OpenText/Micro Focus Deal Signals New Phase of Consolidation
After 30 years in and around the security industry, it’s no surprise to me that business cycles repeat over and over again. I’ve been through a number of boom/bust cycles—in 2022 we’ve clearly transitioned to the bust part.
One way to get a sense of where we are in the cycle is to track mergers and acquisitions (M&A). During the boom, acquirers pay high valuations and lofty multiples of revenue to drive growth. In the security business, those are the 30x to 40x sales deals. It seems like a long time ago, but many were astounded to see Splunk buy Phantom for $350 million back in 2018. As the cycle goes on, the valuations inexplicably go up. Palo Alto bought Demisto about a year later for $560 million. Same market space, similar-sized companies, but that deal was done at a substantially larger valuation.
As the cycle continued, many deals had multi-billion dollar valuations. Okta buying Auth0 for over $5 billion comes to mind. With the deals funded by the go-go growth stocks of the acquirers (or cheap debt leveraged by private equity firms), the valuations don’t seem to matter. Until they do.
At some point, the cycle transitions (usually rather abruptly) to a bust mentality. Chicken Little thinking reigns supreme; the sky is falling and the high-multiple deals stop cold. Then begins a new phase of consolidation. The targets are no longer the high-flying growth companies but rather mature, established companies with significant revenue and real cash flow, albeit with slow or no growth.
It seems that when the global economy starts to slow down, it’s helpful to be able to fund a business through cash flow. Go figure.
Clearly, in 2022, we’re seeing consolidation of bigger, less exciting companies that have missed a product cycle and have seen their competitive position wane. Last year we saw the private equity firms acquire mature security companies like Forcepoint, RSA Security and McAfee Enterprise and FireEye (then subsequently merged by the investor into Trellix). Corporate acquirers are also aggregating assets, as Broadcom bought Symantec (along with CA and VMware) and HelpSystems has done about dozen deals of smaller but similarly slow-to-no-growth security companies.
This brings up last week’s news regarding OpenText’s planned acquisition of Micro Focus. This is the part of our show where aggregators buy other aggregators in tech’s version of Survivor. Only the aggregators with the biggest scale and safest cash flow get to stay on the island. OpenText has been pretty active in buying security companies (Guidance Software, Carbonite/Webroot, Zix, Bricata) and now they add the Micro Focus security brands like ArcSight and Fortify. You remember those companies, right?
Let’s look at the deal from the security market perspective. The two companies’ product lines are pretty complementary. OpenText brings capabilities in the endpoint protection, email security, network detection, backup and incident response markets. Micro Focus has application security and security monitoring capabilities. Although you can’t say the products of either company are market-leading, most have substantial customer bases that are eroding slowly. That means the products continue to generate cash flow on maintenance renewals. OpenText has also been migrating many of its offerings to the cloud far faster than Micro Focus. I’d expect Micro Focus’ offerings to start migrating to the cloud soon after the deal closes.
When mature companies merge like this, most customers don’t perceive much of a difference, at least for a while. Their renewal agreements might come with a different logo on top. But over time, the aggregators need to cut costs to pay for these deals. That means cutting R&D and optimizing sales/marketing. If you’re still a Micro Focus customer, you probably shouldn’t be expecting a lot of innovation, though it’s not like Micro Focus has been very innovative since they acquired the security assets from HP anyway.
Bottom Line: The OpenText/Micro Focus deal makes sense as OpenText looks to continue broadening its product offering, especially in security markets. This doesn’t threaten the security market leaders in any way, but as a way to wring more and better profits from the Micro Focus assets, this looks to be a good move.
