The Current Software M&A Climate: Software Sellers Have Left the Building

1Q2009 Software Industry M&A Recap

Software M&A Deal Volume and Spending
Software M&A transactions accounted for 16.2% of all U.S. M&A activity in 1Q09, up from 15.5% in 2008. The first quarter’s 296 software mergers and acquisitions had an aggregate purchase price of $7.3 billion, compared to 511 transactions aggregating $24.3 billion in 1Q08.

While the drop in software deal activity represents a hefty but not surprising 42.1% year-over-year decline, total dollars spent plunged 70.0% compared to 1Q08, primarily because of the dearth of software industry mega-deals (transactions with enterprise values greater than $503 million). Of 1Q09’s $7.3 billion total outlay, $5.4 billion was spent on two major transactions: Interwoven’s acquisition by Autonomy ($582.3 million, 2.2x TTM revenue), and Metavante Technologies’ acquisition by Fidelity National Information Services ($4.8 billion, 2.8x TTM revenue. The balance of $1.9 billion dollars was paid for the remaining 294 software companies acquired. By comparison, 1Q08’s $24.3 billion total price tag included $18.1 billion from six mega-deals, with the remaining $6.2 billion attributable to smaller transactions. Simply put, there were approximately three times as many mega-deals and corresponding dollars spent in 1Q08 than in 1Q09.

A quarter-by-quarter analysis of U.S. software M&A activity is equally instructive. Through the first three quarters of 2008, aggregate deal activity trailed 2007 by a modest 4.0%, and the aggregate purchase price was 16.9% less (Figures 17 and 18). In 4Q08 and 1Q09, however, deal activity and M&A spending both cratered. In fact, 1Q09 posted the lowest quarterly U.S. software deal total since post-bubble 4Q03, when 259 deals aggregating $6.7 billion were consummated.

Public buyers accounted for approximately 33% of all software M&A purchasers in 1Q09, notably fewer than the previous three quarters (Figure 20). The largest 20 software companies made nine acquisitions in 1Q09, compared with 28 in 1Q08. Apparently, public buyers, noting reduced IT spending and much less demand for replacement systems, add-ons and upgrades, felt little pressure to acquire. For some, reduced M&A spending was a way of signaling caution and conservatism to watchful investors and analysts. Others were focused on downsizing to preserve EBITDA margins, and acquisitions were deemed to be distracting and unseemly in the face of layoffs.

Trends in M&A Valuations

On a TTM basis, the software industry’s benchmark exit metric fell in 1Q09 to 1.3x TTM revenue, down 19% from 1.6x TTM revenue in 4Q08, and down 35% from 2.0x TTM revenue in 2Q08 (Figure 21).

We also analyzed 1Q09 exit valuations on a multiple of EBITDA basis. There was insufficient publicly reported data this quarter to ascertain enough private seller EBITDA multiples to derive a median exit valuation on that basis, so we analyzed public seller EBITDA multiples only. Public software company sellers commanded a modest 12.5x TTM EBITDA, down from 4Q08’s 15.6x (Figure 22). Here again, the median M&A valuation reflected the trend in public market valuation, which fell from a median EV/EBITDA of 8.0x in 4Q08 to 7.2x in 1Q09. Due to an array of factors, including liquidity, many private software companies would likely be valued by buyers at a considerably lower EBITDA valuation multiple than public sellers.

Once again, we caution our readers about using median TTM revenue and EBITDA exit multiples to assess the fair market or prospective exit valuation of a particular software company. It’s more likely than not you’ll be far off the mark. Examples abound of companies selling for modest multiples in strong economies and eyebrow-raising multiples in tough economic times. In every economy, the software company valuation range is wide and the valuation drivers are many and varied.

Over the past two years, vertical software transactions have comprised an unprecedented percentage of total software M&A transactions and vertical software median exit valuations have reached historic highs. Vertical software deals remained a healthy percentage of total software M&A deal volume in 1Q09, but the relatively high exit multiples may be abating (Figure 23).

We believe vertical software providers are more vulnerable than their infrastructure counterparts to a sharp and sustained economic downturn. Many of the industry sectors targeted by the vertical providers – retail, manufacturing, state & local government, education and financial services, to name a few – have been very hard hit by the recession. As these vertical market customers implement major layoffs and sharp IT spending cuts, vertical software providers are seeing cutbacks in the number of licensed users and postponed sales and upgrades. As a result, many vertical software companies are reporting steeper revenue declines than their horizontal counterparts, and acquirers are taking advantage by proffering lower offers.

For a complementary copy of Software Equity Group’s 1Q09 Software Industry Equity Report, which is a comprehensive analysis of public software company financial performance and software industry mergers and acquisitions, and includes the previously mentioned figures, please visit http://www.softwareequity.com/research_quarterly_reports.aspx.