Software AG Brings Stellar Returns to Investors
By Bob Starzynski
One year ago, Thayer Capital Partners, a Washington-based private equity investor, bought a majority stake in Software AG Americas at $1.40 a share.
"Even at that price, Thayer was going out on a limb," said Dan Gillis, president and chief executive officer of the software company, which was splitting off from its German parent after years of slow growth and the parent's profits disappearing into losses.
"We want a company with a good product idea that doesn't have the money to get the product to market."
- Dan Gillis,
The newly independent Software AG Americas, based in Reston, Va., and known as SAGA, went public on the New York Stock Exchange last November at $10 a share. After several months of impressive earnings and marketing performances, the stock closed at $26.75 on April 6, giving Thayer a 1,900 percent return on investment over one year.
"Typically, our target rates [for investments] are 30 to 50 percent per annum," said Rick Rickertsen, a partner with Thayer and a board member of SAGA. "This kind of deal comes around once in a lifetime."
Software AG builds both software development tools and products that allow different computer networks to mingle their platforms with one another.
When Thayer bought its stake in SAGA, the management at the German parent organization maintained an 8 percent stake in the company. Under the terms of the agreement, SAGA continues to sell Software AG products exclusively in North and South America, Japan and Israel.
So far, most new product development is still done by the German company, although SAGA is free to cultivate products as well.
SAGA is already generating more royalties for the German Software AG than it ever did before the separation last year, according to company officials.
Gillis estimated his customer list includes 1,500 corporations, state and local government agencies and universities (in a 60/30/10 split of SAGA's overall business). Customers include Federal Express Corp., Sprint Corp., the Virginia Department of Motor Vehicles, Brown University and the U.S. Office of Personnel Management.
SAGA was down but not out when Thayer came to the rescue a year ago. The company created a name for itself in the 1970s and '80s by making enterprisewide software solutions for corporate mainframe computers. But when mainframes gave way to client/server systems in the late 1980s, the company missed the shift.
However, mainframes have regained their popularity in the past two years, both in government agencies and corporations, giving new hope to Software AG and its American counterpart, SAGA.
"It's not a matter of if the business is out there for them," said Tom Hensel, an analyst with Everen Securities in Chicago, "it's how much they can handle." Hensel initiated coverage on SAGA last month with a six-month target price of $31 a share and an 18-month target of $44.
"Software AG has some promising relationships," said Philip Costa, an analyst with Giga Information Group in Cambridge, Mass. "If things catch on, they could go for a ride."
Costa said much of the company's promise lies in maintaining its relationships with its mainframe customers. "They can take their existing customers and give them a migration path to new technologies," he said.
SAGA, which was a profitable division before the spinoff, was a risky investment for Thayer because it maintained close ties with the German company, which had been losing money for years, said Rickertsen.
"[The German Software AG] owned the technology, and they were not in good shape," he said. "There was a chance that they would either fail or be sold. It was very risky." If the German company went out of business, SAGA could have lost its product-line umbilical cord.
According to Rickertsen, that risk is now gone because the German company has come back into mainframe favor. Aside from that turnaround, SAGA has made several moves of its own in the past year that have breathed fresh air into the company:
- It raised $48 million in the initial public offering for use in acquisitions and product development.
- It brought in two top marketing executives in August from Iomega of Roy, Utah, both of whom recognized the company's lack of image.
- 150 new employees have been added to the company roster in the past five months, bringing the total count to 950.
- Net income has doubled from 1996 to $12.7 million in 1997, while revenue increased 16 percent to $181 million.
- It is currently introducing the first of a series of "middleware" products that will allow mainframes to communicate with disparate software applications and networking equipment. In other words, PeopleSoft can talk with Oracle, and Oracle can talk with SAP.
Competition in SAGA's various markets ranges from IBM Corp. of Armonk, N.Y., to Sybase Inc. of Emeryville, Calif., and Sterling Software Inc. of Dallas to Iona Technologies Inc. of Cambridge, Mass.
But according to Gillis, SAGA does not need to take market share away from its competitors. "We just need part of the 92 percent annual market growth," he said.
Hensel agreed. "They don't need to go head-to-head with the competition, undercutting costs and putting together all these proposals," he said. "Mostly, they are going back to their existing customers with new offerings."
SAGA has not spent any of its initial public offering money on acquisitions to date, but both Gillis and Rickertsen consider that issue the company's top priority. "We would have liked to have done some acquiring of technology already," Rickertsen said.
With the addition of a chief technology officer in December, Gillis said, the company is now looking more actively at acquisitions. Because SAGA is interested in technologies and not company structure, it is doing its shopping at the small, private-company level. "We want a company with a good product idea that doesn't have the money to get the product to market," Gillis said.
One of the most difficult hurdles facing SAGA officials was creating a new image for a company that was not previously seen as an achiever nor innovator.
Gillis hired Timothy Hill and Michael Collins from Iomega eight months ago. "Tim Hill is an expert at creating an identity," Gillis said of his new vice president of
marketing. "Before, our customers knew us, but others may have only recognized the name."
Under Hill's command, Software AG Americas started referring to itself informally as SAGA (said as a word and not an acronym), which connoted hipness and newness. And the company rolled out an aggressive advertising campaign last week to introduce the company to the public. It will include full-page ads in the Wall Street Journal and other business and industry publications over the next several months.
SAGA sources said the company's advertising budget for this year is two-and-a-half times larger than last year's advertising budget.
Meanwhile, Thayer - like any investor - needs an exit strategy. Gillis said he wants to get Thayer's ownership in the company below 50 percent as soon as possible. Under corporate accounting laws, an outside investor, like Thayer, needs to have its holdings below 50 percent for two years before the company can take advantage of certain financial benefits related to acquisitions.
Thayer, which has $364 million in its funds, focuses on information technology, consumer products, telecommunications and travel and leisure services investments. It currently has $164 million uncommitted to investments.
| ||The German headquarters of Software AG. This segment of the company has come back into mainframe favor, according to Rick Rickertson, a board member of SAGA.|