Last week, Selectica (ticker: SLTC) , a solution provider best known in our industry for its Contract Lifecycle Management solutions announced that it had reached a definitive agreement to acquire Iasta, a provider of cloud-based strategic sourcing solutions for $7 million in cash plus 1 million shares (which was valued at $6.2 million at market close on the day the deal was announced). This means that on the announcement date, the deal totaled approximately $13.2 million for Iasta (the final “deal price” paid for Iasta will depend on Selectica’s stock price at closing – note a discussion below that discusses the final value). The deal also includes a reported 700,000 Selectica options for Iasta and three-year employment contracts for some of the Iasta executives. Executives from both companies said that Iasta will operate as its own company within Selectica and be known as “Iasta, a Selectica Company.” The deal is expected to close in June.

About Selectica

Selectica is a long-standing Contract Lifecycle Management (“CLM”) solution provider and one of the remaining CLM “pure plays” from a decade ago (diCarta, acquired by Emptoris in 2006 and Upside acquired by SciQuest in 2012 are two examples of CLM companies that were acquired by larger supply management solution providers looking to build out their solution portfolio with a CLM solution). From a procurement perspective, Selectica can be considered a CLM “pure play” despite the fact that it has a separate solution – an online configurator tool (used to do things like build your own laptop) that businesses use on their eCommerce sites. Selectica has a configurator business that is completely separate from its contract solutions and accounts for a sizable share of the company’s revenues and resources.

Selectica reported ‘recurring revenue’ of $12.2 million for its latest fiscal year ending March 31, 2014 (it has not, as yet, reported its quarterly “non-recurring revenue,” the term it uses to describe its services revenue). Selectica reported a loss from operations for the 9 months ended December 31, 2013 at $5.99 million. While it did not disclose its annual loss in last week’s earnings announcement, we expect Selectica’s full year loss to have exceeded $7 million

Not too long ago, Selectica was a leader in the CLM space from a functionality perspective (along with Upside and diCarta) and was highly competitive in full enterprise contract deals, winning several seven-figure deals in the 2006 – 2008 time frame. At the time, the company led with a very strong product strategy and had a robust sales and marketing operation. But, as a very small, but also, publicly-traded company, Selectica’s business is on full display to the market and that can make things more difficult from both a sales and operations standpoint. For example, several year ago, Selectica ran into trouble due to accounting violations which took several years to resolve and the company has struggled at times to maintain its Nasdaq listing due to share price valuation. These distractions and a shift in the market over the intervening years have enabled other procurement contract providers to catch, and in some cases, pass Selectica from a product standpoint; it has also made it more difficult for Selectica to execute.

About Iasta

Iasta is a provider of cloud-based strategic sourcing solutions. The company was founded 14 years ago by the current management team of CEO, David Bush,  COO, Jason Treida, and CFO, Todd Epple and is headquartered in Carmel, Indiana. Iasta is best known for its sourcing solutions, including optimization and has long been a tough competitor in the eSourcing market, frequently punching above its weight. Over the years, Iasta successfully developed a broader suite of solutions including Spend Analysis, Supplier Information Management, Supplier Performance Management, and a Contracts Repository. More recently, Iasta has focused its effort on solutions that manage performance data and provide executive reporting. Iasta reported $11 million in revenues in 2013 of which we estimate between 25% – 33% was derived from the services which it provides in support of its solutions Iasta reports that it has 125 customers and approximately 60 employees.

Deal Analysis

• Iasta earned approximately $11 million in revenue with operating income of $400,000 in 2013
• The deal on the day of the announcement valued Iasta at $13.2 million as Selectica paid $7 million in cash plus 1 million of its shares (closing stock price of $6.20). On its face, this works out to a 1.2x revenue multiple, based on prior year numbers (this does not account for an illiquidity discount – more on the deal value below)
• Other financial considerations:
• The Iasta founders each received three year employment contracts
• $1.4 million will be held in escrow, with payouts at 12 and 18 months respectively
• The announcement stated that Selectica will issue 700,000 options to Iasta employees. The deal-related filing with the SEC filing reports that Selectica “shall reserve a total of 250,000 shares of Parent Common Stock underlying options to be granted to employees of [Iasta].” It is unclear how, if at all, the other 450,000 options will be handled
• At close, Iasta is expected to deliver between $315K to $385K in working capital
• Iasta will operate as a wholly-owned subsidiary – Iasta, a Selectica Company
• To help fund the acquisition, Selectica issued preferred stock

The Iasta/Selectica executives who briefed Ardent on the deal shared their strategic rationale for the deal which had points including:

• The complementary nature of Iasta’s solutions
• The ability to up-sell & cross-sell each other’s solutions – the two companies count only 5 customers in common today
• Improved scale
• Strong cultural fit
• The natural alignment of contracts and strategic sourcing solutions

Ardent’s Analysis

Several years ago, Iasta began to experience the growing pains that start-ups tend to feel as they approach $10 million in revenues. Software companies in these situations often find themselves struggling to fund the needed investment to get their products to the “next level” and better scale their operations. While the Iasta team considered taking outside funding from private equity investors, they ultimately decided to forego those opportunities. As a result, by waiting, it would appear that the Iasta team traded valuation dollars for the retention of control. We expect that Iasta’s valuation in 2012 would have been substantially higher in the aftermath of the SAP-Ariba deal and SciQuest’s acquisition of Spend Radar & Upside Software.

The question of total deal value is an interesting one as is the level of control retained by Iasta. While the deal does include 1 million shares of Selectica common stock. Selectica shares, particularly that high volume of them, are highly illiquid since, according to Yahoo Finance, there is an average trading volume of 6,200 shares for SLTC. In our view it is not unreasonable to apply an “illiquidity discount” to the SLTC shares somewhere in the range of 20% – 40%. This would mean the actual deal value is approaching a 1x trailing revenue valuation which is a premium to the recent Intesource acquisition.

When looking at control, Iasta will operate as an operating company within Selectica, which was clearly an important consideration for the Iasta leadership team. However, the deal did not include any seats on Selectica’s board which would have been justified considering the ownership interest in Selectica that will be retained by the Iasta executives/owners. The appearance of activist small-cap investor Lloyd Miller III on Selectica’s board does raise a concern about long-term control (and over time, the ability to gain approval to invest cash back into the Iasta solution suite).

From a strictly financial consideration standpoint, the deal raises many questions, some of which we’ve addressed above. However, from Iasta’s perspective, the merger with Selectica is not the sale of the company as an exit strategy, but rather a way to effectively achieve an equity raise and accelerate its growth strategy. Instead of taking outside money and using those funds directly, Iasta believes it can accomplish its internal investment/funding and growth/scale goals faster via this merger and do so with a like-minded technology company that has complementary solutions and an existing infrastructure to help scale its business and products. From that perspective, the “quality” of the deal or valuation seems less of a concern.

We’ll continue this discussion with Part II of our analysis after the deal closes in the early fall and at the market impact of the deal and the opportunities and challenges ahead for the newly merged partners.

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