Its party time!!!

Since I last blogged, the market has been "mildly interesting", to put it mildly!!!

Last weeks rally was the first positive week in a month, and it continued yesterday with an impressive party in stocks all round. And yes, a rally was to have been expected, coming from horrendously oversold levels, at least in the short term, though its very interesting to see the relative winners and losers. And I'm not talking about the reward for lending money to various sovereign Governments around the world based on the risk you are taking on. Whether it’s the mouthwatering 44% on offer for lending to Greece, which has one foot in the grave. Or the 0.0000 miniscule number that you'd be getting for lending to the Japanese with its 200+% debt/GDP. Or to Europe, which arguably may or may not be around in its current states for much longer. Granted, the European balance sheet may look slightly more enticing now that the ECB have moved on from buying the worthless Greek debt to the dubious Spanish and Italian debt!!! Or the US with its $14 trillion and rising deficit? At some point, we'll learn the hard way that "safety" promised by the Governments, is a nonstarter.

Anyway. I'm not talking about all that- that’s the subject of a different post! Back to todays post! It was interesting to see the relative winners and losers. Despite the oversold conditions, and an expected rally, the outlook is not all that rosy. Turbulence continued in Libya, violence worsened in Syria, Israel/Arab tensions, hurricane in the US, plus the eagerly awaited Bernanke speech at Jackson hole (whose remarks were initially perceived as negative, but then markets recovered to finish strongly higher). With hindsight, come September, its possible that the post Bernanke rally was based on "hope". This time last year, when Bernanke spoke, he PLEDGED QE to combat deflationary pressures. This time around, he spoke about fiscal policy and gave his usual "range of tools that could be deployed", but there was very little talk about monetary policy per se. Nevertheless, markets rallied, on what? Hope? There was also the small matter of the first revision to Q2 GDP, which dropped from a preliminary 1.3% to a meager 1%.

However, the market more or less ignored all this, and rallied. And what rallied the hardest? Small cap growth. At least if you're going to party/rally, a rational market would presumably rally in the "safer" asset classes? Small Cap growth, the antithesis of a flight to safety, was up 6.7% for the week, whereas the large cap growth, the epitome of a flight to safety (within the equity space), was the worst performer at 4%. Further, the Utilities and health care stocks, the "boring defensives", performed almost as badly (relatively speaking), whereas the Industrials, the cyclicals, outperformed. However, it is also imperative to point out that the rally was noteworthy for its lack of leadership- the leaders are thinly traded. Additionally, unlike last year when QE2 sparked a massive move out of bonds and into equities with a huge rise in yield as investors sold bonds, this time round, the 10 year hardly moved. And generally, the bonds lead the equity market, and a sub 1% yield on the 5 year speaks volumes for the signal for the economic outlook.

Going back to the GDP report, as well as the downward revision, there is also the statistic that the real GDP year over year change has now fallen to 1.5%. And as can be seen from the following chart, courtesy of Bloomberg, since 1948, each time the real y/y change in GDP has fallen below 2%, the economy has subsequently entered into a recession.

In an uncertain, volatile environment, the one certainty, is that we are in for an interesting, volatile ride!!!

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Is Sage a Listed Private Equity Firm?

I was wondering what the implication was for Sage having being beaten by Bain to the MYOB deal. MYOB (for those unfamiliar) is the equivalent of Sage in Australia.

Accepted wisdom among Sage watchers is that they are a very disciplined buyer and therefore tend not to get into bidding wars with private equity firms.

We have seen examples of this previously when they missed out on Visma (acquired by KKR from Hg Capital et al), and TeamSystems (acquired by Hg Capital, sold by Bain).

The problem with my opening axiomatic comparison between Sage and PE as buyers, is that in my experience the opposite is generally the case. We normally expect that strategic acquirers (Sage, Cisco, Oracle, SAP etc) tend to be able to justify a higher price than PE firms (Hg, Bain, KKR etc).

The reasons for this are fairly simple and boil down to the ability of strategic acquirers, particularly if they are global companies, to gain significant strategic synergy, rather than the pure financial synergy and financial engineering that you would expect from the private equity firms. These synergies might include consolidation of sales, products, core technology which cannot be achieved by a pure financial acquirer.

Perhaps then we need to rethink the category that we place Sage into. They are clearly a global player in the SME software market with important share in all of the key markets (excluding Asia). However when we look under the bonnet what we find is that the federated nature of the set-up gives it some of the characteristics of a more "financial" player. Without going into detail it is clear that relative to other global tech players Sage is really a collection of leading domestic businesses. There is little or no genuine global product range (Sage ERP X3 is a recent attempt) and certainly no integrated global sales and marketing operation.

I want to make clear that this is by no means a criticism. This federated view of the world has long been a pillar of the Sage strategy, mainly resulting from an early realisation that in the realm of small business accounts and business software, local knowledge, tax and regulation is absolutely crucial and has lead to a strategy of acquiring local market leaders and implanting to the extent possible the Sage model of high recurring revenues. The main synergy arising is based on the success of increasing the percentage of acquired customers to long term maintenance contracts, somewhat different to the story you will see when an IBM, Oracle or SAP carries out an acquisition.

On the flip side this is also the main reason why Sage has only on a very limited basis made "technology" acquisitions. Again in the IBM/Oracle/SAP world acquiring technology is done on the basis of the leverage they can achieve by taking a proven technology and using the global sales distribution to greatly accelerate the growth in the acquired company. On the basis that Sage does not have a globally managed sales and marketing operation, there is little point in paying inflated prices for technology, as they have almost no way of leveraging the acquired technology. Given that a high percentage of these acquisitions do NOT yield the expected strategic returns, it follows that this is not necessarily a bad thing for Sage and its shareholders.

There is some chatter in the financial markets that Sage's institutional shareholders showed cool interest in the MYOB deal, notwithstanding that management had not had a chance to present the pro's and con's. If true, then this in itself is a little disappointing and suggests that the company and the new management leading it have some work to do to establish confidence in their ability to execute the type of deal that MYOB offered. (Some 21st century investor relations might help!)

If we are to follow the thesis that Sage is a private equity firm, then I would suggest that they do what the great PE investors do, which is to sell assets as well as acquire them (well over 100 since the IPO in 1989). I am sure that there are a couple of operating companies that could be identified for sale without wishing to state the obvious and this would go some way to showing that Sage understands that value creation can be achieved by realising assets as well as acquiring them.

There are few companies in the UK tech environment that have managed the type of success that Sage has!! Their discipline has been a great asset and although it means that they will miss out on deals like MYOB, it also means that they have almost never disappointed their shareholders.

The press has quoted numbers for Bain's MYOB offer as 13.5x EV/EBITDA on a trailing basis. Sage currently trades in London at less than 8x EV/EBITDA. What can Sage do to garner something close to that valuation. Holding companies typically trade at a discount. Perhaps Sage needs to find a way to break this image that it has gained over the years.

How then does the group management leverage this asset going forward to keep it growing in the absence of financially attractive acquisitions? Answers on a postcard!

Congratulations to Goldrock Israel Growth on IDIT

Goldrock Israel Growth - our vintage 2009 growth equity fund in Israel - recently experienced its first exit with the sale of IDIT Technologies to Sapiens (Nasdaq: SPNS). Press article on the closing below:

Sapiens Closes Merger with FIS, IDIT

By Anthony O'Donnell       

July 21, 2011

Sapiens International Corp. (Rehovot, Israel) has signed a definitive agreement to merge with Cardiff U.K. life and pensions core system provider FIS Software and Beit Dagan, Israel-based IDIT Technologies, a provider of property/casualty insurance solutions. The deal brings Sapiens' global customer base to over 70 and will result in revenues reaching $100 million in 2012 -- double the company's 2010 revenue -- asserts Sapiens CEO Roni Al-Dor.

The deal brings Sapiens into the ranks of very few vendors with established core systems across the life/annuities/pensions, property/casualty and reinsurance sectors and brings important synergies to the component companies, according to industry analysts.

FIS brings Sapiens what the vendor calls a comprehensive, enterprise-level solution for life, pension and annuity, with a global client base across the U.K., Europe, Asia Pacific and North America. IDIT offers a full suite of solutions, constituting a single, end-to-end component-based, integrated solution for the P&C insurance market, with a focus on Europe, the U.K., Australia and the rest of the Asia Pacific region.

"Sapiens' move shows that it is serious about building a portfolio of insurance core systems offerings, both for the U.S. and internationally, across life and P&C," comments Matthew Josefowitz, principal of New York-based research and advisory firm Novarica. "Sapiens' success following the [2010] acquisition of Harcase, which has good momentum based on a recent implementation [of the vendor's RapidSure solution] at Philadelphia Insurance Companies [Bala Cynwyd, Pa.], indicates that it should be able to leverage these new acquisitions well."

The proof will be in the pudding, as integration of acquired companies can bring unforeseen complexities, notes another industry observer who declines to comment on the record. In a statement Sapiens has characterized the deal as promising that the company will "become a major global insurance solutions provider." The company has struggled in the past to succeed in the insurance software market but is on a comeback trajectory. Sapiens has turned around from operational loss and significant debt to three years of profitability and a positive cash flow.

Sapiens' merger with FIS and IDIT will bring a very positive result to the organization as it is now constituted, says Donald Light, a San Francisco-based senior analyst with Celent (Boston). Light characterizes the deal as positioning Sapiens for significant presence and growth.

"We see IDIT as a very strong solution in the European and Middle Eastern markets, and Sapiens has been taking some good steps forward to gain traction in the North American market with the acquisition of Harcase and its RapidSure [P&C] solution," Light comments. "The larger revenue base will play very well in the North American market."

"From a North American insurance company point of view, an important issue is whether a vendor is going to be around in five or ten years," Light adds. "This new organization will have a very positive answer to those types of questions."

Regarding the question of whether Sapiens would introduce IDIT to North America or whether RapidSure would be the foundation of the vendor's P&C policy administration efforts in that region, Light commented, "That's a big road map question that they need to resolve and communicate."

Sapiens CEO Roni Al-Dor clarified the matter:

"RapidSure is the P&C product we will continue to offer for the NA market," Al-Dor says. "It has been well accepted and has a growing customer base. We will now be able to further enhance it with billing and claims that we will bring from IDIT and adjust to the NA market. For life and pensions, we will continue to further develop and enhance the FIS suite as it has been gaining market awareness and acceptance."