Cisco's acquisition of AppDynamics – and the premium it paid – represents a "statement acquisition" that addresses several converging trends in both technology and financial markets. For strategic acquirers and tech investors, the acquisition is about delivering value to users and improving business outcomes through a go-to-market model that drives recurring revenues.
First, the acquisition validates the importance of application performance and user experience (UX) as companies become more software-defined in their digital transformation. To lift employee engagement and productivity, as well as customer satisfaction and loyalty, companies are making secure UX a top priority amid the increased complexity of networked private, public and hybrid cloud architectures and the constant threats they face.
Cisco's stated motivation confirms our recent posts on the needed convergence of network and application performance monitoring and security monitoring to enable the secure UX enterprise. We have posited that next to database, no technology investment is more strategic to the enterprise than a unified approach to secure UX. Advances in technology not only make this convergence feasible, but essential.
The acquisition also addresses the expanding definition of "user" in the Internet of Things (IoT) age to include machines. Machine learning is becoming table stakes technology to monitor and manage machine-to-machine communications. Tellingly, AppDynamics will report to the head of Cisco's IoT and software business.
Finally, the acquisition acknowledges the growth of DevOps practices to improve business performance by delivering higher quality software faster and more efficiently. Container-based stacks that facilitate microservices architecture with more developer-friendly protocols such as REST and JSON have made DevOps easier to implement, driving further adoption.
Cisco CEO Chuck Robbins continues to push the company toward software. With AppDynamics, Cisco can further promote its SDN/NFV initiatives with services providers and enterprises.
The Wall Street View
AppDynamics had raised $314 million in funding over the past nine years. The last round valued the company at $1.9 billion. Cisco's $3.7 billion 11th hour acquisition – or a 60% premium to the proposed IPO price – reflects strong investor demand for the stock.
In fact, it's a favorable sign for the tech IPO market in general that the underwriters kept raising the offering price through the road show. This bodes well for other IPOs on the horizon as the money that portfolio managers had earmarked for AppDynamics is now free for redeployment.
However, expect to see more of these last-minute acquisitions. Companies can now file their S-1 – a registration statement that companies intending to go public must file with the Securities and Exchange Commission (SEC) – just three weeks before listing as opposed to three months previously. The S-1 provides strategic buyers with most of the relevant information they need. But they must act fast.
According to the AppDynamics S-1, the company had an annualized billings run rate of $315 million with year-to-date 9-months revenues of $211 million. The multiples that Cisco is paying for forward billings and revenues were not only negotiated to provide AppDyamics' venture capital (VC) investors ‘upside protection" against the expected pop in the stock post-offering.
The valuation is also consistent with two other investment themes that financial markets have already validated:
Investors continue to have strong appetite for new IPO companies (or any public company for that matter) that show a clear path to profitability while sustaining rapid revenue growth owing to well-developed go-to-market execution within an expanding Global 2000 customer base; and,
That software-as-a-service (SaaS) business models and the greater intelligence advanced analytics provides to drive better decision outcomes fetch substantially higher valuations than legacy on-premises license and maintenance models. This is due to the predictability and long-term customer value of their recurring revenue streams and the cash flows those streams generate.
As enterprise applications become more numerous, intertwined and complex, IT organizations are placing more emphasis than ever on finding new approaches to manage applications and optimize their availability and performance. As they become more software-defined and seek to get better returns on their digital assets with advanced analytics, more are recognizing that this is not attainable without secure UX.
Our 2014 study of S&P 500 companies found that those that take a unified approach to user experience outperform their peer group in revenue growth, profitability and market valuation. These companies grow faster and generate higher profit margins, resulting in premium valuations and stock price performance relative to their respective peer groups. The study also found that companies with a unified approach deploy 30% fewer tools on average to get the job done.
The fundamental investment themes that have driven the stock market higher in the early days of the Trump Administration – increased infrastructure spending and repatriation of cash held overseas – also bodes well for public tech companies and those planning an IPO. The former is expected to drive capital investment with a strong presence for IoT and AI in both smart cities and business applications.
The latter could provide a boost to domestic M&A activity, opening a new door for exit strategy. This would strengthen the leverage of VCs and managements in negotiating the sale of a company. But larger companies are willing to pay premiums for technology that promises to accelerate their time-to-market.
Gabriel Lowy is the founder of TechTonics Advisors, a research-first investor relations consultancy that helps technology companies maximize value for all stakeholders by bridging vision, strategy, product portfolio and markets with analysts and investors.
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