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BMC LBO: “Those Who Forget The Past Are Doomed To Repeat It”

Nate Lentz
June 18, 2013

For the next five years, will interest payments trump innovation at BMC?   If so, that is bad news for their customers, and ultimately for BMC.

Reading the news of the BMC leveraged buyout by Golden Gate, Bain, and others gave me déjà vu.  6x debt to equity ratios are tough to swallow and even tougher for technology companies, which must innovate to live another day.  It seems like a good deal for the investors on the surface – cheap debt, half of the equity contribution coming from cash on the balance sheet, buying a $2.2B revenue company for only a little over a billion dollars in cash – that is if you forget about the six billion in debt that needs to be dealt with before equity is monetized.  Does anyone remember Prime Computer?  Those who were at J.H. Whitney sure do.  The former bankers at Shearson-Lehman-American Express who underwrote the never syndicated junk bonds certainly do.  Prime Computer helped end those organizations as they were known at the time.  It was a story of too much debt, too much reliance on a “sticky” maintenance base, overly aggressive assumptions about new product lines, and an under investment in innovation.  In that case it all fell apart within twelve months.  The combination of excess debt and technology businesses has proven to be a bad formula that is known to past generations of Masters of the Universe.  Possibly the lesson has been lost in translation.

Bloomberg in a recent article on BMC and the transaction wrote:

BMC, a Houston-based provider of software that keeps corporate computer networks running . . . .has had a harder time keeping up with rivals in the market for server software, which has been moving to companies’ data centers as customers rely more on programs delivered over the Web.  “They’ve been outpositioned by some of the growth companies out there,” said Joel Fishbein, an analyst at Lazard Capital Markets. “The world’s changed from a technology perspective very dramatically, and they haven’t been able to keep up.”

The emergence of software delivered as a service via the so-called cloud has helped newer competitors such as ServiceNow Inc. and Splunk Inc. to grab market share. BMC is also contending with traditional rivals CA, Hewlett-Packard Co. and IBM. About a quarter of new ServiceNow customers are replacing BMC products, ServiceNow Chief Executive Officer Frank Slootman said in a recent interview.

OUCH.  This sounds like a company that needs to plough significantly more dollars into innovation – either organic or through acquisition – to keep up with competitors, to maintain customer relationships, and to fight off emerging game-changing entrants.  Instead the company is going in reverse and the i-word will be interest, not innovation.

What are my take-aways from all this?

  • BMC customers will be much more available for new entrants and innovators to steal some or possibly all share of wallet from BMC in the next 2-3 years
  • The best BMC engineers, frustrated by supporting last generation products will be ripe for poaching – and you can find them all on LinkedIn
  • BMC will no longer be an innovation buyer because their stock will be volatile and hard to use as currency and their cash is going to only one place – debt repayment – and not acquisitions
  • The greatest high-value assets of BMC may come into play over time as they are sold to pay down debt – this could put some of BMC’s current crown jewels in the hands of IBM, EMC, HP or Workday further altering the balance of power
  • The vacuum created by BMC’s lack of competitiveness will accelerate the opportunities for new dominant players to emerge in the space.

And if interest rates rise – all bets are off; unless interest rates rise soon enough to squander the deal.

I must confess that I am not without guilt.  I was deeply involved in the senior debt financing of Prime Computer by Chemical Bank (now JPMC).  In fact, a 26 year old, version 1.0 of me got the call from J.H. Whitney on a Saturday morning in May, 1989 and subsequently co-led the senior debt financing.  Somewhere in my files is the credit memo I wrote on the deal, which I signed before sending it off for about 20 tiers of subsequent approvals within the bank.  The funny thing was that the original deal, as proposed, had less than $750M in senior and subordinated debt (which was a stretch) and the final deal, post the battle with corporate raider Ben Lebow, had over $1.3B in debt – with the increase 100% funded by Shearson.  The deal closed, the junk bond market crashed, the maintenance base for mini-computers eroded quickly, and all hell broke loose.  And on the day it closed in August, 1989 – I headed for business school.  By the way, while the deal hurt Shearson and Whitney, the senior lenders, including Chemical Bank, got 100% of principal back and made almost $100m in interest, penalties, and fees.   Sometimes it is better to be lucky than smart.

1989 was a time when innovation was occurring at much slower rates than today.  In 2013, taking a company already viewed as a laggard like BMC and removing both the cash flow for organic innovation and the currency for M&A-focused innovation seems unwise.  Of course, no one asked me.  But I will bet that a whole new generation of entrepreneurs is aware of this new market disequilibrium caused by the removal of BMC as a viable competitor and will quickly be  filling the void with better, faster, cheaper solutions.  At Osage Venture Partners, we will be ready to fund the attack.