Taleo Deal Shows Cloud Premiums Falling

NEW YORK (TheStreet) -- Cloud-based deal premiums are falling as investors and analysts correctly anticipate consolidation between technology giants and specialized cloud players.

In early December, SAP(SAP) bought a cloud-based human resources SuccessFactors(SFSF) at a 52% premium, leading to speculation of other M&A targets. Thursday's announcement that Oracle(ORCL) is buying Taleo(TLEO) for $1.9 billion at an 18% premium signals that premiums are going down as investors anticipate future deals.

When SAP's $3.4 billion Success Factors acquisition was announced, analysts like Karl Keirstead of BMO Capital Markets pointed to other possible deals, anticipating that larger tech companies would continue to look at acquiring specialists in the cloud space as their services come in increasing demand in a mobile business world.

In fact, Keirstead just about nailed Thursday's Taleo purchase by Oracle.

"The cloud software sector is being consolidated faster than we were expecting, and in our view, most investors will likely conclude that Taleo is the most obvious acquisition candidate and that Oracle is the most obvious buyer," wrote Keirstead in a Dec. 5 note that gave Taleo's stock an "outperform" rating and a $40 a share price target. To his credit, Keirstead even downplayed the notion that Salesforce.com(CRM) would be acquisitive and that Workday would be an M&A target.

On news of the Success Factors deal in December, Taleo shares spiked 20% higher and others in the cloud and human resources software space like Kenexa (KNXA) , Saba Software(SABA) and Cornerstone OnDemand(CSOD) saw similar gains. Those companies' shares also are also spiking over after Thursdays deal.

While Oracle's Taleo purchase strengthens the case for consolidation in cloud and business software businesses, it also may represent a turning point for investors looking to get outsized gains by anticipating M&A. Overall, Oracle's $46 a ashare offer for Taleo represents a 18% premium, lower than SAP's 52% premium for SuccessFactors, IBM's(IBM) 57% premium for DemandTec(DMAN) and Oracle's previous purchase of RightNow(RNOW) at a 19% premium.

IBM and SAP's December purchases signaled that premiums were rising, Oracle's February deal may signal that premiums are now falling . Prior to earlier deals, Taleo shares hovered in the low $30's, however they spiked over $40 on anticipation that other acquisitions could happen in the space by analysts like Keirstead of BMO Capital Markets, and others. Without that boost, Oracle's Thursday acquisition would represent a near 50% premium, in line with previous deals.

So the big question for investors who are bidding up the price of Kenexa, Saba Software and Cornerstone OnDemand shares is whether deal activity will continue and if premiums have crested?

In December, Keirstead noted that M&A was likely to continue as cloud-based talent management companies were undervalued and their specialties were of increasing demand. "We don't believe that the major software vendors are finished on the M&A front," wrote Keirstead of possible deals outside of SuccessFactors, RightNow and Taleo.

After Thursday's deal, analysts continue to anticipate deals. "Expect SaaS M&A could continue," writes UBS analyst Brent thil in a note. He sees Concur Technologies(CNQR) may become the target of a larger technology player or even a non-technology business solutions specialist.

"The recent M&A activity in the Cloud/SaaS sector is being driven by a seismic shift to cloud computing, in our opinion. We are roughly 10 years into this shift, which should last another 10-20 years," writes Jeffrey Houston of Barrington Research in a Jan. 23 note on the sector. He recommends SPS Commerce (SPSC) and RealPage (RP) as attractively priced.

However, falling valuations on a fundamental basis may signal that premiums have topped out. Oracle's Taleo offer represents a premium of 5.1 times Taleo's 2012 projected revenue, according to FBR Capital Markets analyst FBR Capital Markets analyst David M. Hilal. Previous deals for RightNow and SuccessFactors were cut at 5.5x and 7.9X revenue valuations respectively, calculates Hilal in a Thursday note.

Even if valuations are falling, deals may continue. "Consolidation in the sector has been prevalent over the past few years and we do not expect it to stop," adds Hilal.

"The most notable change recently has been the willingness for the traditional enterprise software companies to further their cloud initiatives with acquisitions of SaaS companies."

Meanwhile, a wide array of specialist cloud-based H.R. service providers will also help to push Oracle's second acquisition through, signaling that consolidation doesn't create antitrust issues. "Given the many other competitors in the HR market, including SAP, Workday, Kenexa, etc., we do not expect any regulatory hurdles to getting this deal done," writes Jayson Maynard of Wells Fargo in a Thursday note. He believes the deal is consistent with Oracle's strategy, filling a "much needed product gap."

However, with shares rallying in the sector, investors may now have to temper their expectations on M&A premiums. In fact, that may have been the case in December when Taleo rallied on takeover speculation. "While the SaaS stocks may get a near-term boost from the SAP news, analysts should also be questioning whether the consolidation activity is a sign of a top," wrote Keirstead of BMO Capital Markets in his Dec 5 note.

For SuccessFactors and its 52% premium takeout, Keirstead concluded that it may have represented a peak as a result of increasing competition. Watch for premiums to fall if investors continue to bid up sector shares on takeover speculation, valuations fall and others sell out of the competitive cloud services market.

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--Written by Antoine Gara in New York