The Information Technology M&A market began to turn materially upward in the third and fourth quarters, but record weakness early in the year pulled down aggregate M&A results. Announced deals and Enterprise Value (EV) dropped to their lowest levels since 2004, in step with decreases in the tech-heavy NASDAQ stock index, according to FactSet Mergerstat (see Figure 1 and Figure 2). The recession, coupled with the dearth of M&A and IPO exits, also hit the venture investing and private equity markets. VC investments fell to $17.6 billion in 2009, the lowest point since 1997. U.S. private equity investments dropped to $91.6 billion in 2009, down 3% compared to 2008 and off over 77% from the $418 billion invested in 2007.1, 2
A number of positive signs also began emerging in the latter half of the year. IT spending is increasing, technology firms are beginning to bulk up their work forces, and strategic and financial buyers are re-entering the market. Having weathered a year of significantly lower deal totals and valuations, these trends have generated relative optimism that IT M&A activity will continue to rise in 2010 and 2011.
Figure 1: M&A Activity in the Computer Software, Supplies and Services Sector
Figure 2: M&A Activity Over the Past 10 Years Source: FactSet Mergerstat
The first few weeks of 2010 are affirming our thesis. Updata has tracked 83 announced acquisitions in the first four weeks of the year, a pace which if sustained would outperform 2008 and 2009 when Updata tracked 892 and 1058 deals, respectively (see Figure 3 below). Two-thirds of corporate development executives now expect their firms to pick up the pace of deal making in 2010,3 and most acknowledge it will cost them more to acquire targets as the economy rebounds and credit loosens.4 Strategic acquirers are gaining confidence that the economic turnaround will improve returns on both their core businesses and their M&A targets.
2009: More Deals at Lower Valuations??
Though Mergerstat data shows a dip in both deal volume and total EV, Updata's proprietary database, which tracks a sub-segment of Mergerstat, including Enterprise Application Software, Infrastructure Software, Business Services, Financial Technology, IT Security and Internet deals, shows an 18% uptick in the number of deals for 2009 vs. 2008, driven higher largely by activity in the past two quarters. However, revenue multiples were at their lowest levels in several years, as shown in Figure 3: many smaller firms that sold in 2009 did so largely because they had no other options, a sure-fire formula for reduced valuations.
Figure 3: Yearly M&A Data For All IT Deals Tracked By Updata
As we stated above, Updata's quarterly data (see Figure 4 below) highlights the dramatic uptick in Q3 and Q4, which nearly doubled the level of activity in 1H 2009. It is also interesting to note that despite the rise in deal activity, total announced EV was relatively flat at the end of the year, driving median deal size downward.
Figure 4: 2009 Quarterly M&A Data Summary For All IT Deals Tracked By Updata
A number of 2009 multi-billion dollar transactions rivaled bull market deals in scale and prominence, and the largest transactions were spread throughout the year. We also saw a re-emergence of financial buyers such as TPG Capital and Silver Lake who made significant investments in the IT space -- $5 billion and $2.7 billion, respectively (see Figure 5 below).
Figure 5: Top 10 Transactions in 2009 By Enterprise Value
Premiums paid for technology stock buyouts also increased for 1- and 30-day bids in 2009, and although stock prices rose considerably throughout the year, these premiums signaled that buyers and investors perceived significant upside value in technology stocks throughout 2009 (see Figure 6).
Figure 6: Premiums Paid Analysis, 2009
Revenue Multiples Paid In 2009
Overall median EV/Trailing 12-month (TTM) revenue multiples dropped again in 2009 for all IT deals tracked by Updata, as shown earlier in Figure 3. Other than IT Security and Infrastructure which rose markedly in 2009, median revenue multiples fell by varying degrees across Updata's sectors (see Figure 7 below).
Figure 7: Three-Year Median Revenue Multiples by Sector
Still, in a very poor overall macroeconomic climate, we saw 15 deals with revenue multiples above 5x in 2009, with the largest EV transactions valued at 12x revenue and more (see Figure 8 below). Other than Intuit's acquisition of Mint.com, transactions with the highest revenue multiples were mostly within the Internet, Infrastructure and Security sub-sectors. There are few other industries that command multiples this high, even in the best economic conditions, and it is a promising sign that acquirers are still willing to pay out big sums for quality assets in a weakened market.
Figure 8: Top 10 Deals by Revenue Multiple, 2009
Private Equity Deal Activity
The majority of private equity M&A activity took place late in 2009, as private equity firms began to feel comfortable with improving macroeconomic forecasts, the solidity of corporate projections, and corresponding potential returns again. There were five transactions valued at over $1 billion in 2009, a slight increase over the three disclosed $1 billion plus deals in 2008 (see Figure 9 below).
Figure 9: Top Deals with Private Equity Buyers by Enterprise Value, 2009
IPO Activity
The market for Initial Public Offerings doubled in 2009 to 20 IPO's compared to a dearth of offerings in 2008 and not a single IPO during the first quarter. Seven of these companies were VC-backed, and half of the newly-public companies had experienced stock price gains of 20% or more by December (see Figure 10 below). In 2008, the few IPOs that did come to market saw comparatively weaker performance, with some decreases at year end of over 40%. The re-opening of the IPO market, while nascent, is a good sign for M&A activity and expected improvements in demand and valuations.
There were 64 companies in the total market IPO pipeline at the end of 2009 (compared to 57 at the end of 2008) which are likely to debut in the first half of 2010. Many of these companies boast $100 million or more in revenue and are profitable (or will soon be), which could provide for a more active year of IPOs. Dual-track processes are also expected to continue in 2010, similar to China-based Linkage Technologies, which withdrew its IPO filing to merge with AsiaInfo in December, and Gomez, which opted to pull its IPO in favor of acquisition by Compuware in October (Updata advised Compuware on the transaction).
Figure 10: Technology Initial Public Offerings, 2009
Furthermore, many prominent tech companies are sitting on some of the largest cash reserves in their histories (see Figure 11 below). These tech titans are active acquirers to begin with, and there is no doubt they will seek higher returns by deploying some of this cash into M&A activity in 2010.
Figure 11: Cash Rich Companies The remainder of this report discusses in more detail the M&A trends and transactions we have observed in 2009 in our sectors and what we expect to see throughout 2010.
SECTOR ANALYSIS
Updata's sectors of focus include: Infrastructure Software, Enterprise Application Software, Financial Technology, IT Security, Services and Internet. The trading metrics shown in Figure 12 imply that we have emerged from the downturn of the past two years, bargains will be increasingly difficult to find in 2010, and enterprise values and median deal sizes will rise.
Figure 12: Summary Public Company Valuation Metrics
Indices of public equities for Updata's primary sectors are shown in the chart below (see Figure 13). All of Updata's sectors beat the major market indices for 2009 as a whole. Internet companies saw the most growth, as the index climbed almost 100% in 2009. Financial Technology, Services and Infrastructure Software followed as the next largest climbers, all up over 50% for the year. We believe rising public company values are a good barometer for expected improvements in M&A transaction valuations and valuations in 2010.
M&A activity in the Infrastructure Software sector has begun to recover from a substantial slowdown during the recent economic downturn. The deals in the sector during 2009 tracked by Updata are summarized in Figure 14 below, reflecting an increase in both deal volume (in terms of the number and aggregate announced value) and in the Median EV/TTM Revenue Multiple in comparison to 2008. This relatively healthy performance during 2009 is unique among the sectors we track. No other sector reflected an improvement in both number of deals and valuation metrics.
Figure 15 below illustrates that M&A activity in the Infrastructure Software sector improved for 2009 despite a very slow start to the year. Very few transactions occurred during Q1. In fact, we did not track a single deal during the month of March. Total announced EV is skewed somewhat by the $5.6 billion Oracle/Sun Microsystems acquisition and the $2.2 billion EMC/Data Domain transaction, both of which were announced in Q2.
Figure 15: Infrastructure Software Deals By Quarter, 2009
During the last three quarters of 2009, deal activity was marked by diversity across deal size, buyer and sub-sector. Of particular interest was the return of transactions involving growing profitable companies such at NetQoS and Gomez. Also of interest were relatively high profile transactions by buyers that hadn't been active in the sector recently. Microsoft acquired Opalis in a transaction that demonstrates Microsoft's commitment to extending its infrastructure management portfolio into an enterprise class suite. Compuware acquired Gomez (Updata advised Compuware in this transaction) to create a unique end-to-end application performance management offering. We believe such trends during the latter part of 2009 provide fundamental support for continued improvement in the M&A market for Infrastructure Software as we move forward through 2010.
Figure 16: Top 10 Infrastructure Software M&A Deals in 2009 by EV
Updata expects key drivers for Infrastructure Software during 2010 to include the following:
Continued Evolution of Enterprise Virtualization Deployment and Use Cases: Updata expects enterprises to continue extending the footprint of virtualization in their data centers and to seek greater benefits as they continue to shift toward "private" cloud architectures. This trend will highlight the need for advanced infrastructure management capabilities creating big ticket sales for smaller vendors that offer specialized functionality and cause incumbent vendors to acknowledge a need to broaden their offerings to effectively address this rapidly emerging market opportunity. Updata further expects that during 2010, end-user virtualization will begin to take hold in a meaningful way and that enterprises will seek to integrate public cloud services into their portfolio of technology infrastructure. Updata expects these trends will support high levels of M&A activity in related areas during 2010 and beyond.
Tectonic Shifts with the Introduction of Converged Systems: 2009 was a year of major product introductions, high visibility partnerships and large acquisitions as major data center solution vendors (Cisco/EMC, HP, IBM) sought to offer fully integrated proprietary compute/storage/network systems designed to optimize benefits of virtualization and cloud computing. We expect continued maneuvering on this front to drive M&A activity. In addition, we expect a strong push from other vendors staking out their positions as the vendor of choice for heterogeneous and best-of-breed environments to drive M&A as well.
Other Key Areas of Disruption: Storage continues to be an area of compelling growth and technology disruption as data growth continues unabated and virtualization drives significant increases in the complexity of storage management. Enterprise mobility is an area that has for several years held plenty of interest and promise but not a meaningful amount of action. Updata expects that broad adoption of smart phones (such as the iPhone) and end-point virtualization technologies will contribute to enterprise mobility reaching a tipping point. As a result, Updata expects to see meaningful M&A activity across these two sectors during 2010.
Enterprise Application Software
The Enterprise Application Software sector ended the year much more active than it started, with a mostly upward trend in number of deals and median revenue multiples appearing in Q2 through Q4. With the severe recession resulting in so many distressed sales and depressed M&A multiples for much of the last six quarters, the most promising data point is a consistent uptick in the number of deals recently, from a low of 33 in Q2 to 83 in Q4 (see Figure 17). As logic of supply and demand would suggest, median EV/ TTM revenue multiples also returned to more "software like" ranges. Overall, we are seeing and expect to continue to see a reasonable uptick in the number of deals of all sizes but with modest expansion of median multiples as there are still too many sellers seeking too few buyers. However, demand will pick up as there is a significant amount of cash on the sidelines, and growing companies that are profitable and can show predictability in the form of recurring revenue will stand out and command very attractive multiples.
Figure 17: Enterprise Application Software Deals by Quarter, 2009
Year over year data also show significant improvements in every metric except median revenue multiple, which declined for Updata's overall 2009 IT data as well. Large increases in number of deals, EV and average deals size show how far the market has come since the lows of 2008 (see Figure 18 below).
Figure 18: Enterprise Application Software M&A Yearly Data Summary, 2007-2009
Although the sector appears to be rebounding, one metric that has not expanded is median valuation multiples. This metric was down for total 2009 data, but Enterprise Application Software saw the second largest decline since 2008, behind only the Internet sector (which dropped over 40%). We attribute the multiple's decline to fewer disclosed deal valuations, as well as the increased number of fire-sale acquisition prices in Q1 and Q2.
The Business Analytics sub-sector accounted for a significant share of total Enterprise Application Software M&A activity in 2009, contributing 14% of total EV for the sector. Notable deals included the $1.8 billion acquisition of Omniture and IBM's $1.1 billion acquisition of SPSS. In terms of number of deals, E-learning increased 100% as compared to 2008 and ERP ballooned by over 360%. These two sub-sectors contributed two of the largest deals for the sector in 2009: Hellman & Friedman's $570 million acquisition of Datatel and Voyager Learning Company's $470 million purchase of Cambium Learning. Vertical applications contributed the greatest number of deals in 2009 at 41 transactions. The 451 Group expects a hunger for more vertical expertise will drive M&A in 2010. Asset sales are also expected to continue through 2010, as distressed sales of small companies continue and many larger companies look to spinoff less-profitable divisions in an attempt to continue to improve their balance sheets.
Figure 19: Top 10 Enterprise Application Software M&A Deals in 2009 By EV
Updata expects the following themes to be prominent throughout 2010:
Financial buyers are re-entering the market and are not afraid to spend. Financial buyers have begun to return to the market with a large amount of capital to spend and are paying large sums, particularly in Enterprise Application Software. Six of the top 10 private equity deals in 2009 were in the Enterprise Application sector, the largest of which (IMS Health) was valued at more than $5 billion. In December alone, Thoma Bravo purchased AMICAS for $208 million, while Marlin Equity Partners acquired Reader's Digest's CompassLearning unit. Vista Equity Partners also re-entered the market in 2009 with three acquisitions within the sector, after stepping back in 2008 (MicroEdge for $30 million, Intuit Real Estate Solutions for $128 million, and SumTotal Systems for $115 million). The fact that these buyers are beginning to open their wallets again leads us to believe the sector continues to grow profitably and deal metrics could improve as strategic buyers may begin to see more competition for deals.
More emphasis on importance of social networking in CRM and Marketing: The rise of Twitter, Facebook and LinkedIn as social and professional communication tools has taken over the market mind-set in recent years and these modes of real-time communication and collaboration will find their way deeper into the enterprise. IDC predicts that business applications will begin to undergo a fundamental transformation, fusing social/collaboration software and analytics into a new generation of "socialytic" applications and begin to challenge current market leaders. Already, Salesforce.com has announced its plans to launch Chatter, a real-time stream of enterprise data which interfaces with Twitter and Facebook and turns them into business tools. But start-ups like Yammer and Bantam Live are also making business more social and could be targeted by companies without the internal R&D expertise to keep up with this new trend on their own.
The largely consolidated traditional CRM sub-sector has not been particularly active for M&A over the past two years (2009 counted only 10 deals for total of $111 million). The convergence of these new technologies with traditional CRM, as well as the required analytics to measure customer experience, could lead to an uptick of M&A by leaders in the space. As an example, Salesforce.com very quietly acquired start-up GroupSwim, a provider of on-demand social software for businesses. GroupSwim was developing a Web 2.0-based user interface that captures collaborative work in multiple formats using semantic technology. The company's software automatically tags, rates and searches content (discussions, emails, documents, wikis), and identifies topical experts.
Innovation will spur new M&A growth in Enterprise Content Management. The Enterprise Content Management sub-sector has historically been one of the most active that we track. Although the number of deals slipped over the past three year period (and down 33% since 2008), the sub-sector still accounted for more than $840 million in M&A activity in 2009. Microsoft has plans to debut its new SharePoint 2010 suite, which could drive M&A as vendors look for differentiators, specifically in records management and governance. The number of ECM vendors has condensed over the past few years, especially with the acquisitions of Interwoven by Autonomy in January and Vignette by OpenText in May, but we expect other larger players to step up (such as SAP or even Microsoft). There is also a wealth of smaller players in this arena which may attempt combinations among themselves to build the scale and breadth they need to compete with the larger, more established vendors.
Data search and analytics will become a key sub-sector once again. Social networks, text messaging and geo-location are overloading the marketplace with more data than ever. New technologies that know how to mine this data will be increasingly valuable as this swath of information continues to grow, especially as more companies begin to open up their APIs to the public. Start-ups that can restore the balance between how much information we receive and our ability to process it will no doubt be prime targets for acquisition. These could include anything from managing and extracting data from e-mail inboxes, to companies that allow access to personal data, like music and photos, from any computer, at any time.
Further expansion into vertical-specific solutions and embedded processes. Updata has focused on and written about how important it is for application vendors to provide intelligent solutions out of the box for specific vertical industries. This has been playing out for a decade or more but will intensify in 2010 and beyond. One example is that Business Process Management (BPM) is going main stream as evidenced by IBM's acquisition of Lombardi Software for a rumored multiple of upwards of 5x TTM revenue. Of course, Progress (who was an OEM partner of Lombardi's) had to then acquire its own BPM capabilities and announced the Savvion deal, albeit at a much lower multiple. By embedding IT into an industry's key processes, organizations will be able to quickly adjust and adapt to support changing needs, especially those that rely on collaboration. Automating processes such as insurance claims, mortgage applications, procurement approvals, hospital admissions, etc., will eliminate the need for time consuming and complicated intervention.
Financial Technology
Updata tracked 109 Financial Technology ("FinTech") M&A deals in 2009, which was up from 79 deals in 2008. However, the EV of the 2009 deals was down nearly 16% over 2008. Relative to the 2007 peak in EV when the value of FinTech deals reached $46.1 billion, 2009 was off by 77% and, even if we exclude the 2007 buyout of First Data ($27.5 billion), the EV of deals in 2009 was off 42% vs. the 2007 peak (see Figure 20). This trend is consistent with the economic malaise and resulting contraction in overall global M&A during the last 18 months. The 2009 quarter-over-quarter data does not demonstrate a clear trend in either direction although the second half of the year saw 68 deals vs. only 41 deals in the first half (see Figure 21).
Figure 20: Financial Technology
M&A Yearly Data Summary Figure 21: Financial Technology M&A Quarterly Data Summary, 2009
Notable in 2009 were two, billion-dollar strategic deals, both of which were announced at the end of Q1: Fidelity National Information Services' $4.4 billion purchase of Metavante Technologies and Advent's $2.3 billion acquisition of Fifth Third Processing Solutions. These two deals alone make up more than 60% of the year's total EV of announced deals. By comparison, 2007 and 2008 saw total EV spread across a broader number of larger deals.
Although the median revenue multiple for the sector dropped slightly in 2009 (1.7x vs 1.9x for 2008), the sector did have its share of high multiple transactions, particularly within the larger deals. In fact, the 10 largest Fin Tech transactions posted a median EV/Revenue multiple of 3.4x, twice the overall sector (see Figure 22 below). Interestingly, seven of the top 10 deals were in the Payments sub-sector, supporting our standing viewpoint that consolidation among payment technology and services remains a strong M&A theme. Even though only one of the top ten deals was private equity-backed, the PE buyers remained active again in 2009, completing six deals, all in the second half of the year. These included Vista Equity Partner's acquisition of MicroEdge ($30 million); Jack Henry's acquisition of Goldleaf Financial Solutions ($59.7 million); Palladium Equity's purchase of Global Payments Inc/DolEx- and Europhil ($97.5 million); and ComVest Group's $81 million acquisition of Cynergy Data.
Figure 22: Financial Technology Top 10 M&A Deals By Enterprise Value, 2009
Coming into 2010, the banking industry remains cautious on IT spending as participants harbor cash in the face of consumer credit losses and uncertain future capital requirements. Furthermore, the Financial Services sector has its hands tied in terms of future IT initiatives since the pace of regulatory change has been slow to develop. We expected by the end of 2009 that Congress would have enacted financial reform regulation, thereby establishing a path forward for the banking industry. As the Hill was mired in the Healthcare reform process, financial reform took a back seat, leaving IT strategies up in the air. We remain cautious about the pace of financial reform in 2010 as the Federal Government appears to be shifting its attention to jobs and even more stimulus for the economy. However, with the financial services sector generating large profits, we expect to see at least a partial thaw of IT spending. It remains unclear if this expected improvement in IT spending will compel a pick up in FinTech M&A. We expect the payment sub-sector to be the most robust in terms of M&A activity in the coming quarters.
We see the following FinTech M&A trends developing for 2010:
Mobile financial transactions will become more prevalent as consumers turn to mobile devices for more activities. The continued deployment of 3G and 4G mobile devices will drive applications for mobile banking. In particular, we believe mobile payment technology and capabilities will make significant progress in 2010. The potential growth in this area will spur M&A activity among technology companies that are building enabling infrastructure for mobile payments. Some companies are already making waves in this area, including Square, which was launched by Twitter founder Jack Dorsey, and enables an iPhone to be a credit card reader. Verifone and Mophie have also announced competing products, building on the idea that any mobile phone can become a point of sale. These applications enable the mobile payment to connect into the legacy payment systems, back-end accounting, CRM, and other enterprise systems. Payment processors will likely resort to M&A in order to keep pace with this rapidly evolving market, particularly if its growth trajectory is tied to the growth in new advanced mobile devices. There were a number of mobile financial M&A deals in 2009 (Macalla Software/Roamware; Commerciant/BankServ; and Paymo and Mobilcash/BOKU), and we expect to see even more activity in 2010.
Consolidation will continue in payment processing. Strategic combinations within the payment processing industry will continue to proliferate driven by two fundamental themes. First, economies of scale: the greater the transaction volume through a system, the greater the efficiency. This is particularly true in the credit and debit card processing business. Second, the threat of new alternative payment systems will keep the established payment processors focused on acquiring new technologies. 2009 saw a number of such deals along these two primary themes. Perhaps the most intriguing deal was American Express' purchase of Revolution Money. This acquisition gave AMEX a beachhead into both the on-line person-to-person (P2P) payment market and the low cost debit market. We expect 2010 to bring a number of notable acquisitions in alternative payments (mobile payments and pre-paid debit companies are likely targets).
Financial Reform will finally pass in 2010, but M&A may lag by several quarters. We had expected to see a Financial Reform bill from Congress in the second half of 2009 but with attention focused on the Healthcare debate, the bill did not make it through the political process. Furthermore, with Senator Dodd's recent announcement to step down from service later this year, there is a growing concern that Financial Reform may remain on the back burner. We, however, take the view that Dodd's announcement is a minor risk to the process and that the overwhelming force pushing Reform into the spotlight is the growing populist sentiment against industry risk taking and pay practices. Once new regulation is defined, financial institutions will be able to chart their IT strategies and initiate new spending on compliance solutions. Coupled with spending on core systems and risk management technologies, this should lead to a revenue and profit rebound for FinTech companies. As the spending cycle improves, FinTech vendors will seek to enhance their capabilities in specific areas (i.e., anti-fraud or transaction monitoring) and look to M&A as a means to build-out these specific skills. This trend will likely gather steam one or two quarters after Reform is passed.
IT Security
IT Security M&A started off slowly in 2009. However the year's second half, and Q4 in particular, saw steep improvements. Updata tracked 34 transactions in 2H 2009 (19 in Q4) compared with 22 in 1H 2009 (see Figure 23 below). In Q4, total EV of deals grew more than 250% versus Q3 to $898 million, and 26% versus Q4 2008. Median EV/TTM revenue multiples paid in Q4 almost tripled Q1-Q3's mean, jumping to 5.6x, the highest point in two years and a level in line with pre-recession security multiples. These increases in number of deals and values, together with improved public security vendor performance and share prices (58% rise among bellwethers in 2009), plus Fortinet's successful IPO in November, suggest a sector recovery is genuinely at hand.
The fourth quarter saw the three highest-multiple security deals of 2009. Venture-backed Barracuda's 8.0x EV/TTM revenue acquisition of Purewire was driven by the low-cost appliance vendor's desire to offer a SaaS/cloud alternative to customers, and was particularly notable given conservative valuations paid by Barracuda in prior transactions. IBM's estimated 6.1x EV/TTM revenue acquisition of Guardium provided Big Blue a real-time database monitoring and protection vendor of scale. Microsoft's estimated 5.0x EV/TTM revenue acquisition of Sentillion was a strategic deal driven by its prowess in managing single sign-on in the Healthcare vertical. These deals indicate that strategic valuations are again achievable for companies providing direct value to buyers' roadmaps.
Figure 23: IT Security Deals By Quarter, 2009
Second-half strength helped drive full-year median EV/TTM revenue multiples up 54% over 2008, to 3.2x. However, total number of deals and median deal size remained at their lowest points in three years (see Figure 24 below), dragged down by fire-sale prices that prevailed earlier in the year that kept many would-be sellers out of the market (Q1 and Q2 only had seven deals with disclosed valuations). We predict 1H 2010 will show continued volume and valuation recovery, potentially maintaining the momentum of a strong Q4.
Figure 24: IT Security Deals Yearly, 2007-2009
The healthy pace of public security vendor acquisitions continued last year. In 2009, six public security target acquisitions were announced and completed: Aladdin Knowledge Systems by SafeNet/Vector Capital; Certicom by Research In Motion (after a bidding war with VeriSign); Hifn by Exar; Entrust by Thoma Bravo; Integralis by NTT; and phion AG by Barracuda Networks. These transactions were spread across the security spectrum including protection of digital content and identities, network and storage security, and embedded cryptography. In 2008, five public take-outs were announced (though two, Certicom's purchase by RIM and Sourcefire's acquisition by Barracuda, were eventually terminated). We believe 2010 will see further consolidation of the 30 or so security public pure-plays remaining. There likely will also be at least a few security IPOs, spurred in part by Fortinet's recent offering, a pipeline of quality IPO candidates (including such names as AVG, Infoblox, Panda, PGP, Sophos) and improved IPO sentiment in general.
Figure 25: Top 10 IT Security M&A Deals in 2009 by Enterprise Value
As a class, security SaaS companies proved to be in high demand in 2009. Partly in response to Symantec's acquisition of hosted security vendor MessageLabs late in 2008, McAfee acquired MX Logic in July for $170 million, at a 4.9x EV/TTM revenue multiple. That acquisition was followed shortly by Barracuda's acquisition of cloud-enabler Purewire for $22 million (at an estimated 8.0x EV/TTM revenue multiple), and Cisco's acquisition of online content security vendor ScanSafe for $183 million. Most significant security vendors have established beachheads in SaaS and cloud-based solutions, and will be looking to round out their offerings in 2010, driving robust security SaaS M&A activity this year.
Buyers' appetite for content security vendors also showed strength in 2009. Examples include TA Associates' $200 million investment in anti-malware vendor AVG for a minority stake (with an implied EV/TTM revenue value estimated at 5.3x), Cisco/ScanSafe, and M86's purchases of Avinti and Finjan. Content security continues to be a large growth market with a significant number of midsize players ripe for consolidation by pre-IPO vendors.
Updata's predictions for IT Security in 2010 include:
Heavy emphasis on strengthening Web security and trust. Transacting, working, sharing and storing over the Internet requires universally better protection of Web sites, consumers, and Web-accessible applications and data than is currently in place -- the Internet was not designed with security in mind. Consequently, security companies with technology and traction in Web security-related areas stand to benefit. Three of the largest deals of 2009 (AVG Technologies/TA Associates, ScanSafe/Cisco and MxLogic/McAfee) related directly to Web security, demand for which will grow dramatically in 2010 along-side the rise in e-commerce, social networking and cloud-based computing. There is a diversity of potential buyers of Web security vendors, including financial services firms, government contractors, communications providers, technology titans and security pure-plays. Recent intellectual property attacks on Google and Adobe, ongoing security problems at Twitter, and recurring data breaches and identity theft online highlight the need for big spending on Web-facing security.
The year of cloud security. Cloud-based computing and applications challenge the existing model of security by moving infrastructure from behind the corporate firewall to an off-premises, Web-accessible environment. Virtualization of security controls, such as firewalls and intrusion prevention systems, also alter the information security landscape. Areas expected to benefit greatly in 2010 from evolution to the cloud include hybrid on- and off-premises security in the midsized-to-large enterprise; hosted security applications including secure email, identity management, and governance; and compliance monitoring in larger enterprises.
Securing social networks becomes a priority. As more sensitive information and access are shared across Facebook and other social sites, dangers of identity theft, phishing and malware attacks are on the rise. These networks are ramping up investment in improved security on their sites and back-end systems. Addressing the consumer side, we expect established anti-malware vendors to increase acquisitions of new technologies related to online reputation, threat-research and transactional security to incorporate into their arsenal. We also foresee increased investment in threat intelligence and authentication solutions, with targeted offerings around e-crime and fraud prevention to fight threats to the enterprise.
Government means business in security. The United States and its allies have long held a contradictory position regarding security. On the one hand, governments have developed and acquired some of the highest-grade security available, i.e. for hardening signal transmissions and computer devices, controlling network access and monitoring activity. On the other hand, quality of coverage has been inconsistent. U.S. federal agencies, as well as state and local governments, repeatedly get failing grades when it comes to protecting their Websites from attack, securing data stores and deploying multi-layer protection. We believe increased funding, growing attacks, desire to put government online for more services, and greater recognition of the dangers will together create significant new investment and acquisition opportunities in government IT security in 2010. Not the least to benefit will be security consultants who will help guide public entities through the myriad considerations involved in establishing and enforcing security policies.
Business Services
Business Services M&A activity declined again in 2009, down markedly from its 2007 peak. Deal volume and total EV dropped nearly 50% from 2007 highs, and median revenue multiples ticked lower over the past two years, although not quite as drastically as other IT sectors. A bright spot is the jump in number of deals and aggregate EV in the third and fourth quarters of 2009 (see Figure 26 below). The third quarter in particular was boosted by two of the year's largest deals: Dell's $3.7 billion acquisition of Perot Systems and Xerox's $8.3 billion acquisition of Affiliated Computer Services. But big spending continued into Q4 as well, with Adecco Group's acquisition of MPS Group for $1.1 billion, Bain Capital's $1 billion acquisition of Bellsystem24, and KKR and General Atlantic's $1.6 billion purchase of Northrop Grumman's TASC unit.
While average deal size stayed relatively flat through 2008 at just under $270 million, this is skewed upward by multi-billion dollar acquisitions including ACS/Xerox and Perot Systems/Dell in 2009 and EDS/HP, Axon/HCL and Detica/BAE in 2008. Excluding all transactions over $1 billion, average deal size fell to $64 million in 2009 from $94 million for 2008 and $82 million for 2007.
Figure 26: Services Deals By
Quarter, 2009
Figure 27: Services Deals Yearly, 2007-2009
Private equity firms spent big money in the sector during 2009, as mentioned above through the Bain/Bellsystem24 and the KKR-GA/TASC unit transactions. Bain's November purchase of Bellsystem24 for $1 billion marked the sector's first large private equity deal in 19 months, since Apax Partners announced its April 2008 acquisition of TriZetto Group for $1.3 billion. The fact that financial buyers are willing to pour billions of dollars into Services again is a good sign of the bullishness and demand Services M&A markets may see in 2010.
As we noted in our recent Business Services M&A Update, within the top 10 deals of 2009, a handful had revenue multiples well over 1x. There were also EBTIDA multiples that exceeded as much as 12x, which is high for the sector in a healthy economic environment and certainly high in today's difficult business climate. Buyers are willing to pay up for large, high-quality companies, something we expect to continue into 2010.
The Services sector index of public companies rose 55% over 2009, up more than 10 percentage points over the market's leading indices in expectation of backlogged demand spurring growth throughout 2010. Certain niches within Services have performed quite distinctly, however. Updata's index of Federal services stocks, for example, has stayed relatively flat over the past two years in light of record budget deficits and expectations of curtailed federal spending. Other sub-sectors, such as Offshore and Managed Hosting, have thrived, with stock indexes up well over 100%. These sub-sectors have benefited from the ongoing migration of enterprise technology needs to outsourced services providers, and thus, robust profitability levels and above average revenue growth.
Figure 28: Top 10 Business Services M&A Deals in 2009
The Services sector index of public companies rose 55% over 2009, up more than 10 percentage points over the market's leading indices, and ahead of a backlog of Services growth expected throughout 2010. Certain niches within Services have performed quite differently, however. Federal Services, for example, have stayed relatively flat over the past two years, while other sub-sectors, such as Offshore and Managed Hosting, have thrived, growing well over 100%, primarily attributable to robust profitability levels and above average revenue growth.
Some of the themes we expect to dominate Services in 2010 include:
A renewed emphasis on India-based firms diversifying and consolidating. India-based Services firms have been sitting on piles of cash for the past few years and 2010 could be the year they decide to start reaching out and making acquisitions to differentiate their offerings and climb the value chain. A number of major India-based consulting firms, including Tata and Infosys, recently announced hiring plans to meet rising global demand, specifically in places such as the U.S., Europe and Japan. We expect these companies expand their breadth of services. For example, HCL, which acquired Axon in December 2008, highlighted the expanding score of its offerings in its recent quarter announcement. In the words of Dr. Shami Khorana, President, HCL America, "We continued to successfully execute on our highly differentiated GTM [Go-to-Market] strategy of delivering total IT outsourcing solutions to our customers, leveraging a complete vertical portfolio."6
We also believe smaller, Intra-India Tier-3 firms may consolidate to increase their scale. There are more than 30 public India-based Outsourcing firms in the $100 million to $500 million range that would be prime targets for consolidation to compete with the Tier-1 companies, similar to what we are seeing in other markets.7Some examples of firms that are good Intra-India candidates for consolidation include Cambridge Solutions, Hexaware, Mastek, Sonata, and Zensar, which all trade at or below roughly 1x revenues, much lower than typical Offshore multiples.
There will be continued interest in Services by product and product-based vendors. The acquisitions of both ACS and Perot this year underscored that traditional product vendors are reaching to become full-service, one-stop technology shops. ZDnet predicts at least two more mega-mergers similar in scale to Perot and ACS will occur in 2010.8 These mergers could involve traditional incumbents, an India-based service provider, or a combination of BPO and IT-centric services. As an example, research firm IDC names Canon as a potential acquirer in this arena, noting that although it just purchased Oce (whose business includes about E444 million in services), there could still be another acquisition on the way to expand its capabilities and reach, particularly one of the top 10 to 15 ITO and BPO providers.9
Increasing interest in the cloud will propel IT Infrastructure Professional Services M&A activity. We wrote in our 2009 Outlook about the growth of cloud computing and Software-as-a-Service in the enterprise, and on the Services side, we have seen a continued interest in Infrastructure-driven Services throughout 2009. From SaaS to cloud computing and virtualization, a handful of cloud-related Services deals were announced in 2009, although none of them so large in scale to make waves. These included Seco Invest AS's $120 million purchase of TeleComputing ASA; Terremark Worldwide's $11.3 million acquisition of DS3 DataVaulting; and Interactive Data Corporation's $40 million acquisition of 7ticks. There were also a number of network-focused deals, driven by growth in the data center and communications markets. These transactions included Platinum Equity's $26.7 million acquisition of Pomeroy IT Solutions; Capita's $120 million purchase of Synetrix; and most recently, the acquisition of Coleman by Presidio. We could see some interesting M&A activity among traditional service providers and those with cloud and infrastructure capabilities throughout the next year.
Internet
M&A activity in the Internet sector during Q4 2009 extended the volume strength of Q3, with $2.7 billion of Internet acquisitions announced. All told, 2H 2009 saw $8.5 billion in Internet M&A activity and 163 deals announced, a major improvement over 1H 2009 (see Figure 29 below). While valuation multiples continued to show weakness and median deal sizes remain low - reflecting an ongoing shake-out of smaller vendors - the sector has resumed a semblance of normalcy in terms of deal flow. Encouragingly, half of the 10 largest Internet deals of 2009 were announced in Q4, and nine of the top 10 in second half 2009.
We expect continued improvements in activity throughout 2010, tracking statements from Google, Microsoft, Yahoo! and others that they are stepping up acquisition programs. Bolstering this view is the near doubling of Internet sector public share prices in 2009 and rising flow of venture capital into the sector, a precursor of heightened deal activity.
Figure 29: Internet Deals by Quarter, 2009
For perspective, 2007, the most recent peak activity-wise in the sector, saw more than $38 billion in Internet M&A deal value, and 60% higher median deal multiples than 2009 -- EV/TTM revenues of 3.2x vs. 2.0x (see Figure 30 below).
Figure 30: Internet Deals Yearly, 2007-2009
Despite tepid valuations overall, the largest Internet transactions brought in high metrics. Google's AdMob acquisition (still pending at this date) for $750 million garnered an estimated 16.7x EV/TTM revenue multiple -- one of the highest for the entire year. Other strategic valuations included Electronic Arts' acquisition of PlayFish (6.4x); eBay's purchase of Gmarket (4.7x); Silver Lake Partners' Skype acquisition (4.5x); and Intuit's acquisition of Mint.com (17x).
Figure 31: Top 10 Internet M&A Deals in 2009 by Enterprise Value
Updata offers the following predictions of Internet trends in 2010:
Social networks to drive big growth in gaming and virtual goods. Social games took off on Facebook, MySpace and other platforms in 2009. While less than a billion dollar market today, social gaming is taking share from the traditional $20 billion market for console game hardware, software and accessories, and expected to grow 30% in 201010, spreading to other Web-based and mobile-based platforms including iPhone and Android. As evidence of the global trend, China-based Shanda Games recently said it will acquire San Francisco-based Mochi Media, which distributes browser-based games, for $80 million. Mochi has more than 140 million monthly users, with 15,000 browser-based games on nearly 40,000 publisher Web sites. A related revenue opportunity is virtual goods and currencies. Engage Digital Media recently released a report showing that 87 virtual goods companies raised $598 million in venture capital in 2009, up from just 34 in 2008. There were also 18 virtual goods company acquisitions during the year worth $398.3 million, with half happening in the fourth quarter (though most of the value was from the EA/Playfish deal).11
Mobility and geolocation will change how users and advertisers interact with the Web. GPS chips and mobile-based applications are becoming ubiquitous among the one billion mobile devices IDC predicts will access the web by 2010 -- gaining quickly on the 1.3 billion PCs accessing the Internet (with mobile devices growing 2.5x the rate of PCs). Recent advent of Geo APIs from Twitter (through its acquisition of Mixer Labs at the end of December, for $5.2 million), SimpleGeo, Foursquare and Gowalla are examples of vendors adding rich layers of geo-related data to all sorts of applications. We expect a variety of publics to acquire into the geolocation market given its potentially tremendous size. Recently, Networks in Motion, a Aliso Viejo, Calif.-based provider of wireless navigation products for cell phones, agreed to sell itself to TeleCommunication Systems Inc for $170 million.
Real-time search will sort through the deluge of data provided by social networks. After licensing real-time data streams from Twitter, Facebook, MySpace, and others, search leaders Google and Bing are quickly ramping up social search. In 2010, search engines will begin to include searches from social network data that social network users can access in real-time. Startups such as Collecta, OneRiot, and Topsy are examples of firms that seek to advance the real-time search experience. The key will be to combine real-time search with filters so that people are delivered not only the most recent information but the most relevant and authoritative as well.
Banks and retailers invest seriously in online engagement. Following Mint.com's rapid customer growth and high-value exit to Intuit in 2009, global banks have begun pouring more resources into online strategies to boost loyalty and attract a younger clientele. As an example, Citigroup and Microsoft are partnering to create Bundle, potentially a standalone site to compete with Mint. More broadly, brick-and-mortar retailers are expected to boost investment -- and acquisitions -- in their sites to drive brand and traffic in 2010.
TV, Video, Internet Continue Converging. 2009 saw major steps toward unification of content screens and streams. NetFlix has seen success with its recently launched downloading service, meaningfully improving Q4 financial performance. Netflix and Amazon use a set top box from Roku to stream from Web sites to a consumer's tv/monitor. Google, which owns about 38% of Web-based video viewing site YouTube, announced in January it would start offering movie downloads on a limited basis (starting with releases from the Sundance Film Festival). Currently, YouTube users watch about five hours of TV each day versus 15 minutes of YouTube: expect that proportion, and the ad dollars going with it, to change steadily. Apple, on its part, is working on a broadband TV service and reportedly talking to Disney and CBS about supplying content. Comcast's TV Everywhere online initiative is another example of program content delivery convergence.
Independent e-Tailing to Consolidate. Outside of Amazon, eBay and sites linked to major retailers (i.e. Wal-mart, BestBuy), the number of large purely online retailers is small. At the same time the number of e-tailers is quite large. Improvements in online trust via Internet security suites from McAfee, PGP, Symantec and others, combined with reputational services (i.e. Yelp!) are helping independents compete more effectively -- however, they need mass. Hayneedle and CSN Stores are examples of virtual shopping malls that we expect will continue to add brands, growing organically and through M&A. We also foresee a rise in 2010 acquisitions of targets for critical mass in a market, e.g. in pharma Drugstore.com's acquisition of Salu, as well as vertical integration deals.
CONCLUSION
The past two years have been hard on the economy, and especially the M&A market. While we are not completely out of the woods yet, the second half of 2009 provided a glimpse of recovery and we expect that will carry through 2010. Transactions are still taking longer to complete, but we expect the appetite of acquirers with piles of cash on hand to speed the process along somewhat. With much of the fire-sale deals done, there is plenty of room for valuations to increase and significant, strategic plays to be made.
We also expect venture capital exits to help spur increased M&A activity throughout 2010. Many venture firms are well past the desired time-frame for holding on to these assets and are ready to offload the matured companies. There is also a lot of private equity money sitting on the sidelines waiting to be spent. And as we mentioned earlier, 2010 deal announcements are on pace to beat 2008 and 2009 and we expect the M&A market to make vast improvements throughout 2010 and into 2011.
References 1. VC Investments Q4 '09 - Money Tree - National Data. The MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association based on data from Thomson Reuters. January 22, 2010.
2. Data: FactSet Mergerstat. Acquisition purpose: Financial. Announce date: 1/1/07 through 12/31/09. Geography: North America, U.S.: buyer/seller/unit. Excluded cancelled deals.
3. Brenon Daly. "Survey says: Companies ready to deal again." Inorganic Growth, The 451 Group. January 7, 2010. http://blogs.the451group.com/techdeals/investment-banking/survey-says-companies-ready-to-deal-again/
4. Cyrus Sanati. "Price of Tech M.&A. Is Expected to Rise." NYTimes, Dealbook. January 8, 2010. http://dealbook.blogs.nytimes.com/2010/01/08/price-of-tech-ma-is-expected-to-rise/
5. Stock Chart Comps: Updata uses the following data to compile its Indices: The Updata Advisors' Services Stock Index is Market Cap weighted and is comprised of the following 71 companies, organized by sub-sector: Offshore Outsourcing: CTSH, HCL, INFY, PTI, SYNT, TCS, VRTU, WIT; BPO: ADP, APAC, CVG, CSGS, EXLS, G, HSII, HEW, IRM, PAYX, SGS, SRT, SYKE, TTEC, WNS, WW; Consulting: CRAI, DTPI, FCN, HCKT, HURN, XPRT, MMC-GB, NCI, RECN, SAPE; Systems Integration: CAP-FR, GIB, CBR, COLUM-IT, EDGW, ELOY, ITIG, PRFT; Government Services: CAI, DCP, DRCO, ICFI, MANT, MMS, NCIT, SAI, SRX, SXE; Outsourcing: ACN, CSC, IBM, NSTC, TEAM, UIS; IT Staffing: ANLY, CDI, CFS, CTGX, CITP, KFRC, RCMT, TSRI; Managed Hosting: EQIX, NAVI, RAX, SVVS, TMRK. The Updata Advisors' Infrastructure Software Stock Index is Market Cap weighted and is comprised of the following companies, organized by sub-sector: Storage: CA, CVLT, DBTK, DDUP, EMC, FALC, HPQ, IBM, ISLN, NTAP, RVBD, SYMC; Application Infrastructure: CTXS, INFA, IBM, MSFT, ORCL, PEGA, PRGS, RHT, TIBX, SOW-DE; IT Ops & Management: AVCT, BMC, CA, CPWR, HPQ, IBM, KEYN, MSFT, NTCT, NZ, NOVL, OPNT, QSFT, SYMC, VMW. The Updata Advisors' Security Software Stock Index is Market Cap weighted and is comprised of the following companies: ACTI, ARST, BCSI, CHKP, CTXS, COGT, CTCH, F-Secure, INTZ, JNPR, ID, MVSN, MFE, SNWL, FIRE, SBSW, SYMC, TrendMicro, VDSI, VRSN, WBSN, ZIXI. The Updata Advisors' Internet Stock Index is Market Cap weighted and is comprised of the following companies, organized by sub-sector: Internet Search: BIDU, CNVR, INSP, LEDR, LOCM, LOOK, MOVE, TZOO; Digital Media: GIGM GOOG, IACI, ICGE, JUPM, KNOT, NTES, SINA, SNDA, LNUX, SOHU, YHOO; Ecommerce: AMZN, DSCM, EBAY, EXPE, FLWS, GSOL, LOOP, LQDT, OSTK, PCLN, SFLY; Internet Infrastructure: AKAM, CCOI, DRIV, ELNK, GSIC, INAP, KEYN, LNUX, MLNK, RNWK, SNCR, UNTD, VRSN; Online Enterprise Applications: ARTG, CRM, LPSN, RNOW, ULTI, VOCS; Digital Marketing: IIG, PUBGY, WWWW; Online Advertising: MCHX, VCLK. The Updata Advisors' Enterprise Applications Software Stock Index is Market Cap weighted and is comprised of the following companies: Business Analytics: ACTU CHRD DMAN FIC INFA MSTR OMTR OTEX PRO; CRM: ARTG BVSN CRM CTCT RNOW UNCA VOCS; ECM: EMCOTEX; ERP: BasWare EPIC INTU LWSN N ORCL PROJ QADI SAP SGE-GB; HCM: CALD CNQR KNXA SABA SFSF SLRY TLEO ULTI WSTM; PLM: ADSK ANSS CIMT DASTY DLC-GB PMTC; SAAS: BBBB BLKB CNQR CRM CTCT DMAN KNXA LPSN N RHT RNOW SFSF SLRY TLEO TRAK ULTI VOCS WBSN; Supply Chain: ARBA AZPN DSGX GSOL ITWO JDAS KWL-GB MANH MLNK; Vertical Applications: AMSWA BBBB JDAS MANH TYL. The Updata Advisors' Financial Technology Stock Index is Market Cap weighted and is comprised of the following companies: Payments: ADS AXP EEFT GCA GPN HPY HYC MA MGI TIER TNS TSS PAY V WU WXS; Risk Management Solutions: EFX EXPN-GB FIC IDC MCO Norkom RMG; Fin'l Institution Software: ACIW EPAY DST EBIX FIS FDSA-GB FISV FNDT GFSI JKHY LIN-FR MSY-GB ORCC SONE SEIC TEMN-CH SIM-DK, ORC-SE, PTS-GB, FDSA-GB, SOG-GB.
6. HCL Technologies, Ltd. "HCL Technologies Reports 28% YoY Revenue Growth in Q2 FY10." January 25, 2009. Press Release.
8. Phil Fersht. "2010 Predictions for the Outsourcing Industry." ZDNet. December 7 , 2009. http://blogs.zdnet.com/outsourcing/?p=128
9. Frank Gens. "IDC Predictions 2010: Recovery and Transformation." December 2009. IDC.
10. Caoili, Eric. "Analyst: Social Game Revenues To Hit $1.3B In 2010." Gamasutra. February 1, 2010. Http://www.gamasutra.com/view/news/27035/Analyst_Socia_Game_Revenues_To_Hit_13B_In_2010.php
11. Dean Takahashi. "Virtual goods-related companies raised $598M in 2009." GamesBeat. January 19, 2010. http://games.venturebeat.com/2010/01/19/virtual-goods-related-companies-raised-598m-in-2009/
About Updata Advisors: Based in New York and Reston, Virginia, Updata Advisors is a leading investment bank specializing in mergers, acquisitions, private placements, fairness opinions and corporate restructurings for the information technology industry. Updata creates Greater Outcomes for clients measured in growth, innovation and shareholder value. Since 1987, the firm has advised on over $15 billion in transactions for application and infrastructure software, internet, security and IT services companies. Updata Advisors is perennially ranked among the top five advisors in transaction volume to companies in the Computer Software, Supplies & Services industry, according to FactSet Mergerstat. For more information, visit www.updataadvisors.com.
