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Why activist investor surge means more tech M&A

A Riverbed Technology conference sign
Source: Riverbed Technology | Facebook
A Riverbed Technology conference sign

Activist investors are running wild. For tech private equity firm Thoma Bravo, that means a pipeline of deals.

Between 2010 and 2015, assets under management at activist hedge funds soared from $47 billion to $130 billion, according to JPMorgan. Data from Preqin pins the current number currently at $142 billion.

In putting that massive pile of money to work, an expanding class of investors has been buying big stakes in slow-growth technology companies and then pushing them to break up or sell. At the same time, Carl Icahn has pressured Apple to return cash to shareholders and Bill Ackman has poured money into pharmaceutical developers.

With activists scouring the planet for value, it's no accident that Thoma Bravo's three biggest acquisitions have all been announced in the past 16 months. Two of them — Riverbed and Compuware — were purchased after activist hedge fund giant Elliott Management gobbled up shares.

"It's a segment of the capital markets that's here to stay," said Seth Boro, managing partner at Thoma Bravo in San Francisco. "It's definitely creating opportunities."

Of the 51 U.S. tech acquisitions of at least $1 billion over the past three years, 15 have been private equity transactions, according to FactSet. Thoma Bravo has been a buyer in four of them: SolarWinds, Riverbed, Compuware and Intuit Financial Services.

Thoma Bravo's top deals

Target
Price
Announced
Activist pressure
SolarWinds $4.5 bln Oct. 2015 None
Riverbed $3.6 bln Dec. 2014 Elliott
Compuware $2.4 bln Sept. 2014 Elliott
Novell $2.2 bln Nov. 2010 Elliott
Blue Coat $1.3 bln Dec. 2011 Elliott
Deltek $1.1 bln Aug. 2012 None
Intuit Financial $1 bln July 2013 None
Source: FactSet, Thoma Bravo

Among the billion-dollar deals was Blue Coat Systems, which Thoma Bravo purchased for $1.3 billion in 2012 after activist involvement, and sold last year to Bain Capital for $2.4 billion.

Some of the biggest tech sellers, Symantec, BMC Software, Informatica and TIBCO were also pressured by activists. Typically, activist funds target profitable companies with languishing share prices by loading up on so much stock that they can force management to act.

Riverbed CEO Jerry Kennelly had a front-row seat at the movie.

The networking company, which he founded in 2002, came under fire from Elliott after the hedge fund started buying shares in late 2013. Riverbed was struggling to generate growth out of acquisitions and expand beyond its core business, leading the stock to plunge by more than half over the course of two years.

The relationship turned ugly in early 2014, when Elliott put in a bid to buy the whole company and claimed that management was making "highly misleading statements" to shareholders about the level of buyer interest.

Eight years earlier, Kennelly led a hot networking IPO. Now he found himself burdened by public investor demands.

"The problem is that as you get bigger and you have to pivot and do different things, it's harder in the public eye," said Kennelly. "The main value that Wall Street puts on a company is really on short-term revenue growth."

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Thoma Bravo finally acquired a majority of Riverbed for about $3.6 billion in April, winning the bid over eight other investor groups and getting Elliott off Kennelly's back. The deal included $2.1 billion of debt.

Riverbed, out of the public spotlight, has revamped its own deal engine, announcing this week the acquisition of Ocedo to expand in software-based networking.

For Thoma Bravo, the Riverbed opportunity would likely not have popped up without activism, because the company's board didn't want to sell and Thoma Bravo prides itself on being management friendly. In other words, it doesn't go hostile.

"We're seeing companies being much more open to it," Boro said. "Public markets can be tough for businesses going through changes."

The firm has a long history with Elliott: Riverbed, Compuware, Novell and Blue Coat were all pressured by the hedge fund before selling.

Thoma Bravo has existed in its current form as a software and technology-focused firm since 2008. Its last fund in 2014 raised $3.65 billion, and the firm is currently aiming to bring in about $7 billion for its next fund, Reuters reported in November.

There are potential hurdles ahead.

For one, the era of record low borrowing costs is behind us, meaning the leverage piece of leveraged buyouts is getting more expensive.

The Federal Reserve raised its benchmark interest rate last month for the first time since 2006, and Boro said debt markets have been volatile for the past year or so. With markets across the globe plunging to start the year, all bets are off.

Also, the performance of activist funds peaked in 2013 with annual returns of 18 percent, followed by 6 percent in 2014 and 3 percent last year, according to Preqin. While activists' assets continue to rise, the number of funds launched has dropped each of the past two years from 45 in 2013 to 27 in 2015.

Not all of Thoma Bravo's deals are driven by activists. In October, the firm along with Silver Lake agreed to buy IT management software developer SolarWinds for $4.5 billion.

SolarWinds shares had dropped over the previous three years amid acquisition challenges and leadership turnover. The company hired bankers when an acquisition began to look like its best option.

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But other businesses like Compuware weren't looking for an acquirer until the activists arrived. Elliott started buying shares in 2012 and then bid to buy the whole thing.

Compuware rejected the Elliott offer before selling to Thoma Bravo in 2014.

Under the Thoma Bravo umbrella, the company was split into pieces, with the Compuware brand keeping the legacy mainframe software business and the faster-growing Dynatrace unit being spun out to focus on application performance management.

Dynatrace CEO John Van Siclen was initially skeptical of the transaction because "there are a lot of negative connotations that come along with private equity," he said. There are plenty well-documented accounts of buyout firms loading their companies up with debt and forcing rigorous cost cuts that wring out any growth potential.

But Dynatrace is investing to go head to head with rapidly expanding vendors like AppDynamics and New Relic (occasionally even competing with Riverbed and SolarWinds).

By going private, Dynatrace was able to separate from Compuware without a messy breakup and stock sale.

Thoma Bravo's approach was to "keep the management team in place and give them some operational talent and experience on the board," said Van Siclen. "Then let them rebuild in a new image and drive a more efficient and successful company."