Cash is King; Sybase refinances $350m convert

On July 29 Sybase priced its $350million (with a $50 million over-allotment) 3.5% Convertible Senior Notes. Primary use of proceeds is to refinance existing 1.75% convert due 2025 which the holders could put as of July 28, 2009. In conjunction with the new offering Sybase will repurchase $50 million of its stock to support the shares. This is common practice in convert issuances as hedge fund investors typically short the underlying stock as they invest in convertible arbitrage. This strategy essentially lets the investor benefit from the cash coupon as well capitalize on inefficient pricing of the underlying stock, without being exposed to stock price volatility.

If not for the new convert, Sybase would have spent over $400 million to redeem the original convert holders. Although Sybase has close to $800 million in cash, almost half is over seas and repatriating international cash would mean paying heavy taxes. Issuing a convert was a smart use of the capital structure to maintain ample cash and liquidity; a common practice for software and tech companies in this turbulent market...afterall Cash is King

The Best Offense Is Defense: Ericsson ”wins” Nortel asset auction

Ericsson announced that it will acquire a majority of Nortel’s North American wireless assets for $1.13 billion in a bankruptcy auction (Ericsson/Nortel). The all cash bid represented a 74% premium over Nokia Siemens’ stalking horse bid of $650 million. Yes, that is 74% on top.

Why would Ericsson pay so much for an asset that will see revenues decline significantly over the next few years? Here are the highlights:

• Strengthens Ericsson’s position in North America (also boosted by the recent Sprint deal)


• Provides 400 employees focused on LTE (Long Term Evolution) R&D


• Accretive to next year’s earnings with a profitable margin structure

However these points aren’t as solid as Investor Relations would have us believe. Progress in North American and growth in the LTE engineering base (next generation high speed networks will be based on LTE) could be created organically and at lower cost. Additionally, based on Wall Street estimates, while the deal may be accretive in 2010, the decline of the CDMA market will eat into total returns on capital which will come close to double digits, especially with minimal prospects of deal synergies and limited cost cutting opportunities. I do not see returns coming in above WACC.

In the end, this acquisition was a defensive move to keep Nokia Siemens from jumping into the North American market for a bargain price of $650 million. This keeps a major competitor out of Verizon’s LTE network buildout and puts Ericsson in strong position to capture a lion’s share of that opportunity.

Also, it’s interesting to note that RIM announced that they would have bid $1.1 billion for the asset but were prevented from doing so. Ericsson’s bid would have slightly topped that. Perhaps, Nortel should thank RIM for raising the bar and the price tag.

Irony strikes though as the big winner in the auction is a company that did not even make a bid, Alcatel Lucent. A big competitor in the North American market keeps Nokia Siemens out while Ericsson pays picks up the hefty tab. Attention to the folks at Ericsson and RIM, please expect your basket of baguettes, courtesy of the kind folks at Alcatel –Lucent’s HQ in Paris. Merci!

1% Margins, 100% Fun: Why Technology Distribution is Relevant

The “canary in the coal mine,” is what my boss used to say when describing Technology Distributors like Ingram Micro, Tech Data, Avnet and Arrow Electronics. How these players fare can be a leading indicator of what is coming down the pipeline from Technology juggernauts like HP, IBM, Cisco and leading chip manufacturers; all of whom are suppliers into the Channel. But distributors are more than just channel checks, they are the often overlooked and under appreciated engine that powers the supply chain.

Distributors are the middlemen. They do the dirty work of connecting leading OEMs to end-users through a large and fragmented reseller universe. Experts will differentiate between broadline, specialty and component distributors. This classification is not important for us now. The basic facts you need to know are:

• $35 billion in annual sales (Ingram Micro hit over $35 billion in 2007)


• 1.0 - 4.0% operating margins (Tech Data and Ingram Micro have gone sub 1% in recent quarters)


• Each major distributor has issued multiple tranches of straight debt and/or convertible securities

These are big “technology” companies with razor thin margins and high capital requirements. As such, capital structure is important and debt is used often. The capital markets and the banks play a large role in funding operations and covering swings in working capital. This requires true corporate finance advisory work from investment banks; and that makes the industry not only relevant but fun.

Unfortunately for product specialists, when business slow down, these guys are cash machines. Falling revenues lower working capital needs as inventories get worked down and there is no reason to access the capital markets. But when things get going and growth is back, the cash machine will run in reverse and banks will be happy to help. There is also a fair amount of refinancing needed.

On the M&A side, while the industry has already experienced substantial consolidation, there is room for more. And some potential transformational acquisitions could be on the horizon as the industry continues to evolve. More on this to come…

Yahoo! and Microsoft Search Partnership: Does Bing Plus Yahoo Equal Boogle?

On July 29, 2009 Yahoo! Inc. and Microsoft Corp. announced a 10-year strategic search partnership whereby Microsoft’s Bing search engine will be the default search engine for Yahoo!, with Yahoo! selling the search ads for the platform. The terms of the deal are that Microsoft will pay to Yahoo! a TAC (traffic acquisition cost) of 88% for the first 5 years of the partnership on all search advertising on its O&O (owned and operated) and affiliates sites as well as guarantee Yahoo!’s RPS (revenue per search) in each country for the first 18 months. Yahoo! expects the partnership to negatively impact net revenue (due to the 12% revenue share with Microsoft) but generate $275 million in incremental EBITDA, given $650 million in costs savings associated with outsourcing search technology. Capital expenditure savings are expected to be $200 million. In post-announcement trading, Yahoo! shares traded down $2.08 or 12.08% while Microsoft shares traded up by $0.33 or 1.41%.

It seems that while both companies come out ahead on this deal, Microsoft appears to be the bigger winner as it is now able to extend its recently upgraded search engine, Bing, to Yahoo!’s large online audience as well as gaining an all-pass access to users’ search data. Timing of the deal also plays into Microsoft’s favor as this current deal comes at a cheaper price and has been estimated to cost $3.00 per share versus $5.30 per share one year ago.

For Yahoo! the deal allows Yahoo! to turnover the keys to its market share losing search engine, while channeling focus on what it does best which is building an Internet audience and selling online advertising. However, absent from the deal terms was any upfront payment, compensation for any improvement from RPS in Bing searches (if Bing takes share from Yahoo! going forward, Yahoo! is not entitled to share in the success), and higher level of TACs than the 88% stipulated. In addition, Yahoo! will have limited access to data in users’ searches going forward.

How does this impact the Internet search industry overall? Answer is not much, at least not right away. The two companies estimate a 24 month integration time post regulatory approval. The real winner in the near term could be Google which is likely to pick up share during the disruption period. Google is still the 800 pound gorilla in search with a 65% market share in the United States and 67% globally vs. a combined Bing and Yahoo share of 28%.

So Microsoft has doubled down on search at a time when Google has announced the development of its own OS -- time will only tell how the Yahoo! / Microsoft partnership will exactly play out but one thing for certain is the head-to-head battle between Google and Microsoft on each other’s core territory.

IBM adds predictive analytics with $1.2bn SPSS deal; Software M&A intensifies

On 7/28/09 IBM announced its acquisition of SPSS for $50/share ($1.2 bn equity value and $1.0 bn enterprise value) representing a 42% 1-day equity premium. The predictive analytics offerings of SPSS is expected to reside in IBM's Information Management segment. Transaction represents IBM's continued execution on its Information Agenda strategy which began as data on demand for decision support and is blossoming into real-time trend forecasting and optimization capability for businesses. The deal illustrates large software vendors' interest and ability to pay up for strategic and competitive assets.

While the 42% single day premium, which is also well above the 52-week high, seems significant in today's depressed equity markets, the transaction is in line on a revenue multiple basis (3.3x EV/NTM Revenue) and is at a discount to its BI transaction comps on a maintenance revenue basis (7.7x EV/TTM Maint Rev)

SPSS has sophisticated statistical and data mining tools for structured and unstructured data, and predictive applications for enterprise business users. These products utilize algorithmic techniques to forecast potential outcomes or generate a call to action. With the proliferation of data, software vendors are trying to capitalize on opportunity to use data not just to support static decisions, but rather to leverage the data to present precise and relevant analysis that can help enterprises execute on future business opportunities. IDC estimates Business Analytics as a $25 bn market growing at 4% cagr and IBM is looking to establish its leadership. The transaction builds on earlier Analytics acquisitions including Cognos which presented general analytics and business intelligence on historical data. Wall Street expects revenue synergies from selling SPSS solutions through the enormous IBM global distribution network and expense synergies from consolidating operations into IBM's software infrastructure.

As regards Software M&A, more will follow in the footsteps of IBM/SPSS, Oracle/SUN, EMC/Data Domain. Gone indeed, are the bull market excuses of richly valued stocks and inflated private company valuations. The market today supports some of the lowest relative valuations we have seen in a long time; so why has deal flow been muted? Confidence, surprisingly is one often overlooked attribute. Confidence as defined by public market valuations of one's own stock price and, on a related note, inability to estimate revenue and earnings. How can the corporate development team credibly present target company forecasted financials and potential synergy assumptions to the Board when the CFO's office is having a hard time signing off on the company's own next year and next quarter financials. There is a lot of uncertainty in forecasting financials and since valuations in the tech world are driven by multiples on future revenue and earnings, the current market valuations and expectation of valuations remain depressed. This is true for the acquiring company as well as the potential target and this lack of confidence in self valuation drives the hesitation in pulling the "buy" trigger. We are now seeing large software vendors build up their confidence as they sit on large cash reserves and have stronger support for public market valuations. This increase in self-confidence will spark active M&A dialogue from others who have been siting on the sidelines and potentially lead to a robust Software M&A environment.