Dynatrace - exploiting private equity for freedom and growth

The risks now being run by publicly-owned tech businesses have been written about before in diginomica.

The prime one remains the fact that stock traders of just about every category and persuasion have little knowledge or understanding of the dramatic changes in business models now rolling through the tech industries. Digitalisation, in all its flavours, is seriously changing the ways they do business, and the income patterns that follow.

One escape route for a growing number of tech businesses has been to allow themselves to be acquired by equity management businesses. This is a sector of the financial marketplace where the smarter ones have avoided being tarnished by the destructive dismember-and-sell-off approach that older readers might well remember as the hallmark of `equity management’.

Instead, these businesses look to build their acquisitions through the application of business expertise, re-structuring, and selected breaking up and re-mixing of business units to build new companies.

One company going through just such a process is Application Performance Management (APM) vendor, Dynatrace. Having been acquired by Compuware four years ago, the latter was then acquired last year by Thoma Bravo, with part of the deal being that Dynatrace was hived off as an independent company within the Thoma Bravo private equity portfolio.

According to the company’s CEO, John Van Siclen, the benefits can be seen in the way the acquisition has been restructured and remoulded into businesses that, he would contend, are better equipped to meet the needs of the marketplace as it evolves:

I think the thesis that Thoma Bravo had in acquiring Compuware was that they saw a couple of assets that were valuable, but for different reasons. The combination of them together under one roof really didn't make a lot of sense. Nor was it ever going to unlock the value of them.

The mainframe business is a cash business and the APM business is a growth business. Those are pretty different, so you have a value investor who likes the cash, you have a growth investor who likes the growth, yet if you try to blend them you end up with no growth and not enough margin to satisfy either side. It was a tweener in that way.

He sees that as one of the main opportunities the private equity route offers - not just to transform a business but to actually separate it into its logical components so that they can be more focused at attacking their specific market.

As he observes, 20 to 30 years ago the rage was for ever-larger conglomerate businesses. But that has now swung the other way and the focus of attention is aimed, as he put it, at `what do you really do’ and `are you really focused and the leader in that specific space’.

Growth opportunities

From a place four years ago, where it was almost a secret inside Compuware that had been sold for $25,000,000 trailing 12 months revenue, it is now generating around $450,000,000 in revenue running as an independent company as part of the Thoma Bravo portfolio.

This will grow some more with the recent addition of Keynote as a part of Dynatrace. The former was made up of two independent businesses, a telecoms testing company and an APM offering. The former is now a standalone company, Sigos, while the APM half has been merged into Dynatrace.

Van Siclen sees this as a good example of the strength of the private equity approach to managing businesses, as well as the element of good old-fashioned happenstance:

The APM business went from being one of the growth businesses in the $20 billion IT Operations Management space to being the fastest growing. At the same time, the old guard of HP, IBM, CA, and BMC have all fallen away, so there's not only growth in the market, there's also replacement business within the market. The gross growth looks like about 12%, but if you add in the replacement business it's probably around 20% or more growth.

Cry freedom!

One thing that has been said several times recently is that freeing businesses from the restrictions of the quarterly results cycle and stock market performance is one of the best parts of the equity management approach.

This is a view with which van Siclen sympathises. It has allowed him to plan and think through the business over a longer horizon, especially when it comes to the transition from a perpetual licensing model into a subscription or consumption based model:

When you look at IBM, when was the last time they missed 13 quarters? So, they are going through that same transition but it is in the public eye. We have a little more freedom to do it in the private world. It takes two to four years to do it effectively. So that is certainly an opportunity.

That key risk of being a public company rather than privately-held – and privately-held by a company that has resources in both money and expertise, knowledge of a marketplace and enough foresight to see trends out into a reasonable future – is still great.

It is sufficient to prompt what seems like an obvious question: is doing what you have done while still trying to satisfy a stock market, in business terms, basically committing suicide in public? Van Siclen says:

It's pretty close and most boards just have no patience for that kind of thing. Even if they say they do, the pressures of the market can blow against even the best CEOs.

My take

Dynatrace, with the obvious full-on assistance of Thoma Bravo, has managed to restructure in a way that would have been impossible as a public company, certainly not without devaluing it to the point where it could be bought with the small change in your pocket. And that would be unlikely to serve anyone’s best interests.