A Mergers & Acquisitions Study

A Look into acquisition of Demandware by Salesforce

On May 31, 2016, Dynasty Acquisition Corp., a wholly-owned subsidiary of Salesforce, entered a merger agreement with Demandware. On June 10 Salesforce filed a tender offer to purchase all of the outstanding shares (50%+1 share minimum requirement) of common stock of Demandware for $75. Demandware board unanimously recommended shareholders to accept the offer and tender shares.

Let’s take a closer look at the forthcoming acquisition. Recent SEC filings

by Demandware and Salesforce contain the commitment letter, set of agreements, plan of merger, recommendation statement, transcript of M&A call, joint press-release and extensive FAQ and provide the material for this analysis.

Strategic Rationale

Was this transaction an acquisition or a strategic merger? Why?

Tender offer clearly outlines this merger as an acquisition: immediately following the merger, Salesforce “intends to consummate” Demandware and hold all of the outstanding shares of Demandware common stock.

Did the buyer provide a well articulated and convincing argument for undertaking this transaction?

According to Salesforce SFO Mark Hawkins the acquisition is “a game-changing transaction that is highly strategic”. Salesforce is looking at expanding their leadership position and growing their total addressable market (TAM) significantly. Salesforce wants to capture the digital commerce platforms market, which is $4.2 billion now and expected to reach $8.5 billion by 2020 (Gartner). Demandware is seen to be the global cloud leader in this market, while Salesforce is a definitive leader in CRM solutions. Integration is expected to help customers on both sides to leverage the combined platform.

Salesforce understands the existing big overlap in customers, but believes that there are expense, distribution and infrastructure synergies which will help them accelerate revenue growth. Little information about the dollar value is provided, however.

The real possible reason for Salesforce to undertake the acquisition could be the recent drop in valuation of the SaaS companies: although not affected by that trend now, they might want to protect themselves from the possible decline in valuation in the future by growing extensively.

Did they have to undertake this transaction or could they have afforded to let another party take on the business?

Barclays believes that Adobe Systems Incorporated could have been another interested party, given Demandware’s adjacency to the company’s marketing business. Recently, the two companies reported a technical integration.

Were the financial benefits of the acquisition adequately covered in presentations and were they compelling?

Salesforce sees the merger as a strategic one, but does not provide strong financial arguments for the purchase. Short-term they expect the acquisition of Demandware to reduce operating cash flow by approximately $$45–50 million and bring $$100–120 million in incremental revenue in FY2017. While looking at significant market premium Salesforce is about to pay one would expect a more convincing explanation of the implied synergies.

Was the integration plan discussed and were the risks of the transaction identified?

Salesforce makes it clear that at the moment when the transaction is not closed it is “too soon to provide any details” regarding integration. The company notes, however, that they together with Demandware commenced the integration review process, and that prior successful integration with ExactTarget will be used as a blueprint for the forthcoming on with Demandware.

Integration costs combined with transaction fees are expected to be in the range of $30 million.

Terms of the Transaction

Was this acquisition appropriately priced?

Salesforce offer represents 54% to 84% acquisition premium, which is well above median premia for similar past “SaaS transactions” as analyzed by Goldman Sachs. Valuation to revenue multiple of 11x at $75 per share is also significantly higher than multiples for the observed transactions.

Surge in share price following the merger announcement confirms that from the seller standpoint the acquisition was priced appropriately.

Did Salesforce overpay, got a fair price or purchased the business at an attractive price?

As noted above, by acquiring Demandware Salesforce is entering significant and growing market and expects to gain from synergies by providing combined platform to customers. Valuations are based on a long-term outlook: both companies believe that its possible to improve Demandware’s bottom line and start seeing positive net income and free cash flow after 2017. A more skeptical, short-term analysis shows a clear destruction of value for Salesforce shareholders.

Did Salesforce handle the “social issues” in a manner designed to ensure a successful transition and to achieve the strategic objective?

As part of the merger agreement Salesforce generally agrees to retain employees of the Demandware with a “substantially comparable” compensation.

Was the financing of this transaction a major undertaking for the buyer?

Salesforce finished its first fiscal quarter of 2016 with ~$3.7 billion in cash and marketable securities and expects to obtain the necessary funds from its existing cash balances. Thus buyer will have sufficient cash on hand at the expiration of the Offer to pay the Offer Price for all Shares that are tendered in the Offer.

Did it increase financial risk?

As a result of the transaction Salesforce will be short of $$40–50 in operating cash flow for FY2017, and plans to take on a term loan of $500 million. With historically very low D/E ratio this should invoke a significant change in financial risk.

The M&A Process

Was this a competitive process?

It is important to note that Salesforce did not originally submitted a proposal to acquire Demandware: the company was among another 10 contacted to submit a proposal, and became one of only 2 that actually made an offer.

Based on the Background of the transaction included in SEC filings, which describes the timeline of offers and negotiations in detail, the process can be considered to be competitive: Demandware received a series of non-binding exclusive offers from the same prospective buyer, entered the non-exclusive solicitation stage, received further offers from 2 companies and asked for a certain bid in exchange for exclusivity.