Forbes: This Surprising Rival Beats Cisco’s AppDynamics, New Relic in $2.6 Billion Market

Peter Cohan 
February 9, 2017 

I have long thought of private equity (PE) as a group of guys who buy cash rich businesses with a sliver of their own money and lots of debt; borrow more to pay themselves big dividends, slash costs, and trade the husk at a profit.

But over the last couple of years, I have learned about one PE firm that buys under-performing business software companies and makes them better.

I have long thought of private equity (PE) as a group of guys who buy cash rich businesses with a sliver of their own money and lots of debt; borrow more to pay themselves big dividends, slash costs, and trade the husk at a profit.

But over the last couple of years, I have learned about one PE firm that buys under-performing business software companies and makes them better.

What’s more, this firm owns Waltham, Mass.-based Dynatrace — its software helps “over 8,000” companies to monitor and analyze flaws in the performance of their applications — the leader (14.6% market share, according to IDC) in the $2.6 billion (2015 revenue) Application Performance Management (APM) industry.

APM has been in the news this year thanks to Cisco Systems’s $3.7 billion acquisition of APM software maker AppDynamics — which generated about $211 million in revenue in the most recent 12 months while it lost about $127 million.

As I wrote last month, this deal was great news for AppDynamics’s earliest venture investors but bad news for the IPO market and a slap in the face for Cisco shareholders. (I have no financial interest in the companies mentioned in this post).

How so? On January 25 Cisco announced its intent to acquire AppDynamics for $3.7 billion in cash and assumed equity awards — whereas the high end of its IPO range would have valued the company at $1.72 billion — well below AppDynamics’s $1.9 billion value when it previously raised capital in November 2015.

But Dynatrace is a far larger player and based on the valuation that Cisco assigned AppDynamics, I estimate it’s worth at least $7 billion. How so? According to my February 8 interview with Dynatrace CEO John Van Siclen, a Princeton history major who previously ran enterprise content management firm, Interwoven, Dynatrace “has grown to over $400 million in revenues — up 45% in the past quarter — and earns a 30% EBITDA margin.”

I applied to Dynatrace the 17.5x price/sales multiple from Cisco’s AppDynamics purchase — yielding a value of $7 billion. But since Dynatrace — unlike AppDynamics — is profitable, that figure is probably too low.

This valuation is good news for PE firm Thoma Bravo which in December 2014 acquired Compuware — the troubled Detroit-based application performance monitoring and mainframe solutions company — for “$800 million in portfolio money and $1.4 billion in debt,” according to Van Siclen.

Dynatrace was founded in 2006 in Linz, Austria and moved to Waltham when Bain Capital backed it. In 2011, Compuware bought Dynatrace and when Thoma Bravo acquired Compuware, it spun out Dynatrace as a private portfolio company, according to BetaBoston.

Thoma Bravo saw the potential to boost the revenue and cash flow of Compuware’s APM unit and to level off the declining revenues of its highly profitable mainframe business, according to Van Siclen.

Thoma Bravo boosts cash flow by “optimizing anything that is not product development, sales, or customer support. [Thoma Bravo makes sure the portfolio company] hires enough feet on the street to make its bookings goals, creates clear metrics, and optimizes G&A functions such as finance, IT, and human resources,” explained Van Siclen.

The number two player — IDC gave it 6.2% market share — is publicly-traded New Relic with $243 million in most recent 12 months sales and a $65 million net loss, according to Morningstar.

Dynatrace — it provides monitoring and root cause analysis at an average deal size of $80,000  — targets larger companies’ so-called Tier I applications — which account for about 20% of the total number of enterprise applications. By contrast New Relic — which offers monitoring and alert services at an average deal size of $15,000 — focuses on Tier II and Tier III applications for small and medium sized enterprises (SMEs) according to Van Siclen.

He says that the two companies only compete about 20% of the time — but Dynatrace often wins.

A case in point is Mark Kaplan, IT Director at bar exam test prep provider BARBRI, who explained “We were using New Relic, but we never got the full picture of our production environment. So we were limited in what we could do. Their dashboard is also almost non-existent. It would require us to build our own which we did not want to.”

Kaplan is a Dynatrace fan. As he said, “Dynatrace has changed the way we collaborate in the sense that when our team experiences an issue the first place that everyone goes is Dynatrace. Coming from New Relic we could be easily convinced by the ease of setup and an amazing dashboard. Also the excellent customer service is a huge plus!”

This month Dynatrace announced davis, an AI-based virtual assistant that helps IT people diagnose problems with their applications. One davis user seems pleased with how it works.

As Jeppe Lindberg, Application Performance Manager at Denmark retailer COOP, said: “I’ve never seen anything like this before. It’s just like you’re talking to another human IT team member, except a person would never be able to detect and bring to the surface root causes with such speed and precision.”

One challenge facing Dynatrace is that there is a relatively limited number of large companies that it targets. However, Van Siclen is optimistic about growth because those organizations are introducing new applications that need monitoring including microservices — for example, insurance for users of Zipcars — and for the Internet of Things (IOT) – such as telematics in cars.

The way things are going, Thoma Bravo could find itself with a nice profit if a Cisco rival — perhaps Hewlett Packard Enterprise which paid $4.5 billion to acquire IT management software and services provider Mercury Interactive in 2006 — wants to pay top dollar for the biggest player in the APM market.

Read the full article on Forbes here: http://www.forbes.com/sites/petercohan/2017/02/09/this-surprising-rival-beats-ciscos-appdynamics-new-relic-in-2-6-billion-market/#fec81b911b1c