PE-Buyout, Technology Companies and Vertical Integration
When I read articles in the financial press that contain quotes from market participants about the market, I often wonder whose agenda is being served. I read this Bloomberg article that contains some quotes from Charlie Giancarlo at buyout firm Silver-Lake. The title is “Silver Lake Sees Fresh Round of Telecommunications Takeovers,” and it begins by saying that PE-Buyout firms are going to “zero in on makers of telecommunications equipment and mobile devices this year.” I have no idea if this is what Charlie meant to say, but any PE firm buying ALU, NSN, RIMM, TLAB, etc, my comment is good luck. I have immense respect for Charlie and what he did at Cisco, but I question if his list of buyout candidates include aging telecom equipment makers and fading handset makers.
I have written before about a PE-buyout of NSN here and RIMM here and I have also written about the fallacy of valuations being considered cheap. There is a difference between unrealized or hidden value and companies with cheap valuations. In the Bloomberg article there is a quote from an investment advisory saying “The big story to me is the incredible undervaluation of Alcatel, this stock is a screaming buy. Private equity should be all over this.” Everyone is entitled to their opinion and for all I know bankers could he putting the final touches on deal for ALU, but I think we need to be very careful when we discuss technology buyouts, they are the not the same as taking RJR/Nabisco, Albertson’s, Hertz and even Alltel private. Technology companies are different from traditional consumer and industrial markets because of the innovation/product cycle nature of their markets. The Oreo has done well for Nabisco for one hundred years come March 6, 2012 selling over 491 billion cookies according to Wikipedia. That is a long and successful product cycle with no comparison in technology. I inserted two charts a 20 Year and a 10 Year of ALU for review with no comment.
If I was to get a call tomorrow from a PE firm and they were to ask me about buying out any of the public technology companies that have cheap or compelling valuations I would think about their question in four areas and none of them have to do with their balance sheet and current market valuations:
1. What is the state of the present day market construct: I just posted on the service provider market last week. Selling infrastructure equipment to global service providers is hard work and Huawei does not make it easier. Why anyone would want to spend billions to own a business that is difficult and not getting easier is beyond my reasoning skills.
2. Can the legacy company fail fast enough to be successful again? Legacy companies often lack creativity and this is manifested in their product cycles which turn negative and result of that development is a lack of creativity. See my December 2011 post for the details. I do think that large public companies can innovate, but to see the market beyond their past/present view they need to separate a team to prevent innovation from being distracted by the present and blinded by the past. IBM did that with the PC and Apple the same with the iPhone and iPad.
3. Product Cycle Management is the True Measure of Success: I have spent a lot of time posting about product cycles on my blog. They are all listed here. I would ask myself with each buyout candidate: can the product cycle be fixed, can it become a weapon, can the company innovate to take share and differentiate in the market? Just because a company is cheap or has a large patent portfolio does not mean that the team and talent is present to fix the product cycle. Technology companies are very much about the talent level of the team. Hertz may have secured the best physical locations at each airport and that is hard to compete with, but in tech others can find ways to attack your market share and location is not a barrier to entry.
4. How is the Market Changing: Another subject that I have spent considerable time on is the changing nature of networks and the end-user markets. All the posts starting in May 2011 are here. The question I would need to answer is can these legacy companies be players in the changing structure of compute-storage-networking market construct?
I know it is possible to take a company private (e.g. Avaya) or use a private company as a platform (e.g. Genband) to put other companies around it to build solution mass and market share. It is not easy, but it can be done.
There is another market ebb and flow for technology companies that is playing out and that is vertical integration and the world is flat crap. In the 1980s-1990s companies were all about vertical integration such as IBM. The competitors who did well against IBM were singularly focused solution companies such as MSFT, Compaq, DELL, CSCO, etc. Post 2001 the mantra for technology companies was to divest non-core assets, out source businesses such as in-house silicon and functions such as their supply chain and manufacturing to APAC. If you look at what is going on today, the large public technology companies are in the midst of assembling a vertically integrated company from the assets they spent a good 15 years outsourcing.
Take Cisco for an example. Most people think of Cisco as a networking company, but they sell blade servers (i.e. compute) and they have been acquiring optics and component companies as well. IBM who sold their networking business to Cisco in 1999, is now putting it back together. HPQ purchased 3Com (i.e. networking) as well as 3Par (i.e. storage) to go with their compute (i.e. Compaq) business. DELL who started as a PC business and got into servers now owns Equallogic (i.e. storage) and recently purchased Force10 (i.e. networking).
My point is these are large companies all trying to cover compute-storage-networking market and Cisco is no longer a singularly focused networking company. We are on the verge of a new 10-15 year cycle in the network as I described here, here and here. Even Verizon is telling you the network is going to change. My question is why would any of the companies speculated about as buyout targets be the platform of choice to take share in the new emerging compute-storage-network market construct?
* It is all about the network stupid, because it is all about compute. *
** Comments are always welcome in the comments section or in private. **
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Any thoughts on whether Extreme Networks would fit this PE profile? Heavy cash, FCF generative, improved product cycle, activists in charge of the board, cheap valuation