Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 IN THS ISSUE Transaction Highlights Page 2 Transactions shaping the IT mergers and acquisitions space Executive Perspective with Tom Richards Page 4 IT Services Viewpoint by Marty Wolf August 27, 2012 Page 6 IBM (NYSE:IBM) announced that it would acquire Kenexa Corp. Value Lies in the Eye of the (NYSE:KNXA) in a deal worth $46 per share, for a total of $1.26 Beholder billion, representing a significant move by IBM into the Human Capital Page 8 Management space that follows SAP’s 2011 purchase of Five Key M&A Trends in SuccessFactors, Inc. and Oracle’s 2012 purchase of Taleo. Cloud Computing and IaaS September 10, 2012 Page 10 Infosys Ltd. (BSE:500209) entered into a definitive agreement to China’s Dragon Snuffed acquire Lodestone Management Consultants AG, which provides IT Out by Cloud consulting services to financial, pharmaceutical and consumer goods Page 13 enterprises with an implied enterprise value of $349 million. Maximizing Your Place on the Valuation Continuum SaaS Page 14 SaaS — How Long Can August 27, 2012 This Last? Thoma Bravo Fund IX L.P., a fund of Thoma Bravo, LLC signed a definitive agreement to acquire Deltek Inc. (NasdaqGS:PROJ), an Page 17 enterprise software and information solutions provider for $890 Taking the Right Steps to million, approximately $13 per share. Creating Value Page 20 September 19, 2012 Notes from a Dialogue on Lenovo Group Limited (SEHK:992) has signed an agreement to Cross-Border M&A acquire Stoneware Inc., a developer of cloud computing solutions through web technologies for an undisclosed amount. Page 23 ! Selected Transactions October 4, 2012 Page 25 Cisco Systems, Inc. (NasdaqGS:CSCO) completed its acquisition of Select martinwolf vCider, Inc., a virtual cloud networking service for an undisclosed Transactions amount. Page 26 Appendix 1 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 IT Supply Chain Services September 4, 2012 Tech Data Europe GmbH, a leading PC hardware distributor, has acquired Specialist Distribution Group (SDG) Ltd., a distributor of technology products and solutions, for $350 million August 9, 2012 HCL Insys Pte. Ltd., a leading provider of IT and related activities acquired NTS Fz LLC, a distributor of IT hardware and software solutions, for an undisclosed amount.! ______________________________ Executive Perspective: Tom Richards President and CEO, CDW Editor’s Note: In an effort to provide a C-Level perspective on ongoing trends in the IT space, and how they affect business, martinwolf interviews an executive each quarter from a leading firm in this space. Today we include Tom Richards, president and CEO of CDW, who provided his thoughts on the cross-border M&A, the importance of the cloud and other relevant topics. MW: What do you think are the three biggest trends affecting the IT business today? TR: Today’s IT environment is more dynamic than ever; new technologies and products are being introduced and rapidly deployed into our customers’ strategies. The top three trends our customers are engaging us on are mobility, cloud and big data because they believe these technologies — when strategically combined — can deliver a competitive advantage. That being said, there continues to be heavy investment in virtualization and unified communications. Most importantly, our customers continue to prioritize, invest and align their IT strategies with their business strategies and CDW is privileged to be part of that process. MW: Talk through your cross-border M&A Strategy TR: We believe we have 5 percent of a $200 billion market in the US and Canada. There’s plenty of opportunity to drive growth in North America. However, we’re always evaluating our strategy and looking for incremental opportunities for scale. Still, our focus is on executing our core strategy. 2 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 MW: How does the cloud alter your go-to market strategy? TR: It enhances our strategy to be the leading IT solutions provider in the markets we serve. One of our core goals is to continue to expand our solutions suite, which includes providing cloud computing expertise and capabilities. CDW recently announced a new partnership with salesforce.com that will diversify our cloud offerings. Through this partnership, we are able to provide both CDW and CDW- G customers with cost effective cloud solutions, as well as social, mobile and open capabilities of salesforce.com's cloud technologies. In addition, our managed services capabilities are a differentiator for CDW. Whether it’s public, private or hybrid cloud, CDW’s size and technical resources help companies implement and integrate cloud solutions. MW: Where does mobile fit into your long-term strategy? TR: Mobility presents huge opportunities for CDW customers because of its ability to deliver speed and responsiveness to improve their customer experience. We know that people want to use the same technology at work as they use at home, and IT organizations are becoming more comfortable managing BYOD environments because we can provide them with the critical tools to manage the network, risk, privacy and compliance that come along with consumer-based technologies. But, to me, the more exciting aspects of mobile technology are happening with business applications, especially in the areas of CRM, warranty management and service organizations. These applications are profoundly improving the way our customers serve their customers by providing them with the technologies, tools and capabilities to make it happen. MW: What are your thoughts on Social Media (both for customer communications and business strategies)? TR: There are conversations happening every day that shape brands and influence customer opinions, so we think social media plays an important role in both. For CDW, the customer has always been at the center of everything we do, so being able to engage with them in a compelling way via social media has helped us not only improve how we work as an organization, but also build a community of advocates for the brand. MW: Do you tweet or utilize any Social Media tools? BE: CDW continually adopts new strategies in the social space to engage customers, coworkers and the public. Social media has been a great driver of our brand messages. For me personally, I still value 3 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 face-to-face conversations and believe one-to-one relationships are equally important in how a customer feels about you and your company. MW: Do you find yourself working more or less as the digital age progresses? TR: Probably the same. For most people, it’s not always about if we are working more or less but how we work that changes. Technology certainly enables people to be more connected, which can therefore increase productivity and overall efficiency in an organization. It doesn’t mean you have to work 24/7. ______________________________ Viewpoint: Winds of Change By Marty Wolf Founder, President In early October, I was the keynote speaker at a conference on cross- border M&A organized by martinwolf and three other major players in the M&A world in India: Grant Thornton India, HSBC, and Khaitan & Co. The event, presented by the Bangalore Chamber of Industry and Commerce, was remarkable not just for what was said (though as Managing Director of our India practice group Gaurav Sharma, explains on page 20 it provided novel insight on the Indian M&A scene). It was also notable because it demonstrated how the focus of our India initiative has shifted since we established our Bangalore office early this year. When we decided to establish a physical presence marketing India, we expected to be primarily advising large Indian companies interested in purchasing U.S. assets. But our focus has evolved with the rapidly changing landscape, driven by several factors: • The weakening rupee, which has depreciated by nearly 25 percent against the U.S. dollar since August 2010 — an all- time high this past June — drives up domestic business expenses and the cost of overseas acquisition. • Slowing GDP growth in India, which has been steadily declining since the fall of 2010 and is on the path for a 10-year low after achieving only 5.3 percent growth in Q1 2012. 4 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 • The drastic decline in the number of Indian IPOs, which has fallen from a high of 61 in 2010 to just 10 so far in 2012 (as of September 25th). The current situation is the opposite of what we and many other observers had expected: the small, very technical companies with global footprints are in India, while in many cases the private equity investor or the strategic partner interested in buying is in the United States. Now, this does not mean that big companies are completely absent from the India M&A scene — there are still large companies doing sizeable acquisitions on a continuous basis. Regardless of size, though, a new trend is emerging: a shift toward cloud computing. This shift is not just limited to India. We’re experiencing it in our own client base — 30 percent of our companies are cloud services companies. And that doesn’t count all of the traditional Professional Services companies that are rebranding themselves Managed Services providers or the integrators that are now referring to themselves as cloud providers — I’m talking about real cloud-related services. The growing interest in this space is a meaningful change. And it’s not just the big guys like Oracle, IBM and SAP making big strategic investments in niche SaaS companies — there’s a lot of activity and consolidation going on in in the mid-market where we play. Buyers aren’t limited to the usual suspects, either. We’ve run several auctions in the cloud/managed-services space and the companies that have indicated interest are often unfamiliar names. In the coming year we also expect to see increased activity by PE firms both in the cloud and in M&A as a whole. I read a very interesting report recently in the Wall Street Journal about how private equity funds generally have a very narrow window (typically five to seven years) in which to spend their money or return it — and that period is almost up for the funds that were initialized in the peak years of 2007 and 2008. These funds still have $38.9 billion and $57.6 billion remaining, respectively, and I expect that a fair portion of it will end up in the cloud. Now, you can talk about diligence and fiduciary responsibility until you are blue in the face, but given the choice, PE firms would rather invest the money they have from investors (albeit at a potentially lower return) instead of giving it back. In fact, we are already seeing very aggressive moves by PE firms on a global scale. On a less rosy note, it’s important to remember that even with all this attention being given to M&A (cross-border and otherwise), getting 5 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 these deals finished remains difficult for companies of all sizes. There have been several firms in our space that, for reasons of financing, price fit, or some other reason, have been unsuccessful. Our own experience has been that finding the right buyer and understanding current market trends have never been more important. I want to close by returning to something I first brought up in the last issue of VDI: the uncertainty of the current political situation and how it continues to affect the M&A space. Regardless of who wins the upcoming presidential election in the United States, whether destabilization will improve or worsen depends on what they actually do once in office — not what they are saying on the campaign trail. But one thing is clear: if next year the maximum tax on long-term capital gains increases to 25 percent (rather than the current 15 percent) and short-term capital gains are taxed at a maximum of 40 percent plus (rather than the current 15 percent), that will have unintended negative consequences overall on capital markets. And that will affect all of our businesses for the worse. ______________________________ Value Lies in the Eyes of the Beholder By Yousif Abdura Senior Analyst One of the first questions many owners of companies ask when deciding whether to sell is “What is my company worth?” Valuation ranges can be established using revenue or EBITDA multiples based on valuations of comparable public companies, precedent transactions, and, in certain cases, discounted cash flow analysis. These tools give general valuation ranges in which a company can be expected to trade. However, the complete answer to the question has more to do with what a buyer is willing to pay, which is driven by either: a) a greater need for the asset, or b) being able to do more with the asset than the current owner or a competing buyer. For example, we are currently engaged as the sell-side advisor for a number of mid-market cloud-related companies. What we are seeing today is that these companies are far more valuable to prospective buyers (both strategic and financial) than they are to themselves. These companies have established solid businesses with recurring revenue, growing client bases, systematized processes and procedures and scalable infrastructures. They are prime acquisition targets due to the strength of their businesses, but their valuation will be driven primarily by what the prospective buyers believe they can 6 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 do by acquiring the asset. The examples below refer to instances where prospective buyers have seen the ability to capitalize on opportunities that would not have been feasible under current ownership: Accelerating Geographic Expansion / Increasing Market Share A common theme among prospective buyers in the cloud space has been to acquire in adjacent markets to take advantage of consolidation of data center space and resources. These buyers are also able to benefit from knowledge of regional markets, removing a future competitor and establishing themselves as significant regional players. Although cloud computing by its nature is about remote access, in the mid-market space customers are acquired through a traditional sales and marketing model, which is overwhelmingly local. Selling to a Vast Customer Base Value can be driven to high levels when a buyer is able to immediately take a company’s cloud services to its existing customers. In a recent example, a prospective buyer had 15,000+ customers who could be offered the cloud. Due to the scalability that the seller had already built into its business, this would have given it access to a potential customer base that was more than 100 times its existing base. In an example like this, the prospective buyer can justify paying significantly more than standard valuation methodologies would suggest that a company is “worth.” Enabling Business Transition In some instances, companies are looking to provide new, higher value and more profitable services than they currently provide. This is particularly true for companies in adjacent spaces that have industry knowledge and a significant customer base, but lack the in-house ability to develop a cloud-based service offering in a reasonable amount of time. Service providers in adjacent spaces have used M&A to move into cloud computing services in order to gain presence in the marketplace. For example, services providers from telecom (for example, TDS’ acquisition of One Neck or CenturyLink’s acquisition of Savvis), value-added resellers (for example, Best Buy’s acquisition of mindShift) and international buyers (NTT’s acquisition of Dimension Data) have all used M&A to build their cloud services offerings. To capture the most value in the sale of part or all of your business, it is helpful to know what buyers are looking for, but it is crucial to understand each buyer’s pain points and strategic goals. The highest valuations and the most compelling offers come from buyers that have specific and pressing reasons to acquire a business. Based on these axioms, a number of our cloud services companies are finding they 7 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 are significantly more valuable to prospective buyers than they realized. ______________________________ Five Key M&A Trends in Cloud Computing and IaaS By Sunil Grover Executive Vice President In the last edition of Valuation and Deal Insights, we defined the $100 billion+ cloud computing marketplace. We also talked about how various vendors groups — for example, Managed Services providers, Infrastructure as a Service (IaaS) providers, solution providers (traditionally referred to as value-added resellers or VARs) and technology companies — were approaching the opportunity. And we highlighted cross-border M&A opportunities in remote infrastructure Managed Services. We presently have four active engagements in the cloud computing/IaaS space. Based on this experience we see the following five key trends driving M&A in the coming months and quarters: 1. Private equity (PE) is extremely active in recapitalizing companies and driving subsequent acquisitions. The value proposition of IaaS is converting customers’ capital expenses in infrastructure to operating expenses in IaaS. PE professionals appreciate the significance of this value proposition. They are also attracted to the recurring revenue and deep customer engagement inherent in these businesses. Marketplace adoption of IaaS is growing rapidly and the marketplace is highly fragmented, presenting numerous opportunities for growth through selective acquisitions. Private equity recapitalizations in the recent years included GoDaddy, Endurance, Peak 10, Digital Fortress, Softlayer and Datapipe. These companies and several others have all done selective follow-up acquisitions to grow, as summarized in the table below. 2. Telcos are entering the IaaS market. Telecom companies provide the backbone connectivity to data centers. To move up the value chain and monetize their existing 8 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 customer base, several have acquired IaaS providers. Sizeable examples include Verizon’s acquisition of Terramark, Time Warner Cable’s acquisition of Navisite and Windstream and a telco provider for rural locations acquiring Hosted Solutions. Similarly, TDS’s acquisition of One Neck now allows it to offer cloud-computing services to its customers. 3. Public companies are driving strategic transactions. With access to public capital markets and previously established meaningful bases, publicly traded IaaS providers are pursuing strategic transactions that can meaningfully improve their value proposition. Web.com’s acquisition of Network Solutions, for example, was unique in that at the buyer acquired a company least twice its size and, as a result of the transaction, got General Atlantic, a very large private equity investor, as one of its significant shareholders. Rackspace has acquired small technology providers such as Mailgun, Anso Labs and Cloud Kick that will make its offering to enterprise clients more robust. Peer 1 and Equinix have both acquired overseas data center and hosting service providers to enter into new markets and provide their enterprise clients a global managed hosting solution. 4. Solution providers are entering the IaaS market. Value-added resellers and technology solution providers are the first point of contact when a mid-market customer is looking to investigate cloud solutions. Some of these companies have acquired IaaS capabilities. For example, Presidio acquired INX and Bluewater Communications Group to expand its IaaS offering Similarly, office supply retailers like Best Buy and Staples have entered the IaaS space, with Best Buy’s acquisitions of mindSHIFT and White Glove Technologies and Staples’s acquisition of Thrive Networks. Additionally, Konica Minolta has acquired All Covered to cross-sell remote infrastructure management services to its SMB customers, and has been growing further through targeted acquisitions 5. Hosting companies are becoming one-stop shops for mom & pop and small businesses. Hosting companies addressing the mom & pop/small business market are becoming one-stop shops for all their web-marketing needs. Most of them have been providing various SaaS applications as resellers 9 Valuation & Deal Insights® Industry Coverage: IT Services, SaaS, BPO and IT Supply Chain Services 3Q12 and some have recently started acquiring the more popular application providers so they can generate more revenues from their existing customer base. For example, Web.com acquired Register.com and subsequently Network Solutions, Inc. — both domain registrar services. GoDaddy.com similarly acquired Outright, Inc., an accounting SaaS solution for small businesses. In summary, M&A activity in the cloud computing / IaaS marketplace is high. In the recent past, it has largely been driven by private equity recapitalizations and private equity-backed platforms. Some telecom companies have made sizable acquisitions and increasingly publicly traded companies are acquiring strategically important assets. We expect M&A activity in this marketplace to continue to be robust in the near future. For more information, see the list of cloud computing transaction comparables in the Appendix. ___________________________ China’s Dragon Snuffed Out by Cloud By Hao He Vice President One of the main drivers of the transformation of China into a global economic superpower over the last 30 years is this: the Chinese government knows how to get things done. That’s why it is significant that in China’s 12th Five-Year Plan (2011- 2015) one of the seven “national emerging industries” targeted as a way to boost GDP growth was “next-generation IT,” and cloud computing especially. According to the plan, cloud computing will be a chief driver of the IT industry and the development of “e-government” in China. As background, China’s five-year plans lay out both social and economic goals for the country, and over the years the Chinese government has a pretty good track record of meeting or exceeding many of the targets in these plans. While this has become more challenging as the country has grown, China’s five-year plans remain a powerful force for rapid progress in areas China’s leaders deem 10