Advent International signed a deal to acquire Forescout Technologies (FSCT) for $33. I don’t think that the merger contribution is enough. Other competitors with less revenue growth and gross profit margin trade at more significant EV/Sales. Besides, interestingly, the M&A lawyers included a go-shop provision, which indicates that many potential acquirers were not contacted. Taking into account these facts, I believe that the company represents an appealing buying opportunity.
Forescout’s Recurring Revenue Represents 40% Of Total Sales
Founded in the year 2000, Forescout Technologies, Inc. offers device visibility and control solutions. It appears to be an interesting company for financial buyers and other actors in the IT industry.
With large corporations using a significant amount of automation capabilities, Forescout Technologies expects to have an increase in its total market opportunity. Note that there are many tools, which may be vulnerable, and the amount of attacks may increase:
Source: Investor’s Day
The company’s platform helps organizations monitor campus information technology (“IT”) devices, operational technology (“OT”) devices, the campus Internet of Things (“IoT”) devices, and other devices connected to the cloud. Large organizations use more and more of these vulnerable devices. As a result, the company’s TAM is increasing at a high pace. According to the information given by Forescout, since its IPO, the TAM has increased by 25% amounting to $27 billion:
Source: Investor’s Day
The slide below offers further details regarding the total amount of customers with more than 200k devices. From 2016, the total number of customers has increased from 31 to 53:
Source: Investor’s Day
Forescout Technologies is an interesting target for financial sponsors like Advent International because the amount of recurring revenue is significant. In 2018, 40% of the company’s sales were represented by recurring revenue including subscription and licenses. Financial buyers appreciate this type of revenue because the financial models are usually much more accurate. You usually know the amount of money that you are going to receive.
Source: Investor’s Day
Strong Financial Situation
The company’s financial position is quite stable. The company’s asset/liability ratio is 1.3x, and Forescout’s cash in hand equals $55 million and $38 million in market securities. Also, as of September 30, 2019, the balance sheet shows goodwill valued at $92 million, which may offer synergies in the future:
Like other software vendors, Forescout reports a significant amount of deferred revenue; $176 million. The amount of financial debt is very reduced. Given the current amount of cash and marketable securities, the net debt is negative:
Forescout Technologies May Be EBITDA Profitable From 2021
From 2016 to 2018, with 34% CAGR and a gross margin of 78%, Forescout is, in my view, a hidden gem because the FCF was positive in 2018. In my opinion, from 2019 and 2020, the company is about to return significant cash flow. That’s the reason we are right now seeing interest from a financial sponsor. See the image below for more details on the matter:
Source: Investor’s Day
With that, the most interesting plot is shown below. The market is expecting that Forescout Technologies will return a positive EBITDA margin from 2021. That’s not all. Both the EBITDA margin and the sales are expected to grow in 2021 and 2022. The EBITDA margin is expected to reach 3.29% in 2021 and 4.9% in 2022. It is a pity that retail investors will not be able to enjoy the financial profitability of Forescout Technologies:
Source: Author And Guidance
The buyer: Advent International
Advent International is a private equity firm having invested $40 billion and is engaged in more than 335 transactions in 41 countries. I do believe that the buyer has sufficient financial power to absorb a company like Forescout Technologies, which has an enterprise value of more than $1.5 billion. Having said that, I also believe that there are many other companies, which may be interested in Forescout. In my opinion, a merger or an acquisition with an industrial player would make more sense. It would offer additional synergies that Advent International cannot offer. As a result, the merger consideration could be higher than what Advent proposed.
The Go-Shop Period Represents A Clear Opportunity
There is an interesting clause in the merger agreement. Until March 8, 2020, the sellers will solicit alternative acquisition proposals from third parties. As a result, I do believe that the company could receive additional bids from other organizations. In this case scenario, the share price may increase. It could be very profitable for shareholders:
The agreement includes a 30-day “go-shop” period expiring on March 8, 2020, which permits Forescout’s Board of Directors and advisors to solicit alternative acquisition proposals from third parties. Forescout will have the right to terminate the merger agreement to enter into a superior proposal subject to the terms and conditions of the merger agreement. There can be no assurance that this “go-shop” period will result in a superior proposal, and Forescout does not intend to disclose developments with respect to the solicitation process unless and until it determines that such disclosure is appropriate or is otherwise required. Source: Press Release
Conditions To The Merger Agreement
I did not find any surprising conditions in the merger agreement. Shareholders will need to approve the deal. Besides, the parties will need to wait the applicable period under the HSR Act. The acquirer is a private equity, thus I would not expect the acquisition to break any antitrust law. To sum up, I don’t believe that the merger precedent conditions are difficult to meet:
- Requisite Stockholder Approval. The Company’s receipt of the Requisite Stockholder Approval at the Company Stockholder Meeting.
- Antitrust Laws. The waiting periods (and any extensions thereof), if any, applicable to the Merger pursuant to the HSR Act and the other Antitrust Laws set forth in Section 7.1(b) of the Company Disclosure Letter will have expired or otherwise been terminated, or all requisite consents pursuant thereto will have been obtained.
- No Prohibitive Injunctions or Laws. No temporary restraining order, preliminary or permanent injunction or other judgment or order issued by any court of competent jurisdiction or other legal or regulatory restraint or prohibition preventing the consummation of the Merger will be in effect, no action will have been taken by any Governmental Authority of competent jurisdiction, and no Law will have been enacted, entered, enforced or deemed applicable to the Merger, that, in each case, prohibits, makes illegal or enjoins the consummation of the Merger.
- Conditions to the Obligations of Parent and Merger Sub. The obligations of Parent and Merger Sub to consummate the Merger will be subject to the satisfaction or waiver (where permissible pursuant to applicable Law) at or prior to the Effective Time of each of the following conditions, any of which may be waived exclusively by Parent. Source: Merger Agreement
The termination fee is quite significant. Taking into account an enterprise value of $1.5 billion, the parent termination fee represents 7% of the total enterprise value. I appreciate it. In my view, the termination fee will prevent the buyer from walking away from the deal:
Parent Termination Fee means an amount in cash equal to $111,664,539. Company Termination Fee” means an amount in cash equal to $55,832,270. Source: Merger Agreement
Termination Date: June 6, 2020, And No Financing Condition
The acquisition is also expected to happen fast. The termination date is June 6, 2020, so I would expect the acquisition to close in less than five months:
If the Effective Time has not occurred by 11:59 p.m. on June 6, 2020 (such time and date, the “Termination Date”), except that if as of the Termination Date all conditions to this Agreement are satisfied. Source: Merger Agreement
Usually, financial sponsors need to look for financing to acquire targets. Given this fact, it is always very relevant to understand whether the deal is subject to a financing condition. It is not the case here:
No Financing Condition. Parent and Merger Sub each acknowledge and agree that obtaining the Financing is not a condition to the Closing. Subject to Section 9.10(b)(ii), if the Financing has not been obtained, Parent and Merger Sub will each continue to be obligated, subject to the satisfaction or waiver of the conditions set forth in Article VII, to consummate the Merger. Source: Merger Agreement
The Origin Of The Transaction: An Activist Investor
In October 2019, after the company delivered its Q3 sales guidance, Forescout Technologies suffered a 28% decline in its share price. I cannot understand how reporting $10 million less in only one quarter can create such a market decline. Read further information in the lines below:
Source: Seeking Alpha
I am not the only investor believing that the market decline was not justified. Right after the share price collapse, an activist investor reported an 8% stake in the company:
According to the information reported by the activist, the management was about to be contacted to review different actions. Honestly, I have never seen an activist investor working so fast. In only two months, in February, a new acquisition was announced.
The Corvex Persons intend to review their investment in the Issuer on a continuing basis and may from time to time and at any time in the future depending on various factors, including, without limitation, the Issuer’s financial position and strategic direction, actions taken by the Issuer’s Board of Directors, price levels of the Shares, other investment opportunities available, conditions in the securities market and general economic and industry conditions, take such actions with respect to their separate investments in the Issuer as they deem appropriate. These actions may include, without limitation: (i) acquiring additional Shares and/or other equity, debt, notes, other securities, or derivative or other instruments that are convertible into Shares, or are based upon or relate to the value of the Shares or the Issuer (collectively, “Securities”) in the open market or otherwise; (ii) disposing of any or all of their Securities in the open market or otherwise; (iii) engaging in any hedging or similar transactions with respect to the Securities; (iv) entering into discussions with third parties relating to the Issuer; or (v) proposing or considering one or more of the actions described in subsections (a) through (j) of Item 4 of Schedule 13D. Source: 13D
Is $33.00 per share in Cash Enough? I don’t Think So.
With almost no debt and a share count of 48.1 million at $30-34, the enterprise value would be $1.44-1.63 billion. Forescout Technologies is expected to have 2021 sales of $440 million, so it would trade at 3.2-3.7x 2020 sales.
I took a look at other competitors. Cisco (CSCO) has a gross profit margin that is lower than that of Forescout and trades at 3.9x. Besides, Forescout Technologies reports more than two times the revenue growth of CSCO. Taking into account these figures, I don’t think that paying 3.9x sales for Forescout Technologies makes sense. In my opinion, 4.2-4.5x 2020 sales or approximately $41 would be much more appropriate.
Most investors would wonder why Forescout Technologies accepted to sell the company at $33. Well, in my view, with only one bidder, the demand for the company is low, which usually results in lower acquisition consideration. The fact that the M&A lawyers included a go-shop provision means that the market check was not done. The seller has not contacted many potential acquirers. If more parties get to know the company, the acquisition consideration may be a bit larger because the demand will be more significant.
I do agree with other analysts. It is not that likely that other competitors will bid for the company. In my opinion, there are not that many large corporations, which may be able to acquire Forescout Technologies. Having said that, I believe that buying shares of Forescout Technologies is smart. If there is another bid, in my experience, we can expect an increase of 5% to 7% in share price. If there is not another bid, Forescout Technologies would have the offer from Advent. So, we would not lose money. It is a head I win; tails I don’t lose investing strategy.
Morgan Stanley & Co. LLC and Wilson Sonsini Goodrich & Rosati are the advisors of Forescout. Ropes & Gray works as a legal advisor with Advent International. Bidders interested in acquiring Forescout may contact Morgan Stanley & Co. LLC.
The seller did not seem to have contacted many third parties because there is a go-shop provision in the merger agreement. If there is another bidder, there is significant room for improvement. In my opinion, $33.00 per share is not enough acquisition contribution. The company could be sold at $41 or 4.2-4.5x 2020 sales. Other competitors with less revenue growth and gross profit margin trade at 3.9x sales. Besides, notice that the buyer will need to pay for the control premium. To sum up, with one offer to buy the company at $33, buying shares of Forescout Technologies makes sense.
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.