regional Director Ed Ossie to talk about this misperception.

Profit Is King

Ed Ossie

An article hit my inbox last week on mastering the ten value drivers in selling your business. As usual, stable and predictable cash flow was in the pole position at number one, the top driver of business value. But since we deal only in technology, I was really surprised to see that growth hit the chart right square in the middle at number five. To be fair, this was a cross-industry look at M&A and it wasn’t focused on just technology, but it reminded me, and as our clients well know, tech is different and requires special handling. It’s often a race for relevance and scale in a pretty hyperactive ecosystem which is chock-full of other bright problem solvers and solution providers. Over and over, each and every day in our global discussions with tech buyers, both financial and strategic, the question of growth rate usually comes right after what segment they’re in. Clearly, different tech segments have their distinct momentum, and we profile those each month in our webcast. But your business growth rate on your own can be a proxy or translate to just how bright the future can be for the buyer.

As a fifteen-year buyer of businesses prior to joining Corum, when we saw real year-on-year growth, quarter-on-quarter growth, under the seller’s own steam, it really moved our interest needle significantly. High profits and low growth are certainly not a bad thing, but in the M&A process, low growth history can really challenge the buyer internally, especially if the buyer’s investment thesis requires the move to a high-growth trajectory. Recently McKinsey published some great research on software companies titled Grow Fast or Die Slow. Pretty dramatic, but they analyzed the lifecycles of 3000 software and online services companies around the globe, from 1980 to 2012. The three main findings were that growth trumps all, yielding higher returns for shareholders, and as a proxy for predicting future success. Increased growth drove market value improvement versus margin improvement. You’ll never hear us say that profits aren’t important in tech, but at least in the tech world, sharing the growth story with the right buyers exponentially increases the chances of achieving your optimal outcome. Back to you.

Nat Burgess

Thanks for that, Ed. A lot of experience there. We’d like to go to the next myth, which involves finding a comfort zone and settling there and getting it done. Let’s go to John Simpson.

Take The First Offer

John Simpson

Well, congratulations, it’s a very exciting day, you’ve just got an offer for your company right out of the blue. And it seems like a pretty good offer to you. So, why not take it? It’s a bird in the hand, right? Respectfully, not so fast. Here are just a few of the many questions you need to answer. First, is this solo offer really the best market price you can get? As Bruce just said, what we’ve learned over 25 years and 300 transactions in software M&A, most of the time a formal sales process with more than one bidder will generate, on average, a 48% higher price than your first bid. Here’s the point: this is true even if the sale was still eventually made to the same first bidder. That’s where you are today with your offer in hand from that first bidder. Do you really want to ignore your options?

Next, let’s not forget that many deals simply disintegrate as they transition from the offer to signing the final documents. What if this happens to you during the due diligence period? Do you have any backup candidates? Do you have any better idea of what the market might have paid? Unfortunately, maybe not. Now, how about your fiduciary duty and legal liability to your co-shareholders? There are several laws at state and federal levels that protect the rights of minority shareholders, including those of privately held companies. Failure to properly calibrate the company’s market value to the satisfaction of those shareholders could trigger one of three things. One, you could have an embarrassing legal dispute on your hands as the deal progresses, when you least want one. Two, a shareholder lawsuit could delay your closing for a very long period of time. I have personally witnessed this, and it was ugly. Finally, as chief executive, you could be personally liable for damages due to your shareholders if they are angry enough to convince a judge of your executive irresponsibility. So, if you have an offer from a single suitor or even just the possibility of one, don’t take the solo plunge into this pool without fully exploring your options and possible opportunities in the market as a whole. Thank you.

Nat Burgess

Thank you, John. Another myth that we hear frequently from a CEO who is being approached and doesn’t want to break up their deal is, “I really don’t want to bring in anyone else, I don’t want to scare off my buyer.” Let’s hear from CEO VP Jeff Brown to hear about that myth.

Don't Bring Anyone Else In, Don't Scare Your Buyer Off

Jeff Brown

Thanks, Nat. On this point, many sellers are misinformed. They think that buyers prefer that they avoid working with an M&A advisor. In fact, serious buyers prefer the opposite: that you have a skilled intermediary on your side. It seems counter-intuitive when you consider that my job is to get the best valuation and deal terms possible for the seller. So why would professional buyers prefer that you have an advisor and why do they gravitate toward M&A opportunities where an advisor is involved? Here are some of the reasons. Our involvement sends a very important message. It says that you are serious and have invested in the outcome. It means that your approach is premeditated, organized, measured, and professionally run. That it will be free of the artificial barriers and emotionality that come with self-run processes. An experienced buyer knows how to communicate with buyers, and on their terms. We understand how buyers behave, the processes they must follow, the complexities of compliance, and the approvals they need. Complications arise for both parties. They always do. Your advisor is your expert in dealing with these complications. Buyers actually prefer to negotiate the tough points of a deal with an experienced advisor rather than directly with the seller. Advisor-led deals have a much higher close rate than self-run deals. Buyers have too many deals to evaluate these days and they can’t afford to chase good companies using a bad process. Back to you, Nat.

Going To Market Too Early Hurts Valuation

Nat Burgess

That’s a great point, Jeff. There’s so much noise. Our friends at Google are getting 12 unsolicited proposals a day and a good intermediary is a filter, that brings credibility to your process. We’re going to close here with one of my favorites, and I’ll take this one. The myth is that going to market too early can hurt the value of your company. Let’s go way back, to Baron von Rothchild in France a couple of hundred years ago. He was quoted as saying, “I made my fortune by always selling too early. Now let’s forward to the dot-com era. We sold two enterprise fax businesses in the space of about three months, took a third to market, and it was crickets. Tumbleweeds were blowing down the street. The window had closed. The trouble is that these windows open, the M&A process takes time, and you need to be in traffic making something happen, or the opportunity can pass you by. We have lots of other recent examples of this. We sold a company to Quarterdeck years ago, literally a month before Microsoft incorporated memory management into the OS and made them obsolete. That was a $135M transaction that could not have happened two months later. We’re happy to spend a few hours giving more examples of those unhappy endings, and then many other examples where people got into traffic and got stuff done when there was time. The fact is that we’re not damaging companies by being in the market, every good company is looking for ways to get bigger, to play on a bigger stage, and to do that with the help of a larger partner. If you do that professionally and carefully, you’re not going to hurt your value. With that we’re at the end of our 30-minute session. Thank you for joining us.