On May 9, 2018, Extreme Networks (NasdaqGS: EXTR), a San Jose, California based networking company, saw a 26% drop in its stock after it released 3Q’18 earnings (for period ending March 31, 2018) the previous evening. In the earnings release, there was a 23.81% downward earnings adjustment. This included a $1MM surprise revenue adjustment tied to the company’s 2017 Brocade acquisition. The surprise largely stemmed from integrating back-end systems of Extreme, Avaya, and Brocade into a single platform, prohibiting focus on business-forward goals. As a result, the pipeline of incoming orders, contracts, and marketing efforts stalled.
Founded in 1996, Extreme Networks designs, develops, and manufactures wired and wireless network infrastructure equipment and software for network management, policy, analytics, security, and access controls. It serves enterprises and organizations in education, healthcare, manufacturing, hospitality, transportation, and logistics, as well as government agencies. Extreme acquired the networking business of Avaya for $100MM cash in March 2017 after Avaya filed for Chapter 11 bankruptcy. In October, Extreme announced the purchase of Brocade Communications data center switching, routing, and analytics business for $43MM, consisting of $23MM in cash and a $20MM earnout.
Watermark Commentary
Extreme Networks lost $352MM in market capitalization in one day as a result of the earnings surprise. Integration costs are likely weighing down Extreme’s ability to execute in the marketplace and sell its expanding value proposition. Did Extreme ultimately develop the right strategy in blending Avaya and Brocade’s platforms? Did the M&A team overestimate revenue and cost synergies from the transactions, and thus did they overpay for the two acquisitions? Were there oversights in the transaction advisory team’s due diligence efforts? Was the integration playbook poorly developed or is it being poorly executed? Did management underestimate the challenges of running the business while integrating two acquisitions simultaneously? The company’s ballooning debt (38% debt to capital in June 2016 growing to 61% as of April 2018) used to finance its acquisitions is concerning, and it puts increasing pressure on Extreme’s ability to execute its strategy efficiently.
Watermark walks with acquirer clients across the entire “M&A bridge” to help them avoid fumbles. A company exits the “M&A bridge” when it concludes that a transaction was both a strategic and a financial success. Financial success is measured by a ROI that exceeds a hurdle rate above the company’s weighted average cost of capital. Unfortunately, research has proven that 70-80% of all strategic acquisitions fail to achieve a positive, significant return that exceeds the hurdle rate.
Learn more about Watermark’s unique approach to M&A advisory services.
Source: S&P CapitalIQ