Cornerstone OnDemand: How Big Could The Acquisition Be?

Gary Alexander profile picture
Gary Alexander
24.55K Followers

Summary

  • News broke on September 14 that Cornerstone has hired banks and is exploring a sale.
  • While software M&A is down in 2017 compared to its white-hot pace in 2016, acquirers are still actively seeking out targets trading at reasonable multiples.
  • With Cornerstone trading at a measly 4x EV/FTM revenues, it presents an attractive target for either a private equity or corporate buyer.

In my earlier article on Cornerstone OnDemand (NASDAQ: CSOD), I wrote that its low valuation would rebound after a few quarters of outperformance in earnings. I was wrong: Cornerstone rebounded on takeover talks.

On September 14, Bloomberg reported that Cornerstone has hired Goldman Sachs (NYSE: GS) and Centerview Partners to explore a sale and provide shareholder defense against Praesidium, which is pushing the company to sell. The news has helped to lift Cornerstone's stock by ~10%, a welcome respite for bulls that have faced a declining stock price this year as enthusiasm wanes for the company's niche suite of corporate talent and training software.

2017 hasn't shaped up to be the banner year for software M&A that 2016 was - but when good assets like Cornerstone are for sale, there are sure to be buyers doing at least some window shopping. Despite rampant competition in the HCM space, Cornerstone is still growing at 10% - indeed, it's slow for a software company, but it's not nothing. The company is also continuing to add to its client base and is maintaining a 95% retention rate, and the company has recently turned cash flow profitable. These are exactly the kind of metrics that private equity looks for in a technology company - sticky revenues and a basis for cash flows that could be dramatically improved through a trimming of overhead.

Despite its recent run-up, Cornerstone still trades only a hair above 4x forward revenues - the lowest among its peers, and uncertainly untenable for a company still growing its top line and producing positive OCF. It's appropriately priced for interested buyers.

This article will discuss the possibilities surrounding Cornerstone's acquisition by looking at recent transactions in software. Overall, I believe Cornerstone hasn't rebounded far enough to account for the premium possible in an acquisition, and if Cornerstone makes good on its plan to sell itself, investors could see some meaningful short-term upside.

A Look At Precedent Transactions

2016 brought virtually no technology IPOs, but introduced a wave of deal mania that led to many public software companies getting swallowed by large-cap giants or taken private by financial sponsors.

The below chart shows the M&A deals in software in the past year, noting that in addition to the public deals shown below, plenty of private VC-backed companies were swallowed up as well:

Figure 1. Transaction comps

Note: multiples are based on LTM revenues.

Private Equity

Right away from the above chart, you can notice that private equity has had a hand in many of the deals occurring over the past year. Tech-focused "growth equity" funds are hungry for assets to acquire in software.

The targets that private equity focuses on aren't the hottest names of the moment. They likely aren't exploring moonshot deals in AI or autonomous driving - they're not looking for the 20x returns like their cousins in venture capital; they are looking for stable IRR. And that's what a mature software company like Qlik and Cvent provide - a big revenue base with recurring billings, moderate growth, and room for cash flow improvement. In that sense, an enterprise software deal for private equity isn't too different from a traditional management buyout of a manufacturer, with stable operations and a steady client base.

Private equity buyers typically pay lower multiples than strategic acquirers, most likely because they focus more on the financial profile of their targets than corporates, which will pay a healthy premium for the perfect technology asset to add to their product portfolio. From the deals above, we can deduce that private equity pays an average multiple of 5x forward revenues, though Vista paid in excess of 7x for Market and Cvent.

Also note that the average is driven down by ESW Capital's acquisition of Jive Software at 2.28x, with the lower multiple owing to Jive's revenue declines in the year prior to its takeover. This certainly isn't the case with Cornerstone.

Cornerstone certainly provides many of the elements desirable for private equity, and Goldman is almost certainly lining up private equity buyers to take a look. Private equity is probably also the most favorable outcome for Adam Miller, Cornerstone's Founder and CEO - under a private equity owner, he'd likely get to keep his job.

Strategic Acquirers

In the world of strategic acquirers, the elephant in the room is Oracle (NASDAQ: ORCL), who has been bolstering its cloud growth by buying out the competition and tucking in as many applications into its portfolio as possible. In 2016, Oracle alone took three publicly-traded software companies off the market, not counting the dozens of other private companies it has acquired.

In July of last year, Oracle announced its watershed $9.3 billion acquisition of NetSuite, a leading provider of cloud ERP and financial software solutions for small and mid-sized businesses. The combination created good segmentation synergies with Oracle's Fusion and ERP Cloud products, which cater primarily to the enterprise segment.

Oracle paid a staggering 11x multiple on NetSuite's LTM revenues, and as seen from the chart, it's not shy in paying high multiples for smaller deals as well. With Cornerstone's market cap of $2 billion, it lies between Oracle's mega-deal in NetSuite and its smaller, ~$500 million deals for the vertical applications Opower and Texture.

The combination of Oracle and Cornerstone, however, isn't too likely - despite the fact that Oracle's HCM Cloud isn't a dominant product and could use a boost. On Oracle's earnings call in mid-September, Larry Ellison noted the following with regards to M&A during the Q&A session with analysts (link to full SA transcript here):

There is no one left to buy. And it's not like there [...] are a bunch of obvious targets we can go out and buy.

We can interpret Ellison's statement in two ways: Oracle either doesn't have current appetite for more deals, or there just aren't any deals on the table worth looking at. Most investors took Ellison's comment as a signal that Oracle would be slowing down its buying spree in 2017 (though with $66 billion in cash, it certainly has the option to go shopping), but it's also entirely possible that Cornerstone is at least worth taking a look at for Oracle.

The other serial acquirer in enterprise software, Salesforce (NYSE: CRM), is probably not a viable buyer for Cornerstone, as Salesforce has indicated little interest in HCM software and prefers to focus on software for sales and customer-facing functions.

Microsoft (NASDAQ: MSFT), the largest enterprise software company and one of the largest-cap companies overall, makes for an interesting scenario. In January of this year, ZDNet reported that Microsoft was developing its own suite of HCM applications to compete with Workday (NASDAQ: WDAY) and Oracle. Wall Street took Microsoft's seminal $26.2 billion acquisition of LinkedIn as a signal that it would fold LinkedIn into a wider portfolio of talent-related solutions, most likely under the Microsoft Dynamics brand that seems to have everything except HCM.

With $133 billion in cash, Microsoft certainly isn't lacking in resources to buy an ant like Cornerstone, but the question is whether Microsoft will choose to build or buy. Cornerstone, after all, isn't a complete HCM solution - it's best known for its training modules - and Microsoft might want to build a fully fleshed HCM portfolio with core functions first before folding something like Cornerstone in.

In addition, while Microsoft has been active in M&A, it seems to prefer smaller, private "acqui-hire deals," specifically around analytics and machine learning. Outside of LinkedIn, Microsoft rarely moves to buy public companies. However, we certainly can't rule Microsoft out as a buyer, especially with its noted interest in HCM.

Key Takeaways

There are many possible buyers for Cornerstone, beyond those discussed in this article. While a strategic acquisition would likely offer the most generous payout to shareholders (in terms of a higher purchase multiple), private equity seems to be the more likely suitor for Cornerstone.

Cornerstone's technology is steady and solid, but not revolutionary - which is what gets a strategic buyer's appetite going. On the flipside, Cornerstone's stable, moderately-growing revenue base - devoid of too many surprises - is exactly what makes it appealing to the typical growth equity buyer.

Cornerstone's stock has risen only 10% since Bloomberg broke the news of its sale exploration. As seen from prior deals, software companies typically see a ~40% premium upon sale, indicating that Cornerstone could still see some considerable upside if and when a transaction materializes.

This article was written by

Gary Alexander profile picture
24.55K Followers
With combined experience of covering technology companies on Wall Street and working in Silicon Valley, and serving as an outside adviser to several seed-round startups, Gary Alexander has exposure to many of the themes shaping the industry today. He has been a regular contributor on Seeking Alpha since 2017. He has been quoted in many web publications and his articles are syndicated to company pages in popular trading apps like Robinhood.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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