Oracle Corporation's M&A strategy, presented at SIIA PE forum

The Software & Information Industry Association sponsored a presentation with Vishal Bhagwati, VP Corporate Development of Oracle, to discuss Oracle's Acquisition and Integration strategy. Given the spotlight on venture exits, the topic, part of an ongoing series of events the SIIA is sponsoring for its Venture Capital members, was especially relevant.

Here are some quick Oracle facts that highlights its scale:

$22.6B Revenue for FY '08
320,000 global customers
20,000 Partners
80,000 employees

They are the second largest Saas vendor in the world where they think of it as yet another deployment option to make their products available via purchase or subscription.

Oracle Strategy:

To offer the most complete industry portfolio around standards-based architectures that are integrated to work together. They view IBM, SAP and MSFT as their key competitors and try to differentiate their position as follows:

IBM is not in applications
SAP is not in the database or in the application management field
MSFT is totally proprietary

M&A background

50+ acquisitions aggregating $45B in value. Now at the pace of completing 3-4 transactions (not including IP based deals) per quarter.

View M&A as a tool for growth, not a strategy in its own right. Post transaction, having someone accountable for the metrics is critical to bringing planned value.

Their focus is on the following value components (note to self...re-read before presenting any portfolio company considering M&A with Oracle):

* Providing customers with broader and better product capabilities
* As a vehicle to meaningfully enter complementary industries
* Accelerate core product innovation
* Lower cost of customer ownership, through pre-packaged integration (drive towards permacheap).

Oracle has seen successes in their vertical industry offerings where markets such as Communications, Retail and Manufacturing have seen multiple transactions to boost organic growth. They have not yet completed any transactions in the Health care or the Public sector but, given these market sizes, it's logical they are looking deeply in these markets.

The current environment is intensifying their interest in transactions as they have currency and see an opportunity to fill in areas of interest at attractive values. Note that he stressed that Oracle deeply discounts prospective synergies in valuing their transactions.

Integration strategy

Capture hearts and minds of employees and customers
Rapid back-office integration
Track results on a weekly basis

Role of Bankers

He was asked (by me) where bankers bring the most value, introduction or deal structure. He was polite, but it seemed as if his answer was neither. They have an active industry touch program and tend to know many of the people who would be board members of acquisition targets, so approaches are easy and, if a Company is for sale, they inevitably get a call from someone (whether its a banker or board member). On structuring transactions, while they don't need assistance, a professional can readily assist the target's management team/board.

One area, where I have seen bankers greatly assist, is when the board/shareholders/management do not have aligned interests due to a 'funky' capital structure resulting from multiple funding rounds. In these instances, a professional ostensibly hired for their outside expertise can be invaluable when dealing with insiders.

Final thought

Over the years, we have seen a number of companies (best personified by Computer Associates) embark on aggressive acquisition strategies. Notwithstanding the accounting 'mischief' CA really used M&A as an effective means to emerge as a market leader. Their key flaw was abandoning innovation, therefore, when the company grew so large as to run out of meaningful acquisitions as a means to bolster growth, the deck chairs toppled into the ocean. I am not sure how much of Oracle's growth is tied to its thus far successful M&A integration, though I suspect they have the opportunity, to complement their very public transactions with some potential game changing technology based transactions (like Cisco and Citrix have so successfully done).

2008 Public Internet M&A: Year In Review

Bill Burnham, an ex-Wall Street analyst and current hedge fund manager posted reviews on Public Internet M&A, Software IPO, and Internet IPO activity for 2008. As expected, all showed a dearth (understatement) of activity.

Looking at the M&A statistics, it seems to me that the lack of actviity is related to two factors; one short term and the other industry structural. Addressing the short term issue is that it's hard to place a value on a company when it's stock (and yours) is melting down an average 41% in a six month time frame. We have seen spastic run-ups and run-downs and they just about always freeze buying and selling.

The larger issue is the lack of IPO's. This multi-year freeze seems to be turning the software/internet market structure from a classic triangle (with the largest number of companies at the top and the greatest on the bottom), to more of an hourglass where the middle-market public companies, which historically account for an outsized % of transactions, are disappearing. The disappearance of these firms, not replaced by new ones, is limiting M&A volume. Three related factors ought to be in alignment to bring back the software/internet middle market; company performance, ready equity buyers, and Wall Street firms willing to bet their balance sheets.

We are in the midst of some tidal changes that will undoubtedly give us great opportunities, but just not the same one's we saw for the past 10 years. For many investors, as Warren Buffet once said, 'the shifting tides will expose those of us who were skinny dipping'.

Freemium business model

In a number of internet market segments (gaming, content distribution, security, performance enhancement), participants seek to lower the cost of customer acquisition through giving away a starter version of the product and offering a paid enhanced version. Often the board room debate centers around the cost to provide the service (bandwidth, storage, support), marketing, and the conversion rate to an enhanced version that is a gateway to the paid model.

It's important to differentiate between companies that focus their energies around the conversion from free to paid, vs. vendors who concentrate on 'free' to use, but are advertised supported. The later really support themselves via an attention tax that users pay each time they use the product. The beauty of this tax is that, for vendors such as Google, the tax, when properly implemented is not too obtrusive, and adds to the overall user experience.

Chris Anderson posted an insightful article in Wired that discusses his views, with a link to MMMPOW that cites statistics in the gaming market. Per MMPOW, here are conversion rates from free to paid for select successful vendors in the casual gaming arena:

* Club Penguin: 25% monthly uniques pay, $5/mo per paying user
* Habbo: 10% monthly players pay, $10.30/mo per paying user
* Runescape: 16.6% monthly uniques pay, $5/mo per paying user
* Puzzle Pirates: 22% monthly players pay, $7.95/mo per paying user

These are way higher than my experience in horizontal business segments, which mostly do not have the benefit of strong community (anyone know LinkedIn conversion to paid?), where a 2% conversion rate is considered successful.

For awhile, the software and internet industry went through a phase where vendors placed an 'annoyance' tax on users of the free product by bombarding them with pop-ups and other annoyances as a way to improve the conversion percentage. Thankfully, competitive realities have minimized this practice as building negative brand equity is ultimately a poor practice (I wonder if today GM feels their planned obsolescence was a good thing?).

Overall, many mail vendors have done an outstanding job of striking a balance between value offered for their free products and garnering revenue for themselves. In their business, it takes a tremendous amount of capital to subsidize horizontal and global applications, before the business can generate positive gross margins through advertising and upgrades. So much capital that the innovation bar is now so high that entrepreneurs must really be doing something special to succeed here.

I am intrigued by the free/paid line in the security and performance enhancement market where Anti-virus, firewall, registry cleaners, disk maintenance vendors, amongst others, have mostly embraced a free to paid model. Sort of like going to the dentist for a free cleaning, with expectations that they will garner the later root canal work.

Let's be reasonable

One of the smartest guys I know, who would never admit it, is Larry Wagenberg. Usually a market sober person, he's just turned bullish about the prospects for making money through investing in the public sector (that complements his venture activities); it's not that he's optimistic about the economy, just that he sees good long term value to be gained by investing when he sees a sudden buy/sell imbalance. His points about the yield curves, hedges gaining their footing, and consumer indexes are all well grounded and got me thinking about some fundamental points in the venture market.

For some perspective, here's numbers from Goldman Sachs reflecting on public valuations:

Software median expected 3 year growth in earnings: 12.2%
P/E to growth ratio for software: 1.2x (which means that if a company has a 20% growth rate, you would expect a 24x P/E multiple

These numbers highlight the steady, yet unspectacular growth in an industry commonly thought of as a 'growth' market. I suppose there's no better tell tale sign of a mature market than analysts tracking valuation as a multiple of maintenance revenue (5-8x)! Having grown up in the 80's, isn't it striking that they now track a mere 3 desktop software companies; Adobe, Intuit and MSFT? Game over.

This highlights when the turbulence caused by hyper growth settles, customers always anoint 2-5 'winners' from the scores of participants (as Geoff Moore would say 'Gorillas, Chimps and Monkeys'). The enterprise market is well along on the same path and we are seeing accelerated market concentration, where the number of vendors is in steady decline, valuations are based on maintenance revenues, and the best acquisitions are around cost reductions. Charles Wang (CA), you were way ahead of your time.

Expectation of growth has always been a key driver for valuation and the positive liquidity events that are the hallmarks of our industry. Mary Meeker recently cited interesting data in Morgan Stanley's latest Technology/Internet Trends publication:

2002 2007

Broadband growth(%) 78 23

Mobile user growth (%) 20 20

Internet user growth (%) 26 16


With the Internet phenomenon, at least the public companies, entering their 13 year, with revenues and users measured in the billions, it's clear the expectations for gross market growth have slowed and are factored into public valuations. Even given the suddenness of the adjustment, it's hard to find a great deal of fault with today's valuations when compared with expected growth. Per the folk at B of A (Brian Pitz), the P/E to Growth ratio in the Internet segment, based on '09 earnings, looks to be about 1x. Google comes in at .7 and Yahoo at 7x(small e)! They are expecting online advertising to grow at a steady and unexciting 14.6% CAGR (search, display, lead gen, classifieds, etc).

So, why am I an optimist at the prospects for venture investing in the internet, software and technology enabled service arenas?

1. The multi-billion dollar internet industry consists of a myriad of niches; many are emerging each year with hyper growth characteristics. Most will plateau when generating revenues in the sub-billion dollar range and will lead to companies that, when successful, will generate revenues in the hundreds of millions of dollars.

2. These companies have the potential to be created in an incredible capital efficient way. Just in time bandwidth and storage, administrative applications paid per user/month, open source tools and instant metrics for PPC/CPM enable instant adjustments.

3. The capital required to create a self-sustaining market leading player (albeit beginning in a niche) is a fraction of what it once was. Therefore, if a Company reaches a self-sustaining run rate at, after consuming a modest amount of capital, and is executing within a growth segment, it has the potential to handsomely reward its shareholders. Additional capital raised in these circumstances, will be done so at favorable terms to the existing stakeholders.

4. Reaching customers (to sell and support) anywhere in the world, at low price points, can now be profitable at prices that are staggeringly low. Moreover, the drive by entrepreneurs to pass along these cost savings to customers via low prices creates huge opportunities for sustained growth.

5. Customers expect the industry to 'eat its babies'. Out with the old and in with the new only accelerates in turbulent times when folk are forced to save costs, or lose jobs. When the stock shock passes, look for accelerated opportunity for companies with compelling cost saving metrics. Robert Levitan of Pando (I am on the board) leads with the message of 'we will cut your bandwidth costs by 75%, and keep your existing SLA's'. Hard not to listen.