Blue Coat Now Somebody Else's Problem

By Stephen D. Simpson, CFA | December 13, 2011 AAA

For better or worse, shareholders no longer have to worry about the repeated restructuring efforts at Blue Coat Systems (Nasdaq:BCSI), nor the competitive inroads being made by the likes of Riverbed (Nasdaq:RVBD), Cisco (Nasdaq:CSCO) or Fortinet (Nasdaq:FTNT). Private equity investors have stepped up and put an end to this story with an acquisition agreement. Though some shareholders may resent that management took a buyout price some 20% below the 52-week high, the reality is that this is a more-than-fair offer for a company that has been on skids for some time.

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The Deal
An investor group led by Thoma Bravo and including the Ontario Teachers' Pension Plan has offered to acquire Blue Coat Systems for $1.3 billion, or $25.81 per Blue Coat share, in cash. That price represents a premium of 48% to Thursday's close, but merely matches the price of this stock seven months ago.

Looking at the valuation, Thoma Bravo is offering less than three times trailing sales for Blue Coat - quite a bit less than Riverbed or Fortinet shares currently go for, but a nice premium to a comparable like Websense (Nasdaq:WBSN). I had a fair value of about $23 on these shares based on cash flow, so I have a difficult time saying that Blue Coat's board did garner a pretty good deal given the state of the business. (Learn how to filter out the noise of the market place in order to find a solid way of determining a company's value. For more, see Equity Valuation In Good Times And Bad.)

How Did Blue Coat Get Here?
Although Blue Coat management bloviated about the company's "leadership" and "differentiated products," in the press release that announced the deal, the reality is that this company has been struggling. In addition to disappointing earnings in 2011 and the sudden departure of the CEO, there have been multiple attempts at restructuring. Unfortunately, this has done little to dislodge Riverbed or Cisco, nor fend off competitive entries from the likes of Intel (Nasdaq:INTC), Citrix (Nasdaq:CTXS) and Fortinet.

To be fair, fiscal second quarter results were not bad and the company did raise guidance. Even here, though, there is a "but." How much of that improved performance was really just a product of resetting the bar so much lower? Likewise, with rumors all around that Blue Coat was offering big discounts on its ProxySG appliances, the quality of the performance was worth debating as well.

Can Private Do Better?
It will be interesting to see how hands-on Thoma Bravo is, and just how active they are in looking to turn around this business. There is still business out there in WAN optimization and security appliances. Moreover, it may certainly be the case that many of Blue Coat's problems can be solved with a stretch of consistent and quality management - particularly in the marketing and support functions.

Remember, this company was still cash flow positive and had a clean balance sheet. At a minimum, then, it would seem that there's less risk of Blue Coat being a major drain on its new owners.

The Bottom Line
Chances are that this transaction is basically trivial to Cisco and only a slight positive for Riverbed. There will almost certainly be some disruptions to business at Blue Coat through this transition, but if Blue Coat was buying business with price-cutting, that's not necessarily high-value market share opportunity for these rivals. If there is any impact it may be at Websense where it seems like Wall Street has had a "for sale" sign in the yard for some time now - perhaps investors take heart in this deal and assume that Websense can get at least a similar premium in a deal.

For Blue Coat shareholders, this is likely the best outcome that could have been expected. While bargain-hunters who picked these shares up in recent months are probably toasting their success, some long-term holders are no doubt displeased that Thoma Bravo will see more of the benefits of any restructuring and recovery. (For related reading, see Biggest Merger and Acquisition Disasters.)

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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