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TR on Critics

"It's not the critic who counts. It's not the man who points out where the grown man stumbles, or how the doer of deeds could have done them better. The credit belongs to the man who actually is in the arena, who strives violently, who errs and comes up short and again, who knows the great enthusiasms, the great devotions, and spends himself in a worthy cause, who if he wins knows the triumph of high achievement; but who if he fails, fails while daring greatly, so his place will never be with those cold and timid souls who neither victory or defeat"

Theodore Roosevelt

The Art of Insult

It has often been said that Britain and the United States are two great nations separated by a common language. Yet us Yanks have always been a bit envious of our British cousin's ability to turn a phrase. The art of the British political insult, however, appears to have fallen into mediocrity as described in this wonderful article from today's Times Online. As we suffer through the never-ending 2008 presidential race the injection of a few political insults British style might make the process at least somewhat enjoyable. A snippet from the piece includes

"One of the more depressing aspects of political discourse in Britain over the past decade is the lack of memorable insults. The late Robin Cook was the last politician willing and able to dish out really inventive invective, and even he was mild compared with his more malicious predecessors.

In ten years Tony Blair has not delivered a single one-line public insult worth remembering. Even the insults aimed at Mr Blair seem pallid. Thatcher's reign left her festooned with nasty labels: Rhoda the Rhino, Attila the Hen, Virago Intacta, Petain in Petticoats and La Pasionara of Privilege. Poodle Blair just doesn't have the same bite."

I encourage you to read the whole piece which can be found here. Another good diversion of your time on a Summer Friday afternoon would be to check out the Elizabethan Insult Kit referenced in the article here.

Turnarounds the Marc Andreessen Way

Over the past 25 years I have been involved or led about 25 major turnarounds, restructurings, acquisitions, and divestitures. I think that I have developed a pretty good approach to turnarounds that I learned while I worked at Sterling Software. Marc Andreessen, one of the co-founders of Netscape and who is now the chai9rman of Opsware and a co-founder at the new social network Ning has published perhaps one of the best blogs that summarizes what it really takes to turnaround a struggling technology company. My past experience, both the successes and failures, line up extremely well with Marc's guidance. To read the full blog post click here. You can check out Marc's entire blog Pmarca here. The following are a few snippets worth reading.

"Step 3: Identify the 3-5 things that are working surprisingly well in your business, and double down on those. Any big company, no matter how moribund and poorly run, has a number of products and projects that are going better than expected -- and usually come as a complete surprise. Drawing on Peter Drucker's classic admonition to "focus on opportunities, not problems", figure out what these surprise successes are and double down on them. Promote their general managers, elevate their business units in the organization, give them more funding, and get out of the way."

"Step 5: Lay off a third of the workforce. Here's why:

History shows that you're going to have to ultimately do it anyway, either via death of a thousand cuts (or six to eight distinct rounds of layoffs), or all at once. So do it all at once.

A company that requires a turnaround has, in all likelihood, hired too many people for the size of the business opportunity it actually has. This impairs profitability, driving away investors and submerging the stock price at precisely the time the company needs a healthy acquisition currency; this demotivates your great people by surrounding them by too many mediocre people and too much bureaucracy; and this slows everything in your company to a crawl because there are simply too many people running around who have to talk about everything before anything gets done.

Grit your teeth, offer the most generous severance and assistance packages you possibly can, and get it done. Your ability to continue to employ the other two-thirds of your people is at stake."

Let Them Eat Cake . . .

A further evolution of the private equity inspired dividend recapitalizations is the practice of paying management and investors a large dividend with borrowed money prior to the IPO of a firm. As the Kate Kelly recently noted in the Wall Street Journal's Executives Hedge Their Own IPOs (subscription required):

"This upfront payment allows the company's owners an early opportunity to parlay their equity stakes into cash. If their company's stock falls after the public offering, they already have benefited from some of their holdings, potentially mitigating their losses. Often, top executives in companies are prohibited from selling for a certain period after a public offering. So, an early dividend frees up some money beforehand -- a bit like getting a bonus before the year starts, reducing the risk of a lower bonus if your performance tanks"

The infamous Going Private coined the phrase 'LIPO' or Leveraged IPO last year to describe this phenomenon and it's corollary LIPO Suction to "describe that great sucking sound you hear when the market tanks your LIPO". Check out Going Private's excellent summary of LIPO related transactions (Burger King, Sealy, Neiman Marcus) as well as industry debates on the topic here.

Jumping The Shark . . .

In TV-land there is a famous saying about when a series finally crosses the credulity barrier and becomes basically unwatchable. The saying 'jumping the shark' comes from a famous Happy Days episode where Fonzy jumps over a shark on water skis. Once that point has been crossed the show begins an inevitable decline into total oblivion and irrelevance.

A few weeks ago there way a potential 'shark-jumping' moment in the frenzied 'go private' world. In mid-April there was a surprising announcement from Dow Chemical – they had decided to abruptly fire two senior executives for supposedly holding un-approved acquisition talks with a number of private investors. The Wall Street Journal did some excellent reporting on this story (subscription required):

"The tip came from a phone call. Dow Chemical Co. Chairman and Chief Executive Andrew Liveris was surprised to hear what the caller, someone he trusted implicitly, had to report. Two Dow veterans -- one a board member (J. Pedro Reinhard) and the other a top executive (Romeo Kreinberg) -- had been talking to investors from Oman about purchasing the 110-year-old company and taking it private in a leveraged buyout, according to a person with knowledge of the call. There was one big problem: The company's board hadn't authorized any such discussions, Dow says. . . . . Behind the scenes and unbeknownst to Mr. Liveris, however, Messrs. Reinhard and Kreinberg had been trying to arrange an acquisition of the company, said Chris Huntley, a Dow spokesman. The buyout discussions occurred in "multiple meetings in multiple months in multiple locations," and "with a number of different parties," including more than one investment bank, Mr. Huntley said"

The article goes on to state the Messrs. Reinhard and Kreinberg had both been passed over in recent years for the CEO slot at Dow Chemical after former Dow CEO William Stavropoulos retired. It is important to note that both Reinhard and Kreinberg vehemently deny the charges levied against them and they have retained top notch legal counsel to represent their interests in this unfolding drama.

So the worst case scenario in this saga is this: two unhappy senior executives who were unable to win the top spot in their business went out of their way to work with various private investors on an unauthorized basis to spin up a leveraged buyout transaction whereby they could gain control of their company and receive their just rewards. What is perhaps most amazing is that this allegedly went on for an extended period of time before Dow became aware of it.

Stories like this, whether they are true or not, only help to reinforce the general public's natural negative bias against private equity.

Did the Valuation Bubble Pop in the Past Two Weeks?

Did the valuation bubble pop a little in the past two weeks? There have been three recent acquisitions that all went down at a valuation of less than 2x trailing twelve months revenues. Thoma Cressey Bravo acquired Embarcadero Technologies, Infor acquired Workbrain, and Software AG acquired webMethods. All three of the acquired companies were solid – they had decent revenues, acceptable levels of profitability, and significant cash reserves. Yet all three decided to sell at what could be considered average and certainly not premium prices.

Embarcadero Technologies, provides data management solutions, which enable organizations to build, optimize, test, and manage their data, database, and application infrastructures. Embarcadero posted $59.8M in revenues and $11.2M in EBITDA for 2006. They had almost $68M in cash at the end of 2006. Embarcadero agreed to be sold for $186M. When you back out the cash their current enterprise value is $118M or a 1.98x EV/ttm revenue valuation. According to the Software Equity Group database and file management vendors were trading at 2.3x revenue multiple in Q4 2006 while development tool and testing vendors were trading at a 1.2x revenue multiple. A key challenge Embarcadero faced in the marketplace was their relative competitive position. While they have extremely strong offerings their core competitors BMC, CA, and Quest Software all had significantly larger revenues in Embarcadero's core market – Quest alone had over $500M in revenue in 2006. At some point Embarcadero's Board and management decided it was better to proceed as a private entity in Thoma Cressey Bravo's portfolio than as a $60M public company.

Infor, the Golden Gate Capital backed ERP consolidator, acquired Toronto's Workbrain at a 1.58x ttm revenue multiple. What is a bit unusual is that the HR/Workforce management segment posted an average 2.2x EV/revenue multiple in Q4 2006. Workbrain had posted $96.5M in revenues and had breakeven EBITDA in 2006. Kronos (>$500M in revenues), BlueCube (~$40M revenues-- part of Red Prairie now), and NSB Retail ($88M revenues). While Workbrain may never had been able to close the gap on Kronos, they were still the relative leader in their space in comparison to the rest of the competition. Perhaps a driver for Workbrain's board was the inevitable encroachment of SAP and Oracle who have growing offerings in Workbrain's market. By aligning themselves with the #3 ERP provider that has 20,000+ customers the Workbrain solutions are well positioned for the long run.

As noted in an earlier post Software AG acquired webMethods at a 1.8x ttm revenue multiple. This is the same as webMethods smaller competitor PegaSystems.

While three deals don't make a trend it is interesting to see how the boards and owners of three solid public technology companies decided that now was the time to exit. We'll see how this trend either grows or evaporates after the first quarter earnings season completes.

Software AG acquires webMethods

Today Software AG announced their intention to acquire webMethods for $9.15/share. When you back out webMethods $128M in cash you end up with a $380M enterprise value or a 1.8x ttm revenue multiple. PegaSystems (NASDAQ:PEGA), one of webMethod's smaller public competitors carries the same valuation today while Tibco (NASDAQ:TIBX), the 800 pound gorilla in the market carries a 2.5x ttm revenue multiple.

webMethods decision to exit is not surprising. webMethods was an early high flyer in the BPM/EAI space, trading at over $200/share initially. Over the past three years the stock has languished between $7/share and $12/share. Revenues have been basically flat between $190M and $210M. While webMethods has been working on repositioning themselves as an end to end SOA play they have been unable to gain any significant revenue traction. Overall the history of is a great example of how markets form, grow, plateau, and then finally consolidate.

The acquisition of webMethods marks another significant chapter in the consolidation of the former BPM/EAI now SOA platform industry. The only remaining pure play BPM companies are PegaSystems and Tibco. The classic BPM market has been largely consolidated– Sun acquired Seebeyond, BEA acquired Fuego, IBM acquired FileNet (not really a BPM pure play but that's one of the key things IBM did with the technology). Even Vitria took itself private after being unable to find a buyer after a yearlong process. While there are still numerous private and venture backed BPM/SOA firms like Metastorm and Global360, none have a critical mass to seriously rival the new SoftwareAG, Pegasystems, or Tibco.

The significance of the acquisition is that BPM has now become a core piece of systems infrastructure versus a standalone market. Each major software infrastructure player (IBM, Microsoft, Sun, & BEA) has a competitive solution and the leading ERP players have also created BPM/EAI/SOA suites (SAP-Netweaver, Oracle –Fusion, Infor – Progress/Sonic). There are also credible open source solutions (Red Hat / JBoss, MULE, etc.)

Q107 VC Exits

The National Venture Capital Association and Thomson Financial released Q1 results for VC-backed technology company M&A exits and IPOs.  To see the entire press release click here. 

There were 62 M&A exits and 17 IPOs.  Computer software and Internet specific companies accounted for 21 of the M&A exits and 5 of the IPOs.  The number and total value of M&A exits was done from Q1 2006, but IPO exits were up strongly.

M&A exits generated strong returns for investors.  20 of the 62 M&A deals had disclosed values.  Of those 20 deals, 5 returned less than 1x total investment, 5 returned between 1x and 4x, 5 returned between 4x and 10x, and 5 posted greater than 10x returns on total investments.  The fact that more than half of the M&A exits returned greater than 4x to their investors is a good trend.  The IPO pipeline for VC-backed technology companies is also strong, with over 44 companies in registration.

Strong exits are good for everyone -- as the old saying goes a rising tide lifts all boats. 

Sunday LinkList

A few random links to get your week started.

Web 2.0 Enters the Trough of Disallusionment.  Peter Rip a General Partner at Crosslink Capital and author of EarlyStageVC has a great piece on the evolution of the Web 2.0 market.  Check out Web 2.0 - Over and Out. 

Intergalatic Supply Chains.  If you think shipping freight from Cincinnati to El Paso is challenging, imagine trying to deliver an oxygen generation unit from the Earth to a remote location on the moon. To figure out how to do that, MIT researchers Olivier L. de Weck, associate professor of aeronautics and astronautics and engineering systems, and David Simchi-Levi, professor of engineering systems and civil and environmental engineering, created SpaceNet, a software tool for modeling interplanetary supply chains. The latest version, SpaceNet 1.3, was released this month. For more information read the full article here.

April Fool's Fun.  Here a few April Fool's day links you might enjoy:

• Google Romance.  A new product, launched last year, that offers users both a psychographic matchmaking service and all-expenses-paid dates for couples who agree to experience contextually relevant advertising throughout the course of their evening.
• Google TiSP (BETA)™ . A free in-home wireless broadband service that delivers online connectivity via users' plumbing systems. The Toilet Internet Service Provider (TiSP) project is a self-installed, ad-supported online service that will be offered entirely free to any consumer with a WiFi-capable PC and a toilet connected to a local municipal sewage system.
• Google Paper.  is a new feature being promoted on the Gmail home page. You can request a physical copy of any email with the click of a button, and Google will deliver paper printouts to you in 2-4 days via the mail.  Like TiSP, Google Paper is also free and advertising supported. In this case, the “relevant, targeted, unobtrusive advertisements” will appear on the back of printed emails “in red, bold, 36 pt Helvetica.”
• Treo Finally Gets Wi-Fi.  News from treocentral that "In a surprise move, Palm revealed today that all modern Treos were built with a hidden WiFi chip. Today they've released firmware updates enabling it."

Leveratged Recaps Part Duex

While cash is good, there are a number of downsides for management teams associated with leveraged recaps.  The most obvious is that a chunk of the business' heretofore free cash flow now needs to go to service the new or incremental debt that financed the recap.  With effective interest rates in the 10% to 14% range that is no small cost.  Cash that could have been invested to grow the business now has to go to service the debt.  Maintaining compliance with even 'lite covenants' can also impact the business -- such as limiting the amount of cap-ex that can be invested each year or watching your cash balance drop when the lenders do an 'excess cash flow sweep' on a periodic basis.  However, if your firm is in a very mature market with little organic growth opportunity then investing in growth might not be realistic.  If that is the case dedicating free cash flow to debt service versus investing in growth initiatives that will not pay off is a much better choice.  It takes a seasoned management team and board however to come to such a conclusion.

There are two other downsides management teams should consider in evaluating leveraged recaps.  Once your investors have received a solid return on their investment via a recap their interest in driving your firm to grow by taking a lot of risks declines significantly.  They tend to be satisfied with their investment return and their tolerance for risk decreases dramatically.  Ensuring that the debt is serviced appropriately becomes a high priority since problems can impact the investors reputations in the debt marketplace and potentially spill over and cause problems on other refinancings.  Also, a highly levered business is inherently less interesting to potential acquirers.  This can make an eventual exit via a sale to a public company or another private firm challenging. 

While IPOs are on the rise, firms that chose to do a leveraged recap tend not be the best IPO candidates.  It's not the debt load that decreases the IPO opportunity -- it's the business conditions.  Most firms that do leveraged recaps are in a situation where investing in revenue growth is not the most attractive option because of market or competitive conditions.  Solid IPO candidates need to show good to strong organic revenue growth to attract market interest.

At the end of the day the core decision to do or not to do a leveraged recap can be boiled down to one question: What is the best use of a company's free cash flow -- investing in growth initiatives that will actually pay off or creating a significant return for investors now by dedicating free cash flow to debt service.