HP vs Dell vs 3PAR - The Dance

Bidding wars can do wonders for companies looking to exit. It can get you premiums unheard of in the market - case in point was the recent 3PAR acquisition announcement by HP.

Just came back from a presentation at TIE, the entrepreneurial organization that caters to budding entrepreneurs. The presentation was about the 3PAR acquisition and the presenter was Kevin Fong (investor from Mayfield Funds). Originally Ashok Singhal (CTO of 3Par) was supposed to join as well but he had to cancel in the last minute, because HP didn't want too much noise (really!!!) around the acquisition until the deal actually closes. Nonetheless, it was a phenomenal session. The presentation was great, but the part I usually like the most in any presentation is the Q&A, and this session was no different. Lots of very insightful and pointed questions, and very candid answers from Kevin. Unfortunately, since 3PAR is a public company, he could not disclose any non-public information.

Now, first things first.

So what's so unique about 3PAR and why were HP and Dell so desperately interested in it? Well, its all about the so-called "Cloud Computing". Cisco, IBM, HP, Dell are all vying to make it big in the Cloud Computing revolution. Now, one of the big components in the Cloud Computing ecosystem is high-end storage components. 3PAR happens to be one of the technology leaders in the area of the so-called "thin provisioning", which is a form of virtualized storage. In fact, 3PAR, in some sense, directly competed with EMC, a company several times larger than 3PAR itself.

Now as far as the big players are concerned, Cisco had made an acquisition of Andiamo Systems, a storage switch company, way back in 2002, but the integration of the company did not go very well. In 2008, they felt the need for a storage solution pretty desperately, and there were speculations of Cisco acquiring EMC. Eventually, however, they ended up with a partnership with EMC on the storage front and that partnership is apparently going well for Cisco. IBM, on the other hand, made a $300mm or so acquisition of XIV, an Israeli storage company in Jan 2008. So Cisco and IBM were out of the game. HP and Dell, the two other big players and also two of the fiercest competitors, had both been looking for a storage play. They had made some acquisitions of their own, but were still OEM-ing storage equipments from EMC, and wanted to sell their own storage equipments by expanding their storage product portfolio. That besides, both of them were (and still are) sitting on hordes of cash on their balance sheet. The few available companies at that time were 3PAR, Isilon, Compellent and Data Domain. Data Domain was picked up by EMC in late 2008 for an astronomical amount of $2.4 billion, again after a lot of bidding dance with NetApp, and with a $57 mm termination fee paid to NetApp in the process. Termination fee, (a.k.a. break-up fee) as most of you might know, is the amount a target company pays to a potential acquiror, when the former breaks a definitive acquisition agreement. This usually happens, if and when they get a better offer from another suitor. Anyway, coming back to 3PAR, clearly, with its 52% revenue growth rate, it was quite an attractive target for both companies.

The Initial Dance Steps

Apparently, HP was the one to first approach 3PAR with an acquisition offer of $12.75/share, on July 2nd, at a time when 3PAR was trading at $9.65/share, and hence a 30% premium. So what did 3PAR and the investors do ? Firstly, they rejected HP's offer, because they thought that at $12.75/share, they were undervalued. Secondly, they went ahead and hired an investment bank and went on to market themselves to more suitors. For this, they chose to work with Frank Quattrone from Qatalyst Partners, an M&A advisory investment bank, with whom Kevin had good relationship, and who had worked on several relevant high profile deals including HP/Palm, EMC/Data Domain.

3PAR and Qatalyst approached several suitors and obviously, Dell responded saying that they wanted to pay around $15-17/share. Qatalyst came up with a 5-year exit after-tax-EBITDA multiple of 15.0x to 20.0x, which when discounted to present value (at 10-13% discount rate) arrived at a valuation range of $16 - $21 per share of 3PAR. As an aside, EBITDA, which stands for earnings before interest, taxes, depreciation and amortization is a widely used financial metric for any company valuation.

So when Dell came back and offered a price of $18 per share, 3PAR management and investors thought it was a pretty good deal, based on the valuation analyses Qatalyst provided to them. However, their fiduciary responsibility was to maximize shareholder value (which included themselves as well) and so had to think of ways to get higher offers from both parties.

So what did the investors and management do ? They waited for a little bit, expecting HP would respond. But HP, for good or for bad, just went silent. So 3PAR went ahead and signed the definitive agreement accepting the $18/share offer from Dell. As you might imagine, an acquisition agreement comes with several clauses and this one was no different. The agreement from Dell barred 3PAR from shopping the offer due to confidentiality reasons. It also had a break-up fee of $52 million. The offer, furthermore required 3PAR to give Dell a 3-day matching rights clause. This meant that in the event another suitor came in with a counter-bid, Dell would have 3-days to match the offer.

The deal was now announced in public and, in fact, this was the first time the public came to know of 3PAR's intention to make yet another exit after its IPO in Nov 2007. What was 3PAR shares trading at now ? The same $9.65/share, which obviously meant that the non-public information was, indeed, kept non-public. Upon announcement the share price went up to $18, again implying that the markets thought that the deal was, indeed, going to close at $18 a share. Soon thereafter on Aug 6, HP announced the departure of CEO Mark Hurd. It clearly explained the silence on HP's part, but it also confirmed that Dell was going to be the new owner of 3PAR. Meanwhile, an excited Michael Dell flew to Fremont (headquarters of 3PAR), and met with 3PAR management, where they had a company presentation, where Michael Dell welcomed everyone to Dell and explained how it would be a synergistic acquisition and 3PAR would nicely complement its related acquisitions of Equalogic (apparently it was the biggest cash purchase of a private company - $1.4 billion) and Ocarina Networks. Kevin was also preparing to meet with Michael Dell in his office in Dallas. Everyone, including the investors and management, thought it was a done deal. But the game was far from over....

Counter-Offers Abound

While everyone was excited about the new owner of 3PAR, HP recouped from the loss of Mark Hurd, and on Aug 23rd sent a big one-page advertisement to the Wall Street Journal and also to 3PAR announcing its offer price of $24 per share, a 33% premium over the previous offer of Dell. The tables suddenly got turned...

By now, the acquisition premium had risen to 148% over the unannounced share price of 3PAR. Everyone involved realized that the game was not going to get over quickly. Bound by the 3-day matching price contractual clause, 3PAR approached Dell and sure enough, Dell made an offer of $24.30 per share the same day, but also increased the break-up fee to $72 million. Three hours later, right after the markets closed, HP made another counter-offer of $27 per share. Dell immediately matched the $27 per share and the following morning 3PAR accepted the offer from Dell. Later that day HP came back with a $30 per share. This was one of the turning points in the game. The biggest pawn in the game for Dell was its 3-day matching price clause. Dell let the 3-days to expire without providing any counter offer - big mistake, one that later-on cost Dell dearly.

Few days later, after the 3-day matching price clause expired, Dell came back with a counter offer with $31 per share, and with much stringent clauses and a higher break-up fee of $92 million. 3PAR rejected the offer stating that the clauses were too stringent. Dell then made yet another attempt and came back with a revised offer of $32 per share with some of the clauses relaxed but keeping the break-up fee at $92 million, and further stated that it was Dell's "best and final offer".

3PAR was now in a pretty bad dilemma. The bidding war had stretched far too long and they knew that if they accepted the offer, there was a chance HP would never come back with a counter offer. As a result they could not reject the offer, in fear of getting into a shareholder lawsuit in case HP did not come back with a counter offer. They also could have gotten into a shareholder lawsuit, if they did not approach HP for a higher offer. But remember, 3PAR was bound by contractual agreement to not approach HP for a counter offer.

So what did 3PAR do ? They went up to HP and without mentioning anything about their outstanding Dell offer, asked HP for its "best and final offer". Fortunately for them, right before markets opened on Sept 2nd, HP made their final offer of $33 per share topping that made by Dell by $1. Around the same time, Dell withdrew its offer and 3PAR went ahead and accepted the offer from HP before the opening of the trading day at $33 per share, a whopping 241% premium over the unannounced 3PAR share price, and at a valuation of $2.4 billion. 3PAR immediately wired the $72 million over to Dell from the $100 million, Kevin said, they had in the bank in cash. Also Kevin finally did make his planned trip to Dallas to meet Michael, but the discussions were, I guess, entirely different.

One thing that did strike me, while listening to the whole story was, if all is true, then 3PAR never told HP about Dell's $32 offer. How could HP then come back with an offer that topped Dell's "final" offer by $1. Additionally, why did Dell withdraw its offer right at the time HP's offer came in ? Kevin did not clearly explain this, but said that everything was done keeping shareholder's value maximization in mind. He also said that HP (owner of 3PAR) is now in a shareholder lawsuit by 3PAR shareholders because of some odd reason. (are you kidding me!!).

In the End

3PAR had raised a total of $183 mm in venture money out of which, $100 mm came from strategic investors like Cisco, IBM, and some other early investors. The rest came from VCs like Mayfield Funds, WorldView Technology Partners and Menlo Ventures, who at the time of acquisition still held ~40% of the company's equity and made it like bandits, a whole $560 million !! Looks like they can let their next 9 investments go under and still return money to their investors.

So in the end it was a win-win situation for everyone involved -- VCs, shareholders, 3PAR employees, HP, and even Dell, that stood to gain $72 million in break-up fees !! Heard they went ahead and acquired Boomi, another cloud-computing company, for an undisclosed sum (I am guessing probably $72 million :)). Not bad at all. For the rest of us, we got a phenomenal nail-biting bidding war story. Way to go 3PAR !!!