October 15, 2019

Breakingviews: UK’s $4 bln cyber buyout is pricey but defensible

by Breakingviews.

The UK’s latest technology buyout makes little sense within the traditional private-equity mould – piling huge amounts of debt on a company, slashing costs and wringing cash from the assets. Readjust your preconceptions, though, and it’s possible to see how Thoma Bravo can make a success of its $3.9 billion bet on cybersecurity group Sophos.

The first puzzling aspect of the deal, announced on Monday, is the price. The American firm’s offer of $7.40 a share is a punchy 37% premium to Friday’s closing price, quoted in sterling. Yet Sophos reports in dollars, and the valuation multiple including debt looks high at almost 6 times last year’s revenue. Recent acquisitions – like Thoma Bravo’s purchase of cybersecurity group Barracuda Networks – were struck at roughly 4 times revenue. Sophos boss Kris Hagerman should have little trouble convincing his shareholders to tender.

The second LBO oddity is that Thoma Bravo can’t put much debt on the company. Even if it cranks leverage up to a toppy 6 times consensus EBITDA for the current financial year, borrowing would only fund 18% of the $3.9 billion acquisition enterprise value, compared with half or more in many buyouts. Meanwhile, billings for Sophos software, which provides antivirus and ransomware protection for medium-sized businesses, were flat in the financial year ending in March, having grown by a fifth the year before.

Yet Thoma Bravo, whose co-founder Carl Thoma has been doing “buy and build” deals since the 1980s, is no mug. Academics at HEC Paris reckon it’s the best-performing firm in the private equity industry, based on funds raised between 2005 and 2014. Its niche is buying fast-growing technology companies and folding in smaller acquisitions to boost growth and cut combined costs; Bain & Company reckons private-equity returns in the technology sector trailed only those in healthcare between 2009 and 2015.

Sophos fits Thoma Bravo’s model well. Even if sales grow merely as analysts expect and margins don’t move, the fund could see a five-year 12% internal rate of return according to Breakingviews calculations. That’s probably a minimum. Sophos has built up a network of 45,000 sales partners like regional computer shops and consultants, who sell its products to businesses. That’s hard to replicate. The new owner can buy up other products and turbocharge sales by pushing them out to Sophos’ distributors. That makes Britain’s latest tech buyout pricey but defensible.

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