Violin Memory Changes Its Tune

NEW YORK (The Deal) -- Investment bankers figuring out how much to price an initial public offering at usually try to do right by their client, both on the upside and on the potential downside.

It's a question of striking the right balance. Either the range tends toward underpricing, so that the company ends up with less than it should by rights expect; or overpricing, leaving the underwriter with unsold shares and, possibly a damaged image for its client in the market debut, as was famously Morgan Stanley's dilemma in taking Facebook (FB) public.

But if the company and its bankers know offers are already on the table, that might have unintended effects on the newly public company.

Such may have been the case with computer flash storage drive maker Violin Memory (VMEM) which had suitors knocking at the door prior to its September IPO -- and still does, according to someone familiar with the situation. Buyout interest around Violin has increased even more so now that the company has jettisoned its founder and CEO and brought in an executive with all the earmarks of someone well-versed at selling tech companies.

The companies that had been talking to Santa Clara, Calif.-based Violin Memory include some of the biggest in enterprise technology service providers: Hewlett-Packard (HP), Seagate Technology (STX), IBM (IBM), Samsung Electronics Co. and EMC (EMC), an industry source said. At least one had gone so far as to provide Violin Memory with a term sheet, albeit one that was contingent on due diligence and hedged with conditions, the person said.

Violin Memory did not respond to a request for comment. Hewlett-Packard and Seagate said it was company policy not to comment on rumor or speculation. Samsung could not be reached for comment, while IBM and EMC did not respond to requests for comment.

In fact, Hewlett-Packard already had an agreement in place to resell Violin Memory products, but the company ended the arrangement in the fall of 2012, ostensibly in favor of the 3Par products it acquired in 2010 as part of a $2.3 billion deal.

Despite the buyout interest, Violin went public in September. Barely three months later, founder and CEO Donald Basile was let go by his board.

The IPO was rocky. After pricing at $9 per share on Sept. 26 to raise $162 million before expenses, the stock opened at $7.50 and closed at $7.02 on its first day of trading.

Making matter worse was Violin Memory's first earnings report as a public company: a net loss of $34 million for the third quarter of 2013 on revenue that was up 37%, to $28.3 million, year-over-year as compared to a $25 million net loss for the same period a year earlier. (The company has yet to turn a profit.)

The less than stellar earnings report led JPMorgan Chase & Co. analyst Mark Moskowitz to downgrade the stock. The price practically halved -- going from a close of $6 on Nov. 21 to $3.11 the following day. (JPMorgan was also the lead underwriter on the stock offering; Deutsche Bank, Bank of America Merrill Lynch, Barclays plc, Baird & Co. and Pacific Crest Securities Inc. were co-underwriters.)

Though reports linked Basile's ousting to the unprepossessing IPO, one person familiar with the situation said it was more about the decision to go public when suitors were already knocking on the doors. "[Basile] insisted on the IPO," that person said.

Basile did not respond to an e-mailed request to discuss his tenure at Violin Memory.

Activist hedge fund Clinton Group Inc., which claims to have a "meaningful stake," said in a letter to Violin Memory's board on the occasion of Basile's ouster, that at least one of those potential buyers had made an offer "at a valuation far in excess of the IPO valuation" -- about $736.4 million based on the company's outstanding shares, not including various stock options.

Clinton Group's own estimation was that a strategic acquirer would be willing to pay at least between $400 and $500 million, or between $6 and $7 per share.

These are heady times for valuations for flash-based storage systems, which is becoming ever more important as companies' need for storage capacity and speed increase, especially as more take to the cloud.

IBM bought Texas Memory Systems Inc. in 2012 for undisclosed terms, in a deal that one source said was valued at 8 times to 12 times revenue. And, as Clinton Group noted in its letter, Cisco Systems Inc.'s deal to buy solid-state memory company Whiptail Technologies Inc. for $415 million came in at mid-teens times revenue, while privately owned Peer Storage was recently reportedly valued at more than $1 billion in its last fundraising round.

Then, there is peer Nimble Storage Inc., currently trading at 20 times its third-quarter revenue of about $33.4 million.

The issue for Violin Memory is one of those factors favored by activist investors as they evaluate whether they have a case for a sale at a company: ability to scale.

Clinton Group, which said it believes that Violin Memory produces a best-in-kind flash memory product, wrote in its Dec. 19 letter that the chances for the company succeeding as a standalone against its big rivals wasn't good, its technology could be exploited best by "putting it in the hands of an industry player with an existing global sales and marketing infrastructure and an established customer base."

New Violin Memory CEO Kevin DeNuccio has already said that he will expand the company's indirect marketing efforts.

Moreover, DeNuccio also brings M&A experience to the table. He was the CEO of Redback Networks when it was sold to Ericsson AB in 2006 for $2.1 billion.

Sources predict DeNuccio will barely have time to finish furnishing his corner office before another potential suitor shows up at his door. That suitor is likely to be Dell Inc., the newly private company that has staked a lot on its enterprise business, according to an industry insider.

Dell declined to comment.

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