Betting Big on the Cloud
Mergers & Acquisitions
Cloud computing has revolutionized information technology (IT). The technique leverages a network of remote servers hosted on the Internet to store, manage, and process data, rather than a local server or a personal computer. By enabling on-demand delivery of IT resources and applications via the Internet with pay-as-you-go pricing, cloud computing has paved the way for a slew of efficient, inexpensive services. You couldn’t ask for a technology more tailor-made for private equity investors, whose appetite for efficient, cost-effective strategies is legendary.
Witness Thoma Bravo’s commitment to the cloud. The venerated 35-year-old technology-focused private equity firm based in Chicago and San Francisco, has backed 25-plus companies that leverage the cloud, including TravelClick, which it bought in May, as well as Sailpoint, GHX, Vision Solutions and Hyland Software. In May, the firm raised a $3.65 billion fund, its biggest to date.
“The cloud has been talked about for years as something that would happen in the future,” explains managing partner Orlando Bravo (pictured). “The future is here, and the trend toward the cloud is irreversible. There’s no more debate about it anymore. The cloud is the preferred model of consumption. There are three reasons for its popularity: First, it is feasible, given developments in communication and data infrastructure. Second, it’s a more efficient way to engineer and deliver software, since it allows customers to use the latest software releases all the time, taking away the need for multiple versions of software to be supported. Third, when you adopt the cloud model, you are tapping into customers operating budgets that are much larger than capital expenditure budgets.”
Migrating to the Cloud
With most companies now looking to transition at least some of their services to the Web, strategic acquirers and private equity firms want in on the action. As strategic acquirers look to migrate to the cloud, they are gobbling up companies that can help them make the transition.
Subscriptions of Adobe Systems Inc.’s (Nasdaq: ADBE) Creative Cloud suite fueled revenue, enabling the software company to close the $800 million purchase of stock-photography provider Fotolia LLC in January. Other tech giants to buy cloud companies include: Amazon.com Inc. (Nasdaq: AMZN), Cicso Systems, Inc., Citrix Systems (Nasdaq: CTXS), Google (Nasdaq: GOOGL), Hewlett-Packard (NYSE: HPQ), IBM (NYSE: IBM), Oracle Corp. (NYSE: ORCL), SAP SE (NYSE: SAP) and VMware (NYSE: VMW).
For private equity investors, the software industry’s high growth, recurring revenues and strong profit margins – which can be as high as 50 percent, according to Bravo – are the appeal.
Broadly speaking, the numbers show technology, media and telecom (TMT) M&A deals have been increasing since 2010. Cloud computing is one of the sectors fueling tech M&A.
Global TMT deal volume hit $293 billion in 2014, according Pitchbook Data. That’s up from $95 billion in 2010. Additionally, dealmakers are even more bullish on TMT in 2015. Transaction professionals expect middle-market M&A in the TMT sector to continue expanding, according to Mergers & Acquisitions’ Mid-Market Pulse (MMP), a forward-looking sentiment indicator derived from monthly surveys of approximately 250 executives and published in partnership with McGladrey LLP.
“We saw a tremendous pick up in M&A volume in the software sector in 2014. It was up 30 percent at our firm,” says Terry Schallich (pictured), co-head of investment banking with technology investment banking firm Pacific Crest Securities. “Last year, 75 percent of our deals were software deals and the majority of those were cloud applications or infrastructure deals.”
Global cloud computing in M&A deal flow has increased tremendously quarter over quarter as well. In 2014, deal volume for cloud computing companies hit $20 billion, according to Pitchbook Data. There were 260 deals reported. That’s up from just 31 cloud computing deals with deal volume of $7 billion in 2010.
While both strategic buyers and private equity firms have what seems like an insatiable appetite for cloud companies, strategic buyers have taken the lead as they strive to make the transition from using legacy, on-premise systems to cloud-based applications.
“The strategics are very active right now. We are approached all the time by strategics looking to buy numerous portfolio companies of ours,” says Richard Lawson, a managing partner with Palo Alto, California-based private equity firm HGGC. “It’s a ground war and they are in good position with cash on the balance sheets to make purchases. We will see quite an interesting two or three quarters coming up.”
SAP’s December 2014 acquisition of Concur Technologies Inc. is a perfect example of the type of deals strategic acquirers are interested in completing these days. Concur was a leader in the multi-billion dollar market for travel and expense management solutions. Concur’s software can book flights and submit or approve expenses on the Internet or on mobile devices. Its clients include corporations such as Google, Kellogg Co., Hess Corp. and Elizabeth Arden Inc. With the acquisition of Concur, SAP advanced its business network strategy by delivering a cloud-based model for managing business resources, processes and spend. SAP paid $8.3 billion for the company.
“Companies like Concur get a lot of attention and they command the largest multiples in M&A. Acquirers are drawn to companies like Concur, which have subscription-based models, reoccurring revenue streams, and highly scalable technology. Concur was a leader in its sector and commanded over 10 times revenue sale multiple,” says Tyler Dewing (pictured, left), a director with Harris Williams & Co.
SAP is not alone in its quest of owning cloud companies. Oracle acquired three cloud companies in 2014, Corente, GreenBytes and Front Porch Digital as did Google, which added Firebase, Stackdriver and Zync to its cloud platform in 2014.
With Amazon Web Services, Amazon has emerged as the leader in the space and relies less heavily on an M&A strategy.
“Amazon hasn’t acquired many companies to date, because they have a cultural bias toward building internally and don’t have the legacy issues that many of the older vendors have. We are witnessing a major battle for the cloud between established vendors and new entrants. Legacy vendors see Amazon’s success and will likely have to restructure internally and acquire certain technologies to catch up, but there is no clear winner yet in the cloud game,” says Michael O’Hare (pictured, right), a managing director with Pacific Crest Securities.
The strong interest from strategic buyers is certainly fueling private equity firms of all sizes to show interest in owing cloud-centric companies. Devin Mathews’ new middle market private equity firm ParkerGale Capital was founded to make investments in the sector.
“If you invest in tech, you can’t avoid the cloud. All software is moving there, because there are great growth prospects, and the industry is in transition. One of our core investment theses at ParkerGale is to participate in the transition that is taking place in the cloud sector,” says Mathews.
ParkerGale joins many private equity firms that have already been living and breathing the space for quite some time. Thoma Bravo, HGGC and Vista Equity are a few of private equity firms that have had a head start and have become known to seek out cloud companies.
Many of Thoma Bravo’s deals in the cloud space are around buying companies that need help transitioning to the cloud. Once the transition is made, Thoma Bravo is able to sell the companies to strategic buyers at a premium. For example, in December, Thoma Bravo took Detroit-based Compuware Corp. private in a $2.5 billion transaction – Thoma Bravo’s largest acquisition in at least a decade. Thoma Bravo is working to carve out Compuware’s older mainframe software and services segment and its growing cloud business that is now called Dynatrace. While the company enjoys 75 percent profit margins from its mainframes segment, those revenues are projected to shrink 5 percent to 7 percent a year as fewer businesses use mainframe computers, according to the Detroit Free Press.
“We are especially positioned to execute with Compuware. They are a leader in the mainframe business, and we have lots of expertise to help them with Dynatrace, the application performance business. We needed to separate the two companies and Dyntrace is instrumental to the cloud. We specialize in this space,” says Bravo.
While Thoma Bravo is just getting started with Compuware, the firm has had a knack for buying companies, getting them cloud-ready and selling them to strategic buyers at a good price. Thoma Bravo scored one such sale when Belden Inc. agreed in December to buy cybersecurity software developer Tripwire Inc. for $710 million.
HGGC has also been quite active in the sector. In April 2014, HGGC acquired AutoAlert. The Irvine, California-based company, founded in 2002, provides cloud-based leads to auto retailers. The software maker has more than 2,700 car dealerships using its software. Then in March 2014, HGGC inked a deal to acquire San Francisco-based software maker, Serena Software from private equity company Silver Lake. Terms of the deal were not disclosed. Serena makes products to help businesses handle their software services.
Lawson expects his firm and the industry to be just as active in 2015 as they were in 2014. “In 2015 you have a confluence of events. The strategic universe has cash on the balance sheet and the private equity firms have raised more money which suggests to me that you will see a tremendous amount of capital going into the sector,” he says.
“The idea here is to upend the incumbents. The winners will be the companies that can create a hybrid strategy. Not every firm wants to move everything to the cloud,” he adds.
Vista Equity Partners’ $4.3 billion take private-deal for data management and analytics software maker Tibco Software Inc., ranked as one of the largest private equity transactions of 2014.
Additionally, there are a slew of smaller deals taking place in the sector every day. In January, Veronis Suhler Stevenson (VSS) completed the sale of health care information technology portfolio company Strata Decision Technology to Roper Industries (NYSE:ROP), a diversified technology company. Financial terms of the transaction were not disclosed.
Founded in 1996, Strata provides a cloud-based, financial analytics and performance platform for financial planning, decision support, and continuous cost improvement to more than 1,000 hospitals and some of the largest health care delivery systems in the U.S. Under VSS’s leadership Strata recruited a stable CEO and CFO, commercialized support tools, expanded sales and service teams, and significantly increased the product offering.
“It’s interesting to see traditional economy companies buying cloud solutions to differentiate their offerings and create deeper customer relationships, but it’s where the industry is headed so it’s not really a surprise,” says Dewing.
With this sentiment in mind, in May, Thoma Bravo completed its $930 million acquisition of TravelClick, a provider of cloud-based revenue-generating solutions for the $500 billion global hospitality industry.
The New York-based company provides cloud-based services for hotels around the globe that aim to increase revenue, reduce cost, improve performance and create a strong brand. TravelClick’s suite of products and services includes reservation solutions, business intelligence solutions, media solutions, web solutions and guest management solutions.
Despite all the excitement around the industry, there are challenges that lie ahead for investors. The main challenge: finding the right path to profitability.
“Everyone is jumping on the bandwagon. When revenue starts to slow down there will likely be a shakeout in the industry. The winners will be the firms that have figured out a path to profitability,” says Bravo.
The other main challenge companies face is that simply getting up and running on the cloud is a challenge. That can hurt investments, as progress can be stalled. “Wall Street doesn’t appreciate the process. It can be painful and long,” says Bravo.
Still, the future looks bright for the industry, especially for those who are already entrenched in it. “Private equity firms will also continue to play an important role as they buy cloud companies, consolidate them and sell them to the larger strategic buyers,” says Harris Williams’ Dewing.
As key strategics continue to shift their software solutions to the cloud, acquisitions will continue to play a critical role in helping them to make quick progress, he says, adding, “There will be a lot of good opportunities in 2015.”
As more companies consider migrating to the cloud, security concerns have been thrust into the spotlight. Data breaches, data loss and account hijacking – Sony Corp. (NYSE: SNE) serving as an example – are among the issues that scare companies from moving to a cloud-based solution. A report featured in online tech magazine eWeek found that numerous businesses are taking advantage of the power of the cloud, with 74 percent of companies expecting to adopt cloud services in 2015, according to a survey. The report points out that 73 percent of respondents named security concerns as their top challenge when it comes to adopting the cloud.
“Interest in cloud computing has had, and will continue to have, huge implications on information security. When you expose your data outside the firewall you have to know who the bad guys are and how to keep them out,” says Orlando Bravo, a managing partner with private equity firm Thoma Bravo. “Secure access is a problem and we are trying to solve it.”
Identifying the need for more security on the cloud, Thoma Bravo invested early on in the subsector and has been able to realize returns in the space already. In January, the firm completed the sale of Tripwire, a leader in advanced threat, security and compliance solutions, to Belden Inc. in a $710 million all-cash deal. Thoma Bravo acquired Tripwire in May 2011. During Thoma Bravo’s ownership, Tripwire grew revenues 70 percent and improved profitability by 400 percent.
In 2009, Thoma Bravo bought Entrust, which helps secure the most common digital identity and information protection pain points in an organization, including SSL, authentication, fraud detection, shared data protection and email security. In 2013, Entrust was sold to Datacard Group, a privately owned, global issuer of secure credit and financial cards, passports, national IDs, employee badges, mobile payment applications and other credentials on behalf of financial institutions, government agencies and other enterprises.
In addition to private equity firms gobbling up security companies, strategic acquirers have also been very busy buying security companies. In 2014, Cisco Systems, Inc. (Nasdaq: CSCO) picked up New York-based ThreatGrid, a company that offers malware analysis and threat intelligence technology. The deal allows Cisco to provide cloud-based technology that combines malware analysis with analytics and actionable indicators to enable security teams to proactively defend against and to quickly respond to advanced cyber-attacks and malware outbreaks. Terms of the deal were not disclosed.
In another deal completed by a strategic, in May 2014, French tech giant Athos acquired Bull Group for $847 million in an effort to become a leader in the cloud, big data and cybersecurity market while in August 2014, Armonk, New York-based IBM (NYSE: IBM) bought Lincoln, Rhode Island-based Lighthouse Security Group, a cloud security system, in an effort to make its customers feel safe storing data in the cloud.
“M&A in the security space will be busier than ever as the industry matures,” says Bravo. “This is really just the beginning of the security deals. Everyone wants to make sure their data is safe on the cloud.”