Tech companies' vision hampered by growth goggles as M&A picks up

In a little more than a week, the tech industry has lost its M&A mind. As technology companies stretch for growth they are reaching for acquisitions in the name of diversification and showing a willingness to overpay for assets.

To wit:

• Dell decides to pay $1.15 billion for 3Par, a high-end storage company that had a market cap just north of $600 million or so just a week ago. Dell obviously wants to sell storage gear, but is the 80 percent premium worth it? The real kicker is that Dell may raise its bid for 3Par.
• Intel announced that it would buy McAfee for $7.7 billion a week ago. This deal was all about diversification. Intel would enter security software, leverage relationships with PC vendors and venture out into new markets. We'll overlook the fact that Intel's previous diversification moves into communications chips didn't pan out.
• And then HP on Monday decides it wants to really overpay for 3Par. HP will offer 3Par $1.6 billion. You can argue all you want about HP buying 3Par just to screw Dell, but the move is questionable. HP is a CEO-less company with its checkbook open. Sure, Dell was trying to take advantage of HP as it went through a leadership transition, but is 3Par worth the $1.6 billion just to wave your finger at a rival. Meanwhile, HP's offer raises a bevy of questions. Does HP need to beef up its storage products? What does 3Par really add? Can HP handle three acquisitions at once---3Com, Palm and 3Par---without a leader at the helm?

These deals signal the following:

• Sans organic growth tech companies need to go shopping to boost revenue and earnings.
• Tech companies have a lot of cash and are willing to pursue questionable deals to spend it.
• Some sectors---storage and independent (for now) security companies---will be the belles of the merger ball.

The latest flurry of tech M&A activity is fun to watch---if only because it looks a bit desperate. You could argue that tech companies should just hand out higher dividends, but it's more fun to gamble on acquisitions.

Love those growth goggles

The spate of recent deal making has a familiar ring to it. First, you take a company that has decent technology, but lacks distribution. Then you take a hefty buyer. And you plug the two firms together.

The Data Domain bidding war is a fine example. Data Domain, which focused on data deduping was growing at a rapid clip, was initially chased by NetApp. Then EMC swooped in and ultimately won the deal with a stronger balance sheet.

However, 3Par doesn't have the same profile of Data Domain. 3Par in its most recent quarter delivered revenue of $54.3 million with net income of $1.01 million. Those fiscal first quarter results met expectations.

For fiscal 2011, 3Par is expected to deliver revenue of $235.3 million, up from $194.3 million in fiscal 2010.

Dave Donatelli, HP's general manager of the company's enterprise servers, storage and networking business, said on Monday that 3Par was worth it since it played into its converged infrastructure vision. He said:

This is a company that has good technology but does not have the ability to bring it to market. We can bring it to market directly, we can bring it through our channel partners, we can bring it through our services group. And that gives us the ability to scale this asset quite rapidly.

Analysts were mixed on HP's move. HP has said for months that it wanted to commoditize storage. Now it's spending a lot for a business with proprietary offerings.

Barclays Capital analyst Ben Reitzes said:

We think 3PAR is a very good fit for HP strategically. That said, the timing and level of premium may raise a few concerns, in our view, even though it is largely immaterial to HP’s financials.

Susquehanna Financial analyst Jeffrey Fidacaro said:

We believe 3Par would arguably put HP in a better position to compete with the Cisco/EMC joint venture Acadia and roll out solutions that are effectively HP’s own version of Vblock solutions. Furthermore, HP’s Cloud Computing work with Microsoft (Azure) and with others can effectively utilize 3Par’s utility or grid storage solution.

Intel was also wearing growth goggles---a close cousin to beer goggles---when it decided to buy McAfee in a surprise move last week.

There's no need to recap all of the head scratching over Intel's purchase of McAfee. I've thought about the deal for days and still don't quite get it.

Forrester Research gave the McAfee purchase its blessing and tried to answer the burning questions. Forrester analyst Jonathan Penn writes:

Practically every analysis I've seen calls this a "head-scratcher", and so they slam deal simply because they don't understand it.

Memo to Penn: When folks don't understand a merger quickly it's usually a bad sign. The last deal that had me this perplexed was eBay's purchase of Skype. Remember call to click commerce? And we know how that one turned out---even though eBay got out of the deal fairly whole.

Intel CEO Paul Otellini laid out the rationale behind the McAfee deal:

We have concluded that security has now become the third pillar of computing, joining energy-efficient performance and Internet conductivity in importance. We believe that the future of computing will rest on improvements in and the integration of these three key pillars. We believe that security will be most effective when enabled in hardware. Joining the assets of McAfee with Intel will accelerate and enhance the combination of hardware and software solutions, improving the overall security of our platforms. Bringing together McAfee and Intel will facilitate innovative breakthroughs in security going forward.

Piper Jaffray analyst Auguste Gus Richard was one of the many analysts who were mixed on Intel's purchase of McAfee. Richard asked if Intel was thinking out of the box regarding McAfee or simply out of its mind. Wedbush analyst Patrick Wang noted that Intel's McAfee purchase was a long-term strategic move---very long term.

Storage and security hotties

While it's unclear whether there will be clear returns driven by these aforementioned mergers, the surge in acquisitions is a nice sign for shareholders and venture capitalists.

Simply put, any security company still independent is likely to be acquired. It's a similar story on the storage front. If 3Par can command a ridiculous premium just imagine what NetApp would go for. In fact, if HP really wanted storage glory it should spend big for NetApp, one of the storage leaders.

As for security companies, there's a new phase developing: Security isn't a standalone software effort anymore. Security is part of an overall IT stack. With McAfee off the table, it's likely that smaller rivals will also be gobbled up.

The love affair with storage and security companies really makes you wonder what will happen with Symantec, which happens to straddle both security and storage. If Intel ultimately proves that the McAfee purchase was brilliant rest assured Symantec will be part of a larger company down the road.