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Software M&A - Q2 Review
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Product Category Consolidation
Consolidation plays, which saw a sharp increase in the first quarter, slowed in Q2 with fewer buyers acquiring a smaller player in their space in order to gain market share and eliminate competition. Consolidation median deal multiples were a low 0.8x in 1Q05, but a few larger deals in 2Q05, including Adobe/Macromedia (7.8x), Dassault Systems/ABAQUS (4.1x) and Scansoft/Nuance (3.9x) raised the consolidation category median multiple to 2.5x. Other notable deals in this category included Ecometry, a privately held customer relationship management provider backed by Golden Gate Capital, which acquired Blue Martini to gain revenue and market share. SDL, provider of software for language translation, acquired fellow translation software provider TRADOS for $60 million at an estimated 2.3x.
Investment Opportunity
4% of software buyers in 2Q05 were venture capitalists and private equity firms who acquired directly. This is a decrease from the 8% seen in 1Q05 but in line with 2004's 3%. First-party private equity deals had a median multiple of 1.8x, a modest deviation from 1Q05's 1.9x. Francisco Partners took advantage of the undervalued supply chain management vertical by acquiring RedPrarie, and private equity firm Lotus Fund jumped into the IT security fray by acquiring PIVX, an intrusion prevention provider.
Software M&A Trends and Insight: Industry Consolidation and the Mix of Buyers
The software industry is undergoing unprecedented consolidation. Large public software companies, hungry for more market real estate, competitive advantage and top line growth are aggressively acquiring smaller public software companies. Legato Systems, PeopleSoft, Documentum, Macromedia, Veritas, JD Edwards, Brio, Crystal Decisions, Ascential, Mapics, Rational and scores of other public software companies have exited in the past few years. Virtually all of the acquired were, themselves, acquirers.
While software industry consolidation is certainly not a new phenomenon, what is new is the rate at which these public companies are being replaced. Historically, software IPOs and smaller, rapidly growing public companies would quickly take up the slack left by recently acquired public companies. That's not happening today at a rate nearly sufficient to maintain a constant number of buyers. Many smaller public software companies have been unable to grow at a 25% or better CAGR, increase their market caps, add cash to the balance sheet and pursue acquisitions. In the past four years, relatively flat IT budgets and an erratic economy have taken their toll.
The dearth of viable public buyers to fill the ranks of the recently acquired is compounded by a lackluster IPO market. Historically, the buyer market has been fed by a bevy of new public companies, flush with the proceeds of a successful IPO, in hot pursuit of acquisitions. However in the past 30 months, only 27 software companies have gone public, while more than 150 public companies have been acquired. The result is a significant diminution in the number of software company buyers.
There's another trend we observed in Q2 we also find disturbing. Financial buyers and VCs, it seems, are less enthusiastic and far more circumspect today about acquiring software companies. In 2004 the number of private buyers averaged 35% of all buyers. Most of these were either private equity firms or private, venture-backed software companies. In 1Q05 the number of non-public software company buyers dropped to 31% of total and dropped again in Q2 to 29%. Those remaining, particularly private equity buyout firms, refocused on established ($100M+) software companies with solid recurring (M&S) revenue and bloated operating expenses ripe for cost cutting.
Yet despite these recent trends, the second quarter saw an increasing number of software company acquisitions and an improved valuation multiple. How is that explained? Some of the consolidation slack has been taken up by more public software companies engaging in multiple acquisitions. Q2 saw 19 public companies acquire two or more smaller entities. Several, including Computer Associates, IBM and Sun Microsystems, acquired three or more companies during the quarter. But the increased activity of some traditional buyers is not nearly sufficient to compensate for acquisition attrition of others.
Closer examination reveals the buyer mix is changing. Three non-traditional buyers types are especially active.
Of the 124 M&A transactions we analyzed in Q2 involving public buyers, foreign stock exchange buyers accounted for 16.4% of the total, up from 2004's 12.4% average. Examples include TietoEnator/AttentiV, CEGEDIM/Target Software and EDB Business Partner/BanqIT. We project the trend will accelerate. The number of venture-backed European companies going public doubled to 14 in the second quarter of 2005 compared with the year prior, according to data provided by VentureOne. Conversely, the second quarter marked the fewest number of venture-backed European company M&A exits, 32, in two years.
Also more active than in prior quarters were OTC/Pink Sheet software companies seeking greater viability through acquisitions, representing 15% of Q2's public buyers. Examples include NewMarket Technology/Classified Information, SDL/ TRADOS and Reality Wireless Networks/PeopleMatter. Many of these buyers use stock, in whole or part, as deal currency and prices paid are ordinarily below the prevailing deal multiple, but others have significant cash on their balance sheet earmarked for acquisitions.
There was also a sharp Q2 uptick in the number of non-IT public buyers, which represented 7.5% of the total, up from 2004's 1.2% average. These non-IT buyers were primarily vertical market equipment manufacturers and service providers seeking to enhance their offering with bundled software. Examples include Plantronics/Octiv, Clark/BancPlan and Aetna/Active Health.
Together, these non-traditional public buyers of North American software companies (foreign stock exchange, OTC/Bulletin Board and non-IT public companies) aggregated 39% of the total, up from 2004's 27% average.
One final observation about the changing buyer environment. Even the traditional public software company buyer listed on a major U.S. exchange is far more focused, circumspect and disciplined in its acquisition activity than at any time in the past. Acquisitions must adhere strictly to the buyer's clearly defined corporate strategy. The market opportunity and deal upside must be quantified, significant ($100M+ - $500M+ minimum) and appealing to the buyer. Seller financial statements must survive deep probing about revenue mix, product operating margins, product line performance trends, revenue predictability, recurring revenue reliability, and countless other financial parameters. The product fit and technology synergy must be perfect. Customer references (lots of them) must be laudatory.
What does all this portend for a privately held software vendor? First, the ISV must understand its prospects for sale are not materially better, or worse, than in 2004, but the landscape is changing rather markedly. The ranks of traditional public software company buyers are thinned. Should such a buyer be interested in acquiring the ISV, it will scrutinize the market opportunity, products, technology, customer base, historical financials and future projections as never before. For the seller, careful, detailed strategic exit preparation and planning are essential. Nevertheless, many previously attractive sell-side candidates will not pass muster. ISV's entertaining exit should be prepared to cast a wider net, identifying and approaching alternative buyers who are entering the market in greater numbers. They must, however, be able to separate the wheat from the chaff.
MERGERS AND ACQUISITIONS: MOST ACTIVE BUYERS
Multi-transaction buyers were active in the second quarter. Some of this quarter's most active buyers:
20-20 Technologies
· eTechLogix
· MindAvenue
Amazing Technologies
· Clear Objective
· Versifi
Autodesk
· Colorfront
· C-plan
Cerner
· Axya
· Bridge Medical
ChoicePoint
· EzGov
· Magnify
Cisco
· Sipura
· Topspin
· NetSift
Computer Associates
· Concord Communications
· Niku
· Tiny Software
DealerTrack
· Chrome Systems
· North American Advanced Technology
International Business Machines
· Gluecode
· Isogon
· Meiosys
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KeyCorp
· Fox Tech
· Payroll Online
Knight Trading Group
· ATTAIN ECN
· Direct Trading Institutional
NewMarket Technology
· Classified Information
· Vera Technology
Progress Software
· Apama
· EasyAsk
Quest Software
· Imceda
· Vintela
Retalix
· Integrated Distribution Solutions
· TCI Solutions
ScanSoft
· MedRemote
· Nuance Communications
Sun Microsystems
· SeeBeyond
· Storage Technology
· Tarantella
Sybase
· Avaki
· ISDD
Trend Micro
· InterMute
· Kelkea
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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 details, please visit
www.softwareequity.com, or phone (858) 509-2800.
 
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