Last October, one of the IT industry's oldest companies, Software AG, laid out its strategy to become, as CEO Sanjay Brahmawar told diginomica, "the number one enterprise integration company." Two months later, the company revealed it is selling the business at the heart of that strategy to IBM, and there are reports it is looking to sell off other products, too. Just months after private equity investor Silver Lake took majority control, are we witnessing the break-up of a company that has been a fixture in the software industry for more than half a century?
The arithmetic makes sense for Silver Lake. Its bid for a controlling stake in Software AG succeeded in June, valuing the company at €2.4 billion ($2.6bn), with just over 84% of the shares ultimately secured. Three months after closing this transaction in September, the sale of the webMethods and StreamSets business to IBM was announced in mid-December at a purchase price of €2.13 billion ($2.3bn) in cash, turning in a handy paper profit for Silver Lake in just a few months. Further sales will cement that gain, but would represent a dramatic reversal of the growth strategy Software AG has been pursuing in the past few years. Silver Lake has now launched a further offer for all remaining shares as a prelude to delisting the company from the Frankfurt Stock Exchange, where it is quoted.
Silver Lake and the Software AG Foundation
Software AG in part owes its hitherto longstanding independence to a 30% shareholding entrusted to the Software AG Foundation, a non-profit organization set up and led by Dr Peter Schnell, one of the company's original co-founders in 1969, and later its chairman of the board for many years. His personal shareholding was used to establish the Foundation in the early 1990s, prior to Software AG's IPO in 1999. With assets worth around €1 billion as of December 2022, the Foundation provides grants to support research and projects in health and wellness, nature, social care and education.
The Foundation shareholding has always presented a significant obstacle to external bidders for the company, but Silver Lake was able to prevail because it took time to build up the Foundation's trust in its intentions. The PE firm first invested in Software AG with €344 million convertible debt, announced in December 2021. According to Bloomberg, other PE investors including Thoma Bravo and CVC Capital had been considering outright acquisition bids and M&A speculation drove up the share price. The decision to stay independent came as a disappointment to stock market punters, but was more in line with Software AG's historic path. Silver Lake nevertheless took a casting vote majority on the company's Supervisory Board, appointing its European head along with Red Hat's former CEO and senior IBM alumnus Jim Whitehurst as its board nominees.
At the time, Software AG was in the midst of a five-year internal program, dubbed Helix, which aimed to transform it from a legacy software business, sustained by license sales of its longstanding mainframe tools Adabas and Natural, into a fast-growing Software-as-a-Service (SaaS) provider offering a range of digital tools for enterprise IT. These spanned integration and API management with its webMethods product family, IoT and analytics with Cumulocity, Trend Miner and Apama, and business transformation with ARIS. These newer products had been added largely by acquisition over the years, and within months of Silver Lake's investment, the acquisition of StreamSets in the first half of 2022 added a modern data integration platform into the Helix plan.
By April last year, Silver Lake had gained the Foundation's trust to the point where, at the time it presented its plan to the Software AG board for an all-out acquisition, negotiations to buy the bulk of the Foundation's shareholding were already well in hand. According to a filing with the German stock market regulator, this effectively stymied any alternative bid. As the document states (translated from the German original):
On 16 April 2023, the Management Board received a non-binding expression of interest from Silver Lake for an acquisition of up to 100% of the SAG Shares. According to the letter, Silver Lake was already in advanced negotiations with the Foundation about the acquisition of 25.1% in [Software AG (SAG)] on an exclusive basis, which precluded the Foundation from speaking or negotiating with any other potentially interested parties, effectively eliminating the chances for SAG to run a formal competitive sale process. As subsequently stated by the Foundation, it had previously held discussions with several interested parties before making its decision to sign an exclusivity agreement with Silver Lake.
Rocket Software's bid
Within days of the offer being made public, a higher bid arrived from US-based mainframe tools vendor Rocket Software, which is owned by private equity firm Bain Capital. But while Silver Lake had already prepared financing for its own offer, the Bain/Rocket offer had not yet had time to put finance in place — and crucially, in the meantime the Foundation had signed a binding agreement to sell the bulk of its shareholding to Silver Lake, retaining just 5% of the company. The Software AG board concluded that this, along with other factors, meant the Bain/Rocket bid was unlikely to succeed. It therefore rejected the offer of €36 per share, instead accepting Silver Lake's €32 per share, up from its initial offer of €30 per share.
The largest minority shareholder, Schroders, went public with its displeasure at the board accepting the lower price. But in a statement, the Foundation's management reiterated that it was "convinced that Silver Lake is the right long-term partner" for Software AG. The regulatory filing reveals that a particular concern was that a takeover by US-based Rocket Software, a long-term rival in the mainframe tools market, would significantly impact the workforce at Software AG's headquarters in Darmstadt, Germany. Among other reasons for going with Silver Lake, it records that the SAG board considered that:
Silver Lake has proven to be a reliable partner of [SAG] over the last years, with respect to financial and strategic matters. It has committed to the existing strategy of the Management Board. Also, there is a higher risk that, after a successful offer, [Rocket Software] would change the headquarters of [SAG] and reduce the work force significantly [and] ... a combination ... would not be beneficial for SAG's stakeholders, inter alia, due to a lack of strategic alignment.
IBM swoops in
Once the transaction had closed, October saw the announcement of the Super iPaaS platform, which brought together the webMethods and StreamSets products into an AI-enabled platform to co-ordinate enterprise integration, arguably the culmination of the Helix program. Barely two months later, IBM snapped up the platform in a transaction that CEO Brahmawar welcomed as "a major validation of our strategy and a recognition of the products at the heart of our Super iPaaS vision." Perhaps not, however, what was understood by the intention to support Software AG's long-term strategy set out in Silver Lake's offer document.
Now leading German news title Handelsblatt has reported that Software AG is also looking to sell its Cumulocity and Trend Miner products, which are used in Internet of Things and Industry 4.0 applications, as well as Alfabet, an IT asset mapping and analysis tool. While this prospect only remains a rumor at present, if the company did sell off these products too, it would pare the remaining business back to its original mainframe toolset, along with the ARIS business process mining and management tool.
Software AG declined to comment for this article.
The break-up of Software AG, Germany's second-largest software company after SAP, has long been foreseen by observers. An article last April in German-language business weekly Wirstschaftswoche saw a break-up as almost inevitable, pointing out the differing needs of the core traditional business compared to the new growth product lines, while noting that the Helix strategy had failed to meet its promised targets. As to why the Foundation had finally relinquished its influential shareholding, it quoted a former Software AG manager, who argued that managers at the Foundation were less attached to the historic link with Software AG than its founder, and would be keen to diversify more broadly rather than concentrating so much of its equity investment in a single company.
Private equity firms, of course, are often characterized as asset vultures that specialize in breaking up long-established businesses to sell off the components to the highest bidder. In truth, their track record in the technology sector in recent years has more often been a case of taking an underperforming business away from the quarterly scrutiny of the public markets to invest in an aggressive growth strategy that yields unrealized value. It's typically more a case of fix-and-flip than break-up-for-scrap.
Software vendors that need to make the transition from traditional licensed software to cloud-based SaaS have provided rich pickings for such strategies. The switch to SaaS requires a multi-year investment that public markets find hard to digest, whereas private equity firms are geared up to invest big sums in expectation of even bigger returns on a five- to seven-year timescale. Meanwhile, the locked-in revenue from the installed base of legacy customers at a company like Software AG provides plenty of cash to cover the day-to-day needs of the business until the transition is complete.
The difference with Software AG's core business is that it was never going to the cloud. Mainframes are inherently an on-premise platform, and that is where Adabas and Natural run — there's no point in running them in the cloud except as part of a legacy migration project. Therefore diverting resources into building up a new portfolio of SaaS products was simply a distraction from the core business. It might have worked if it had gained enough escape velocity, but this was a tall order when there was so little synergy across the full breadth of the digital business portfolio.
It may seem premature to have sold off the integration business so very soon after completing the purchase of Software AG, but bear in mind that Silver Lake has been involved in the evolution of this platform since its initial investment two years ago. The opportunity to sell to IBM came at an opportune time and gives the platform even more chance of success, given the further resources and channels IBM can bring to bear on it. And once that integration platform is removed from the business, there's little rationale for retaining the other products that are now said to be up for sale.
Was this always the plan, right from the outset? With the benefit of hindsight, it's easy to pull together a narrative that argues that it was. But it's far more likely that the pieces simply fell into place, one step at a time, until the ultimate outcome became inevitable.
How will the story end? There has to be real concern among Software AG's remaining employees and the wider community in Darmstadt that what's left will get gobbled up in a final transaction that sees the company lose its independent identity. Joining forces with another mainframe software company would make a lot of business sense, perhaps even bringing another bid from Rocket Software or some other player such as BMC Software.
But it would be more in line with Silver Lake's stated intentions at the time of its offer to maintain Software AG's independence by doubling down on a simplified, SaaS-first product line. Is that either possible or likely with the few products that are set to remain in the business? Let's see what Silver Lake can pull out of its hat in the coming months.