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Software M&A – Q3 Mega Deals

By Ken Bender and David Legacki, Software Equity Group, L.L.C.

With two exceptions, deals profiled this week are characterized by increasing multiples, as buyers dig deep in their pockets to access new markets or fend off competition. EMC pays a hefty premium to pick up a strategic enhancement that opens a higher growth, higher margin market. Francisco enters the security sector at a bargain basement price. Hewlett Packard enhances its software offering with its acquisition of Mercury. Secure Computing responds to recent acquisitions by its competition by acquiring a leading security appliance vendor. Verint expands into the mid market with Mercom, and Viisage extends its product line by acquiring Iridian.

Listed below are some of notable software M&A deals.

EMC (NYSE: EMC) Acquires RSA Security (NASDAQ: RSAS)
Category: Security Software
Purchase Price: $1,881,900,000EV
Seller Revenue: $339,890,000
Seller EBITDA: $57,370,000
Revenue Multiple: 5.5xEV
EBITDA Multiple: 32.8xEV
Payment Terms: Cash

SEG’s Perspective:
EMC, the leading developer of storage and data management hardware and software, acquires RSA Security, a well-known identity and access management security provider. With growing competition in EMC’s core storage hardware market from HP, Hitachi, and CA, and the threat of a fully integrated Symantec/Veritas, EMC has relied on non-array based software (Vmware and content management) for both top line and bottom line growth. RSA helps shore up EMC by adding state of the art authentication, access control, and encryption solutions to EMC’s storage and information management product suite. Goldman Sachs predicts 12% IT spending growth in the security sector in 2006, with identity and access management as the priority. With multiple bidders at the table, RSA was not cheap, garnering 4.9x CY07 revenue and 6.2x TTM revenue (equity value) – a premium even in the highflying security software sector where the median TTM revenue multiple is 5.2x. RSA is EMC’s sixth acquisition in 2006 and is the largest security software transaction since Juniper’s $4 billion (13.2xEV TTM revenue) acquisition of Netscreen in 2004.

Francisco Partners Acquires WatchGuard Technologies (NASDAQ: WGRD)
Category: Security Software
Purchase Price: $77,145,000EV
Seller Revenue: $77,170,000
Seller EBITDA: $(5,900,000)
Revenue Multiple: 1.0xEV
Payment Terms: Cash

SEG’s Perspective:
Francisco Partners, a technology-focused private equity firm with $5 billion under management, acquires WatchGuard Technologies, a provider of unified threat management software. Although CTOs and CIOs are clamoring for security solutions and WatchGuard’s publicly traded peers have grown revenue 12.4% over the last twelve months and 73.0% over the last thirty-six months, WatchGuard has lagged far behind, posting declines in revenue of 2.5% and 12.7%, respectively, over the same period. Despite $73 million in cash on its balance sheet, no debt, and an array of acquisition targets in the security sector, WatchGuard opted to leave the public spotlight and chose Francisco as its white knight. Francisco essentially funded 47% of the acquisition with cash from WatchGuard’s balance sheet, resulting in an effective valuation of 1.0x TTM on an enterprise value basis. WatchGuard passed on a 24% premium offered by Vector Capital to accept Francisco’s 14% premium. Francisco then shared the acquisition 50-50 with its bidding rival Vector Capital, a chain of events that likely befuddled WatchGuard’s shareholders.

Hewlett-Packard (NYSE: HPQ) Acquires Mercury Interactive (OTC: MERQ.PK)
Category: IT Asset Management
Purchase Price: $4,422,030,000EV
Seller Revenue: $775,520,000
Seller EBITDA: $173,170,000
Revenue Multiple: 5.7xEV
EBITDA Multiple: 25.5xEV
Payment Terms: Cash

SEG’s Perspective:
In a defining acquisition that almost doubles its annual software revenue to $2 billion, Hewlett-Packard aggressively expands its OpenView software suite by acquiring Mercury Interactive, a best-of-breed Business Technology Optimization (BTO) company. Mercury, coupled with its 2006 acquisition of Systinet ($105 million, 4.6x est.), will help HP stay relevant in systems management software and SOA governance, where competition from the likes of IBM, CA, and BMC is fierce. With multiple bidders at the table (rumored to include Symantec, EMC, and CA), HP won the contest by paying a 33% premium to Mercury’s pre-announcement closing stock price, and a higher multiple than the median M&A valuation in the IT asset management category (3.4x TTM revenue). Still, the price tag is reasonable, considering Mercury’s dominance in BTO and its severely depressed stock price reflecting troubles over Sarbanes Oxley non-compliance. HP is no stranger to distressed assets after acquiring Peregrine ($425 million, 2.2x) in September 2005.

Secure Computing (NASDAQ: SCUR) Acquires CipherTrust
Category: Messaging Security Software
Purchase Price: $263,600,000
Seller Revenue: $65,000,000 (estimate)
Revenue Multiple: 4.2x (estimate)
Payment Terms: Cash, Stock

SEG’s Perspective:
The security sector continues to consolidate, as Secure Computing acquires CipherTrust, the leading provider of messaging security gateway appliances. According to IDC, the secure content management appliance market, where CipherTrust holds approximately 20% market share1, is expected to grow to $1.7 billion by 2009, a 47% CAGR from 2004-20092. The addition of CipherTrust plugs a hole in Secure Computing’s unified threat management suite, enabling Secure to compete head-on in the messaging security sub-market against the likes of Symantec and McAfee. CipherTrust shareholders received $185 million in cash, 10 million shares of Secure’s stock (giving them 14% ownership of Secure), and a $10 million seller note. Secure’s notable miss in achieving its 2Q06 financial targets, compounded with its dilutive CipherTrust acquisition, was enough to drive Secure’s stock price down 38%, reducing the purchase price by $28.7 million. For CipherTrust investors ($42 million in invested venture capital), the deal includes $10 million if certain financial targets are met.

Verint Systems (NASDAQ: VRNT) Acquires Mercom Systems
Category: Contact Center Software
Purchase Price: $35,000,000
Seller Revenue: $15,800,000 (estimate)
Revenue Multiple: 2.2x (estimate)
Payment Terms: Cash

SEG’s Perspective:
Verint Systems, a provider of analytic software for security and business intelligence, acquires Mercom systems, a developer of interaction recording and performance evaluation solutions for small and mid-size call centers. The software market for large call centers has matured, leading vendors to the relatively unpenetrated, highly opportune mid-market. Mercom brings Verint 6,000 worldwide installations and a stable of well established VARs and channel partners. Verint and its key rivals, Nice and Witness, together account for approximately 82% of the $1.03 billion call center software market, which made Mercom one of the few remaining players of significant size. Mercom shareholders stand to earn an additional $17.5 million in future earn-out assuming certain financial targets are met.

Viisage (NASDAQ: VSAQ) Acquires Iridian Technologies
Category: Biometric Software
Purchase Price: $35,000,000
Seller Revenue: $8,100,000 (estimate)
Revenue Multiple: 4.3x (estimate)
Payment Terms: Cash

SEG’s Perspective:
In its third acquisition of 2006, Viisage Technologies, provider of biometric hardware and software identity solutions, acquires Iridian Technologies, developer of iris recognition technology. With Iridian, Viisage adds iris recognition to its existing finger and face biometric offerings. Thus far in 2006, Viisage has used cash and stock to acquire main rival Identix ($770 million, 9.2x) and SecuriMetrix ($30 million, 4.5x) in order to compete against highflying Cogent, a company with almost twice Viisage’s revenue and three times its market capitalization. The acquisition was funded with proceeds from a $100 million investment made by L-1 Investment Management (L-1 owns 28% of Viisage) in late 2005.

1. Based of 2004 Revenue
2. IDC: Worldwide Secure Content Management 2005-2009 Forecast Update and 2004 vendor shares: Spyware, Spam

Software Equity Group, L.L.C. (SEG), a mergers and acquisitions advisory firm serving the software, life science and technology sectors, prepared this report. 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.


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