DIR’s Ralph Gammon and Xamcor’s Paul Carman Discuss the Lexmark / Kofax deal
On Tuesday, March 24, after the close of the markets, a shockwave was sent throughout the document capture and information management markets. Kofax, the leader in enterprise capture software, announced that Lexmark had agreed to pay $1B to acquire it, in a deal that is expected to close before the end of the second quarter. (http://xamcor.com/?p=709)
The following is a correspondence between Ralph Gammon, the editor of the Document Imaging Report, and Paul Carman, President and CEO of Xamcor, discussing what this deal means to the companies involved, as well as the industry as a whole.
Ralph Gammon of DIR: So, no surprise that an MFP vendor has announced plans to acquire Kofax. What is surprising is that it was Lexmark, instead of Xerox.
Paul Carman of Xamcor: I agree. Of course, it’s no surprise that Lexmark made another software acquisition , as they have been very active in building their software capabilities. However, Kofax does come as a bit of a surprise. With Brainware an earlier acquisition and then ReadSoft closing some months ago, the capture space didn’t seem to be the next logical area of opportunity.
Ralph: No, but it seems to me like an opportunistic buy. Xerox was heavily invested in a partnership with Kofax (http://www.documentimagingreport.com/index.php/item/1773-could-xerox-kofax-partnership-lead-to-something-bigger), and was just getting ready to start selling solutions with the Kofax technology embedded. When you couple that with the capture requirements of its Xerox Services (the former ACS) business, Kofax just seemed like a natural fit for Xerox and the rumor circulating at last week’s AIIM show was that the Xerox acquisition was going to happen sooner rather than later. Then, last Friday morning, someone mentioned that the Xerox deal had fallen apart. Next thing I know Lexmark had jumped in.
Paul: While anything is possible in the M&A field, one thing I have learned is that rumors in most cases are highly inaccurate! I think when Xerox signed the major partnership agreement with Kofax in January, it may have led to the natural assumption that the next step was a Xerox purchase of Kofax. In fact, those discussions may have occurred. However, it would be unusual if Perceptive just entered the fray one week ago. There are at least two facts against that. First, if Xerox was continuing discussions with Kofax and was one week away from signing a term sheet, common practice would be to have a Letter of Intent or similar document in place. In almost all cases, that type of document prevents a company from negotiating with any other entity while they are negotiating with, in this case, Xerox. Second, while Lexmark is a smart company and knows our industry well, it would be a very rare occasion when they would go from an expression of interest to an offer in one week! Just the logistics of approvals of the two Boards could prevent this. In addition, being a savvy buyer, I am certain Perceptive would have to conduct some level of due diligence before making an actual offer. It is hard to imagine this can happen in a few days, especially with a company with as many pieces and as complex as Kofax.
Ralph: Those are good points. What somewhat surprises me, however, is that as recently as last month, when discussing its year-end results, Lexmark management was discussing reaching a goal of $500M in Perceptive Software revenue by the end of 2016. The acquisition of Kofax obviously blows that out of the water. In my mind, there is a disconnect there. You’re right, I’m sure Perceptive performed due diligence prior to the offer—probably in the event that something opportunistic happened, like the Xerox and Kofax talks falling apart. I know $1B seems like a lot of money, but based on Kofax’s portfolio, global presence, and leadership position in the capture, and now the emerging smart process application (SPA), market, I think Lexmark is getting a bargain that was just too good to pass up.
Paul: It’s not unusual that Lexmark provided numbers based upon their current operating plan. As a public company they have to be extremely cautious about providing any clues about an upcoming transaction. Had they raised those numbers to a level that would be unbelievable through organic growth, they may have been accused of trying to artificially prop up their share price. Regarding the $1B valuation, I would disagree and say that it was probably a fair price given the current state of Kofax. With their revenue is north of $300 million, a $1B valuation is very good at just over 3x revenue. I think most deals Kofax has closed were closer to a 2x revenue multiple. However, an important factor in all deals is EBITDA. In 2014, Kofax’s EBITDA declined significantly to $42.1M. As a factor of EBITDA this deal represents almost a 24X multiple, a huge number in today’s markets. Also, as a public company, this deal is really based on market cap. Prior to the acquisition, the market cap of Kofax was over $600M. With the offer by Lexmark, that market cap is now almost $1 Billion, representing a 60% premium to their market cap, which is not an unusually high premium for a strategic deal. As a market leader with a growing solutions portfolio, some premium can be expected. In addition, Perceptive will benefit from Kofax’s global presence. I think the only questions revolve around how successfully Kofax has integrated its acquisitions, and how Lexmark and Perceptive can improve this integration.
Ralph: I don’t think there was any question that one or more acquisitions were part of Lexmark’s plan to get Perceptive to $500M – just not necessarily something as big as Kofax. Regarding integration, I was just at the Kofax Transform conference, and came away thinking that Kofax has done a pretty good job of integrating its various acquired companies (along with its mobile capture technology) with its legacy capture technology in its Kofax TotalAgility offering. The challenge is selling this integrated offering. Realizing this vision for SPAs is clearly in the early stages. From an integration standpoint, I think Perceptive faces some real challenges, as there is serious overlap among the Kofax, ReadSoft, and Brainware lines – which Lexmark has paid a total of $1.4B to acquire. I could see ReadSoft and Brainware as somewhat complimentary, based on ReadSoft’s strength in Europe, but Kofax seems to overlay both of them. I don’t suppose that with Kofax now in the fold that Lexmark would turn around and let Hyland buy ReadSoft from them.
Paul: As an M&A company, we believe this deal accomplished a number of things. First, it certainly reinforces the fact that consolidation is ongoing and will continue for the foreseeable future. Second, it also reinforces the notion of valuation as a factor of what the buyer sees as their vision for the future of the combined entity. While multiples of revenue and EBITDA are easy numbers to calculate, this once again proves that real valuation is determined by the buyers’ vision of the future. As we say, beauty is in the eye of the buyer! Finally, we are convinced that the biggest effect of this deal may not be between Lexmark and Kofax, but rather the impact it will have on the entire industry. Many companies that in various ways compete with the Lexmark/Perceptive offering have been partners of Kofax. They now are in the awkward position of buying from and relying upon a primary competitor! While the notion of “coopetition” will suffice for some, other major players are right now huddling to determine their go forward strategy. All partners of Kofax are trying to determine what effect this deal will have on their company. Further, large ECM and BPM players who rely on Kofax Capture now find themselves in a very awkward position. For example, Xerox announced a major partnership with Kofax in January, yet they do not sell Perceptive solutions – and in fact compete with Lexmark in the managed print services (MPS) market. Konica Minolta, another Lexmark MPS competitor, just received a partner award from Kofax, but they are also partnered with Hyland, not Perceptive. This also has a major impact on Hyland, especially in light of their counter offers for ReadSoft some months ago.
Ralph: I agree. Kofax, ReadSoft, and Brainware all being combined under one flag should create some opportunities for smaller vendors to step in and fill holes created by some of the awkward positions you mentioned. Do you think there is still a chance for that Xerox will come in with a higher bid, or, based on your experience, do you think the fact that talks were broken off prior to the Lexmark offer means the window for Xerox acquiring Kofax is closed?
Paul: The one thing I have learned in all my years in M&A is to never say never! Certainly, having this deal announced allows another suitor to make an unsolicited offer for Kofax. With a starting point of $1B, however, it will take a major player to make a competing offer. Xerox has the potential to do this, and if truly interested they could yet come forward. That said, I believe an offer from Xerox would need the support of all their regions, which could be problematic and far more difficult than creating a partnership. Other large companies that serve the ECM and capture spaces, such as Oracle, HP, and SAP could come forward, but at this point that certainly would be a long shot. Finally, one group of companies we could hear from are the copier/MFP vendors. As a group they seem to be trying to add value to their core offerings, mostly in the form of software solutions. Some are invested in Kofax as partners, such as Konica Minolta and Ricoh.
With the Boards of both Kofax and Lexmark already approving the offer, any new suitor has a steep mountain to climb.
What have you heard as the reaction in the Kofax Partner and user community?
Ralph: There is mostly surprise right now among the Kofax partners. I think many of them were braced for a Xerox acquisition, but Xerox, because it does not own ReadSoft and Perceptive, brings a lot less baggage. For most reseller partners, this will likely be a non-issue at least for a couple years, until Lexmark’s efforts to reach its stated goal of 25% operating margins in its software business start to negatively effect development and support. Maybe that will never happen. And while I’m sure Lexmark will do its best to get partners to take on Perceptive over Hyland and other ECM offerings, I think Lexmark and Perceptive are wise enough not to try and force the issue and risk alienating high quality resellers (of which Kofax still has a good stable). If things do become too uncomfortable for resellers, there are options out there, and I certainly expect fallout from Lexmark’s consolidation of ReadSoft and Kofax to lead to the development of more options. I couldn’t believe, for example, how many ex-Kofax people were at the recent Ephesoft conference.
Paul: I agree; as you stated, Lexmark and Perceptive are smart, have faced these issues before, and have a very savvy and experienced management team. However, I think most partners will really need to assess all possible options. Most have been comfortable with Kofax for a long period, and a change like this tends to send shock waves. Frankly, we always recommend to our clients that they create and always update their strategic plan, as well as their M&A and exit plans. I also think that the larger Kofax partners, like Ricoh and Konica Minolta, will be reassessing their overall strategy. In addition, large vendors such as Hyland, HP and others will do the same assessment to be sure they have a clear solution strategy for the future.
The bottom line is that this deal confirms several trends we have seen:
- Consolidation will continue in the space for companies of all sizes
- Valuations continue to hold at a high levels and are based on future results
- It is critical for companies to create a living business plan, as well as an M&A and exit plan, so they are not left out of potential opportunities
- Capture is still valued in the sector and beyond
- The remaining independent capture companies need to have a clear plan for the future. This could be a valuable time to exit, or if they stay independent, they need to critically assess their point of maximum valuation.