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Private Equity's Software Buying Binge

In 2004 there were, by my count, about 18 acquisitions of public software companies and Private Equity firms made none of them.  By 2006 however, not only had the number of acquisitions risen to 32, but Private Equity firms accounted for 25% of them, up strongly from 11% of deals in 2005 (See table below).

Year Total Deals PE Deals % PE
2004 18 0 0%
2005 27 3 11%
2006 32 8 25%

At this rate I wouldn't be surprised to see private equity account for over 50% of deals in a couple years.

Who Said Maintenance Revenues Aren't Beautiful?
Private equity firms have taken a liking to software firms not because they believe software to be a great growth market but largely because most software firms have what PE firms might call "immature" balance sheets, with little or no debt and relatively high levels of cash.   Rather than targeting fast growing software firms, PE shops typically target "mature" software companies as they not only tend to have lots of cash but they also derive a large percent of their revenues from maintenance revenues.  These revenues are seen by private equity investors and, more importantly their lenders, as a stable source of cash flow that can be used to finance lots of debt.

Seven Steps To Carry
The basic private equity software play book goes something like this:

  1. Buy software company
  2. Do dividend recap in which you simultaneously lever up the balance sheet and dividend out all the cash you just borrowed plus most of the existing cash on the balance sheet.
  3. Raise new fund off of massive IRR created by dividend recap.
  4. Do lots of acquisitions to make organic growth impossible to discern
  5. Raise prices, slash R&D, increase sales and marketing.
  6. Take company public/sell it at same PE you bought it for to investor/large company apparently unfamiliar with the concept of enterprise value.
  7. Repeat.

Now I admit this is a bit of snarky characterization of PE software deals because software offers some unique scale effects in SG&A, but I think this characterization is probably closer to the truth than a lot of mumbo jumbo about "value add" "synergies", etc.

And the Winner Is....
For my money,the most notable (and most ironic) private equity buyout of public company in 2006 was the acquisition of SSA Global by Infor. Why?  Because SSA Global was itself a private equity sponsored roll-up of public software companies (including Baan, Ironside, and Epiphany) which was public for all of a year before it was bought by another private equity sponsored roll-up of public companies, Infor, which now rather immodestly claims to be "the fastest growing enterprise software company in the world".

To have the two companies that are following the private equity playbook to a T merge with one another after the first one was only public for a year is just priceless.   I can't wait to see the prospectus for Infor and how they back up their claim to be the fastest growing enterprise software company in the world, it should be a classic.

January 19, 2007 in Stocks, Venture Capital, Wall Street | Permalink | Comments (4)


36 Days: Online Storage Ain’t All It’s Backed Up To Be

Online back-up is getting a lot of press lately thanks primarily to a slew of Web 2.0 start-ups focused on online storage/back-up as well as the impending debut of Windows Vista, which imbeds back-up functionality into the core operating system.

On the surface online backup seems very appealing. Not only do you get anytime/anywhere access to your data, but you also get professionally managed, secure, and (hopefully) disaster proof off-site storage. What’s more, thanks to rapidly declining storage prices and generous VCs willing to subsidize “loss leading” businesses, all this goodness can generally be yours for the very low price of “free” for quantities under 5GBs and just $50-$100/year for 10-100GBs of storage.

But before you decide to “upgrade” to online backup be sure to do some basic math. You see, as great as online backup/storage is, it also happens to be painfully slow thanks to the very poor upstream bandwidth associated with most Internet connections. For example, while the average cable connection might advertise a 1.5 megabits per second (mbps) download speed, that same connection can usually only upload at 256 kilobits per second (kbps). Fact is, the average consumer and most small businesses are stuck at somewhere between 128 kilobits and 768 kbps for their upload speeds.

Why does this matter? Because it takes a long, long time to back-up a reasonably sized hard drive at 256 kbps per second. How long? Well if you have 100 gigabytes (GBs) of information @ 128 kilobits (kbps) per second it will take almost 36 days!!  (And that assumes your connection is working perfectly the whole time.)  See the table below to see just how long your connection would take to back-up 100 gigabytes:

Connection SpeedDaysHours
64 kbps15117
256 kbps3515
1.5 mbps (T1)522

Granted, most online backup services only force you to do a full back-up once and then do incremental back-ups thereafter (often in the background), but even incremental back-ups will run several gigabytes (my outlook files only take up close to 2 gigs) and that will take a least 24 hours to run. Compare online backup to the more pedestrian external drive alternative and the advantage is clear: while it takes 36 days to backup 100 GBs over your cable connection, a standard Firewire drive can handle that in about 1 hour. Add the fact that a 120GB external drive will only set you back $100 these days and it seems pretty clear that online back-up won’t be threatening external drives anytime soon.

Once you realize that backing up your hard drive can take up to 36 days, you tend to look at online back-up in a slightly different light. First you realize that online back-up is really a misnomer as online storage, for now, is practically limited to small subset of files that are either A) so critical that you need to have remote copies of them stored away for safe keeping or B) important enough for you to need to have anytime/anywhere access to them C) files that you need top share with others on a regular basis. For true backup, nothing beats a decent external drive attached via a Firewire cable. Second, you realize why some start-ups are charging only $100/year for 100 GBs of storage: because they know that almost no one will be able to use that much capacity.

Ultimately, the real promise of online storage is not as a backup medium, but as the primary storage medium behind the “web desktop”. This is worthy of a whole other post, but suffice it to say, the combination of very cheap online storage with reasonably fast downstream bandwidth and next generation web browser interfaces makes it increasingly likely that a lot of user data will never leave “the cloud”. When this happens the desktop (and its OS) become much less relevant and that is why Google is so excited and Microsoft is so scared. But as I said, that is best left for another post.

January 15, 2007 | Permalink | Comments (7)


Top 10 Software Stocks of 2006

Software stocks may have only performed in-line with the rest of the market, but these stocks were at the top of the class.  The easiest way to make this list in 2006 was to be bought by a strategic acquirer such as IBM, HP, pr EMC.  Other than that, it's pretty much a grab bag of stocks but medical software stocks were particularly strong, as were open source and VOIP related stocks.

To qualify for this list a company had to start 2006 with at least $50M in market cap and its main business had to be selling software as a license or a service.  So, without further ado, here are the Top 10 Software Stocks of 2006:

  1. Interactive Intelligence
    Price Change: 340% Ticker: ININ
    : Pioneer in enterprise IP Telephony saw rapidly increasing sales as enterprises started to take VOIP seriously, especially call centers.
  2. VA Linux
    Price Change: 183% Ticker:LNUX
    :  Operator of  open source software portal ""  and geek news site saw shares rise as grew quickly and as it released an enterprise software version of  I will be moving this to the Internet sector for 2007 given that it is more much a content/e-commerce play now than it is a software company.
  3. RSA Data Security
    Price Change: 149% Ticker: RSAS
    Comment: Early leader in hard tokens and public key encryption was bought by EMC this past summer for a nice premium.  May be first of several security acquisitions by EMC.
  4. Smith Micro Software
    Price Change
    : 143% Ticker: SMSI
    Comment: Provider of a multitude of wireless software products and owner of the venerable Stuffit program, saw sales rise as carriers such as Verizon stuck deals for several of their software products.
  5. Allscripts Healthcare Solutions
    Price Change: 101% Ticker: MDRX
    : Strong demand their medical records management software thanks in part to government mandates helped propel this stock upward.
  6. Quadramed
    Price Change
    : 92% Ticker: QD
    : Another medical records software company.  I think I see a trend.
  7. Acutate
    Price Change: 89% Ticker: ACTU
    : Business intelligence vendor benefited from finally turning profitable and from it's emerging open source platform.
  8. Mercury Interactive
    Price Change
    : 87% Ticker: MERQ
    :  Application performance management vendor that  put enough of its accounting problems behind it to secure a sale to HP.
  9. MRO Software
    Price Change
    : 83% Ticker: MROI
    :  One of 3 public software companies that IBM bought in 2006.  Not sure how this fits into IBM's "we don't compete with our application partners" party line.
  10. Mentor Graphics
    Price Change
    : 74% Ticker: MENT
    : EDA tools vendor saw a nice rebound after a terrible 2005 as license sales picked back up.

January 5, 2007 in Software, Stocks | Permalink | Comments (2)

Top 10 Internet Stocks of 2006

While 2005's Internet winners were dominated by the themes of online advertising and gambling, 2006's key themes were China and broadband.  Four of the Top 10 stocks were focused on China while 3 were focused on broadband infrastructure.

To qualify for this list the company had to start 2006 with at least $50M in market cap and its business had to be focused on the Internet.  So, without further ado, here are the Top 10 Internet Stocks of 2005:

  1. Navisite
    Price Change: 458% Ticker: NAVI
    : If you need proof that hosting is hot again, look no further than Navisite.  This once left for dead application hosting company  had a huge year including  a suspiciously  strong December.
  2. Gigamedia
    Price Change: 243% Ticker:GIGM
    : What do you get when you combine China with gambling? An incredibly hot stock that's what.
    Price Change: 197% Ticker: CHINA
    Comment:  The right ticker at the right time.  With anything China related hotter than a  Szechuan Spicy  Beef, it was's time to shine.  It didn't hurt that  they made a major move in online gaming too.
  4. Akami
    Price Change
    : 167% Ticker: AKAM
    Comment:  Internet video was white hot in 2006 and Akami's CDN serves the most video of anyone so investors saw them as platform level pure play on the growth of internet video.
    Price Change: 129% Ticker: KNOT
    : After a successful merger with long time competitor The Wedding Channel, the proved that near monopoly positions in attractive internet content niches can be quite rewarding.
  6. C-Trip
    Price Change
    : 117% Ticker: CTRP
    : China's top online travel agency benefited from the overall China craze and increased travel by the emerging chinese middle class.
  7. Omniture
    Price Change: 117% Ticker: OMTR
    : The only IPO on the list.  Omniture didn't go public until mid-year but made up for its late start as it became the SASS darling of online analytics and took market share quickly.
  8. The9
    Price Change
    : 111% Ticker: NCTY
    : China.  World of Warcraft.  Need I say more?
  9. Internet Gold
    Price Change
    : 100% Ticker: IGLD
    : Israeli ISP rises due to merger with rival and ventures in online video and broadband access.
  10. Priceline
    Price Change
    : 99% Ticker: PCLN
    : Rising hotel and airline fares combined with increasing business travel send consumers scrambling to find cheap deals the Internet.

January 5, 2007 in Internet, Stocks | Permalink | Comments (1)


Guess What? Internet Stocks Had A Terrible 2006

Lost amidst all the Web 2.0 hype, the eye popping deals like Google's $1.65BN for 18 month old YouTube and the huge increases in VC Internet-related investments is a open secret which many people in Silicon Valley don't seem to have fully assimilated: Internet stocks had a pretty terrible year in 2006.

While all the major indexes had decent years with the Dow up 16.3%, the S&P 13.6% and the Nasdaq up 9.5%, the Internet sector actually turned in a return of negative -2.8%.  Now that doesn't include dividends, but few if any Internet stocks pay dividends so I think it's safe to say that Internet stocks, as a whole actually lost money in 2006.

"Just how is that possible?" you might ask, well you need to look no further than the 5 largest Internet Stocks.

The table below lists the Top 5 Internet Stocks in terms of market cap:


In aggregate the market cap of the Top 5 Internet companies dropped $18.5BN or 6.7%.   That's a huge hole for the rest of the sector to try and make up (which it didn't).  Matters weren't helped by the complete implosion of the online gambling sector either which lost well over half its value.  And don't try to blame it all on Yahoo and Ebay either, even small cap internet stocks had a bad year.  While they didn't lose money, they gained a paltry 2.6% compared to the Nasdaq's 9.5% return.  Even the Net's new standard bearer, Google, underperformed the market, a fact which could probably win you more than a few bar bets this week. 

So don't let all the hype fool you, the Internet remains a pretty treacherous corner of the market no matter how much AJAX and Adsense you throw at it.

January 4, 2007 in Internet, Stocks | Permalink | Comments (2)

The Storage Explosion

I am a big believer in the “scarcity and abundance” theory of IT development. The theory basically postulates that if you want to understand the near term future of information technology development the most important thing to consider is the scarcity and/or abundance of the “big 3” foundations of computing power: processing power, storage and bandwidth. Understanding the absolute and relative levels of these three technologies is the closest thing possible to having an IT industry crystal ball as they have a huge influence over everything from system architectures to capital investment plans to end user demand.

A 15 Year Rocket Ship Ride
It is with this in mind that I found a recent article on Tom’s Hardware to be fascinating. The article details the increases in storage capacity and performance over the last 15 years. Some of the numbers involved are mind boggling.  In the last 15 years, the storage capacity of top-end hard drives has increased 5,907X from 130MB in 1991 to 750GB in 2006. To put this in perspective, during the same time period here are some increases in the other core technologies of a “bleeding edge” PC:

End User Technology19912006X Increase
LAN Bandwidth10 mbit/s (10BaseT)1 gbit/s (1000BaseT)102X
WAN Bandwidth14.4 kbit/s (v.32bis)3 mbit/s (Cable)213X
CPU Performance54 MIPS (486DX)27079 MIPS (X6800)501X
Hard Disk130MB750GB5907X

The price difference is even more dramatic. In 1991 a megabyte of storage cost about $7.00, now it costs $0.000527. That’s a 13,274X price improvement or a 99.9925% price drop in 15 years. Not too shabby.

It’s interesting to note though that disk I/O performance improvement has lagged dramatically with only a 121X improvement from 0.7 MB/s to 85 MB/s. This clearly makes disk I/O one of the biggest, if not the biggest bottleneck in a modern PC. Put another way, it would theoretically take 3.1 minutes to write the entire contents of a 130MB  disk drive in 1991 while it takes about 2.5 hours to write the contents of a 750GB drive in 2006 (as anyone who has tried to back-up a monster like this well knows).

Forecast Calls For: More, Cheaper Storage
The near term prospects for additional gains in storage capacity remain promising. For traditional magnetic storage hard drives, the introduction of perpendicular recording should continue to drive platter densities higher, but much like CPUs, the limits of physics are starting to catch up with magnetic hard drives which suggests that they will not be able to continue their capacity gains indefinitely. Not to worry though, two new storage technologies are finally coming to market this year including Flash memory hard drives and holographic storage. Flash memory hard drives use NAND chips instead of magnetic platters to store data. They have a number of important advantages over traditional magnetic media including dramatically faster file access times and the ability to process far more I/O operations per second.  For example, SanDisk just announced today a 32GB flash drive that accesses files in 0.12 milliseconds vs. 8 milliseconds for the best magnetic drive, a 67X improvement (although its read rate is only 64 MB/s).  Flash drives also draw 50-70% less power than magnetic drives, weight about 50% less, do not produce noise or vibrations, give off very little heat, and are less fragile than magnetic drives. But all these improvements do not come cheaply as the initial 32GB flash drives will cost more than $20/GB or about 35-40X more than a magnetic drive.  Still you should expect to these as an option on high end ultra-portable laptops in a few months.  I also expect that many PC enthusiasts may buy a flash drive for their "C:" drive to dramatically improve Windows Vista boot times.

2007 will also see the first commercially available holographic storage drives, although these drives are likely to only compete with archival media, such as tape drives and Blu-Ray media, for the foreseeable future. Holographic areal storage densities have doubled in just the past year and at 515Gb/inch are already more than 2X those of the most advanced magnetic drives.  To put this in perspective, Sony’s Blu-Ray disks which have just started shipping after many delays have a 50GB capacity while InPhase’s initial holographic disk (which had it’s 1st shipments just a few days ago) have a 300GB capacity and should go to 500GB in the next year or so. Put another way, you could store 106 DVDs on a single (slightly larger) holographic disk (although you can only write to these disks at about 23 MB/s, so be prepared to spend over 6 hours putting you DVD collection on a single holographic disk). Because it uses light rather than magnetic heads to access data, holographic storage should theoretically delivery better access times and faster read throughput than magnetic storage mediums. Holographic storage is expected to seriously challenge tape backup systems in the short term, but could also displace consumer storage mediums such as DVD and Blu-Ray as prices fall. Holographic disk drives are theoretically possible, but significant technical challenges still have to be overcome especially in terms of being able to rewrite the media and improve write speeds.

What Happens In A World Awash With Storage?
You may be asking yourself, this is all very interesting but why do you, someone who generally is focused on software and the internet, care so much about storage? I care because storage capacity is clearly the most abundant and faster growing component of the “big three”(processing power, bandwidth, and storage) today and it looks as though the relative disparity between the three may even increase further in the short term.  This situation should have some very interesting implications for both software and internet related businesses, some of which I will outline in my next post on the topic.

January 4, 2007 in Database, Internet, Software | Permalink | Comments (5)