Only an exclusive group of companies -- including Larry Ellison's Oracle (ORCL), which recently raised $10 billion in notes in addition to its roughly $45 billion in cash and securities, and Microsoft (MSFT), where CEO Satya Nadella oversees a $95 billion war chest -- would be capable of pulling it off.
A successful takeover would underscore the increased value of cloud services and the software-as-a-service business model, in which applications developers seek recurring payments rather than large license fees and regular charges for maintenance.
While private equity firms would have to sit out a contest for Salesforce.com, buyout shops are increasingly making their mark on enterprise software. The emergence of predictable SaaS revenue is part of the appeal. Private equity investors have also purchased mature software developers with legacy models that encountered hiccups, often after an activist investor put the company in play.
On one front, buyout firms such as Thoma Bravo, Vista Equity Partners and Bain Capital Partners have shown a taste for larger, infrastructure software companies such as Informatica (INFA), Tibco Software and Riverbed Technology that have slowing revenue growth but still produce cash. In some cases, enterprise software has seen a nexus of private equity and activist investment, with firms such as Paul Singer's Elliott Management prodding software developers to conduct reviews that lead to buyouts.
Private equity firms are also backing middle-market applications developers with cloud business models. Investments in companies such as staffing applications developer Bullhorn or cloud marketing technology company Vocus don't move public equity markets, but they are increasingly common as private equity investors warm to emerging business models and other characteristics of the software business.
"Broadly speaking, the world has woken up to how attractive the software asset category can be for investors," said Ryan Hinkle, managing director at Insight Venture Partners. "It has unusually high potential for recurring revenues. The number of players in software investing feels like it is rising all the time."
Insight, which makes both venture capital and private equity investments in software companies, purchased E2open (EOPN) for $273 million in March. As part of the deal, Elliott Management took a minority stake in the company, reflecting the increased role of activist investors in the software sector.
"I don't think they are different things, activist activity and PE activity," Hinkle said, referring to the recent nexus of private equity and activist investment in enterprise software. "They go somewhat hand in hand."
"The activists have gotten accustomed to, if they start a process, PE will be there to buy it," Hinkle added. "That may be true in April 2015. I'm not sure if that's true forever."
Elliott has been a driving force in recent software infrastructure leveraged buyouts. Infrastructure software ranges from security and IT operations management to database management, storage and operating systems. Often, infrastructure companies are mature businesses that obtain much of their sales through licenses.
In January, Singer's firm questioned the valuation of Informatica, which develops software that enables databases and other sources of corporate information to work together. Permira and Canada Pension Plan Investment Board agreed to take the company private for $5.3 billion in April.
Thoma Bravo acquired Compuware, another Elliott target, for $2.5 billion. Elliott had also taken positions in BMC Software, which Bain Capital Partners and Golden Gate Capital took private by for $6.9 billion, and in Riverbed Technology, acquired by Thoma Bravo and Teachers' Private Capital, the investing arm of the Ontario Teachers' Pension Plan, for $3.6 billion.
Praesidium Investment Management took a position last year in Tibco Software, which develops middleware that enables legacy software to interact with newer software and has also developed a data analytics business. Vista agreed to buy Tibco for $4.2 billion last year.
"A lot of the big deals that you've seen -- Tibco, Compuware, BMC, Informatica -- those are all infrastructure systems software companies," said Raj Seth of GE's (GE) GE Capital. "They are large. They are more mature. They tend to be somewhat slower growth and they've been around for a while."
The joint activity by PE firms and activists is "less correlation and more causation," said Jason Freedman, a lawyer at Ropes & Gray. "You're seeing the activists come in and push for sales because the markets aren't valuing the company correctly ... Whereas sponsors have placed some pretty attractive valuations on these companies."
Aside from the disparity in public and private valuations, the capital markets have also facilitated leveraged buyouts.
"The availability of low-cost capital in the form of debt allows a PE shop to buy a company that is growing at high single-digits and low double-digits, put a big chunk of leverage on it and watch the margin characteristics improve as they SaaS-ify the business," said Terry Schallich, co-COO and co-head of investment banking at Pacific Crest Securities.
Leveraged buyouts of public software companies have grabbed headlines, but private equity firms have also been active among middle-market, privately held software companies. Many of the deals involved applications developers, rather than infrastructure software companies. Applications software ranges from enterprise resource planning, supply chain management and customer relationship management software, to applications developed for a particular industry, or "vertical," such as health care.
While the software-as-a-service model has clear appeal, GE Capital's Seth said it is not the sole driver of investment. "There are a lot of reasons that software is attractive to PE," he said, pointing to high returns, resilience in downturns if they are critical to operations and low capital expenditure.
In 2014, Seth said, PE firms invested more than $10 billion in middle-market software deals, ranging from $20 million to $1 billion with a median value of $100 million. PE firms made 53 middle-market software investments, an increase from 46 the year before. Software deals also increased as a percentage of total PE investments in telecom, media and technology.
Middle-market PE software investment totaled $10 billion in 2013 but was substantially higher than the $4.7 billion of middle-market software deals in 2012.
"If you are assembling a computer and you source your hard drive from one place and your motherboard from another place, those manufacturers outsource component pieces of those two devices," Insight's Hinkle said. "It takes multiple levels to get from the computer manufacturer all the way up to the copper and silicon that goes into the production of it."
Changes aren't limited to the billing model. "We talk about the consumerization of the enterprise," Hinkle said. "We're rethinking everything we thought we new about enterprise software; that it had to be this big clunky license maintenence product, that it had to be multimillion dollars of licenses with multiples of that service implementation costs and that only the big companies can afford it."
While Vista paid billions for Tibco, in 2012 it backed middle-market staffing software developer Bullhorn, which makes applications for tracking job applicants, recruiting through social media, posting jobs and other processes.
Bullhorn bolted on MaxHire Solutions and Sendouts, which provides SaaS-based software in November 2012; EASY Software Solutions in July 2013 and The Code Works in August 2014. GTCR acquired cloud marketing and PR software developer Vocus for about $450 million last year.
Catalyst Investors announced in late April that it had closed a $377 million fund. The firm will invest between $10 million to $60 million in a range of sectors, including cloud computing. SaaS investments by Catalyst include recruiting technology company Jobvite and human resources and payroll group Ascentis.
Catalyst invested in online messaging and Web security services company MessageLabs Group in 2000. Symantec (SYMC) acquired the company for $695 million in 2008, saying that it would benefit from MessageLabs' expertise in software-as-a-service offerings.
Making the transition to higher-growth models is difficult for mature software companies and can be painful in the public markets. One company that successfully remade itself through software-as-a-service model is travel and expense management applications developer Concur Technologies. The company and its shareholders were rewarded with an $8.3 billion sale to SAP (SAP) last year.
Health care is a prime industry for developers. "That's one of the really big verticals, where there are a lot of archaic systems," said Pacific Crest banker David Spitz.
Private equity has not always been so active in software. "In the early 2000s, it was still a little bit of a Wild West in terms of software buyouts," said Jeff Becker, managing director at Jordan, Edmiston Group. "The venture guys were really driving the market," he added. "The lenders at the time were still trying to figure out how to lend to the prevailing revenue model at the time, perpetual license models."
Tech played by different rules than the rest of the economy. "As a result, companies were valued and financed in different ways than in other industry sectors," Becker added. "Companies were often valued on revenue multiples. Companies didn't have to be profitable to go public and be afforded premium valuations."
Oracle's hostile bid for PeopleSoft opened a period of consolidation. Ellison's software group offered $5.1 billion for PeopleSoft in June 2003, and eventually agreed to pay $10.3 billion in late 2014.
"Larry Ellison said the tech industry would eventually mirror other maturing industries, such as the auto industry, and that consolidation would be a big part of the industry as it grew up," Becker said.
Oracle's hostile takeover, a rarity in tech at that point, coincided with increased M&A in tech. "Wells Fargo Foothill was more aggressive in lending to mature software companies because they figured out that the maintenance stream was highly recurring and sticky and predictable with high margins and could be lent against," Becker said.
Firms such as Thoma Bravo began to take software companies private, usually with smaller deals. "In enterprise software you now have companies growing at 20% 30%, 40% or more, all SaaS-based revenue," JEGI's Becker said. "Often times, 90% of the revenue is pretty visible. So now, once the SaaS company gets to some level of critical mass and has a track record of strong renewals/low churn, you can borrow against it, and a PE firm can get their investment committee pretty comfortable with it."
The natural result of consolidation is fewer consolidators. "If you started an M&A process as a banker 12 years ago or 15 years ago you were watching companies get acquired that were buyers in your processes," said Pacific Crest tech banker David Spitz. "There weren't many PE buyers because the models didn't work. It was such lumpy, unpredictable business."
Deals were valued on multiples of revenue rather than EBITDA, the standard metric for PE deals. "The thing about the subscription model, the SaaS model, is almost by definition the gross margins are pretty high. They can be in the 90's, or certainly the 70s or the 80s," Spitz added.
The regularity of SaaS revenues provides more comfort to private buyers and lenders. "A banker would never call on a traditional PE firm before 10 years ago perhaps not even until seven or eight years ago," Becker said. "Only a handful really 'got it.' These days, half of our sale processes wind up with a PE buyer rather than a strategic buyer, and almost all of our processes include a meaningful number of PE firms included anytime a company is looking for a liquidity event."
Moody's Investors Service analyst Raj Joshi said that a confluence of factors have drawn activists to software companies. "They are relatively less levered," he said. "Some of them have relatively good cash profiles. The activists find them very easy targets for quick returns."
As activists complete successful campaigns and raise more funds, they have to look for new companies to target.
"They are not only targeting large companies, they are going after mid-sized companies and smaller companies too," Joshi said.
An LBO could allow a company to rework its business model without the scrutiny of public markets. It would also increase leverage. While activists work to boost the value of shares, Joshi said, their initiatives may be less balance-sheet friendly.
"The general observation is you could argue that the activists by breaking up the company ... make it more efficient or you impose some sort of financial discipline on management," Joshi said. "What we have seen is the first action is typically either large capital returns or an enhanced buyback plan, which in some cases results in additional debt on the balance sheet. Balance sheets have generally deteriorated."
Moody's assigned a negative outlook to Juniper Networks (JNPR) in December, after the company said it would return an extra $1.1 billion to shareholders. Moody's has also put eBay (EBAY) on review for a possible downgrade after the company announced plans to breakup its businesses.
Joshi does not expect activists' interest in enterprise software to wane. "The shareholder activists have more funds deployed, so they will cast a wider net," he said.
Meanwhile, PE firms have capital and a role to play in the software M&A ecosystem. "Microsoft, Oracle and SAP might buy 12 to 16 companies per year," JEGI's Becker said. It's hard to make that list, he said, even if a company is a good fit.
"You're looking for buyers and now you also have the PE world you can consider," he said. "They have a lot of cash, they are eager to invest in this space to get some more exposure to growth assets, and they have helped keep M&A activity strong in tech."