Click here for PDF

TABLE OF CONTENTS
Introduction: Infrastructure Sector Down, But Not Out
Public Equity Performance
M&A Activity in Infrastructure Software Q3 2009-Q2 2009
Why Infrastructure Software Is A Bright Spot In A Dim Economy
Updata Infrastructure Software Transactions
References
Contact

Infrastructure Sector Down, But Not Out
The infrastructure software sector is beginning to show signs of a return to more normal market conditions after a particularly weak 12 months. For Q2, Updata tracked a total of 14 deals, which represents the second consecutive quarter of increases in deal volume. This is a promising change from the miserable market for M&A transactions in the 12-month period ending June 30, 2009. During that period, nearly every trend was in decline: deal value, aggregate value, and median multiples of enterprise value to trailing revenue.

Typically the M&A results for this sector are buoyed by a few key characteristics: a brisk pace of M&A activity among the largest vendors, several mega-deals and a reasonable proportion of deals done at above average valuations. With a few exceptions, each of these characteristics have been notably absent from the infrastructure software M&A scene for the past twelve months. This is not a surprise given the broader economic conditions, which have had a substantial impact on virtually all segments of the economy on a global basis.

But there is some potentially good news. Total announced deal value ballooned for Q2 to $3.2 billion, buoyed mostly by EMC's announced $2.1 billion acquisition of Data Domain. But even excluding the Data Domain numbers, total deal value still shows a substantial rise over past quarters. Also, while enterprise IT spending is down across the board, certain areas of infrastructure are still expected to grow at a relatively quick pace, specifically through the growth of cloud computing.

Public Equity Performance
For the twelve month period ended June 30, 2009, all public security indices are down markedly, although our index of public infrastructure software companies is down less than the broader market indices (see Figure 1).¹When viewed over the last six months, (see Figure 2) the picture is materially different, with all indices performing well and with the infrastructure companies outperforming the market as a whole. What is particularly interesting is how far the stock prices have moved since the lows that were touched during Q1 of 2009. Updata's infrastructure software index has climbed nearly 40 percentage points since the end of February to an increase of 20% for the six months ended June 30. This increase drives the index well above the other market indices and 3.5 percentage points above the tech-heavy NASDAQ.

We believe that low stock prices and trading multiples of key buyers were a significant contributing factor to the slow down in M&A activity and the reduced M&A transaction multiples over the past year. The third quarter is already starting out strong, with Software AG's $705 million announced acquisition of business process management software provider IDC Scheer AG. In the July alone, the infrastructure software index gained 5 percentage points, keeping pace with the other indices. The improvement in the market for publicly traded securities has already lent some support for improvements in the M&A market and we expect it to continue to do so.

Figure 1:Infrastructure Software Stock Price Performance Against Broad Market Indices, Year Ended June 30, 2009


Figure 2: Infrastructure Software Stock Price Performance Against Broad Market Indices, Six Months Ended June 30, 2009


M&A Activity In Infrastructure Software Q3 2008-Q2 2009
Infrastructure software M&A activity was substantially below traditional levels during the entire 12-month period ended June 30, 2009. During the year, Updata tracked 47 infrastructure software deals aggregating approximately $4.5 billion in announced transaction value, compared to 80 transactions with an aggregate announced deal value of about $17.1 billion during the previous twelve months. The median multiple of enterprise value to last twelve months (LTM) revenue for transactions during the year is also down to 1.4x from 2.9x during the previous year.² 

However, there are several indicators of improvement emerging across the sector. First, deal volume, aggregate announced value and median LTM EV/Rev are up for Q2 2009 after four consecutive quarters of decline (see Figure 3). Second, in that same quarter (Q2 2009), we have seen the return of larger deals in the M&A market and some competitive bidding situations such as the NetApp/EMC duel over Data Domain. While one quarter does not necessarily establish a new trend, it is a clear departure from the persistent negative trend that has existed over the previous year. When combined with the improving market for publicly traded securities, we are confident that metrics for the M&A market will continue to improve and result in higher volumes and valuations than those experienced over the past year.

Figure 3: Deal Metrics For Infrastructure Software Q3 2008-Q2 2009

• Multiple buyer types are driving M&A activity. During this period of low M&A transaction volume, it is not surprising to see that the level of activity among the sector leaders has been low. On a combined basis, BMC, HP and IBM accounted for only three transactions in the sector. While activity among this group was particularly low, we continued to observe activity from emerging participants in the sector as it continues to evolve and change. Oracle and Cisco each completed three transactions in the sector, not including Oracle's announced acquisition of Sun Microsystems. We also noted the return of CA to M&A after a long hiatus, with its acquisition of Cassatt. It also acquired security vendor Orchestria -- an Updata client -- during this period. The balance of the M&A activity during the past year was accounted for primarily by transactions involving smaller, more focused buyers such as Micro Focus' acquisition of Compuware's application testing and automated software quality business and Novell's acquisition of Managed Objects (both of which were Updata transactions). We also observed a number of transactions involving the merger of two private companies, such as Barracuda Networks' acquisition of Yosemite Technologies (an Updata transaction) and SpringSource's acquisition of Hyperic.

• Storage and data center virtualization and automation continues to thrive. As we have mentioned in previous publications, key areas of M&A interest continue to be around storage and data center virtualization and automation. During this difficult period, these two sub-sectors accounted for the two transactions with the highest reported multiples of enterprise value to LTM revenue -- EMC/Data Domain at 6x and Cisco/Tidal Software at 3x -- and approximately 40% of the overall deal volume with 20 out of 48 transactions (see Figure 4). These two areas combine large, rapidly growing sources of enterprise demand with high levels of market disruption and technical innovation which are fundamental characteristics of active technology M&A markets. As the overall economic environment and M&A market conditions improve, we expect these two areas to continue to account for a substantial portion of the overall deal activity, as well as some of the highest valuations and highest profile transactions in this sector.

• Innovations Bring Savings. Recent and continued innovations, such as virtualization and automation, are enabling enterprises to realize meaningful savings in capital and operating expenses. By investing in these technologies, enterprises can improve infrastructure utilization and eliminate certain personnel expenses, resulting in rapid realization of savings and the ability to establish newer, cost-effective practices going forward.
  
  
• Cloud Computing Brings New Opportunities. Several of these same technologies are also enabling the establishment of a new flexible, scalable architecture for IT infrastructure that we have referred to as cloud computing. Broader implementation of cloud computing in turn enables new business models and new sources of demand for IT infrastructure. The consumer market, with applications such as YouTube and Twitter, provide a compelling illustration of this evolution.
  
  
• Data Management Remains Important. Data growth has continued unabated through the downturn and will only accelerate as additional business processes are automated and new applications and services are adopted. The importance of managing, accessing and protecting this data will increase accordingly.
  
  
• The Landscape Is Changing. One compelling illustration of the disruptive nature of this market is the emergence of VMware, a virtualization solution provider, as an almost $2 billion business in the heart of a territory dominated by large entrenched vendors of operating systems and IT management solutions. As the limits of market opportunity are being redefined, we expect to see high levels of activity continue across the spectrum of major and emerging IT infrastructure vendors as they develop new products, establish new partnerships and pursue M&A. Recent examples of potentially game changing initiatives include Cisco's introduction of its Unified Computing System and Oracle's acquisition of Sun Microsystems.