Marketo Inc. co-founder Phil Fernandez put his Silicon Valley company up for sale in 2016 with the expectation it would be folded into a technology giant. Marketo had built a reputation for providing effective business-to-business and business-to-consumer marketing technology, and appeared to make sense that it would integrate well with large software suites that companies use to run their operations.
SAP SE and Oracle Corp. had expressed interest in buying Marketo to bulk up on automated marketing software, according to people familiar with the matter, who asked not to be identified because the process was private. With both willing to pay cash, it was highly unlikely a private equity firm could assemble a financing package quickly enough—or pay an acceptable premium —without putting its required return at risk.
Two months later, Vista Equity Partners agreed to buy Marketo for $1.8 billion. The buyout firm leapfrogged the two corporate suitors currently with a combined market value of more than $316 billion by pledging its $5.7 billion fund as collateral, one of the people said. Vista paid a 64 percent premium above Marketo’s unaffected share price, the value before the company’s sale process was reported by Bloomberg. SAP and Oracle representatives declined to comment.
The acquisition is one of several recent Vista deals targeting high-growth assets that aren’t conventionally suitable for private equity. Rather than zeroing in on efficiencies to boost the margins of software companies running legacy systems, the Austin-based firm is increasingly betting on unprofitable growth companies to chase returns. To out-pitch corporate competitors pursuing the same assets, Vista is willing to commit billions of dollars of equity from its funds, subtracting the vagaries of debt financing from the equation.
“When it comes to getting a deal done, price matters and certainty matters,” said Mike Wyatt, co-head of Morgan Stanley’s global technology mergers and acquisitions group. “Comparing price is straightforward. Comparing certainty is subjective. When someone like Vista takes the financing risk off the table, that de-risks the transaction for the seller.”
Whether Vista’s strategy will pay off remains to be seen. Its latest pool, Vista Equity Partners Fund VI, is less than two years old and largely still yet to be deployed. Vista can claim an enviable record since its inception in 2000, though. Four of its six earlier funds rank in the top quarter measured against its peers, with one in the second quarter and one in the third, according to data compiled by Bloomberg. Vista declined to comment on its strategy and Fernandez didn’t respond to a request for comment.
Private equity firms typically can’t top strategics in contested acquisitions. Verizon Communications Inc., for example, triumphed with its $4.5 billion Yahoo! Inc. bid last year even though smaller firms offered more, people familiar with the matter said at the time. Verizon’s plan for merging Yahoo and AOL Inc. operations won the day over private equity firms saddled with the industry’s reputation for slashing costs to make returns, said the people.
Vista founder Robert F. Smith and the buyout firm’s backers have invested about $3 billion in equity on high-growth, high-valuation companies in the past two years, according to one of the people. Vista is specifically targeting companies showing at least 15 percent annualized growth in strategic technology verticals, the person said.
The day after announcing the Marketo deal, Vista drew from the same playbook to buy Ping Identity Corp. for $600 million, beating out CyberArk Software Ltd. to win the deal, according to a person with knowledge of the matter. A CyberArk representative declined to comment.
Buying companies requiring higher investment levels—for both products and staffing—bucks the private equity blueprint of paying off debt with cash-generating assets. Having a larger equity component increases the risk and curtails the use of debt for dividend re-capitalization, a tool that Vista and other private equity firms tap to make returns.
In a typical Vista deal, almost all aspects of the acquired company are subjected to reforms. Employees attend boot camps while old research-and-development projects are put on hold or dropped. Vista’s standard operating procedures, designed to rapidly and aggressively impose change, are spelled out in a handbook.
In contrast, Vista has taken a hands-off approach to Marketo, leaving it free to develop new products, according to one of the people familiar with the transaction. Operational screw tightening has been largely limited to areas such as real estate and accounting.
Vista can enact its traditional playbook as the companies mature under its ownership, said Ted Smith, co-founder of Union Square Advisors LLC, who has worked with Vista on several deals including a $4.3 billion takeover of Tibco Software Inc. in 2014.
“The traditional private equity thinking was, ‘Let’s take these slower growth, nicely profitable companies and layer debt on them right away, help them operationally, and sell them after we’ve used leverage to optimize our returns,”’ Smith said.
Vista has figured out how to buy companies with marginal or no profit and tap their fast growth to boost their size and income, he said. “At that point they can turn on the second phase of the rocket and treat them like a more traditional private equity purchase,” Smith said.
Vista’s strategy, with the backing of CEO Smith and co-founder and President Brian Sheth, has been championed by Monti Saroya, a principal who has been with the firm since 2008, one of the people said.
The firm’s sole focus on enterprise software eliminates another advantage of strategic acquires by giving it a stable of related companies and technology to fuel synergies, Union Square’s Smith said.
Last year, Vista acquired event management software company Cvent Inc. for $1.65 billion. The firm, which again outbid suitors including at least one large strategic bidder, put up most of the deal price in equity, one of the people said. Vista then merged Cvent with Lanyon, another of its portfolio companies, giving Cvent Chief Executive Officer Rajeev Aggarwal control of the combined entity.
The lower debt load—a typical buyout is two-thirds debt—coupled with a pledge of further investment gives Aggarwal the financial freedom to invest in customer service and building sales teams.
One feature of Vista’s playbook that remains the same is bringing in fresh management.
In Marketo’s case, Fernandez stepped down as CEO months after the buyout and was replaced by former SAP executive Steve Lucas. At Ping, Raj Dani was brought in as chief financial officer in November. He previously served in the same role at audio-visual group AVI-SPL, which has been backed by private equity firms HIG Capital and Silver Lake.
While Thoma Bravo and some other buyout firms have used similar strategies as Vista for high-growth technology assets, most still focus on traditional targets, relying on debt-financing models to generate returns. But expect them to become more comfortable committing more equity if they continue to lose out on deals, said Wyatt of Morgan Stanley, which represented Cvent as well as Marketo on their deals.
“When it’s about financial engineering, getting the right debt terms is essential,” Wyatt said. “In a high-growth deal, debt is important but the real difference maker is can you judge the business and manage it for long-term growth instead of short-term profits.”
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