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Private Equity on Steroids (Part 1)

Posted on Tuesday, Apr 8th 2008

By Dominique Trempont, Guest Author

For the last couple of years, we saw an unprecedented wave of private equity deals. Even though the current debt crisis is drying up some of Private Equity’s easy cash source, there are opportunities for savvy investors in the midst of the current chaos.

Much of those opportunities are the creation of the Venture Capital industry. VCs tend to overinvest in high tech sectors such as security, web 2.0, etc. and have short runways. VCs are now looking for liquidity as the IPO market has dried out.

This is a great opportunity for tech savvy private equity investors to engineer interesting leverage opportunities with strategic re-engineering, not just financial re-engineering. You take a mature, cash producing company with attractive channels and start acquiring (at fairly low valuation) a series of start-ups in adjacent spaces but targeting the same buyer. I call this framework Private Equity on Steroids, as it could yield potentially superior returns. I dialogued on this framework with Dave Roux at Silver Lake, one of the largest high tech private equity firms.

There are a few tech PE firms that have the DNA to practice this framework: Silver Lake Francisco Partners, Vector Capital, and potentially a few others. I met with one of Silver Lake’s portfolio companies, Serena Software, and spoke with its Chief Marketing Officer Rene Bonvanie who is thinking along the same lines. Serena is an example of how a smart management team decided to transform its sleepy business by going private and by acquiring several technology ventures in the process. The executive team charted its strategic transformation course and Silver Lake took the risk and agreed to let Serena make the acquisitions and change its business model.

The legacy Serena Software business: extremely profitable and very “sticky”

Serena Software has existed for a little over 27 years. Its roots are in what is today referred to as change management on mainframes. Change management is software that helps people manage the process of change predominantly in the application development lifecycle. That business is a very stable business for a couple of reasons. Applications are constantly being developed in the world. But the Application Lifecycle Management business does not grow. It is an old industry with a couple of competitors: Serena, IBM and Computer Associates. This legacy business is $270M in revenue and 32% profit for Serena. It is one of the most profitable software businesses around: top 5 on NASDAQ as a % of revenue.

First step of transformation as a public company: significant acquisitions

Four and a half years ago, Serena merged with an equal: Merant Corporation that had the wherewithal in the open systems technology. They had a highly popular tool for change management on PCs. Literally hundreds of thousands of people used that product. The business became two pieces: a mainframe business with large transactions and large customers, and a volume business with small transactions with many customers.

Then, Serena continued to do more acquisitions around the sweet spot. One of the subsequent acquisitions was a business process modeling technology from a company called TeamShare. Imagine a process where people can bring up their ideas and requirements, decide what to build and what to buy, how to track the application development, the release to production, the helpdesk for issue resolution. Serena added toits change management process an application development lifecycle module.

This happened in 2005, a very rough time in the enterprise software market. Serena had been public for four years. It had made the acquisition of TeamShare and Merint and was now a mid-sized software company, growing at only 10% a year. With the legacy business growing 5-7% a year, however, Serena was printing $8-$9M of cash every month and producing an EBIT of about $90-$100M annually.

Serena had to figure out how to grow faster. In this endeavor, they were competing against companies that did not have the burden of being public.

This segment is part 1 in the series : Private Equity on Steroids
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