Time for SaaS M&A

The recent acquisition activity by public IT companies provides just an initial taste of what will be a very active year for cloud-based vendors.  To recap, IBM bought CastIron to improve its capability in data integration among SaaS applications as well between on-premise and SaaS applications, SuccessFactors bought CubeTree to improve its cloud-based collaboration capabilities, Salesforce bought Jigsaw to enhance its sales force automation offering with cloud-based sales-related content, CA bought 3Tera and Nimsoft so that it can start offering cloud computing solutions, and VMWare bought GemStone to provide data management for the applications developed under SpringSource.  There are several reasons for my conclusion:

1. Improving macroeconomic environment.  The recovery appears to be taking hold, and companies are investing in IT again (we continue to expect a 5% growth in this year’s IT budgets).  Public IT companies are reporting strong results.
2. Cloud computing is considered the next IT platform.  SaaS applications are demonstrating significant successes and they are now being adopted aggressively even by Global 1000 companies.  The move to cloud computing is considered inevitable.  Companies are starting to spend disproportionately for SaaS applications than for on-premise applications.  CIOs expect that at least 10% of IT workloads will be running in the cloud by 2013.  During the recession, corporations have been impressed with the lower TCO they achieved through the use of SaaS applications.
3. Public IT companies, e.g., IBM, Microsoft, Google, have large cash reserves and are getting low returns from the interest this cash is earning.  For example, Cisco has $39.5B in cash, Microsoft has $36B, Google has $26B, and IBM has $14B.  In addition, over the last 6 months 4 of the 5 public SaaS consolidators have raised over $1.1B (Concur $250M, SFDC $600M, Taleo $150M, and SuccessFactors $200M).  Salesforce and SuccessFactors are obviously starting to put this money to use.  I’m sure Google is thinking that it will need to improve Google Apps through a combination of internal development, partnerships and acquisitions.  Microsoft could also use some of its cash for acquisitions aimed at further rounding out Azure.
4. Based on their 1Q10 financial results and subsequent stock movements, the public markets are rewarding SaaS that have reached scale and have strong growth rates.  However, the markets still don’t reward (as they used to) IT companies with less than $100M in annual revenues that are going public.  Furthermore, the management teams and investors of such private companies realize that it takes a long time to build a SaaS company of scale.  As a result, the bigger and higher growth SaaS companies will aim at getting bigger “inorganically, and, for the right price, private companies would prefer to be acquired rather than attempt to go public, providing liquidity to their investors and employees.

The anticipated M&A wave will be led by the SaaS vendors.  IT vendors primarily with on-premise solutions, e.g., Oracle, SAP will not be as aggressive for another 12-18, i.e., until they determine that they cannot transition to cloud computing on their own but will need to acquire the right DNA.  CA provided an early example of such a strategy, through its acquisition of 3Tera and Nimsoft.  Over the past year Adobe, Compuware and the SAS Institute had shown a similar approach with their acquisitions of Omniture, Gomez and IDEAS respectively.  Applications, analytics, data management, and security are some of the areas that will attract the acquirers’ attention.  I can tell that management teams, venture investors and investment bankers are all getting ready for a very busy year.