Gartner rallied some 50% last week as the company made two announcements: The first was an acquisition of
TechRepublic, an online resource and portal for technology professionals that Gartner will use to lever its core research products to a wider audience.
The somewhat more exciting news -- depending on how you look at it -- was the announcement that
Silver Lake Partners
, a high-profile venture capital fund backed by
Integral Capital Partners
, is going to invest $300 million in Gartner via a convertible bond and that Silver Lake principals Roger McNamee and Glenn Hutchins are going to join the Gartner board.
Great news ... I think?
I've bandied Gartner about in earlier columns as a
relatively cheap special situation, and then, as the shares dropped, an
absolutely cheap technology play with three main attractions: a steady core business, huge cash flow and a fast-growing consulting arm.
I was paying 20 originally for about $1.20 in earnings per share and fortunately had the stamina and the nerve to buy an awful lot of the B shares when they sank to 10. Now both classes of Gartner stock are up nearly 80% from their lows and the company expects earnings of 25 cents this year, which legitimately translates into 45 cents of cash earnings. Huh?
Here's what bugs me a bit: Gartner took its lumps early as new CEO Mike Fleisher retooled the strategic plan, calling for upfront spending on proverbial "e-initiatives" as well as a more aggressive expansion of the small but fast-growing consulting business. That, and the pathetic mishandling by
of the spinoff of its stake in Gartner cratered the stock. But when the two deals were announced, the Gartner shares were in the midst of a steady rebound, partly on a technical basis and partly on steady fundamentals.
The night before the Silver Lake deal was announced, Gartner closed at 15 and change. Silver Lake bought $300 million of a 6%, three-year convertible bond that will probably end up with a $16 conversion price. The stock soared on the after-the-close announcement, and ended the day over 21. So unless I am missing something here, Silver Lake got the deal of the century. They bought what is basically an in-the-money convertible with no premium and an abnormally high coupon for such a convert.
recently did a convert and had to pay a 6% coupon. Gartner has been around for 20 years, generates $160 million in EBITDA (earnings before interest, taxes, depreciation and amortization) with little capital expenditures. It should not be paying 6%.
What the Silver Lake deal produces is immediate and unnecessary dilution to existing shareholders to the tune of 20%. Why couldn't this deal have waited until after the quarter, which management claims is nicely on track. This could have pushed the stock somewhat closer to fair value, making the dilution more palatable. At the least, there should have been a premium of around 30%, which again modestly minimizes dilution. The three-year lockup aside, Silver Lake already has $90 million of the $300 million investment effectively repaid with the current share price.
Management and Silver Lake argued persuasively and successfully on the conference call (replay at
www. Gartner.com) that Silver Lake is connected up the wazoo, that Roger McNamee is a venture capital legend, and yet this is the only board that he has ever joined. Gartner is a grossly undervalued company with world-class yet underleveraged IT resources. The blend of Gartner intellectual capital with Silver Lake's connections means huge things to come.
This alliance also helps close a huge credibility gap for Gartner, helping it to retain current employees as well as attract new ones -- an issue which should not be downplayed in the IT world. It also relieves them of some of the restrictions of the bank covenants, which is both good and bad depending on your confidence in management.
At this point, you and
might be thinking: "So why the whining -- the stock is up."
I'm just trying to understand what I thought I owned and what I own now. These two deals turn my Gartner investment from a relatively straightforward (successful execution aside) valuation exercise into a dot-com, follow-the-metrics, damn-the-financials deal where I am having problems trying to find intellectual footing. Is this a gift horse that will attract silly money and "realize value" for people like us, or is this just the beginning of a new paradigm with massive valuation creation? (Is that me talking?)
Gartner's worth has become a much tougher question than it was a week ago. The answer appears to be less in the short run given the dilution, and more in the upside of the long run, which the stock price appears to reflect. On the value-creation front, while management says they "had to" repurchase stock in the low 20's after the IMS spinoff, there is still the question about management's mindset: Do they understand what it means to buy stock at 22 and sell it at 16?
What's interesting also is that the top 10 institutional holders of Gartner' stock are value-tilted, and their investment has clearly taken on a new hue. Let me try this one out: Gartner is now selling at a very reasonable "price to alliance" and its acquisition of TechRepublic was done at a mere $100 per eyeball, which is excellent in relative terms.
The other half of the announcement duo, the purchase of TechRepublic, makes both conceptual and strategic sense. Gartner badly missed the first few innings of the e-commerce world (a somewhat embarrassing omission for the world leader in IT intelligence) and this deal appears to get them to the plate today, albeit at a cost of eating a big chunk of earnings dilution. I think this trade-off makes some sense, though. A start-up business almost always eats wads of cash upfront, but must be viewed via the discounting function of what the future profits are worth today. In this case, I also sense a "we-had-to-do-this-deal" attitude, which I hope did not utterly cloud judgment in the price paid here.
What I get as a result of this pondering is ... a little confusion. What is attractive about value investing in my opinion is that when you get into trouble or unfamiliar ground, you can point to tangible things, like they earn x, generate y cash and book value looks solid at z. (Unlike a lot of what passes for investing today, when your silly stock can go from 241 to 160, bringing it down to 40 times revenue -- all with the company's historical financial statements going back only five quarters. Where's the foundation there?)
The Gartner deals took a whack at the foundation, but also opened up the heavens a little (block that metaphor!). Frankly, we're mulling it over, and the old adage, "When in doubt, do nothing" works in a surprising number of cases.
And in closing, what the heck is with the spread between A shares and B shares? To the reader who can give me a halfway intelligent answer to that question -- one that does not include liquidity or
selling -- goes a box of
Reed Conner & Birdwell
Jeffrey Bronchick is chief investment officer at Reed Conner & Birdwell, a Los Angeles-based money management firm with $1.2 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value Fund. At time of publication, RCB was long Garner Group and IMS Health, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at