Anyone following the technology industry of late will have started to notice a new trend, and for once I’m not talking about yet another three-letter acronym to join the likes of SOA, BPM and ROI. We’re increasingly seeing publicly traded technology companies spurn the markets and return to private ownership.
But what’s driving the trend, and what does it mean for technology buyers? I decided to jot down some thoughts, spurred on by a meeting with the CEO of Serena Software, which went private in a $1.2bn deal led by Silver Lake Partners on November 13 last year.
In fact you would be forgiven for thinking that the latest trend for mature technology companies to buyout their shareholders and return to private ownership could be explained by those three words: Silver Lake Partners, or SLP. Whoops – seems I am talking about a three-letter acronym after all.
Silver Lake Partners is the private equity firm that has blazed a trail in returning companies to private ownership, a service perhaps best exemplified by their $11.6bn deal to take data-management software and services vendor SunGard Data Systems private. Not only was that the largest leveraged technology vendor buyout yet; it was also the third largest leveraged buyout in any sector.
SLP are not the only ones at it. Both WRQ and Attachmate were taken private and then merged to form a big host connectivity software vendor, AttachmateWRQ, when they were acquired by an investment group led by Golden Gate Capital, Francisco Partners, and Thoma Cressey Equity Partners last year.
True, it is SLP that has been the greatest influence in the public-to-private moves of a handful of technology vendors – including Avago, Seagate and Serena – but it could equally be argued that SLP merely had the backing, know-how and ambition to make the most of the prevailing financial climate that these technology companies found themselves in.
Silver Lake Partners’ founders, the four tech-industry veterans David Roux, Jim Davidson, Glenn Hutchins and Roger McNamee risked $112m of their own money and raised a further $400m or thereabouts for the first fund they would use to buy technology companies out of public ownership. But they first had to come to the realization that a number of technology companies would make good candidates.
While leveraged buyouts were relatively common in other sectors until Silver Lake Partners came on the scene, private investors had tended to avoid them in the technology sector because they was seen as too volatile. Silver Lake though proved that they could work just as well in the technology sector, as it had reached a new level of maturity, with more predictable revenue and cash generation. That gave them the confidence that they would be able to pay back the debt they would inevitably be saddled with after buying out the respective shareholders.
The process is relatively straightforward. SLP puts together a fund from its own and private investors’ purses, and uses this to buy a technology company. The shareholders in the company receive cash for their shares, and the company is now owned by Silver Lake Partners.
Silver Lake then uses the profits from the company it has acquired to pay back the debt it raised to buy it in the first place. Once the debt is paid back it could take the now debt-free company public again in an IPO, sell it in a trade sale, or hang onto it for a few years and cream off the profits it is (hopefully) still making.
But why would a public company choose to be taken private? I heard it from the horse’s mouth, so to speak, from another of Silver Lake Partners’ public-to-private converts, Serena. As Serena’s CEO Mark Woodward told me, “When you’re a public company, all Wall Street looks at is license revenue growth. They don’t care about total revenue or even earnings much, so if you have a wobble with license growth they hammer you.” You can read my initial take when Serena was taken private here.
Woodward said Serena was constantly frustrated by chasing the 90-day cycle of quarterly results demanded by the Securities and Exchange Commission (SEC) and analysed to death by Wall Street and the financial analysts. “You spend a lot of time dealing with analysts and so-called financial ‘experts’, but at the end of the day if you hit their estimates for your quarter you are doing something right, and if you miss it by a penny you are doing something drastically wrong. It’s madness.”
Woodward also noted that being public meant for Serena spending around $2m a year on achieving and maintaining Sarbanes Oxley compliance. Furthermore Woodward says the recently introduced Regulation FD (Fair Disclosure), which was meant to prevent companies giving institutional investment analysts privileged information that was not made available to the public, has had the reverse effect.
Companies are now so worried about complying with Regulation FD that they now provide only bland information, Woodward argues, and as a result “you’ve gone from lots of information given to some people, to very little information given to lots of people.” The result? Analyst expectations are less accurate, and companies miss their expectations more often.
To make matters worse, Woodward notes that prior to his company’s acquisition of Merant, Serena had sales of $110m and a market capitalization of $800m. After it bought Merant it had sales of $260m and double its former profit, and still had a market cap of around $800m. “Explain that to me,” says Woodward.
Finally Woodward argues that the restrictive effect of trying to hit analyst expectations every ninety days meant that the company could not make the $1.5m investment in its Asian business it wanted to without upsetting its earnings expectations, and it could not move some of its sales from one-off payments to term licenses where it charges a series of payments rateably over two years: “The Street just wouldn’t allow it, even though it would mean exactly the same amount of revenue, and we think also faster growth and more stable revenue,” he says.
Whatever the reasons, I don’t think customers should be especially wary of technology companies that have been taken private. Often it means they are able to redouble their investment in R&D because they don’t need to worry so much about its effect on earnings in the short to medium term. The company may well be less distracted, as it is no longer laser focused on a ninety day cycle of quarterly results, and on top of that it may well get some good business model and strategic advice from the firm that invests in it: all good news for the customer.
Being taken private is not a sign that the company is in a less stable financial position, in fact the reverse is often true.
So while the trend for technology companies being taken private looks set to continue, I don’t think that’s a bad thing for technology buyers. Of course there’s a parallel trend, which is for companies to sell up to other technology companies, for which the word ‘Oracle’ has a lot to answer, but that’s another story. Maybe that one can be analysed without coming across a three-letter acronym, but then again…