Some stories are just so great they cause you to rip up your notes on another topic and begin again. And so it is with the attempted $2bn leveraged buyout of Nasdaq-listed software infrastructure company Quest Software by private equity firm Insight Venture Partners.
First, the equity component by Insight is $210m, a little more than the company’s last reported cash pile of $193.8m, as at the end of the third quarter for the three months ended 30 September.
Its also a little more than 10% of Quest’s nominal enterprise value of $2bn, according to Insight’s offer of $23 per share. Its nominal as though Insight’s offer was a 19% premium to the closing price the share price climbed to $24 per share after the buyout offer was announced indicating potential rival bids or a higher offer are expected by the market. Quest had, however, seen a 28% fall in its share price over the 12 months to the buyout offer from Insight.
Second point, the debt component is $1.2bn, which is nearly six times the equity coming in from Insight and above the more usual 50:50 debt to equity split. The debt, however, is fairly comfortably covered by annual revenues and earnings before interest, tax depreciation and amortisation (loosely extrapolated to about $800m and $100m from Quest’s Q3 numbers).
The remainder of the enterprise value for the buyout is coming from shares owned by Vincent Smith, Quest’s chief executive (CEO). Last month, Smith took back the role of CEO as well as his existing role as chairman with the move of incumbent Doug Garn to be vice-chairman "given pressing health issues," the company said.
Smith has been executive chairman of Quest since October 2008, and previously as CEO of Quest from 1997 to 2008. If the buyout succeeds, Smith will retain his shareholding and job.
And on to point three: keeping close to portfolio companies. During his first tenure as CEO, Smith had seen entities affiliated to Insight buy 15.8% of the company in April 1999 for $9.5m. (Bank UBS had bought 4.3% of the stock at the same price at the same time, according to regulatory filings from the time.)
Four months later, after a stock split, Quest floated at $14 per share and saw a first day pop of 236% to close that day at $47 per share.
As Michael Triplett, managing director at Insight, said: "Insight has known Vinny Smith for many years and is pleased to support him and management as they seek the stability and long-term focus required for the company to achieve its potential."
That Insight has moved from venture capital to also cover buyouts as part of a private equity firm with $5bn under management is no surprise – leverage can magnify returns quite spectacularly – and is an increasing trend as industries mature and public markets remain in a trading range over the past decade.
Its a strategy other firms are also using – to find smaller companies that could potentially grow to larger deals. Buyout firms Carlyle, Blackstone, Bain Capital, Silver Lake and Kohlberg Kravis Roberts all have venture/growth equity units, with TPG setting up a $500m clean-tech venture fund to complement its biotech division (pharmaceutical legend Geoff Duyk will run the new fund and is a speaker at Global Corporate Venturing’s annual Symposium on May).
But, to point five, the insights Insight can bring to bear for Quest can help it remain focused on innovation and growth in the information technology sector and prevent middle age spread.
Smith said: "As a private company, we will have increased flexibility to drive innovation across our product lines and execute our long-term strategy."
Quest has been an active corporate venturing group, including deals such as Jaspersoft and Symplified, as part of a broader business development and acquistions strategy.
Last month, on taking over as CEO again, Smith said he would continue to "evolve Quest to a strategic IT management solutions vendor" focused on database management, windows server management, performance monitoring, identity and access management, data protection and user workspace management.
Not bad for a company that in 1998 posted a net loss of $2.3m on revenue of $34.8m based primarily on database management tools for Oracle products.
The question will be whether Quest’s planned debt load and interest payments suck up cash that could be used for its development, such as through corporate venturing. Quest said it was too early to comment but it seems unlikely this will happen as the debt load is very manageable and with about $700m in annual cost of revenues there could be room to squeeze more profits out.
There are also few better times to borrow than now if you can get the bankers to lend and given its short-term assets on its books and free cashflow there’s more chance of a dividend recapitalisation in, say, 18 months than a shortage of cash for investment.
The other factor encouraging continued investment in Quest’s corporate venturing strategy and in innovation, if Insight’s buyout succeeds, is it will be a crucial metric when the private equity firm looks for an exit. Given lengthening hold periods and shareholder demand for growth, cutting back on longer-term investments is a short-sighted strategy.