Quest Deal at Lowest Premium Poised to Lure Higher Bid: Real M&A
A buyout of Quest Software Inc. at the industry’s lowest premium is leaving the door open for higher bids by companies from International Business Machines Corp. (IBM) to Dell Inc.
Quest, the provider of business software for managing and protecting data, has traded above a $23-a-share offer every day since the company agreed last week to sell itself to Insight Venture Partners, which also owns stakes in Twitter Inc. and Zumba Fitness LLC. The New York-based investment firm offered a 13 percent premium, less than half the average for billion-dollar acquisitions of applications software companies in North America, according to data compiled by Bloomberg.
Quest is worth 22 percent more than Insight’s proposal, based on the software provider’s sales and cash flow, and could attract IBM, Dell or private equity firms, JPMorgan Chase & Co. said. By acquiring Quest, which has 60 days to shop for a better deal, a potential buyer would get a company that has boosted revenue in 13 of the past 14 years and throws off almost twice the free cash, relative to its stock price, as the industry average, data compiled by Bloomberg show.
“The general feeling from the market is that the price is too low and that they can do better,” Chris Konstantinos, who helps oversee $3 billion as director of international portfolio management at Riverfront Investment Group LLC in Richmond, Virgina, said in a telephone interview. Quest’s stock price “indicates to me that there’s probably some interest from other buyers out there,” he said.
Konstantinos said Quest could be worth as much as $28 a share in a takeover and interest IBM or Dell because of its products, cash flow and customer base.
Today, Quest advanced 2.1 percent to a 10-month high of $24.50 a share. The gain was the biggest among software makers in the Standard & Poor’s MidCap 400 Index.
Ed Barbini, a spokesman for IBM in Armonk, New York, and David Frink, a spokesman for Round Rock, Texas-based Dell, both declined to comment on whether their companies were considering an acquisition of Quest.
James Lucas, a spokesman for Aliso Viejo, California-based Quest, declined to comment on whether it had been approached by other potential bidders and referred to the company’s March 9 statement when asked about the terms of the deal.
In the statement, Quest said a special committee of the company’s board members will “actively solicit, receive, evaluate and potentially enter into negotiations with parties that offer alternative proposals.”
Quest will pay Insight $4.2 million if it finds another buyer during the “go-shop” period.
Founded in 1987, Quest sells software that lets companies back up and recover data, manage their databases and control who can access the information stored on their computers.
Under the terms of the $2 billion cash deal with Insight, Quest will operate as a private company with its current managers, led by Chief Executive Officer Vinny Smith, retaining their positions. Smith, who owns 34 percent of Quest, agreed to forgo payment and transfer his stake into the new entity.
“As a private company, we will have increased flexibility,” he said in the statement announcing the deal.
Insight’s offer, which was about 13 percent higher than Quest’s average share price of $20.44 in the 20 days before the announcement, was less than any other takeover in the software applications industry in North America valued at more than $1 billion, according to data compiled by Bloomberg.
Including net debt, the buyout also values Quest at 12.85 times earnings before interest, taxes, depreciation and amortization, about half the median multiple for comparable acquisitions, data compiled by Bloomberg show.
“The valuation is low both from an absolute and relative valuation perspective,” Aaron Schwartz, a New York-based analyst at Jefferies & Co., said in a telephone interview.
Quest, which fell 27 percent in the 12 months ended March 8, jumped by the most in more than a decade on the day the agreement was announced and surged past the offer price. The company ended at $24 a share yesterday, 4.3 percent higher than Insight’s bid, a sign merger arbitragers are betting a higher offer will emerge.
Even after the shares rallied, Quest is still trading at 2.4 times sales in the past 12 months, about half the industry median, according to data compiled by Bloomberg.
After deducting capital expenses, the company also generated cash from its operations in the past year equal to about 7.9 percent of its stock price. That’s 87 percent higher than the median free cash flow yield for comparable applications software companies, the data show.
Take A Look
“The initial price will encourage alternative strategic and financial buyers to at least take a close look” at Quest’s assets, John DiFucci, a New York-based analyst at JPMorgan, wrote in a report dated March 12.
Quest’s systems management services, which design and make products that support software and hardware platforms made by vendors such as Microsoft Corp. (MSFT) and Oracle Corp. (ORCL), could entice IBM because it would fit well with its existing service management brand, he said.
Dell, the third-largest maker of personal computers, has made a push into software through acquisitions and may be attracted to Quest’s data protection and back-up products, said Brian Freed, an analyst at Wunderlich Securities Inc. in Denver.
The company, which last month hired former CA Inc. CEO John Swainson to oversee its new software group, announced this week its purchase of SonicWall Inc., gaining technology that detects and protects networks from intrusions and malware attacks.
“Dell certainly has aspirations in the security space,” Freed said in a telephone interview. Quest would be a “very good strategic fit,” he said.
He cited Oracle, the world’s second-largest software maker, as another potential acquirer. Deborah Hellinger, a spokeswoman for Redwood City, California-based Oracle, declined to comment on whether it was considering buying Quest.
Insight’s agreement with Quest has a relatively low break-up free, which could draw out bidders and may have been designed to encourage competing offers, according to Alec Levine, an equity derivatives strategist at Newedge group SA in New York.
The termination fee equals 0.2 percent of the announced total value of the deal, the lowest among all technology deals in North America over $500 million in the last five years, according to data compiled by Bloomberg.
“You can almost make a case that they’re inviting another bidder to appear,” Levine said in a telephone interview.
Still, Quest’s management may prefer the Insight deal, which lets them retain control, said Diane Garnick, chief executive officer of Clear Alternatives LLC. Its string of a dozen deals since 2008 has left it with businesses that may not appeal to just one buyer, according to Rob Owens, an analyst with Pacific Crest Securities in Portland, Oregon.
“Quest has a fairly wide array of products and it may be difficult to find the perfect fit,” he said.
Some potential buyers may also be wary of acquiring a software company that has slower sales growth than its competitors, Owens said. Since 2007, Quest’s revenue has risen by an average 9.1 percent a year, about half the average for comparable software makers, data compiled by Bloomberg show.
By at least one measure, Quest is already worth more than Insight’s $23-a-share offer. JPMorgan’s DiFucci estimates that the current value of Quest’s future cash flows from its maintenance revenue -- or the fees customers pay to keep their products current, get enhancements, bug fixes and obtain support -- is about $28 a share.
His projection assumes no growth in maintenance revenue.
The terms of the deal “create a situation where you could have strategic buyers come in,” Jefferies’ Schwartz said. “The company has to consider the best interest of the shareholders as well and ultimately that comes down to price.”
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