Tech Banker

THE STRATEGIC GUIDE TO SELLING YOUR SOFTWARE COMPANY

Brad Feld alerted me recently to a newly published book by William H. Venema, entitled Top Secret:  The Strategic Guide to Selling Your Software Company, Essential Advise from a Veteran Deal Warrior.  Mr. Venema is an attorney who has represented a number of software company executives with the sale of their businesses.

I applaud Mr. Venema for the effort and feel the book gives a good overview of the types of processes and issues that executives and boards need to navigate when selling a business.  What this book fails to do, and to be fair, no book would accomplish, is to equip the constituents involved with a sale of a company with the depth of knowledge and judgment that only comes with years or decades of transaction experience.  Mr. Venema, does make this point but it’s worth reiterating; sellers should surround themselves with deeply experience advisors including accountants, lawyers and in many cases investment bankers.

While its detailed military analogies fail to deliver better understanding and are a distraction, I recommend this book to any technology entrepreneur who is seeking a sense of the M&A process.  The issues around intellectual property and where value lies (or not) are just as relevant to any technology company not just software vendors.

Corporate Governance

My father, Ralph Risley, was an executive at General Electric in the 1960's and 1970's then was recruited to several successful start up (in one case going public) enterprises in the energy industry during and following the first "energy crisis" in the mid-late 1970's.  Over the past couple of years he has become engaged with the topic of corporate governance.  He provides the following thoughts:

The business models of start up companies focus on product, markets, distribution, financing and technology development. Insufficient attention is placed on those governance and ethical oversight issues which will become critical as a company grows, especially when a public offering is considered.

Early stage Boards of Directors have a much narrower interest spectrum than those of public companies where the shareholder base is more diverse, less knowledgeable of industry specifics and expectant of candid disclosure.

When early stage investors and venture capitalists use the term "Adult Supervision" I doubt that they are referring to governance at the Board level but rather they are injecting the lixor of experience and insight on operational and budgeting elements.

Regardless of the success of the business, initial investors will eventually seek liquidity. Without strong independent Board oversight an undesirable company culture can root itself so deeply that removal may be next to impossible.

IBM / FileNet Update

John Newton has some insight into the consolidation within the content management sector.  A bit of wild speculation by Seth Gotlieb, a content managment consultant and another take on the deal and the sector by IT Analysis.

Actions Speak Louder Than Words

Fred Wilson, of Union Square Ventures and A VC fame, posted a good reminder for all today.  Watch how a person acts, not what they say for true insight.  Fred, thanks for refreshing us on that valuable lesson.

Macrovision Convertible Financing -- The Trend Continues

Macrovision is leaping aboard the trend that we have highlighted several times in the past few months -- debt is playing an increasing role in software company capitalization.

Macrovision announced the offering of $175mm of convertible notes today.  Of particular note is that they are also entering into a call spread arrangement (which we highlighted in detail in a previous post on Symantec's recent financing) and using a portion of the proceeds ($50mm) to repurchase common stock.  Just like Symantec and CA, they are doing a leveraged recapitalization.  Instead of turning to the straight debt markets, such as high yield or bank, they have chosen to use a convertible bond as the funding vehicle.  Why?  Lowest cost and execution risk.

CA and Leverage

Today CA announced earnings, a material restructuring intended to reduce ongoing expense levels and the expected initiation of their previously announced $2 billion stock repurchase program.

CA's Capital Structure Philosophy

CA has historically been the most aggressive user of debt within the software sector as a mechanism to finance its business.  While the management team has seen much change in the past five years, the aggressive use of debt remains firmly in place.  As we have seen with the recent Veritas financing as well as the financing of the Secure Computing acquisition of CipherTrust, debt has found its way into the mainstream of the software industry.

CA intends us the Microsoft technique and initiate a tender offer to repurchase $1 billion of its common stock.  The Company expects to financing between 50% -75% of the purchase price with a bank facility and the balance with cash from the balance sheet.  The net effect is that leverage ratio's will rise to the highest levels of the past several years.  Today CA's debt / common stockholder equity ratio is 40%.  Following the buyback that ratio will rise to between 57% - 67%, well above CA's previous debt levels.

Convertible Preferred Stock

I ran across a terrific summary of preferred stock structures for private companies this morning published by Alexander Muse.  It's a good primer on the subject.

Advice on Software M&A

Perhaps a worthy read.  Brad Feld reviewed a book entitled "The Strategic Guide to Selling Your Software Company" by Bill Venema.  I'll share my personal thoughts when I get a chance to review the book myself.

IBM / FileNet Update

NY Times DealBook published a short piece on Friday speculating that another bidder may be lurking in the shadows for FileNet.  We place the probability as quite low. 

We believe that FileNet has been receptive to a sale for quite some time and it's been very well shopped informally.  I'm also certain that alternative logical buyers were approached as part of the recent transaction process.  This is wishful thinking on the part of investors who are reacting to the 1% stock price premium offered by IBM.  What they are forgetting is that the stock has moved upward 27% in the past month or so on acquisition rumors.  See our recent assessment of the transaction.

Transaction Alert: IBM Buys FileNet

Well, IBM is getting aggressive.  In it's second large acquisition in a week, IBM announced that it is purchasing FileNet for $1.6 billion.  This comes on the heels of another recent acquisition in the enterprise content management sector, the purchase of Hummingbird by Open Text for roughly $500mm. 

Transaction Terms

Purchase Price:                                                                        $35.00/share

Premium to Pre-Announcement Price:                                        1%

Enterprise Value:                                                                      $1.2 billion

Enterprise Value / 2006E Revenues:                                           2.5x

Price / 2006E EPS:                                                                    30x

Target:  FileNet

FileNet is an enterprise content management platform vendor.  In other words, customers use FileNet's suite of products to build content management applications suited to their own needs. 
Web pages, word processing documents, spreadsheets, HTML, XML, PDF, email messages and other digital content are all examples of the types of content that FileNet is capable of cataloging, organizing and making available as needed.

FileNet has been in a bit of the doldrums over the last several years, with stock performance being essentially flat since the beginning of 1994 and revenue growth sub-10% annually.  While net income has increased nicely over the past several years, operating margins remain rather lackluster at 10% over the past 12 months.  Many believe that FileNet, as an independent entity, was not particularly well positioned with tough competition on the high end from EMC/Documentum and Microsoft showing early success at the low-end with Sharepoint.

Strategic Rationale

IBM, showing a bit of a "me too" mindset with EMC, is justifying this transaction under its "Information on Demand" initiative.  No doubt, managing information assets within an enterprise is a challenging and high value effort which equals expensive projects with lots of services work to make right.  Perfect for IBM's capabilities and strategy.

Architect Partners Assessment

IBM has shown it's smarts again with this acquisition.  FileNet's products fit well within IBM's overall product set, albeit with some overlap, and importantly to IBM's strategy, FileNet products drive considerable service revenue as well.  Although as we mention above, FileNet's software should be considered a platform, it does continue to move IBM up closer to the application category and as we speculated in our post on IBM's acquisition of MRO Software, we believe this add further validity to the notion that IBM's strategy around owning applications has shifted.  Time will tell if our premise holds true.

One interesting dynamic worth mentioning is the lack of premium offered.  Historically, on average, public company control premia have been on the order of 35%-40%.  Clearly a 1% premium to pre-announcement stock price doesn't incent shareholders to act.  The markets immediate reaction was to bid the price above the offer price by IBM, believing an alternative suitor will emerge.  While it's possible, we believe that all logical purchasers had more than adequate time to consider this purchase and have likely chosen to pass on the opportunity.  One also need to consider that FileNet's stock price rose over 27% in the preceding month or so, suggesting takeover rumors were rampant.  We bet that shareholders will be disappointed when other bidders fail to emerge.  We'll be watching closely.