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Riverbed Technology (RVBD) is in play after Elliott Management made an unsolicited offer for the application performance infrastructure player. The news does not come as a total surprise after the fund already bought a 9% stake in the struggling company back in November of last year.

Riverbed Is In Play

On Wednesday, Elliott Management announced that it has made an offer to acquire Riverbed Technology for $19 per share in cash. Riverbed confirmed that it has received the unsolicited proposal, and that it will review the offer and its terms, updating the market when necessary.

The offer appears not very aggressive, especially not for an unconsolidated deal. The $19 offer price implies a 6.4% premium over Tuesday's $17.85 per share closing price. The offer values the business at $3.1 billion.

There Is More Ahead?

Riverbed is in play and investors clearly expect much more to come. Shares rose to $19.53 on Wednesday, trading some 2.8% above the offered price. Just after the news broke out, shares touched upon $20 as the market clearly expects more.

In options trading, most activity for the regular January and February expiry could be found in the $20 calls as well.

Shares of Riverbed rose from $5 in 2009 to highs of $40 early in 2011. Ever since it was downhill with shares falling to lows of $14 in October of last year. Then came November of last year. Shares rose 16.1% on the 8th of November after Elliott took a 9.1% stake in the "undervalued" company. The fund holds another 1.5% stake in Riverbed through derivatives at the moment.

Since that time shares traded between $17 and $19 per share. Based on the share price before Elliott announced its stake, then trading at $15.11 per share, the offer represents a much healthier and nearly 26% premium. Despite this premium, the offer would still imply a greater than 50% loss for those buying shares just three years ago, possibly creating some opposition against the deal.

Besides traders, analysts are expecting more as well. Daniel Ives, analyst at FBR Capital Markets believes this is the first step in a "game of high stake poker."

Elliott Management Is Active

Hedge fund Elliott Management has large technology investments other than Riverbed. In May of last year, Elliott as part of an investor group acquired BMC software in a $6.9 billion deal. Earlier that year, Elliott tried to acquire Compuware (CPWR) in a potential $2.3 billion deal.

In November, Elliott believed Riverbed has been significantly undervalued. At the time it argued that the company should maximize the operational as well as the capital structure of the business, while reviewing strategic alternatives.

Riverbed reacted promptly at the time, adopting a stockholder rights plan. This plan was aimed to promote the fair and equal treatment of all shareholders, allowing the board to remain in the best position to fulfill its fiduciary duties to the company as well as its shareholders.

Those adopted rights will become exercisable if a person would acquire an ownership of 10% or more, including positions held through options or other derivatives. Given the "hostile" nature of the deal, the fight between Elliott and Riverbed is expected to be fierce.

The aggressiveness of Elliott follows private dialogues with Riverbed's top executives which appear to have gone nowhere in recent weeks, prompting Elliott to make this unsolicited offer.

Riverbed's Struggles

Between 2009 and 2012, Riverbed has more than doubled its annual revenues towards nearly $837 million. Earnings rose sharply as well, increasing from $7 million to nearly $55 million. Note that earnings fell by nearly 15% in 2012, despite 15% revenue growth that year.

These trends have continued and accelerated into 2013. Revenues for the first nine months of the year rose by 26.4% to $757 million, making the company on track to generate a billion in revenues. Yet profits took a move for the worst. So far in 2013, Riverbed reported a $20.8 million loss which compares to earnings of $49.8 million in the comparable period in 2012.

Despite these operational problems, the balance sheet is still reasonably solid. The company operates with $433 million in cash and equivalents, while operating with $522 million in total debt. This results in a very manageable $89 million net debt position.

Revenues Growing, Earnings Are A Problem

As you can see from recent financial statements, Riverbed continues to grow nicely in terms of revenues, even as they fell short to consensus estimates in recent times. Yet the lack of earnings and actual losses based on poor sales execution and the disappointing integration of Opnet, are the main reasons for concerns.

Part of this problem is the reliance on WAN optimization, from which Riverbed generates roughly two-thirds of total revenues. The migration to cloud and browser-based applications might have a real detrimental impact on this segment as enterprises quickly adopt the cloud. Riverbed's Granite storage solutions and Stingra's application delivery offerings are much more interesting parts of the business.

What To Do?

Riverbed is now clearly in play, in a move which could be expected after Elliott took an initial stake in the company back in November. While Elliott appears to be a mixture between a hedge fund and a private equity fund, some natural buyers might have a look as well. This includes the normal candidates, including Cisco Systems (CSCO), among others.

I am not convinced that shareholders will tender the majority of their holdings at current levels, based on the historical performance of the shares, creating a loss for many of them. As such, Elliott will most likely have to come with an $20-$22 offer, while a bidding war could possibly ignite an offer of $25 per share. With shares trading just $0.50 above the offer price, some longer dated $20 calls or an outright long position might be worth the gamble, based on the assumption you can offer your shares at $19 to Elliott.

Good luck.

Source: Riverbed Technology - In Play As Elliott Steps Up