Why Advent’s Acquisition Of Forescout Should Be Renegotiated Lower Or Abandoned Given Post COVID-19 Developments: 35%-50% Downside Risk (NASDAQ:FSCT)

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Spruce Point Capital Management is sharing its thoughts on the acquisition of Forescout Technologies (FSCT) by private equity firm Advent. The exclusive slide content will be available on our Twitter account @sprucepointcap We are short the stock of Forescout. Please see our investment disclaimer below.

Executive Summary:

On Feb 6, 2020 Forescout Technologies, Inc. (“FSCT” or “the Company”) announced its purchase by Advent International for $33/share in a $1.9bn deal (4.7x 2020E sales). We believe investors ascribe too high a probability that it is a done deal. Upon conducting a forensic analysis of deal proxy statements, we observe that some financial forecasts reviewed by Forescout internally may not have been shared with prospective acquirers – and that some of these forecasts, notably “Illustrative Guidance” (developed by management in January 2020 per the proxy) were materially worse than those known to be disclosed to buyers. Based on the $335m 2020E Illustrative Guidance, Advent is paying 5.1x sales. Whether or not this would represent a breach of reps and warranties, we believe it should serve as grounds for Advent to negotiate a lower share price. Advent’s interest in revisiting the terms should be high given that the deal was struck just weeks prior to the WHO declaring COVID-19 a pandemic, which we believe dramatically alters the financial outlook for Forescout, a negative EBITDA business which was already under growth pressures and missing its guidance. Importantly, with the onset of the pandemic, Spruce Point estimates that it is likely in Advent’s interest to walk away from the deal – even after taking into account its $112M termination fee. We believe Advent substantially overpaid, underscored by Investcorp’s recent purchase of Avira in early April at 2.2x sales. Avira, a profitable cybersecurity company, was acquired at a revenue multiple >50% less than Forescout’s. We believe that Advent can, and should, use this as leverage to renegotiate the deal price lower by 35%-50%. In our opinion, Advent, a steward of public pension capital, must negotiate a lower deal price more reflective of Forescout’s ominous outlook, rather than unjustly enriching management with a $100m payday, and early VCs for having created limited / no value as a public company.

Was Forescout’s Complete Financial Outlook Shared With Prospective Buyers?:

Upon a close forensic analysis of the deal proxy statement, Spruce Point believes that some financial forecasts prepared by management may not have been shared with prospective buyers. In particular, forecasts which projected FY20 sales 8%-9% lower than the Company’s primary “Target Plan” (Target: $389m vs. Illustrative: $355m) were prepared and analyzed internally at various points through the acquisition timeline, but appear not to have been submitted to potential acquirers. In each case, these internal financial forecasts appear to have represented plausible outcomes for Company performance based on management’s best knowledge of the state of the business at the time, and, accordingly, should have been shared alongside its more optimistic forecasts. One of these forecasts (the Illustrative Guidance) was management’s preliminary Q1 and full-year FY20 revenue guidance which it planned to (but did not) share on its Feb 6, 2020 (Q4 FY19 earnings) – a call which was cancelled upon the morning’s deal announcement. With the Q1’20 guide a full 20% below consensus Q1 estimates and suggesting year-over-year contraction, the announcement could have dealt a crushing blow to the stock, possibly altering the course of any acquisition talks. With Advent – a financial buyer – having shown a relatively high level of sensitivity to forecast adjustments over the course of the negotiation, Spruce Point believes that the later disclosure of this guidance revision lower in the deal proxy may serve as motivation for the firm to walk away from the deal, or at least demand renegotiation.

A Busted Dinosaur IPO Under Greater Pressures Remarketing Debt Capital In A Highly Discriminating Environment:

It took Forescout 17 years to IPO, giving analysts reason to dub it a “dinosaur” IPO. As a public company, FSCT was showing signs of fundamental growth strain even prior to the onset of the COVID-19 pandemic: a disappointing Q3 FY19 preannouncement sent shares tumbling down ~37% as top-line growth decelerated to single-digit levels for the first time in years. Spruce Point finds evidence of widespread dissatisfaction among its employee base (per various and recent Glassdoor reviews), notably the front-line sales force which has shown significant turnover. The product itself has also received increasingly unfavorable reviews through the past several years as the competitive landscape has grown more crowded. Based on our primary due diligence, we learned that competitors are bundling more solutions, and cyber deals for small and medium sized businesses are being delayed, leading to pricing pressure. With a large percentage of its customers tied to government spending where margin upside is generally limited, a history of negative EBITDA and free cash flow, and an uncertain SaaS transition, investors should be worried about $400m of debt capital needed to fund the transaction during a newly disclosed “remarketing” period (note: the shareholder call referenced “remarketing” vs. press release “marketing”. At the April 23rd shareholder meeting where they voted for the deal, it was suggested by Forescout the deal would close on May 18th. However, Bloomberg emailed Advent for confirmation, and it did not confirm or deny the date. It would be in Forescout’s best interest to expedite a deal close.

A Favorable Cost / Benefit Analysis Gives Advent Leverage To Demand New Terms:

Spruce Point estimates that, given (1) Advent’s potentially incomplete view into Forescout’s financials during the negotiation process, and (2) pandemic-related developments which we believe erodes the Company’s outlook going forward, a conservative reevaluation of the deal featuring NO multiple compression could see Advent value FSCT more than 20% below the $33/share deal price. There are already examples of security firms withdrawing guidance as Q1’2020 earnings season starts (eg. FEYE). We will be following others in the Cybersecurity ETF (HACK) such as RPD CYBR SAIL PFPT QLYS NET FTNT PANW CRWD. Despite facing a $112M termination fee, a straight-forward cost/benefit analysis reveals that, at the current terms, Advent would do better to walk away from the deal rather than complete it. We believe that, in a more realistic scenario in which Forescout’s projections are revised downward, and the multiple compressed, FSCT shares should be valued between $17-$22 regardless of whether the deal is renegotiated or annulled completely, yielding 35%-50% downside to the $33 price.

Thank you for your continued interest in our research activism and opinions. We wish everyone health and prosperity in these challenges times.

Disclaimer:

This research presentation expresses our research opinions. You should assume that as of the publication date of any presentation, report or letter, Spruce Point Capital Management LLC (possibly along with or through our members, partners, affiliates, employees, and/or consultants) along with our subscribers and clients has a short position in all stocks (and are long/short combinations of puts and calls on the stock) covered herein, including without limitation Forescout Technologies, Inc. (“FSCT”), and therefore stand to realize significant gains in the event that the price of its stock declines. Following publication of any presentation, report or letter, we intend to continue transacting in the securities covered therein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. All expressions of opinion are subject to change without notice, and Spruce Point Capital Management does not undertake to update this report or any information contained herein. Spruce Point Capital Management, subscribers and/or consultants shall have no obligation to inform any investor or viewer of this report about their historical, current, and future trading activities.

This research presentation expresses our research opinions, which we have based upon interpretation of certain facts and observations, all of which are based upon publicly available information, and all of which are set out in this research presentation. Any investment involves substantial risks, including complete loss of capital. Any forecasts or estimates are for illustrative purpose only and should not be taken as limitations of the maximum possible loss or gain. Any information contained in this report may include forward looking statements, expectations, pro forma analyses, estimates, and projections. You should assume these types of statements, expectations, pro forma analyses, estimates, and projections may turn out to be incorrect for reasons beyond Spruce Point Capital Management LLC’s control. This is not investment or accounting advice nor should it be construed as such. Use of Spruce Point Capital Management LLC’s research is at your own risk. You should do your own research and due diligence, with assistance from professional financial, legal and tax experts, before making any investment decision with respect to securities covered herein. All figures assumed to be in US Dollars, unless specified otherwise.

To the best of our ability and belief, as of the date hereof, all information contained herein is accurate and reliable and does not omit to state material facts necessary to make the statements herein not misleading, and all information has been obtained from public sources we believe to be accurate and reliable, and who are not insiders or connected persons of the stock covered herein or who may otherwise owe any fiduciary duty or duty of confidentiality to the issuer, or to any other person or entity that was breached by the transmission of information to Spruce Point Capital Management LLC. However, Spruce Point Capital Management LLC recognizes that there may be non-public information in the possession of FSCT or other insiders of FSCT that has not been publicly disclosed by FSCT. Therefore, such information contained herein is presented “as is,” without warranty of any kind – whether express or implied. Spruce Point Capital Management LLC makes no other representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. You should assume all statements made are our opinions, unless sourced as facts where practical.

This report’s estimated fundamental value only represents a best efforts estimate of the potential fundamental valuation of a specific security, and is not expressed as, or implied as, assessments of the quality of a security, a summary of past performance, or an actionable investment strategy for an investor. This is not an offer to sell or a solicitation of an offer to Buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction. under the securities laws of such jurisdiction. Spruce Point Capital Management LLC is registered as an investment advisor with the SEC. Spruce Point Capital Management LLC is not registered as a broker/dealer or accounting firm.

All rights reserved. This document may not be reproduced or disseminated in whole or in part without the prior written consent of Spruce Point Capital Management LLC.

Disclosure: I am/we are short FSCT.


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