Since 2003, Onyx Software's (NASDAQ:ONXS) stock has been a laggard -- a common theme for many small and midsize enterprise-software companies. Yet value investors are starting to see opportunity in this area, as evidenced by Tuesday's announcement that Onyx would sell itself to M2M Holdings.
Since 1994, Onyx has developed customer relationship management (CRM) software for major customers such as AIG (NYSE:AIG), Unum Providant, and Starbucks (NASDAQ:SBUX). Onyx's solutions allow companies to improve lead generation, track customers, and manage marketing activities.
M2M Holdings is jointly owned by two private equity firms, Battery Ventures and Thoma Cressey Equity Partners. Such firms look for undervalued companies, whether they're public or privately held. In a typical transaction, they will invest 10% to 20% of their own capital for a purchase, then borrow the rest, usually in bank debt or even junk bonds.
Why the buyout?
So what's the attraction of Onyx? Its financials still appear weak, with first-quarter revenues falling from $14.1 million to $12 million, accompanying a net loss of $2.2 million.
Despite this, Battery and Thoma Cressey have agreed to shell out $92 million in cash for the company -- causing the stock price to jump 13%. Why? For one thing, Battery and Thoma Cressey have experience in consolidating slow-growth industries. They tend to buy up a variety of related companies at low valuations, which lets them cut out duplicative expenses, merge customer accounts, and even cross-sell to a larger customer base.
For example, M2M Holdings previously purchased Made2Manage Systems, whose enterprise resource planning (ERP) software helps companies manage payroll, inventory, and invoicing. Made2Manage has more than 2,200 customers, all of whom could be prospects for Onyx's solutions.
In addition, Onyx has an enticingly steady source of revenue. It sells its software by charging an upfront license, followed by a yearly maintenance fee, which generally ranges between 15% and 20% of the initial license. Because customers are reluctant to switch complex products like CRM software, Onyx's maintenance revenue is fairly secure. In the first quarter, revenue from new license sales fell from $3.8 million to $2 million, suggesting that the company is having difficulty finding new customers. However, revenue from recurring service fees fell only marginally, from $10.1 million to $9.9 million.
More to come?
Private equity deals have recently flourished in the enterprise software industry. In late May, Symphony Technology Group offered to buy Hummingbird Ltd. (NASDAQ:HUMC), which develops software to help companies manage, analyze, and protect business content. The proposed deal would total $465 million, a 16% premium on Hummingbird's market cap at the time of the offer.
Also in May, ERP software provider Infor made a $1.4 billion purchase of competitor SSA Global (NASDAQ:SSAG). Infor is backed by private equity firms Golden Gate Capital and Summit Partners.
Given private equity firms' well-funded coffers, and the thousands of small and midsize software companies having difficulty finding growth, it's reasonable to expect consolidation to continue. Such deals will probably be the main way these companies provide returns to their shareholders.
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Fool contributor Tom Taulli does not own shares mentioned in this article. Starbucks is a Motley Fool Stock Advisor pick. The Fool has a disclosure policy.
