Tech

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

Activist investors determined to walk their own path have found a place to stretch their legs in solitude, even if it's only in one corner of the market. 

By targeting unloved software companies Qlik Technologies, Autodesk and Cornerstone OnDemand, the likes of Elliott Management, Sachem Head Capital Management and Praesidium Investment Management have been broadly able to avoid copycat bets that have plagued the returns of their rivals. (Elliott disclosed its stake in Qlik just last week.)

At first glance, their playbook looks the same: Buy battered shares, push for changes including the removal of executives, make tweaks to compensation and perhaps agitate for the sale or spinoff of non-core businesses or even the entire company. But activists have another motivating factor for targeting software firms and it has to do with the fact that many of these companies spend a ton on functions like sales and marketing.

Because there are so many software makers growing at different speeds, it's easy to see which ones -- regardless of the pace of their revenue growth -- are forking out more cash than they should. 

Out of Whack
The software companies that activists target often have higher costs than their peers.
Source: Bloomberg, SEC filings
*Current activist targets

The frequency of such situations may even be on the rise. Based on data from Moody's Investors Service as of October 2015, tech companies represented one-third of all companies targeted by activists, more than double the next sector (commercial and distribution services). 

A separate Boston Consulting Group study found that traditional activist annoyances, including skimpy dividend payouts and the combination of high capital expenditures and low returns on capital, were correlated with shareholder crusades at tech firms, too. But the research also found 45 percent of tech firms targeted in activist campaigns had relatively high spending on sales, general and administrative costs.

Age Doesn't Matter
Activist investors are targeting software companies of all ages, meaning it's not just about slowing growth.
Source: Bloomberg
*CDK Global was spun out of ADP in October 2014.

Of course, companies selling software and other services to businesses -- particularly to the biggest corporations like banks -- rely on fleets of salesmen and support staff to explain how their technology works, crunch the return on investment for customers watching their bottom lines and ensure the software meshes well with a company's existing technology. Most big businesses wouldn't write a seven-figure (or higher) check for software without at least a few meetings with a sales representative in a suit.

Many of the biggest spenders on sales and marketing are young software firms such as Qlik that went public during the last few years, and lured investors with promises of high rates of revenue growth. And they need to keep up sales spending to grease the growth machine. Still, many software firms have to find the right balance between the costs of their sales forces and the pace of revenue growth.  

In the event that boards are unwilling or unable to find that balance, there's always another option, which can result in a huge payoff for activists: A takeover. While financing may sideline some buyout firms in the near term, it isn't an issue for strategic buyers such as Microsoft, Oracle, IBM and Salesforce, which may prefer to buy technology outright rather than develop it from scratch. 

Activists eventually tend to herd around similar corporate problem areas. That means software executives and directors need to take a hard look in the mirror. If you have a big tab for sales spending, watch your back.

Target Practice
These companies have relatively high expenses compared to their annual revenue growth.
Source: Bloomberg, SEC filings

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Gillian Tan in New York at gtan129@bloomberg.net
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net