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International Business Machines (IBM) announced on Monday that it will acquire Kenexa Corporation (KNXA), in a deal valuing the firm at $1.3 billion. Shares of Kenexa rose 41% to all time highs at $45.79 per share.

The Deal

IBM announced that it will acquire Kenexa Corporation, in an attempt to bolster the company's position in social business analytics. By acquiring Kenexa, IBM hopes to gain insights in the enormous streams of information generated from social networks. Kenexa's 2,800 employees, which serve over 8,900 customers, will help to achieve IBM's ambitions in the field.

Shareholders of Kenexa will receive $46 per share in cash, a 42% premium compared to Friday's closing price. Currently, shares trade $0.21 below the offer price, leaving shareholders another 0.5% return.

General manager of IBM's social business, Alastair Rennie commented on the deal, "Every company, across every business operation, is looking to tap into the power of social networking to transform the way they work, collaborate and out innovate their competitors. IBM is uniquely positioned to help clients generate real returns from their social business investments, while helping them gain intelligence into the data being generated in these networks to be more competitive in their markets."

For the first six months of 2012, Kenexa generated revenues of $164.1 million. The company net lost $4.3 million, or $0.15 per diluted share. For the full year, Kenexa guides for revenues between $352-$359 million. The $1.3 billion offer, values Kenexa at roughly 3.7 times annual revenues. The company is most likely to lose money for the full year of 2012.

The transaction is subject to regulatory and shareholder approval, and is expected to close in the fourth quarter of 2012.

Valuation

For the first six months of 2012, IBM generated $50.5 billion in revenues, down 1.6% on the year. The company net earned $6.9 billion, up 6.5% on the year. Earnings per diluted share rose by 12.3%, as a result of share repurchase programs, to $5.95 per share. For the full year of 2012, IBM expects to earn at least $14.40 per share.

IBM ended the second quarter with over $11 billion in cash, making the acquisition of Kenexa, a mere rounding error in the firm's cash balance. Based on IBM's market capitalization of $223 billion, the market values IBM at roughly 0.5 times annual revenues and 14 times annual earnings.

Currently, IBM pays a quarterly dividend of $0.85 per share, for an annual dividend yield of 1.7%.

Investment Thesis

Year to date, shares of IBM have returned about 6%. Shares steadily moved upwards to $210 by March of this year, but shares fell back to levels around $195 at the moment.

Over the past five years, shares have returned over 70%. Between 2008 and today, annual revenues stagnated just above the $100 billion mark. At the same time, earnings rose from $12.3 billion in 2008, to estimated earnings north of $16.7 billion in 2012. Over those years, the company retired roughly 15% of its shares outstanding. Earnings per share got a double boost, and grew from $8.89 in 2008 to an expected minimum of $14.40 in 2012.

Annual dividend rose from $1.90 to $3.40 over the time period.

The acquisition of firms like Kenexa hardly makes a dent in IBM's operations. The deal value is equivalent to merely half a percent of Big Blue's market capitalization. At the same time, deals like these are important to continue to have access to emerging technologies and industries. While valuation levels on the back of traditional valuation methodologies are not cheap, IBM most likely considers acquisitions like these as cheap options to future growth.

In April of this year, I already took a look at the prospects for IBM. I applaud the management's insight to move away from hardware and personal computing, and transform the business into a software and cloud-based organization. By reacting early, IBM has avoided the same implosion seen at other big technology names. This includes Dell (DELL) and Hewlett-Packard (HPQ), which failed to change in time, or in the right manner.

Shares of IBM traded around $200 at the time, and I warned for few short term triggers after the large move upwards in recent years. Today, I reiterate that stand, staying on the sidelines.

Source: IBM's Acquisition Of Kenexa Is Just Another Option On Future Growth Opportunities