M&A OVERVIEW: DESPITE BRIGHT SPOTS, IT M&A FEELS THE STING OF A ROUGH ECONOMY...read more>> Economic Downturn Has Not Stopped America's Acquisitiveness Abroad...read more>> Challenging Environment Slows IT M&A Activity Overall...read more>>
M&A OVERVIEW: DESPITE BRIGHT SPOTS, IT M&A FEELS THE STING OF A ROUGH ECONOMY
First the good news. Total announced enterprise value of the IT deals tracked by Updata was roughly $31 billion in Q2 2008, up 3% from Q1 2008 (see Figure 1).1 Helping the figure for total announced enterprise value for this quarter was the roughly $14 billion bid HP made for EDS on May 13, 2008. Additionally, overall median enterprise value/TTM revenue multiples are up 8% from last quarter.
Over the last 12 months, public market indexes of the five sectors that Updata tracks have surpassed the broader NASDAQ index (see Figure 2).2 Corresponding valuation metrics of the underlying public companies in these sectors are also shown below (see Figure 3).
Now the less-than-good news. Total announced enterprise deal value is down a hefty 59% from prior-year Q2 2007, although that quarter includes the $27 billion acquisition of First Data Corporation by Kohlberg, Kravis, Roberts. Excluding this transaction, enterprise value still fell by 35% from Q2 2007 to Q2 2008. The number of transactions declined 25% from the prior-year quarter and median multiples of EV to TTM revenue are down 8% from one year ago.
Figure 1 M&A Analysis For Deals Tracked By Updata
Figure 2 One Year Relative Stock Price Performance By Sector Versus NASDAQ
Figure 3 Public Company Valuation Metrics In Each Sector Tracked By Updata
While Q2 2008 has not seen a deal comparable in size to Microsoft's (ultimately terminated) bid for Yahoo! early this year, a few big ticket bids were made (see Figure 4). Most notable was HP's $13.9 billion offer for outsourcing megalith, EDS. In fact, three of the four biggest deals Updata tracked in Q2 2008 were IT services transactions with the only exception being CBS Corporation's $1.7 billion bid for global interactive media corporation, CNET Networks. Total enterprise value for deals greater than $1 billion was just over $23 billion making up about three quarters of all the Q2 announced enterprise value. This is up from Q1 2008 when deals greater than $1 billion in enterprise value totaled $18.5 billion and made up 61% of the total.
Figure 4 Announced Deals With Enterprise Value Greater Than $1 Billion
Economic Downturn Has Not Stopped America's Acquisitiveness Abroad
In terms of the number of announced transactions in Q2 2008, cross-border deals made up about 39% of all the acquisitions tracked by Updata. Interestingly, fewer of these deals than expected have been inbound to the US, despite the historically cheap dollar (see Figure 5). In fact, the weakened dollar notwithstanding, our data shows that American buyers are still acquiring relatively expensive foreign companies. Only 17% of the cross-border deals tracked by Updata involved a US target. Most US acquisitions overseas involved a European target; 40% of the European targets were based in the UK.
Figure 5 Representative Cross-Border Transactions
Challenging Environment Slows IT M&A Activity Overall
From Updata's perspective, buyers have become more patient and selective about targets given their increased M&A options. Large public companies say that they have seen an uptick in sell-side approaches. Lower public buyer valuations also have had a slowing effect as companies are often more reticent to do deals when their stock is lower. Companies with growth and good cash flow still attract attention from potential buyers (including financial acquirers), but they are not commanding the frothy valuations of nine to 12 months ago. Also, a pipeline of potential deal activity is growing toward the next few quarters when macroeconomic conditions improve and psychology reverses; buyers will move before valuations go up.
It is the smaller companies with flat or declining revenues and cash burn that are experiencing the pain of the distressed economy reflected acutely in their sell-side M&A processes. Targets with these characteristics are finding limited interest and tend to be more appropriate for boutique buyers focused on distressed targets - as a result, the spread between valuations for these types of companies versus fast growers has widened. Shown below are the deals by financial buyers that Updata tracked for Q2 2008 (see Figure 6).
Figure 6 Deals By Financial Buyers In Q2 2008 Tracked By Updata
SECTOR ANALYSES
Updata regularly tracks five core subsets of the technology sector: Infrastructure Software, Enterprise Application Software, IT Services, Security, and Internet (see Figure 7). In Q2 2008 certain sectors fared better than others. Overall, deals in the IT services space made up the bulk of the activity while deals in the Internet sector have commanded the highest multiples of enterprise value to TTM revenue.
Figure 7 Sector Data
Infrastructure Software
The total number of infrastructure software deals that Updata has tracked is down slightly from last quarter and at 16 deals represented only 8% of total number of IT deals (see Figure 8).3 Due to a few big-ticket acquisitions last quarter (such as Oracle/BEA Systems and Sun Microsystems/MySQL) and an absence of big deals this time, overall deal volume is down significantly as well. We have noticed the following trends in the infrastructure software sector:4
Virtualization and automation technologies remain popular. Enterprises are spending liberally on technologies that allow users to reduce costs and increase flexibility by virtualizing elements of their infrastructure. Automation solutions result in lower personnel costs in terms of labor expense, improved productivity, and higher levels of performance. Q2 deals in this space include VMWare's acquisition of B-Hive Networks and Symantec's acquisition of AppStream.
Storage software companies are attractive targets. The storage software sector showed relative strength among the infrastructure deals this quarter as the volume and value of stored data continues to grow rapidly across enterprise, SMB, and consumer segments. Deals in this sub-sector include IBM's acquisitions of Diligent Technologies and FilesX and Symantec's acquisition of SwapDrive. SwapDrive was represented by Updata in this transaction.
Cloud computing is set to disrupt IT. Although full-scale adoption of cloud computing has yet to be seen, the promise of it has been demonstrated by several narrowly-focused offerings that utilize an architecture similar to computing in the cloud. One of the fastest-growing examples of a targeted cloud computing offering is online backup and storage. Examples of Q2 deals in this space include Symantec's acquisition of SwapDrive as noted above and the acquisition of AmeriVault by PHNS.
Enterprise application software deals were fairly well represented this quarter. Forty-four deals made up about 23% of the total deals Updata tracked, although enterprise application software represents only about 8% of total announced enterprise value (see Figure 9).5 While deal activity is down in this sector from Q1 2008, stock prices continue to outperform all other sectors tracked by Updata. We have seen the following trends in enterprise apps in Q2:
Demand for SaaS has not abated. Twenty-five percent of the deals in the enterprise application software space involved software-as-a-service (SaaS) targets. This nascent market is experiencing high growth rates. This is not altogether surprising in an economic downturn as SaaS offers the benefit of lower upfront costs vis-a-vis a traditional on-premise software installation. Q2 SaaS deals include Blackbaud's acquisition of Kintera and the acquisition of OpenAir by NetSuite.
Financial technology deals are going strong. Despite troubles in the financial services industry and reported IT budget tightening, financial technology deals made up 23% of the enterprise apps deals this quarter. Examples include SunGard's acquisition of Strohl Systems Group and IBM's acquisition of electronic trading data vendor InfoDyne. Financial customers remain one of the largest and most lucrative verticals in terms of IT spending.
Deals in enterprise applications may temper as buyers wait out the market. While we expect general consolidation to continue in this space, deal-making may decelerate as buyers nurse wounds inflicted by the economic downturn. We predict that many strategic buyers in enterprise application software will adopt a bit of a wait-and-see approach and put off more aggressive buying until the market picks up again. But we do expect to see certain smaller and weaker players with something to offer (such as best-of-breed technology, strong customer base, attractive maintenance revenue, etc.) to be taken out by "value-oriented" consolidators, which are often backed by PE firms.
IT security deal volumes and valuations have tempered this quarter as the sector divides more into haves and have-nots.6 Overall, the six security deals last quarter represented 3% of the total number of IT M&A deals tracked by Updata (see Figure 10). While several large public vendors actually saw share prices rise during the quarter, most publics, particularly smaller ones, have seen share prices decline. Trends and opportunities in the security sector include:
Reduced financial transactions may be made up in cross-border activity. Half of the IT security deals Updata tracked in Q2 were cross-border deals. Such deals include France-based Sopra Groupe's acquisition of public US-based identity management provider Tumbleweed, and US-based EDS's acquisition of managed security services provider Vistorm Holdings, which is based in the UK.
Identity and access management companies are attractive targets. Compliance with federal regulations remains a top-of-mind concern with enterprise IT organizations; identity and access management is a crucial component of compliance. Examples of deals in this subset of IT security include Sopra Groupe's acquisition of Tumbleweed and Hitachi's acquisition of M-Tech Information Technology.
GRC is coming. Governance, Risk, and Compliance management spending is rapidly growing - 70% year-over-year according to Gartner Research - and significant consolidation of this promising (but fragmented) market is likely over the next several quarters.
Mobile security will be a strong M&A driver in security. As more functionality becomes available on mobile phones, consumers and business users are using these devices to do more. Security concerns go hand-in-hand with this rising use as mobile phones become popular gateways for shopping, banking, and other activities requiring the use of sensitive information. Expect M&A in mobile security to accelerate in the near future.
IT services has weathered the economic downturn better than several other technology sub-sectors in Q2, and consolidation is occurring at a good clip (see Figure 11).7 Forty-two percent of all deals and 74% of the total announced enterprise value tracked were related to services deals. Deal volume in this sector has dropped off less than that of other sectors tracked by Updata at only 19% since Q1 2008.8 We have observed the following trends in the IT services space:
Several large deals carried hefty price tags. Three of the four largest deals across all IT sectors were for IT services firms. Even without HP's mammoth $14 billion offer for EDS, deals in IT services have higher average enterprise values than other sectors in Q2 2008.
Hot areas include Oracle implementation and legal services. Traditionally we have seen SAP specialists dominate the systems integration M&A market, but Oracle shops are on the rise this quarter. RCM Technologies, Accenture, and Deloitte all bought Oracle implementation providers in Q2. Additionally, we are seeing the emergence of an M&A specialty market for providers in the legal vertical. Acquisitions of this type include Electronic Evidence Discovery's bid for Daticon and Integreon Managed Solutions' acquisition of Datum Legal.
There is increased activity in the federal government sector. About 18% of the IT services deals in Q2 involved targets that either exclusively or predominantly provided services to the government. This is up from 12% of the services deals tracked by Updata in Q1 2008. Most of these deals had a Department of Defense focus. Acquisitions in this space include Raytheon's acquisition of SI Government Solutions and Lockheed Martin's bid for Eagle Group International.
Figure 11 Representative IT Services M&A Transactions Q2 2008
Internet
While certainly not immune to economic headwinds, Internet deal activity makes up 17% of total deals tracked by Updata in Q2 (see Figure 12).9 With 33 deals, Internet deal activity has fallen 28% from Q1 2008. Valuations remain high relative to other sectors. In fact, evidence suggests that the troubled economy may be doing much to help push applications online for their cost advantages. Sector trends in Q2 include:
Online advertising continues to draw significant spend despite economic downturn. Market research firm eMarketer has projected that online advertising spend will not only weather the economic downturn, but will grow in spite of it. eMarketer predicts that Internet ad revenue will reach $25.9 billion in 2008 and make up 10% of all US ad spend in 2009.10 Key players are continuing to buy online advertising capabilities and new entrants to the market are paying up to establish a presence in this area. Recent deals in this space include Cox Enterprises' acquisition of Adify and .FOX Networks' acquisition of Utarget.
The Internet search arms race continues. Microsoft, Google, and Yahoo! continue to battle it out in search, which is a key to the online advertising kingdom. This will continue to drive deal activity. In Q2, Microsoft acquired Powerset (with limited revenues) for a rumored value in the range of $100 million. Although Yahoo! has been grabbing headlines largely due to its ongoing acquisition fight with Microsoft, it too has been making deals in Internet search acquiring Inquisitor for an undisclosed sum this quarter.
Social networking is maturing into mobile. Increasingly, users want to carry their social networks with them wherever they go. And as location information becomes standard in cell phones, the appeal of mobile social networking will only grow. Social networking deals announced in Q2 include Nokia's acquisition of Plazes and Radio One's acquisition of Community Connect.
Figure 12 Representative Internet M&A Transactions Q2 2008
UPDATA TRANSACTIONS: SECOND QUARTER 2008
REFERENCES
1. Updata's internal deals database is not all-inclusive as we track very specific subsets within the information technology sector.
2. Updata's enterprise application softwareindex is comprised of the following companies: ACTU, CHRD, COGN, DMAN, FIC, INFA, MSTR, OMTR, OTEX, PRO, SPSS, UNCA, ARTG, BVSN, CRM, CTCT, FPND, IMNY, KANA, RNOW, EMC, IWOV, OTEX, VIGN, BasWare, EPIC, INTU, LWSN, ORCL, PROJ, QADI, SAP, SBN, CALD, CNQR, KNXA, SABA, SFSF, SLRY, SUMT, TLEO, ULTI, WSTM, ADSK, ANSS, CIMT, DASTY, MSCS, PMTC, ARBA, AZPN, DSGX, GSOL, ITWO, JDAS, LGTY, KWL, TYL, BBBB, AMSWA, WBSN, VOCS, SGE-GB, DLC-GB, BLKB, HIRE, LPSM, LWSN, N, RHT, OMTR, TRAK, TZIX, CHINA, and MANH. Updata's Internet index is comprised of the following companies: GIGM, GOOG, IACI, ICGE, JUPM, KNOT, LNUX, NAPS, NTES, SNDA, SINA, SOHU, YHOO, IIG, MIVA, PUB, WSPI, AMZN, DSCM, EBAY, EXPE, FLWS, GSOL, LOOP, LQDT, OSTK, PCLN, SFLY, AKAM, CCOI, CMGI, DRIV, ELNK, GSIC, INAP, KEYN, RNWK, SNCR, UNTD, VRSN, MCHX, VCLK, ARTG, CRM, LPSN, RNOW, ULTI, VIGN, VOCS, ABTL, BIDU, INSP, LOCM, LOOK, MOVE, RATE, SOLD, and TZOO. Updata's infrastructure softwareindex is comprised of the following companies: CTXS, INFA, JAVA, MSFT, ORCL, PEGA, PRGS, RHT, TIBX, AVCT, BMC, CA, CPWR, HPQ, IBM, KEYN, NOVL, CVLT, DBTK, DDUP, EMC, FALC, ISLN, NTAP, RVBD, SOW-DE, IVF-FR, NTCT, NZ, OPNT, QSFT, VMW, and SYMC. Updata's security index is comprised of the following companies: Trend Micro, CHKP, CTXS, JNPR, MFE, MVSN, SYMC, VRSN, WBSN, F-Secure, ACTI, ALDN, BCSI, COGT, DMRC, ENTU, FIRE, HIFN, ID, INTZ, SCUR, SBSW, CIC-CA, CTCH, SNWL, TMWD, VDSI, and ZIXI. Updata's IT services index is comprised of the following companies: CRAI, DTPI, FCN, HURN, XPRT, MMC.GB, NCI, RECN, SAPE, AXO.GB, BE, CAP-FR, GIB, CBR, EDGW, ELOY, MPS, PRFT, ANLY, CDI, CFS, CTGX, CITP, KFRC, NTSC, RCMT, TSRI, CAI, DRCO, ICFI, MANT, MMS, SAI, SINT, SRX, ACN, ACS, CSC, IBM, NSTC, PER, UIS, TEAM, CTSH, HCLT, INFY, PTI, SAY, SYNT, VRTU, WIT, ADP, APAC, CVG, CSGS, EXLS, G, HSII, HEW, ICTG, IRM, PAYX, PSPT, SYKE, TTEC, SRT, ETEL, HCKT, TGIS, TMNG, WNS, and WW.
3. Updata defines the infrastructure software sector to include: network and systems management, IT asset management, storage software, networking software, application development tools, enterprise application integration, application infrastructure, and business process management.
5. Updata defines the enterprise application software sector to include: software-as-a-service (SaaS); business analytics; customer relationship management; enterprise content management; enterprise resource planning; human capital management; supply chain management; product lifecycle management; and vertical applications.
6. Updata defines the IT security sector to include: identity and access management, traffic security, content security, vulnerability, and managed security service providers.
7. Updata defines the IT services sector to include: IT outsourcing, business process outsourcing, offshore outsourcing, IT consulting, systems integration, IT staffing, network and systems infrastructure services, and government IT consulting and integration.
8. Deals have dropped off 24% in infrastructure software, 19% in IT services, 38% in enterprise application software, and 40% in security since Q1 2008.
9. Updata defines the Internet sector to include: search, digital media, e-commerce, online advertising, infrastructure, and applications.
