Vice President: Ivan Petkov
Associate: Riccardo Vittorio Perego
Analysts: Adam Hrehovcik, Adwait Rayate, Leonardo Mottareale, Simon Sandewall
On the 23rd of October, 2023 Vista Equity Partners announced its acquisition of EngageSmart (NYSE: ESMT) in an all-cash transaction valued at approximately $4 billion (Investors EngageSmart, 2023). Under the terms of this agreement, EngageSmart stockholders will receive $23.00 per share in cash upon completion of the proposed transaction, representing a 30% premium over the volume-weighted average price of EngageSmart’s common stock for the 30 days ending October 4. Upon completion of the transaction, affiliates of Vista will hold approximately 65%, and affiliates of General Atlantic, a leading global investor, will hold approximately 35% of the outstanding equity.
This acquisition further consolidates Vista Equity Partners’ position in the US-based enterprise software market, which is in line with their overall sector-focused private equity approach of expansion and saturation in the IT industry.
Vista Equity Partners
Vista Equity Partners (Vista Equity Partners, 2023) is a private equity firm that specialises in investing in enterprise software companies across a broad range of maturity, from emerging and lower middle-market organisations to large-cap enterprises. The firm is renowned for its expertise in software and technology as well as for its ability to identify undervalued assets and transform them into market leaders and invests through 4 investment strategies: private equity, permanent capital, credit and public equity.
Founded in 2000 by Robert F. Smith, Vista has grown to become one of the most successful private equity firms in the world. Over its 23 years of operations, it has completed over 610 transactions with an aggregate value of $297 billion and is currently holding over $101 billion in assets under management. Vista has five offices across the United States as well as one in Hong Kong counting a team of over 650 employees. Over the years, Vista has opened multiple funds, currently including Flagship, Foundation, Endeavor and Perennial, and completed its first IPO in 2019 with Ping Identity. In 2023, Vista Equity Partners received numerous marks of recognition, with Private Equity International naming the fund’s Citrix acquisition the “2022 Deal of the Year in North America”, GrowthCap naming Vista one of the Top Private Equity and Growth Firms of 2023 and Inc. names Vista a Founder-Friendly Investor for a fourth consecutive year.
EngageSmart (EngageSmart, 2023) is a provider of vertically tailored customer engagement software and integrated payment solutions that drive engagement between customers and their clients. The company offers single instance, multi-tenant, true Software-as-a-Service ("SaaS") vertical solutions, including SimplePractice, InvoiceCloud and DonorDrive, that are designed to simplify the customers' engagement with their clients by driving digital adoption and self-service. EngageSmart’s platform helps companies optimise their customer interactions across email, SMS, and social media by utilising artificial intelligence and machine learning, enabling businesses to personalise their communication with customers, automate repetitive tasks, and improve customer engagement and loyalty. The company focuses on helping businesses achieve their customer engagement goals by providing easy-to-use, scalable, and cost-effective solutions.
As of December 15, 2023, EngageSmart serves 116,200 customers in the Small And Midsize Businesses Solutions segment and 3,400 customers in the Enterprise Solutions segment across several core verticals: Health and Wellness, Government, Utilities, Financial Services, Healthcare and Giving, allowing them to focus their resources on initiatives that improve their businesses and better serve their communities. Additionally, EngageSmart was recently added to the Deloitte 500 fastest-growing technology companies in North America.
EngageSmart is a leading provider of tailored customer engagement software. EngageSmart specializes in providing unique SaaS (Software as a Service) solutions to its variety of customers. EngageSmart’s value proposition lies in its having expertise in the sectors it serves which thus propels them to provide specific solutions. SaaS companies undergo specific business cycles which are peculiar to this industry. The development and implementation of a SaaS solution is an extremely tedious and time-consuming process. Along with being time-consuming, it also demands a lot of resources for research, development of proprietary technology, and rigorous testing so that when the product is sold to clients, it works seamlessly. Hence, generally, bootstrapped businesses develop a SaaS product, launch it, and try to maximize it for generating revenues before starting to develop a new product. Therefore as a thumb rule, the faster a firm is able to launch new unique SaaS products, the faster its profits grow.
The more successful a single product is, the more liberty a firm has to expand into developing new SaaS solutions. This is exactly when external capital comes extremely handy. External capital gives the comfort to a SaaS firm to not worry about the research costs and rather leverage their resources, and expertise to develop unique SaaS products.
The acquisition of EngageSmart by Vista Equity Partners adheres to the same philosophy. Moreover, Vista Equity Partners is a specialized firm concerning software businesses and has the experience of investing in business across a range of maturity stages. Vista Equity Partners has its portfolio companies across a variety of sectors and they can leverage their wide exposure to propel the current SaaS solutions that Engagesmart provides.
For example, Vista Equity Partners has had a long-term investment in a firm called Bonterra since 2014. Bonterra specializes in helping non-profits work efficiently. On the other hand, the most recent SaaS solution of EngageSmart Donor Drive helps streamline the fundraising for non-profits. These two wonderfully complement each other and provide a comprehensive proposition for reaching numerous non-profits.
Management and Financial Analysis - Engagesmart
As of FY2023, the company has a topline of around 304 million which has doubled from what it was at the end of FY2021. The firm’s profitability has increased as well considering its transition from being a loss-making firm three years ago to having a net profit of close to 10% as per the latest published 10-K. The improvement in the bottom line implies a growth trajectory in its EPS and is expected to deliver similar performances in the coming years. Consequently, an improvement in operating cash flow has been observed in the past 3 years. However, one concern remains in the company’s ability to convert earnings into cash. The firm has a cash conversion ratio of a mere 16% and must focus on improving it.
The company has experienced significant improvement in its financials after the appointment of Bob Bennett as the CEO in 2023. In his erstwhile role, Bob has been an entrepreneur developing two ventures MicroFridge and InvoiceCloud in 1988 and 2003 respectively. Most probably he will continue his role as the CEO post this take-private deal. Engagesmart has a vibrant leadership board with all of the CXOs being appointed out of independent merit as opposed to adhering to a legacy. The collaboration of Vista’s expertise in tech ventures and the competent board of Engagesmart exhibits an exciting opportunity for the firm.
The global Software as a Service (SaaS) market is projected to grow from $273.55 billion in 2023 to $908.21 billion by 2030, exhibiting a CAGR of 18.7% over the period. (Fortune Business Insights)
Factors like the COVID-19 pandemic have accelerated the speed at which firms, and organizations both large and small are saving data digitally. Having a digital database has numerous benefits including it being easily accessible, easily analyzable and easily retrieved. The only challenge with having a digital database is the penetration into the database by an unwanted intruder but this can largely be prevented by developing highly complex security. As more data moves to the cloud, it demands the development of unique SaaS solutions to leverage it. As a result, all the big firms in the world including Google and Microsoft are betting big on developing SaaS solutions. Does that mean that there is no space for relatively smaller players? Absolutely not. Each SaaS solution caters to a unique set of clients and if a market participant is able to differentiate itself, there is significant potential upside in this industry. The enabler of this is going to be a superior management that can capitalize on its strengths and most importantly become the market leader in the kinds of solutions it aims to provide.
Leveraged Buyout Model
The following table portrays the assumptions that were made for the LBO model. Over the past 5 Quarters, Engagesmart’s revenue has increased significantly, and the industry CAGR portrays this trend with an expected rate of 14.3% from 2020-2030 (GlobalData). This upward momentum suggests that Engagesmart is strategically positioned to capitalise on emerging market dynamics, contributing to its sustained success in the foreseeable future.
The financing structure of this deal relies entirely on cash, leading us to exclude the debt schedule from our model in alignment with this strategic approach.The model assumes entry EBITDA multiple and exit EBITDA multiple are the same. The increasing profit margins and growth trend is elucidated from the difference between Net Income being 9.8% of total sales in Year 5 against 8.7% in Year 1. The motivations behind this profitability enhancement are derived from operational enhancement and total COGS growing at a slower rate than revenue.
Using these assumptions, our LBO model implies a 17.3% IRR, which is determined to be much more attractive than the average annual return of 2.4% delivered by FTSE 250 (FTSE Russell, 2023). This robust IRR underscores the attractiveness of the investment, signalling its potential for superior returns compared to broader market benchmarks. While the IRR serves as a valuable metric for evaluating investment performance, it's crucial to highlight its sensitivity to fluctuations in exit multiples. Even a marginal decrease in exit multiples can exert a considerable impact, leading to a notable reduction in the overall IRR of the investment. This underscores the importance of carefully considering and mitigating factors that might influence exit multiples to ensure a more robust and realistic assessment of the investment's financial viability.
Risks and Prospects
EngageSmart is also a great addition to the portfolio of Vista Equity Partners with a sound position in software, data, and technology-based businesses. With substantial experience and expertise in enterprise software, Vista is well positioned to capitalise on the projected growth in the vertical software market and the high customer retention in the tailored SaaS solutions. SmartEngage had in fact 117% and 119% dollar-based net retention rates as of December 31, 2022 and 2021, respectively (EngageSmart Inc., 2023), which highlight the high predictability of its cash flows. This means Vista may be able to take on more risks in terms of planned projects with higher potential profitability due to the stable underlying revenue streams that could act as a cushion in case of poor performance of these risky projects. Another attractive feature of the high steady cash flows is the possibility of continuous funding of R&D, which is often viewed as a key revenue driver in the enterprise software industry (Future Market Insights, 2022).
Another aspect of EngageSmart that further supports its revenue stability is the nature of verticals it operates in. Its target sectors are large, non-cyclical verticals with low levels of penetration, such as health & wellness, government, utilities, or financial services. This creates an additional attractive growth prospect, as Vista could significantly increase its market share in these sectors with lower level of competition by investing in sales force, digital marketing, improving brand awareness, and building new partnerships.
There could also be potential synergies with other portfolio companies of Vista, such as Alegeus, which runs a SaaS platform for the management of consumer-directed healthcare benefit accounts. The synergies could take the form of integrating some solutions of EngageSmart into the platform of Alegeus and thus leveraging them in a new market. Similar strategic moves could accelerate expansion to new verticals, which could be a strong growth lever. Moreover, Vista could utilise cross-selling strategies to provide better customer value by bundling or integrating different solutions of its portfolio companies.
On the side of risks, it is important to mention EngageSmart’s historic reliance on inorganic growth. EngageSmart has completed 7 acquisitions since 2015. Most of these acquisitions served as an entry mode into a new sector. An example of this can be entering the wellness vertical with the acquisition of SImplePractice in 2017 or non-profit vertical with the acquisition of DonorDrive. It is, therefore, reasonable to ask a question of how will the current macroeconomic environment that has fostered little M&A activity limit the EngageSmart’s growth potential in the near future. Although the aforementioned synergy utilisation could be used for entering new verticals, EngageSmart has limited experience with such strategic initiatives. This makes potential growth through integration among Vista’s portfolio companies highly uncertain. Moreover, EngageSmart has heavily and repeatedly relied on M&A entry model in the past, which implies that other entry modes are less attractive for EngageSmart. Consequently, there may be limited ability of EngageSmart to grow inorganically, which could limit its overall growth prospects. Therefore, the level of deal activity in the global M&A landscape will likely impact growth strategy and potential of EngageSmart. This can be quite a significant risk that should be considered. Other more general risks to this acquisition are regulatory changes, and technology integration challenges on the side of customers. Particularly the integration challenges may become more prevalent in the future because of growing complexity of technology ecosystems and increasing popularity of agile development methodologies and DevOps practices (Knowledge Hut, 2023).
In conclusion, Vista’s acquisition of EngageSmart is a clear move towards capitalising on the growth of the vertically integrated software market. The deal further strengthens Vista’s position in the enterprise software market and opens up opportunities for integration between its other portfolio companies and EngageSmart’s solutions. In fact, these possible synergistic effects are likely among the key drivers behind this transaction. Vista is also looking to take advantage of stable revenues in the SaaS industry and the relatively low level of saturation of verticals in which EngageSmart operates. However, the overall success of the deal will probably depend on the abilities of EngageSmart to increase its market share in its current verticals and to replicate its inorganic growth from the past despite the potentially more challenging macroeconomic environment, at least in the near term. Therefore, a clever strategic planning and execution of growth initiatives on multiple fronts will be vital to extract the full potential from EngageSmart’s promising future.
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