Full Steam Ahead for Tech M&A
The technology sector continued its dizzying pace of innovation in 2017, with extraordinary advances in a wide range of areas, from Artificial Intelligence (AI) and machine-learning software, to autonomous vehicles, advance robotics and drones. The past year broke through new frontiers in global deal-making activity, targeting innovative technology companies. With 3,389 M&A record-breaking transactions in the technology, media and telecommunications space last year, per research firm Mergermarket, 2017 was a year of firsts.
M&A activity is likely to remain robust in 2018, due to several factors, including the increasing appetite for technology startups among investors, both financial and strategic. “This is a strong trend we’ll continue to see in the coming year,” said Joe Allegra, a general partner at venture capital firm Edison Partners. “Once companies in our portfolio hit the $30-$50 million revenue range, they attract the attention of private equity acquirers, which is something we rarely saw in the past.”
Allegra said the number of private equity funds that have broadened their investment focus to include technology has increased dramatically, as they come to the realization that every business today is a technology business and that companies of all stripes must integrate digital tools into the core of operations if they want to succeed.
“Investors recognize that technology now underpins business in every industry,” said Alex Castelli, CohnReznick’s managing partner of Emerging Markets. “Technology is proliferating every sector. Just look at a company like Walmart. Most of their acquisitions are now tech companies or tech-enabled businesses, because that is clearly the future and key to how they are going to continue to be competitive for their customers.”
The U.S. Tax Cuts and Jobs Act 2017 also is likely to spur M&A activity in 2018, as companies have more capital available that they can put to work. Moreover, large tech companies are now beginning to repatriate foreign earnings at a reduced tax rate of 15.5%, which will further accelerate acquisitions at home. In January, Apple announced it would pay $38 billion in tax to repatriate some of the $252 billion it’s holding overseas. “Expect them to use a portion of these funds to continue acquiring AI companies to build on recent acquisitions of Lattice, init.ai, and Shazam,” said Castelli.
The obvious question: How will this stream of new capital impact valuations of tech companies? Valuations are already at record levels, but have the potential to go even higher as corporate buyers now have more cash at their disposal and can afford to pay even higher prices. “Not only will strategic acquirers have more cash for acquisitions, but companies will have more cash on their balance sheets to continue to invest in innovation and product development. This will make these companies even more valuable to investors,” said Castelli.
“Expect to see valuations keep ticking up and up,” said Christopher Pedone, executive director at Freeman & Co., an M&A advisory and strategic management consulting firm. “People already are paying prices that their investments will have to grow into. But prices will remain high until financing gets tighter or there is a real scare in the market that causes acquirers to pull back and be more rational.”
Certain technology industry subsectors are primed for higher M&A activity than others. For instance, healthcare IT is likely to see a lot of action as the healthcare landscape continues to evolve and the large players in the market look to place their bets on next-generation technologies and services.
Similarly, the financial services market is undergoing rapid disruption. “Many tech startups are trying to redefine the future of banking and figure out how they can disintermediate the traditional banks,” said Pedone. “All financial services used to be bundled under the big banks, but that has been slowly crumbling with tech disruption. As technology subsumes these old-school financial services, that will create a lot of deal activity across the sector.”
Cybersecurity is another area attracting significant attention from buyers. There have been massive venture capital investments in this space over the past few years, with literally hundreds of new cyber startups getting funded each year. Venture capital firms invested $7.6 billion in 548 cybersecurity companies in 2017, per research firm CB Insights.
“The last few years have seen a cybersecurity arms race and I don’t see that abating anytime soon,” said Allegra. “I expect to see some consolidation in the space, but we’re still in the early days of innovation here. There will always be new threats and better ways to solve the problems, so we’ll continue to see a lot of acquisition activity as the best cybersecurity startups get snapped up.”
“There is no doubt that the quickest way to improve your product or service offering is to acquire technology along with the talent to continue to innovate and develop new offerings for your customers. The amount of private capital available will remain at a high level in 2018 and we will continue to see strong, well-positioned and well-managed companies receive the higher valuations and raise significant amounts of capital,” said Castelli.
While tech M&A is clearly on the rise, the IPO market has seen a steady decline in activity. This trend is likely to continue in 2018 as well. Last year there were 37 tech IPOs that raised $9.9 billion. That’s an increase from the 21 IPOs in 2016 that raised a $2.9 billion but, it’s well below the 56 IPOs in 2014 that raised $32.9 billion.
“IPOs are becoming less and less common because there are so many private investors in the market that are able to fund a tech company at every stage of its lifecycle,” said Pedone. “You will continue to see only the biggest, more mature tech companies go public, because there are so many options from everyone else. The necessity or allure of going public is just not there anymore for many companies.”
Allegra said that for some companies, this presents an opportunity. It probably is a good time to go public because there are so few others doing it now. There is pent-up demand for rapidly growing, profitable tech companies among public investors.
This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.