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While venture capitalists are waiting for the tech IPO window to crack open, buyout shops are having a field day taking public software companies private.
Three of the five top software deals in the U.S. this year have been take-private transactions, according to data from FactSet. Two were announced last week and the other was in April. The three targets — Qlik Technologies, Marketo and Cvent — sold for a combined $6.5 billion.
It's a brave new world for private equity.
Known for aggressively pursuing job cuts and office closures with debt-fueled deals, leveraged buyout firms are now banking on businesses that are still expanding but have fallen out of favor with Wall Street. They're playing into the trend of web-based applications and the software as a service (SaaS) delivery model, which is rapidly displacing legacy packaged software.
Gartner predicts the SaaS market will grow 20 percent this year to $37.7 billion, while worldwide IT spending as a whole is increasing only 0.6 percent. To make healthy returns on their investments, private equity firms now have to prove they can juice growth.
"The old wave of software LBOs was more about cost-cutting," said Owen O'Keeffe, head of West Coast technology M&A at Morgan Stanley, which advised Cvent, Marketo and Qlik in their sales. "This wave will be more about continuing to invest in growth with some cost optimization."
Private equity isn't without competition in the cloud consolidation war. Salesforce.com agreed last week to buy e-commerce software provider Demandware for $2.8 billion, CEO Marc Benioff's biggest purchase ever. Oracle announced plans in the last three months to spend $1.2 billion on Textura and Opower.
Driving the surge in activity are depressed stock prices. The Bessemer Venture Partners cloud index, which tracks more than 40 publicly traded cloud software companies, plunged 35 percent in the first six weeks of 2016. It's recouped most of its value, thanks largely to the big premiums that acquirers agreed to pay, but is still down more than 6 percent this year. The S&P 500, meanwhile, is up 3.5 percent.
Starting late last year, investors moved from growth mode to a focus on profitability, whacking most SaaS companies with cash-burning operations. IPOs have been nonexistent because start-ups that raised private rounds at steep valuations in recent years would have to take a discount if they were to go public.
But the business environment hasn't really changed and revenue projections remain largely intact. That's enabled buyers to find some hefty discounts. In the Bessemer index, the average price-to-sales ratio (based on enterprise value) for cloud software companies has dropped to 5.4 from a peak of 9.5 in early 2014.
Technology Crossover Ventures, a Silicon Valley firm that backs late-stage start-ups and invests in public companies, used a 60-plus percent plunge in LinkedIn shares as an opportunity to snap up a stake during the first quarter, in what founding general partner Jay Hoag called the "sale of the year."
Similarly, Battery Ventures, a software-focused venture firm that also does buyouts, is actively searching for potential takeover targets.
"Historically, there just hasn't been an opportunity for take-privates in SaaS-land," said Chelsea Stoner, a partner at Battery and investor in Marketo back when it was a start-up. "With multiples compressed, we're certainly on the lookout."
When Vista swooped in to buy Cvent in April for $1.65 billion, the price of $36 a share marked a 69 percent premium to where the stock was trading. Prior to the announcement, the stock was down by more than half in a little over two years.
Vista won a bidding war that involved another private equity firm and multiple companies, according to Cvent's proxy filing.
"They weren't even frankly on our radar screen," said Cvent CEO Reggie Aggarwal, who took the company public in 2013. "They came unsolicited to buy us."
Cvent's web-based software helps businesses, schools and nonprofits plan and manage events and conferences.
The deal is expected to close in the third quarter, and Aggarwal is now rallying the troops. After all, when employees hear private equity, they think cost efficiencies and job cuts.
On Tuesday, Aggarwal held two quarterly webcasts from his office near Washington D.C., for Cvent's 2,000-person global workforce. For 90 minutes in the morning and again in the afternoon, employees grilled Aggarwal on whether they'd still have jobs, opportunities to advance and keep their benefits.
To reassure them, Aggarwal pointed to the company's 180 job openings, the dozens of people hired since the deal was announced and the millions of dollars Cvent is spending to expand three offices.
"Their investment thesis for us is growth," Aggarwal said in an interview, repeating his message from the webcast. "You don't pay that kind of premium and then squeeze it for a profit."
Aggarwal's story stands at odds with the public perception of Vista. The firm, led by Robert Smith, is known for firing high-paid executives, replacing many U.S. positions with cheaper off-shore alternatives and milking the cash from the resulting earnings.
Byron Deeter, a partner at Bessemer, said it's called the "Vista playbook." He's skeptical that these deals will be any different.
"They're trying to promote the idea that this is the new Vista," said Deeter, whose investments include Box, DocuSign and Twilio, which filed to go public last month. "I suspect they will spin some other things together and then manage for profitability at a larger scale."
For example, Cvent could team up with Lanyon, another event management software company in Vista's portfolio, combining their sales and marketing efforts.
One thing is clear — Vista isn't slowing down. The firm, with offices in San Francisco, Chicago and Austin, Texas, is in the process of raising a fund that reportedly may reach $10 billion. In addition to Cvent and Marketo, Vista recently purchased Ping Identity, a privately held security software vendor, and partnered with Bain Capital to buy insurance software provider Vertafore for $2.7 billion.
A spokesperson for Vista said the firm was unavailable to comment for this story. A Marketo spokesperson declined to comment because the deal hasn't closed.
Thoma Bravo, based in San Francisco and Chicago, agreed last week to spend $3 billion on data analytics provider Qlik, the firm's third biggest purchase, according to FactSet.
Like many of Thoma Bravo's deals, including Riverbed Technology, Compuware and Blue Coat, Qlik was pushed to sell by activist hedge fund Elliott Management. Elliott said in March that it had built a 5 percent stake in Qlik, calling the company "significantly undervalued."
Less than three months later, Thoma Bravo came in with a purchase price 40 percent higher than when Elliott disclosed its ownership, but still 27 percent below the stock's record high in August.
Seth Boro, a managing partner at Thoma Bravo, told CNBC.com in January that activist funds represent "a segment of the capital markets that's here to stay." A Thoma Bravo representative said the firm wasn't available to comment for this story.
Qlik's growth has slowed dramatically in recent years, but analysts still project a 16 percent increase in 2016 revenue. Marketo is predicted to grow 30 percent, and analysts expect 23 percent growth for Cvent.
A company that grows 25 percent annually doubles in size in a little over three years. So if private equity owners can achieve or maintain those levels and possibly see an improvement in the multiples that investors are willing to pay, it's not hard to see how they make money in short order. Each of these deals was significantly cheaper than the average software acquisition over the past seven years based on a multiple of revenue, according to analysts at D.A. Davidson.
Getting there will require nailing the subscription model. The value in SaaS companies is the continuing renewals of their existing subscriber base, thus converting upfront costs into long-term predictable revenue. Investments in customer service and product development are critical if clients are to keep writing bigger checks.
As the CEO of a Marketo rival, Andy MacMillan is watching closely to see what path Vista chooses and how customers react. MacMillan's company Act-On Software is a smaller player in the marketing automation business, helping corporate marketing departments manage and analyze their campaigns.
"It's certainly a different dynamic for me as a competitor in the market," said MacMillan, whose company has raised over $70 million from investors including TCV and Norwest Venture Partners. Any frustration from customers, "might mean I win a larger share of new deals," he said.