Software industry M&A update Grant Thornton Corporate Finance, Mergers and Acquisitions Summer 2011 U.S. M&A update Software industry M&A activity in the United States remained healthy in Q1 2011, with nearly 400 announced transactions. This followed a strong 2010 during which M&A activity rose 45%. Aggregate disclosed deal value climbed to $50 billion in 2010 from $20 billion in 2009, but it was still significantly lower than the $74 billion peak of 2007. Highlights Improving confi dence driving increased M&A activity Buyers targeting younger, fast-growing software companies Valuations on the rise, fueled by stronger earnings and IT spending Cash-rich strategic buyers looking to expand via acquisitions U.S. software M&A activity Number of deals 450 400 350 300 250 200 150 100 50 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2007 2008 2009 2010 2011 Grant Thornton Corporate Finance Mergers & Acquisitions Stephen McGee Practice Leader, Corporate Finance T 617.848.4988 E stephen.mcgee@us.gt.com Brian Lee Associate, Corporate Finance T 617.848.4967 E brian.lee@us.gt.com Grant Thornton Corporate Finance LLC 226 Causeway Street Boston, MA 02114 www.grantthornton.com Sources: GTCF research, certain financial information provided by Capital IQ, Inc.
Although the average disclosed deal size in 2010 was considerably smaller than that of 2007 ($34 million vs. $47 million), larger transactions have returned, in a clear sign of renewed confidence. The number of announced deals with transaction values greater than $500 million climbed to 19 in 2010 from nine in 2009; Q1 2011 saw another four such transactions. In fact, all of the four largest transactions in the first quarter of 2011 were valued at more than $1 billion. Microsoft s recently announced $8.5 billion purchase of Skype further illustrates the return of large transactions. With the strong rebound in software M&A activity in 2010 and improving market confidence at the beginning of 2011, transaction activity in the sector is expected to be robust for the remainder of the year. Software deals over $500M Number of deals >$500M transaction value 25 20 15 10 5 0 Number of deals >$500M transaction value Average deal value ($M) Sources: Company filings, certain financial information provided by Capital IQ, Inc. Software M&A buyer categories 2010 Public companies 46% Private equity 28% Private companies 26% Average deal value ($M) 2005 2006 2007 2008 2009 2010 Q1 2010 Q1 2011 $50 $40 $30 $20 $10 $0 Buyers and sellers Buyer composition within the software sector remained steady during 2010 with public companies and their subsidiaries accounting for approximately 46% of all transactions in 2010. Of the 15 most active acquirers, 11 were public companies, while the remaining four were venture capitalbacked. Interestingly, half of the top 10 buyers were Internet companies looking to purchase smaller startups or middle-market companies that offered innovative Internet solutions and services. Google, for example, topped the chart with 26 announced deals in 2010, many of which involved young Web companies that were focused on up-andcoming segments such as mobile and social media applications. Sources: GTCF research, certain financial information provided by Capital IQ, Inc. 2010 top software acquirers Google IBM HP EMC/VMware Automatic Data Processing Facebook Oracle Zynga AOL Salesforce.com Cisco Dell Groupon, Inc. Trilogy Software Yahoo 0 5 10 15 20 25 30 Number of deals announced Sources: Press releases, certain financial information provided by Capital IQ, Inc. 2 Software industry M&A update Summer 2011
Nearly 28% of software deals that took place in 2010 involved either private equity firms or private equity-backed buyers. According to PitchBook Data, Inc., private equity capital investments in the sector jumped from $1.7 billion in 2009 to $3 billion in 2010. Additionally, private equity firms focusing on IT have become increasingly interested in software companies; software deals rose from 55% of private equity IT transactions in 2006 to 67% in 2010. In recent years, buyers have shown a growing interest in younger startups with unique solutions that fill gaps or add to existing product offerings. Over the past five years, the percentage of software deals involving target companies that are less than five years old has increased markedly, from 14% in 2006 to 22% in 2010. Private equity IT transactions by category Software Hardware Services Communications and Semiconductors networking 100% 80% 60% 40% 20% 0% 2006 2007 2008 2009 2010 Source: PitchBook Data, Inc. Age of target companies in software transactions Under 5 years old 5 years or older Age unknown 100% 80% 60% 40% 20% 0% 2006 2007 2008 2009 2010 Sources: GTCF research, certain financial information provided by Capital IQ, Inc. Earnings and valuations The Grant Thornton Corporate Finance (GTCF) software index includes public software industry participants, broadly categorized as providers of vertical application software, general enterprise application software, infrastructure software, consumer applications, and Internet applications and services. The vertical software sector includes companies that provide applications used in specific industries (e.g. education, financial services and health care). The general enterprise software sector includes companies that provide applications for use across all industries for purposes such as enterprise resource planning (ERP), customer relationship management (CRM), and HR. The infrastructure software sector consists of companies that provide solutions for operating systems, networking and storage, along with information security applications. Public company software index valuation multiples by sector Median EV/revenue multiple 4.00x 3.50x 3.00x 2.50x 2.00x 1.50x 1.00x 0.50x 0.00x Vertical application software General enterprise application software Infrastructure software Consumer application software Internet 2006 2007 2008 2009 2010 2011 Sources: GTCF research, certain financial information provided by Capital IQ, Inc. 3.15x 2.81x 2.52x 1.97x In recent years, buyers have shown a growing interest in younger startups with unique solutions that fill gaps or add to existing product offerings. 1.24x 3 Software industry M&A update Summer 2011
The market value of the GTCF software index climbed by 23% in 2010, while the S&P 500 index posted a more modest rise of 13%. In Q1 2011, the software index continued to outperform, achieving a 7% increase in value compared with 5% growth in the S&P 500 index. The software industry as a whole traded at approximately 2.5x revenue. Each segment of the sector experienced Public company software index earnings by sector Cumulative LTM earnings growth index (EBITDA) 400% 350% 300% 250% 200% 150% 100% Vertical application software General enterprise application software Infrastructure software Consumer application software Internet 2006 2007 2008 2009 2010 2011 Sources: GTCF research, certain financial information provided by Capital IQ, Inc. SaaS vs. traditional growth in valuation multiples during the past 12 months, with multiples for general enterprise application software providers growing the most from 2.1x to 2.8x revenue as a result of higher enterprise IT spending. Internet companies traded at approximately 2.0x revenue supported by strong earnings in the past two years. Companies that use a software as a service (SaaS) revenue model generally trade at a premium when compared with companies using the traditional license and maintenance revenue model. SaaS multiples have increased considerably in the past six months, currently trading at approximately 5.5x revenue compared with 2.5x revenue for traditional software license companies. Investors have been attracted to the rapidly rising popularity of SaaS solutions and the consistent revenue streams generated by the subscription model. Although valuation multiples for SaaS providers have been growing quickly, pure-play SaaS companies are underrepresented in the GTCF software index, accounting for roughly 1% of its overall market value, and hence valuation for the index as a whole remains closer to 2.5x revenue. The market value of the GTCF software index climbed by 23% in 2010, while the S&P 500 index posted a more modest rise of 13%. Median EV/revenue multiple 6.00x 5.00x 4.00x 3.00x 2.00x 1.00x SaaS Traditional 0.00x 2009 2010 2011 Sources: Company filings, certain financial information provided by Capital IQ, Inc. 4 Software industry M&A update Summer 2011
Trends in 2011 M&A We expect software M&A activity to remain healthy for the remainder of 2011; strategic players hold record amounts of cash and have demonstrated a desire to deploy it via acquisitions. Sectors of particular interest will include mobile technology and e-commerce, while SaaS companies will generally continue to be in favor. Many software companies were able to stockpile a significant amount of cash during the downturn. At the end of 2010, cash accounted for 22% of total assets for companies in the GTCF software index, as compared with 7% of total assets for all U.S. companies. The top 10 technology companies added more than $26 billion in cash to their balance sheets in the past 12 months and currently hold a combined $227 billion in cash. As the economy continues to recover and IT spending increases, these companies will be eager to build market share, access new customers and acquire innovative technologies. With sizable war chests to fuel acquisitions, some of these corporate buyers have already shown a strong desire to put their capital to work. Oracle, Dell, IBM and HP each spent in excess of $1 billion on acquisitions in 2010, and during that period, HP alone made three purchases totaling more than $1 billion each. Google and IBM have historically used acquisitions to grow and add product offerings. Google started off 2011 at a blistering acquisition pace, buying 18 companies in the first four months of the year. IBM, on the other hand, despite having made only one announced acquisition in the first quarter of 2011, plans to spend $20 billion in M&A over the next five years. 5 Software industry M&A update Summer 2011 Cash and cash equivalents for top tech companies Number Company 1 Cisco 2 Microsoft 3 Google 4 Apple 5 Oracle 6 Dell 7 IBM 8 Intel 9 HP 10 ebay Total Cash 1 year ago ($B) $ 39.6 $ 33.2 $ 26.5 $ 23.2 $ 17.5 $ 11.0 $ 14.0 $ 16.3 $ 14.0 $ 4.9 $ 200.2 As of 3/31/2011 Sources: Company fi lings, certain fi nancial information provided by Capital IQ, Inc. Mobile applications With more than 5 billion worldwide subscribers buying record numbers of smartphones, the mobile application market is expected to triple to $15.1 billion in 2011, according to Gartner Research. The increasing popularity of smartphones coupled with improved mobile technology has introduced new markets ranging from mobile entertainment to mobile commerce. Numerous startup companies have emerged to serve the different segments within the burgeoning mobile sector. As this sector develops, companies from multiple IT disciplines will be looking to acquire additional capabilities in order to tap into it. For example, Facebook recently acquired Snaptu, a creator of mobile phone applications, to help the social networking company provide a better experience for its users. Current cash ($B) $ 40.2 $ 40.0 $ 36.7 $ 29.2 $ 24.4 $ 14.4 $ 13.2 $ 12.0 $ 9.9 $ 6.6 $ 226.6 1 year change ($B) $ 0.6 $ 6.8 $ 10.2 $ 6.1 $ 6.9 $ 3.4 $ -0.7 $ -4.4 $ -4.1 $ 1.7 $ 26.4 E-commerce In the evolving world of e-commerce, better payment technologies and sounder Internet monetization business models are helping companies drive sales and reach greater numbers of online customers in innovative ways. This promising business climate will continue to foster M&A activity as more and more companies from diverse markets seek to expand their e-commerce offerings. E-commerce in the entertainment segment has become an attractive area for larger players looking to generate additional revenue through social gaming. For instance, Electronic Arts acquired Playfish for approximately $390 million in 2009, while Walt Disney entered the social gaming space in 2010 with the $760 million purchase of Playdom. Websites that offer private sales to members or feature daily deals (e.g., Gilt Groupe, Groupon) have become the newest way to engage consumers online. Other Internet companies as well as traditional brick-and-mortar retailers have been interested and will continue to be interested in building or strengthening their presence in the online marketplace. Nordstrom s recent $180 million purchase of Hautelook, a members-only fashion deal website, is a prime example of how larger retailers are adapting to the changing ways in which consumers shop online.
SaaS With the SaaS market expected to grow by 16.2% to $10.7 billion during 2011, and with businesses migrating to cloud-based services, many vendors are beginning to offer a choice between cloud- and application-based solutions. 1 SaaS capabilities will likely be of interest to traditional on-premise software providers that want to meet increasing consumer demand for lower-cost subscription solutions. Meeting that demand will help these providers solidify their presence in the rapidly expanding SaaS market. Lawson Software is one example of such a company. Despite previous resistance to the SaaS model by its CEO, Lawson (which is being acquired by Infor) was one of the first major on-premise software companies to enter the SaaS market. Lawson did so by purchasing Enwisen, a provider of on-demand workforce communications solutions, at the end of 2010. Conclusion Software M&A activity remained healthy in Q1 2011 as large deals made a comeback and market confidence continued to grow. Public companies accounted for nearly 50% of all transaction activity, while private equity investors comprised roughly 28%. Given the considerable interest being shown by various types of buyers, sellers will likely benefit from increased competition for acquisitions. In order to expand their range of offerings, buyers are seeking out larger numbers of young software companies that sell proven products. Young businesses that can demonstrate strong market adoption of unique solutions are attractive targets for larger players looking for innovation. Software valuations have risen significantly during the past 12 months, with the industry as a whole trading at approximately 2.5x revenue. Valuation metrics will likely continue to be robust in 2011 as a result of improved earnings. Companies that use a SaaS revenue model are commanding multiples that are more than double those received by traditional on-premise software companies (5.5x revenue vs. 2.5x revenue). Strategic buyers are flush with cash and have already demonstrated an appetite to put their capital to work. The mobile, e-commerce and SaaS sectors in particular are expected to generate sustained interest among strategic buyers. Growing market confidence, strong valuation multiples and large cash reserves will contribute to a robust software M&A market for the remainder of 2011. Software M&A activity remained healthy in Q1 2011 as large deals made a comeback and market confidence continued to grow. 1 Gartner: SaaS sales will grow 16.2% to $10.7bn in 2011. ComputerWeekly.com 14 Dec. 2010. 24 May 2011. 6 Software industry M&A update Summer 2011
HR software subsector focus The HR software subsector offers enterprise applications ranging from payroll processing and time management to succession planning and performance management. The HR software industry experienced a significant increase in M&A activity during the past year. Transaction volume rose more than 60% as strategic players returned to the market, seeking to deploy capital through acquisitions. Financial buyers were also active in the sector through both platform and add-on investments, accounting for nearly 50% of all transactions in 2010. M&A activity in this subsector remained strong in Q1 2011 and was roughly in line with that recorded in Q1 2010. This activity U.S. HR software M&A activity 50 40 30 20 10 0 Strategic Financial Number of transactions 7 Software industry M&A update Summer 2011 is likely to continue as HR software vendors, particularly providers of talent management (TM) applications, strive to offer a broader set of solutions covering the entire talent life cycle. Valuations Transactions within the HR software industry had a median disclosed valuation multiple of 1.7x revenue. (Deal multiples vary based on company-specific factors relating to product offerings, technology and expertise; contracts and customers; and growth opportunities.) Taleo s acquisition of Learn.com for 5.2x revenue in September 2010, illustrates a buyer s willingness to pay a premium for a target 2005 2006 2007 2008 2009 2010 Q1 2010 Q1 2011 Sources: GTCF research, press releases and certain financial information provided by Capital IQ, Inc. Top buyers among HR software companies, 2006 Q1 2011 Category TM/HRMS TM TM TM TM/HRMS TM Company Kronos Incorporated Kenexa Corp. Salary.com Taleo Corp. Automatic Data Processing, Inc. SuccessFactors, Inc. Sources: Press releases, certain fi nancial information provided by Capital IQ, Inc. # of Deals 10 9 8 8 5 4 with a strong strategic fit. Learn.com not only expanded Taleo s market in the TM space, but also offered solutions that complemented Taleo s suite of existing products. Generally, buyers will pay a higher price for proprietary solutions, recurring revenue streams, consistent customer retention ratios (particularly in the case of SaaS providers), and leveragability and scalability. Buyers Buyers in the HR software industry tend to come from one of two segments: TM software or HR management systems (HRMS) applications. The TM software industry encompassing performance management, learning, compensation and recruitment applications is experiencing significant demand from customers for a vendor that offers a complete set of solutions. Instead of having to mix and match products from multiple providers, HR professionals would prefer to work with a single vendor that produces cost-effective, integrated solutions that are usable throughout the employment life cycle. M&A activity in the TM segment has reflected this demand as companies have rushed to provide a greater breadth of functionality. Consequently, TM companies have been the most active buyers in the HR software space for the past five years. HRMS providers which offer benefits, payroll and personnel administration solutions operate in a relatively mature segment of HR software. The products sold by HRMS providers are usually found within ERP suites. M&A activity in the HRMS space has focused on building market share, acquiring customers and adding product offerings. HRMS vendors with SaaS capabilities have become attractive targets, accounting for nearly 30% of transactions in the HR software sector during the past 12 months.
TM areas to watch TM will be a driving force in HR software M&A activity. Many TM vendors still have holes to fill in their product offerings, predominantly in three areas: recruiting, workforce planning, and learning management systems (LMS). These vendors are likely to be interested in developing these capabilities in-house (which can be time-consuming) or, alternatively, obtaining capabilities via acquisitions (which is usually a far quicker process). Recent M&A activity has shown that a number of these vendors prefer to expand their offerings quickly through acquisitions as opposed to risking being late to market by developing the functionality in-house. During 2010, Taleo acquired Learn.com to add LMS capabilities to its suite of TM solutions. In response, SuccessFactors purchased Plateau Systems in April 2011, quickly gaining a large stake in the LMS market as a result. Most TM vendors are lacking in workforce planning and analytics capabilities. With business executives and HR leaders turning to software to help guide strategic planning and TM activities, providing this functionality has become increasingly important for TM players. SuccessFactors was one of the first major TM vendors to add workforce planning to its product suite through its acquisition of Inform in 2010. Taleo has also complemented its TM solutions through its partnership with Aruspex, which offers workforce planning products. In April 2011, Peopleclick Authoria emulated its competitors by purchasing Aquire Inc., a leader in workforce planning and analytics solutions. Subsector summary The HR subsector is continuing its consolidation; financial buyers accounted for 50% of all transactions in the space during 2010. HR software companies typically change hands at a median disclosed transaction multiple of 1.7x revenue, but targets demonstrating a strong strategic fit for the buyer can warrant a premium. Acquisition targets offering SaaS solutions with strong renewal rates can attain higher multiples, often in excess of 3.0x revenue. TM companies have been the most active buyers, expanding their product offerings through acquisitions. Vendors with a complete and integrated TM product suite are better-suited to increase their market share in the HR segment because customers prefer to work with fewer vendors. The majority of TM vendors hope to add workforce planning and analytics solutions to their product offerings. Given that rising numbers of HR executives are in search of business metrics to help organizations make strategic decisions, sustained buyer interest in the workforce planning segment is expected. With M&A activity at healthy levels and many HR software companies wanting to build out their product offerings through acquisitions, business owners looking to exit are well-positioned to benefit from current market conditions. About Grant Thornton Corporate Finance Grant Thornton Corporate Finance provides boutique investment banking services to privately held middle-market businesses in the United States and around the world. As a recognized advisor on middle-market mergers and acquisitions, we offer a range of investment banking services including sell-side advisory, buy-side advisory, management buyouts, restructurings and capital raising. Grant Thornton LLP provides investment banking services through its wholly owned broker-dealer subsidiary, Grant Thornton Corporate Finance LLC, member FINRA, SIPC. About Grant Thornton LLP The people in the independent fi rms of Grant Thornton International Ltd provide personalized attention and the highest-quality service to public and private clients in more than 100 countries. Grant Thornton LLP is the U.S. member fi rm of Grant Thornton International Ltd, one of the six global audit, tax and advisory organizations. Grant Thornton International Ltd and its member fi rms are not a worldwide partnership, as each member fi rm is a separate and distinct legal entity. The factual statements, including data from third-party sources, contained herein are taken from sources believed to be reliable, but such statements are made without any representation as to accuracy or completeness or otherwise. Grant Thornton Corporate Finance LLC does not engage in the business of recommending or effecting transactions in securities. The above information is presented solely in connection with describing Grant Thornton Corporate Finance LLC s mergers and acquisitions services and should not be considered as constituting a research report or as providing information reasonably suffi cient upon which to base an investment decision. www.grantthornton.com 2011 Grant Thornton LLP All rights reserved U.S. member fi rm of Grant Thornton International Ltd 8 Software industry M&A update Summer 2011