Well, 2012 has come and gone, and we all persist. The Mayans were apparently wrong (although most archeologists claim the Mayans NEVER, EVER predicted the end of the world . . . .they just had an incomplete calendar!). Whatever the case, we are still here to look back on 2012 in Tech and forward to the year ahead.
2012 was a less robust global Tech M&A market in general, with total deal value down 44% (to $77B) and, more ominously, deal volume (# of transactions) was down 11%. In our comments this time last year, one of our top highlights was the “mega deals,” i.e., those exceeding $10B in consideration: Google/Motorola Mobility and HP/Autonomy. No such deal occurred in 2012. In fact, there were no deals greater than $5B in 2012 and four fewer deals of $1B or more. Of those deals greater than $1B this year, 38% were done by private equity firms, compared with only 25% last year. Interestingly, 2 of the 10 largest deals (including the largest deal of the year) were in the video delivery space: Cisco’s $5.0B acquisition of NDS and Arris’s $2.4B acquisition of Motorola Home from Google. Each of these transactions is intended to strengthen the acquirer’s position in the emerging multi-screen home information market. The explosion in volume of video content, coupled with the blurring of the lines of computing, information and content delivery to the home, have made content “anywhere, anytime, any device” a key strategic area for all vendors, especially those focused on service providers.
While it is difficult to hone in on any single over-arching trend in the year’s M&A activity, it is clear that a couple of wars continue to rage. First, the patent wars. Two of the year’s most significant events were AOL’s sale of 925 patents and patent applications to Microsoft for $1.1B and a San Jose jury’s award of $1.1B to Apple from Samsung for infringement. While the final outcome of the latter is far from certain, two of the more intriguing follow-on effects of the former were Microsoft subsequently selling to, and licensing from, Facebook 650 of those patents, and AOL’s stock jumping 43% following the initial patent sale transaction. While the patent bubble may be waning, the war rages on.
The “stack” wars among major enterprise vendors have also reached a fevered pitch. Leading enterprise vendors Cisco, Dell, EMC, IBM, and Oracle all amassed more acquisitions in 2012 than in 2011. In aggregate, 60% more! Among the most intriguing transactions in the enterprise were VMware’s acquisition of Nicera and Oracle’s acquisition of Xsigo. VMware’s deal marked its entry into the software-defined networking market and was widely (and properly) perceived as a shot across Cisco’s bow by both VMware and EMC. Oracle’s deal represented its entry into data center networking and, similarly, a direct challenge to Cisco. This unsettling of the status quo in the enterprise will have far-reaching implications for all vendor’s strategies. Look for serious M&A action in next generation stack technologies in storage, networking and data management from this gaggle of behemoths in 2013.
Nearly as intriguing were the moves made by Oracle, SAP and, to a lesser extent, IBM to build major positions in SaaS. In 2012, Oracle announced the acquisitions of Taleo and Eloqua for a total of $2.7B, SAP announced the acquisition of Ariba three months after completing the purchase of SuccessFactors for a total of $4.3B and IBM bought Kenexa for $1.3B. Clearly, these major software vendors have bowed to customer demand for a new economic contract beyond the perpetual license approach they have held so dear for so long, and their intent is to challenge Salesforce for leadership in cloud-based applications delivery.
In light of sluggish topline growth, uncertain global economic conditions and the looming fiscal cliff, the U.S. Equity markets were surprisingly strong with the NASDAQ and the S&P 500 up 15.9% and 13.4%, respectively. So the question is, why? On the surface, one could point to reduced volatility. After an extremely volatile 2011, in 2012 the VIX (the most widely accepted measure of market volatility) remained below 30 for the entire year. A deeper look, however, suggests the most significant force driving the stock market was an extraordinarily robust Bond market.
For those of you who don’t follow the Bond market, you will be stunned by just how epic 2012 was. Every major bond index traded to its all-time historic low in 2012. . . .literally. The widely-cited Barclay’s Index (U.S. Corporate Investment Grade), initiated in 1973, bottomed out at 2.65% in November and ended the year at 2.72%. The 30 year average year end close for this index had been 7.5%! To give you a sense of the historic nature of this market, Texas Instruments sold 3-year bonds in July at a rate of 0.45%, the lowest rate ever for a corporate issuer. IBM completed 8 bond issuances in 2012 raising $7.6B; 6 of them, with terms of 3 to 10 years, had interest rates ranging from 0.55% to 1.875%. IBM’s July issuance of $1.0B at 1.875% set the all-time record for lowest coupon ever for a 10-year corporate bond. At the time IBM issued those bonds at a 1.875% rate, its dividend yield was 1.78%, a ratio of 1.05:1 (1.875% to 1.780%). This is unheard of! The 30 year average ratio of the S&P 500’s average dividend yield to Moody’s AA Bond Index is 3:1 (7.54% to 2.47%). At year end 2012, the ratio was 1.65:1 (3.75% to 2.27%). Is it any wonder corporate bond issuances set an all-time record in terms of dollars raised, and that equity markets were up all over the world?
But one cannot talk about the Equity market without mentioning what was unquestionably the #1 event of the year: the Facebook IPO. As we all know by now, Facebook (NASDAQ: FB), the most anticipated IPO in history, debuted on May 18 and priced at $38 following a last minute increase in both stock price and deal size, and raised $16B. In early trading, the stock rose to $45, but closed the first day at $38.23, and broke issue (traded below its IPO price) by 9:30AM the next day. It has struggled ever since, trading as low as $17.55 (on September 4) and closing the year at $26.62 (down 30% from its IPO price and 41% from its peak). While much as been made of the role of NASDAQ’s first day trading snafus in the debacle, the plain truth is this: the Facebook IPO was over-priced. Fundamentals matter. At $38 per share, the deal valued Facebook at 23x trailing revenues and 44x trailing EBITDA. As a point of comparison, at the time Google was trading at 3x revenue and not quite 10x EBITDA. Growth rates the difference you say? Well, Facebook’s trailing growth in revenue and EBITDA were 71% and 62%, respectively; Google’s analogous numbers were 28% and 27%, respectively (while having 10x the scale, in revenue, of Facebook). Certainly Facebook should have priced at a premium to Google’s multiple, but 4x greater in EBITDA and 8x greater in revenue when its growth was only about 2.5x faster? Note that at year end, Facebook still traded at 9.7x FY13 revenue vs. Google’s 3.9x. Their consensus forward growth rates in revenue? 30% for Facebook and 24% for Google. Hmmm.
Now, having said all of this, raising $16B was an incredible achievement for Facebook and their bankers. To put this number in context, consider this: The prior 85 Tech IPOs, dating all the way back to March 2010, raised less money in total than Facebook raised.
In our view, the larger stock market story in Tech was that the whole “mobile/social/gaming” trend has been over-hyped in the short-term. This is not to say that such businesses are doomed to fail, rather it is a comment on timing….i.e., the market’s desire to play this space (and the venture community’s desire to sell it) may be greater than the opportunities currently available. At year end, the market caps of the 6 pure play “mobile/social/gaming” stocks (Facebook, Groupon, Jive, LinkedIn, Pandora, and Zynga) were down 30%, in aggregate, from their IPO price. Indeed, only LinkedIn, whose financial performance has been nothing short of spectacular, and Jive are up vs. their IPO price, propping up the index. Groupon and Zynga, two of the most anticipated IPOs prior to their offerings, and darlings of the pre-IPO secondary market, are each down roughly 75% from IPO, never mind their peak. We strongly believe that “mobile/social” is real over the longer term; the question is which companies are the long-term winners? Recall that at the peak of the NASDAQ in 2000, the 3 largest market cap Internet stocks were Yahoo ($47B), eBay ($25B) and Amazon ($23B). While these companies, in aggregate, lost 69% of their value from March 10, 2000 through October 10, 2002, Amazon and eBay are now trading at 4.9x and 2.6x their valuations achieved at the peak of the NASDAQ on March 10….while Yahoo still lags. The lesson is that over the long term, it’s fundamentals that matter. . . . . no matter how many times we click the heels of our ruby red shoes.
Overall, the Tech IPO market was lackluster. Only 32 deal priced in 2012, down from 42 in 2011. The good news is only 13 of these deals were trading below offer at year end 2012, about the norm one would expect (note: historically it has always been true that approximately 50% of all Tech IPOs trade below offer within 12 months of their debut, and many recover). Interestingly, the best performing IPO of the year was Guidewire (NYSE:GWRE), a solidly performing software company that is not SaaS and serves the always exciting property and casualty insurance market, replacing “green screen” legacy systems. Following its debut, the company has crushed it, reporting 4-20% higher revenue growth in each of the past 4 quarters and exceeding earnings estimates dramatically in every quarter. . . . including reaching profitability immediately following the IPO, two quarters ahead of plan. As a result, the stock is up 129% since the IPO. Priced at issue at a “humble” 3.4x trailing revenue and 18.5x EBITDA, investors have rewarded the company’s superior performance with improved multiples which, at year end, were 6.1x FY13 revenue and 54.9x FY13 EBITDA. Fundamentals are rewarded! Could rational IPO pricing and strong post IPO performance become the “new normal”?!
Among large cap Tech stocks, there were four big winners and one spectacular loser. The biggest market gap gainer was, of course, Apple (NASDAQ:AAPL), up 31% and adding an incredible $123B in market value during 2012. To put this achievement in perspective, it took Apple nearly 23 years to achieve its first $100B in market cap and only 6 U.S. tech companies have a total market cap larger than that which Apple added in 2012! Topping the charts in terms of percentage increase was eBay (NASDAQ:EBAY), up 68% for the year and adding over $27B in market cap. Close behind was Salesforce.com (NYSE:CRM), up over 66% for the year and adding over $10B in market cap. Both companies are capitalizing on key trends in Tech: eBay in eCommerce and next generation electronic payments, and Salesforce in cloud computing and SaaS. Both are challenging incumbents and winning, and are using their financial clout to make acquisitions to extend their advantage. However, since enough kudos have been tossed Apple’s way by everyone, our pick for the stock market story of the year is SAP (NYSE:SAP), up more than 52% for the year and adding $33B to its market cap. Facebook may not be worth $100B, but SAP is close! ($98B at year end). How and why is simple. SAP has done a great job executing, both gaining share and expanding profits in its core while also positioning themselves well in critically important growth markets. Specifically: (a) they have developed strong products in the next generation areas of mobility and Big Data; (b) they have acquired aggressively in cloud computing and SaaS, where they lacked DNA; (c) they have communicated transparently with Wall St., showing the revenue breakdowns of these high growth areas separately; and (d) they have delivered the numbers with LTM growth in revenue of 6.9%, compared to -1.7% IBM and 1.4% for Oracle, even in the face of significant exposure to Europe, which declined. While they trade at a premium to IBM and Oracle, its deserved…..they are growing much faster. In fact, on a PE / growth (PEG) basis, one could argue they remain undervalued relative to their peers. The big loser, of course was HP, down 45% at year end and losing $23B in market cap. No other Tech stock came close. We will pass on further commentary for now, as we commented last year on our (negative) view of the Autonomy deal and the HP folks have been beaten up enough.
2012 was another terrific year for Evercore. We finished the year ranked #9 in Thompson Reuters year end M&A Rankings, with over $92B of consideration. In a difficult banking environment, our stock (NYSE: EVR) was up 13.4%. Landmark transactions we announced during the year outside of Tech included three of the five largest deals of the year:
- The acquisition of T-Mobile by Metro PCS for $24.2B
- The sale of Kinder Morgan’s EP Energy unit to Apollo and Riverstone for $7.2B
- The acquisition of Amylin by Bristol-Myers Squibb for $6.9B<
We also advised several public company boards on the evaluation and execution of various strategic alternatives, including those proposed by activists. For example:
- McGraw-Hill, including the pending $2.5B sale of its education business
- Kraft Foods, including the $36.1B spin-off of its Kraft unit
We had a solid year in the Tech group as well. Representative transactions included:
- Arris’s pending acquisition of Motorola Home Solutions from Google for $2.4B
- AOL’s sale of over 925 patents and related applications to Microsoft for $1.1B
- Providence Equity’s syndicate’s acquisition of Q9 for $1.1B
- Samsung’s acquisitions of both CSR’s handset business (for $310M) and Nanoradio (value not announced)
- Nuance’s acquisition of Transcend Services for $300M
- Xsigo’s sale to Oracle (value not announced)
Finally, it was a decade ago (2002) that Sarbanes-Oxley (SOX) was signed into law. This was the last of several pieces of legislation that, along with some structural changes to the investment banking industry, had the unintended consequence of negatively impacting the emerging growth company IPO market. It is fitting that, on this anniversary, the first modest step to repairing that damage was taken with the signing of The Jobs Act in 2012. While The Act includes many measures, the most important provisions streamline the IPO process and establish a regulatory “on ramp” for companies that qualify as an “Emerging Growth Company” (EGC). At a high level, an EGC is a company that has less than $1B revenue and $700MM in public float, and has been public 5 years or less. Among the specific provisions of assistance to young Tech companies:
- Ability to file with the SEC confidentially, avoiding disclosure until an IPO is more certain
- Ability to communicate with institutional investors, pre-filing, to assess demand
- Exemption from certain reporting requirements of SOX 404(b)
- Exemption from certain provisions of Dodd-Frank, including “Say on Pay”
We believe The Act is a constructive step toward the rehabilitation of the Tech IPO market. Of the 60 IPOs that came out in 2012 (in all industries) since The Act passed, 56 (>93%) have been EGCs. Most are taking advantage of The Act’s provisions by filing privately, reducing costs (SOX relief) and “testing the waters” with investors, pre-IPO. This later point is getting rave reviews from CEOs and institutional investors alike. A special shout out goes to Kate Mitchell of Scale Venture Partners, who under the guidance of the U.S. Treasury Department, assembled and managed the group of CEOs, board members, venture capitalists, institutional investors, exchange staff, lawyers and bankers (including our own Paul Deninger) to develop recommendations and help craft this bill.
Happy New Year to everyone. Here’s to a peaceful and prosperous 2013, including greater harmony and bi-partisanship in Washington!
Paul Deninger is a Senior Managing Director of Evercore‘s advisory business. Mr. Deninger joined Evercore in 2011 to help lead an expansion of the firm’s Technology practice. He has over 25 years of advisory experience and has completed over 150 technology and cleantech transactions in his career. Mr. Deninger was most recently a Vice Chairman at Jefferies & Co., where he led the Technology Group’s entry into the IPO market, working on such deals as the highly successful Qlik Technology IPO.