We hope you find the below introduction to our annual Tech M&A Outlook useful as an overview of the broad- market trends that are shaping acquisition activity across a number of key technology sectors. For an in-depth look at specific markets - including application software, information security and IoT - we recommend learning more about the full M&A Outlook report.
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With business slowing and concerns mounting, shoppers stepped to the sidelines. (The M&A KnowledgeBase shows that December posted the lowest spending on acquisitions of any month in 2018, less than half the monthly average.) The late slide took last year from 'all but certain' to 'oh so close.' In the end, 2018 came up about one big deal short of topping the previous record. Buyers around the globe spent $573bn on tech and telecom acquisitions last year, just shy of the $574bn recorded in the M&A KnowledgeBase for 2015.
As to whether last year's momentum will continue, most corporate acquirers we surveyed indicated that they still plan to step up their shopping in 2019. More than half of the respondents to the annual 451 Research Tech Corporate Development Outlook in December predicted that their company would be more active in the coming year. The 56% that forecast an acceleration in acquisitions is nearly five times the 12% that expected a slower pace.
Undoubtedly, some of the corporate confidence that was on display throughout much of 2018 and appears to be set to carry over into 2019 came as their already-stuffed treasuries received the windfall of the earlier tax law changes. Corporate tax rates got slashed from roughly 35% to 20%. More significant for large tech vendors – many of which do more than half of their business outside the US – the tax overhaul did away with much of the penalty for bringing home profit generated overseas.
Of course, not all of the money went to M&A, as tech companies ramped up their own share repurchases to record levels in 2018. Buying their own equity, even at historically high prices, proved far more popular than buying the equity of other companies.
Yet whatever the particular capital allocation decisions each tech giant made, the point is they had a lot of capital to allocate. In addition to the means to shop, they also had the will to shop. Confidence flowed in the executive suites and boardrooms for most of last year. When public companies looked at their stock prices, which had tripled or even quadrupled since the start of the decade, they got a very visible reassurance that business was headed in the right direction. That emboldened them to do deals.
Secure in their strategy and flush with cash, corporate acquirers shook off the timidity they have demonstrated in recent years and started buying boldly once again. (Or, in the case of SAP and Adobe, buying boldly 'twice' again, since both of those companies put up a pair of billion-dollar transactions in 2018.) Big buyers showed that they would pay virtually any price to get deals done, particularly if those deals could be labeled a 'transformative transaction.'
That confidence proved contagious. Tech companies that had only dabbled in M&A placed big bets. For instance, Workday and Twilio announced $1.6bn and $1.7bn purchases, respectively, in 2018 after never having spent more than $100m on a transaction. Additionally, BlackBerry more than tripled the size of its biggest acquisition, paying $1.4bn for endpoint security startup Cylance in November.
Or take the case of IBM, a company that has shrunk every quarter except three over the past six years. Even as some of its growth initiatives of recent years dwindled away, it still managed to pull off the largest software deal in history. The $33.4bn transaction appears pricey by any measure: IBM is paying the highest-ever stock price for Red Hat, and valuing the open source specialist at more than 10x trailing sales. (For comparison, Big Blue trades at about 1x sales. It doesn't even garner a double-digit multiple on a price-to-earnings basis.)
In the annual 451 Research Tech Corporate Development Outlook survey, dealmakers voted IBM-Red Hat as the most-significant deal of 2018. However, underscoring the concerns around IBM's big bet, the survey respondents overwhelmingly selected the same transaction as the most likely to struggle to generate the hoped-for returns. Fellow corporate buyers noted the vast cultural divide looming between buttoned-up Big Blue and the more freewheeling open source vendor.
Based on their assessment of current pipelines, bankers forecast that the information security (infosec) market will continue to be a bustling bazaar in 2019. That's true even after acquirers in 2018 announced the second-highest number of infosec deals in history, according to the M&A KnowledgeBase. Last year's surge was driven by increased activity by many of the industry's biggest names – Palo Alto Networks did three acquisitions in 2018, with Symantec notching two deals – as well as a record number of PE purchases. And those infosec acquisitions went off at record prices. According to our tally of disclosed and estimated terms, acquirers paid a median 7.3x trailing sales in their security transactions last year, up from 4.5x in 2017 and 3.5x in 2016.
In a related question, however, bankers overwhelmingly indicated that many of the broader trends currently sweeping through the IT industry are likely to generate much more M&A activity than any single sector. And among those trends, machine learning (ML) cemented its standing as the technology that will drive the most deals in the coming year. Since ML debuted as an M&A theme in the 451 Research Tech Banking Outlook Survey three years ago, it has taken the top spot each year.
Trailing slightly behind both ML and cloud, the Internet of Things (IoT) drew a bullish forecast from 72% of bankers. We would note that outlook comes after a year in which the M&A KnowledgeBase recorded more IoT acquisitions than any year in history. The number of IoT transactions in 2018 rose almost 20% year over year, while overall tech M&A volume ticked slightly lower.
The largess of acquirers across all sectors shows up clearly as we look at the list of transactions that stood out last year:
- Big Blue's big bet on Red Hat valued the open source software pioneer at its highest-ever stock price. At an equity value of $33.4bn, IBM's purchase is as large as the second- and third-largest software deals combined, according to the M&A KnowledgeBase.
- Microsoft picked up GitHub, the software giant's most significant – and most speculative – acquisition in two years. And it paid handsomely for the deal. The $7.5bn purchase probably works out to a valuation of more than 30x trailing sales for the DevOps darling.
- After consolidating much of the semiconductor industry, Broadcom made a puzzling $18.9bn reach for CA Technologies. The cost-conscious acquirer handed out a richer multiple for the target than any of its other purchases of public companies, paying the highest price for CA shares since the dot-com days.
- Atos paid $3.4bn for Syntel as the French giant looked to expand into North America. In the deal, Atos paid a valuation that's roughly 50% richer than the median valuation for other significant transactions in the IT services and outsourcing market.
- Adobe announced its biggest deal yet, handing over $4.8bn for Marketo. The price is more than twice the level the marketing automation provider fetched when it went private two years earlier. Abode also paid a double-digit multiple in its $1.7bn purchase of Magento Commerce in May.
- Underscoring the importance of identity in overall cybersecurity, Cisco Systems paid $2.4bn (nearly 20x trailing revenue, in our estimate) for Duo Security. The transaction represents the largest-ever sale of a VC-backed information security startup.
- KKR shelled out an estimated $8.4bn for BMC, the largest pure software deal in history by a PE firm. The price is roughly 20% higher than the enterprise software vendor's value in its leveraged buyout five years earlier.
- In its biggest purchase (by far), Salesforce paid $6.6bn, or 22x sales, for MuleSoft, the richest multiple ever paid in an infrastructure software deal valued at more $1bn listed in the M&A KnowledgeBase.
- To head off Qualtrics' planned IPO, SAP had to hand over $8bn for the customer engagement software specialist. The valuation worked out to 21.5x trailing sales, which is more than twice the 9.3x trailing sales it has paid in its previous billion-dollar deals, according to the M&A KnowledgeBase.
Yet like the recent slide of stock prices, any decline in acquisition valuations would have to be considered in the context of the record levels of both markets. On Wall Street, stocks have been moving steadily higher since the recession ended in 2009, which makes it the longest-running bull market in US history. Similarly, M&A valuations have more than doubled since the start of the decade. (To illustrate, the M&A KnowledgeBase shows that the five largest tech deals in 2009 went off at an average of just 1.6x trailing sales, compared with 5x trailing sales last year.)
The sense that the boom times may be fading in 2019 also came through in our survey of the other main segment of the tech M&A community, corporate acquirers. More than six out of 10 (62%) respondents to the 451 Research Tech Corporate Development Outlook indicated that we are in the late stage of the post-recession M&A cycle. That was 10 times the 6% that said the cycle was just starting, and nearly double the number (32%) that slotted us as in the middle. (Roughly seven out of 10 respondents to that survey work at publicly traded companies, so they have a front-row seat to how the cyclicality is playing out in the equity market.)
The current head-spinning pace is being driven by massive buyout funds that are built to transact. Vista Equity Partners averaged three announced acquisitions every month last year, while Thoma Bravo clipped along at two transactions per month. That vastly outstrips the M&A pace of even the most-aggressive tech vendor. Most major strategic acquirers run closer to an average of a deal every month or every other month.
Broadly speaking, early PE deals in the tech industry shared a lot of the same characteristics as their handiwork in the retailing and manufacturing sectors, for instance. Regardless of the industry, buyout firms primarily went after big targets that generated a ton of cash but may not have been growing much, if at all.
That profile seems a bit quaint these days. Financial buyers are increasingly paying growth multiples, much richer than the traditional 'value' acquisitions they put up previously. (Or as some observers would have it: 20x EBITDA is the new 10x EBITDA.) Further, in some cases, the companies they are pursuing aren't even generating any cashflow. This is a radical departure from the traditional PE practices since in most other industries, the cash generated by the acquired business goes to support the leverage that buyout firms use to purchase the business in the first place.
The result of those adaptions to the tech industry is that the list of hardware and, especially, software targets got a whole lot longer for PE shops. For instance, deeply unprofitable software companies that were still spending heavily in growth mode – and were valued as such – suddenly popped up as potential acquisition candidates. The twin themes of growth targets securing rich valuations came together in Vista's take-privates of MINDBODY and Apptio late last year. Vista paid slightly more than 8x trailing sales for both of those software vendors, which were still burning cash.
Their ascent certainly comes through when we look at PE activity on a relative basis. Since the start of the decade, buyout shops have more than doubled their share of the tech M&A market, as calculated by the M&A KnowledgeBase. They now account for nearly one-third of all tech deals. At the same time, the number of tech transactions done by publicly traded companies has slumped below the number done by their rival financial acquirers.
Further, the gulf between the two primary buyers in the tech M&A market could get larger in 2019. When asked to assess the competitive playing field in the current tech M&A market, corporate acquirers we surveyed in December said they expected more competition from rival financial buyers than fellow strategic acquirers in the coming year.
More than half (53%) of respondents to the 451 Research Tech Corporate Development said they expected to have to elbow PE firms out of the deals they wanted to do more often in 2019, while just four out of 10 (41%) said the same thing about other corporate acquirers. Although that is the second consecutive survey that the competitors have been ranked that way, it reverses the long-standing order. In the first decade of the 451 Research Tech Corporate Development Outlook, respondents ranked their strategic brethren ahead of rival financial acquirers every single year.
Whether it's the 'SoftBank effect' or simply more late-stage investors, the net result is that VCs are writing bigger checks. Trade group National Venture Capital Association reported that there were 199 companies that raised $100m or more in a single round in 2018. That was nearly twice as many as the previous year. In many cases, the private funding effectively replaces the proceeds that a startup would pocket through an IPO. (We look at the tech IPO market at the end of this report.)
As one example, consider this: In 2018, the M&A KnowledgeBase shows that, statistically speaking, a VC-backed startup was more likely to sell to a PE buyer than a fellow VC-backed vendor. That's the first time financial acquirers have added more startups to their portfolios, a stunning reversal from when 'inter-species deals' were the norm. In 2015, for instance, the M&A KnowledgeBase shows almost three times as many VC-to-VC transactions as VC-to-PE transactions.
That disconnect stands out most clearly at high-profile startups. For instance, since its founding a decade ago, Airbnb has announced 17 acquisitions. However, only one of those printed in 2018. That inactivity comes despite raising $1.5bn in debt and equity over the previous two years. For comparison, Dropbox purchased at least four companies each year from 2012-15, a span during which it raised $850m in debt and equity. Elsewhere, Uber did only one acquisition last year, which was actually through its recently created Uber Eats subsidiary, while Palantir Technologies hasn't been in the M&A market since 2016.
Meanwhile, PE firms have started reaching into VC portfolios much more frequently and aggressively. The M&A KnowledgeBase shows that buyout firms, which once operated on the diametrically opposite end of the corporate lifecycle from VCs, are now providing almost one out of four venture exits. They are doing this by bolting on startups' assets to their ever-increasing number of existing portfolio companies, as well as by recapping a startup, or buying out an existing syndicate of venture investors.
Amid the changes on the demand side of the M&A equation for VC-backed startups, the amount of supply (i.e., VC portfolio companies for sale) appears likely to increase in 2019 and beyond. The reason? Venture dollars are expected to be harder to find.
Nearly four out of 10 respondents (38%) to the 451 Research Tech Banking Outlook Survey said venture funding is likely to dry up in the coming year, more than three times the 11% that forecast more freely flowing funds. The most-recent forecast represents a deterioration in the VC climate from the previous survey, when 33% predicted pinched access to capital but 18% saw it flowing more freely.
Of course, the IPO activity late last year was hit hard by the fact that the broader US stock market was also hit hard. The US equity indexes all recorded mid-single-digit percentage declines in 2018, their worst performance since 2008. The dip into the red, which played out sharply and swiftly in the final three months of the year, left many investors rattled. They were used to stock prices only going up. In that regard, even a relatively mild 4% decline in the Nasdaq in 2018 could have felt like a vicious bear market to investors who had seen the index average 20% annual returns over the previous half-decade.
When the broader equity market started plunging in early October, the IPO market got pulled down as well. Carbon Black barely held its unicorn status at the end of 2018, even after enjoying a peak valuation of twice that level. Shares of high-profile debutant Dropbox spent the first few months on the Nasdaq valued solidly above $12bn. The enterprise software provider exited the year at a $9bn valuation. Similarly, DocuSign, which came public in April, closed out 2018 down over one-third from its peak.
It's the companies beneath those high-fliers – the ones that don't necessarily measure their revenue or valuations in the billions of dollars – that are likely to suffer from the market turmoil. If that's the way 2019 plays out on Wall Street, then the IPO market is also likely to be characterized by the fewer, but bigger trend that's also shaping M&A exits for startups.
That showed up in the rather muted forecast for IPO activity in December's 451 Research Tech Corporate Development Outlook. Respondents predicted just 21 public offerings by tech startups in 2019, which was slightly below the average forecast in recent years. In other word, the respondents – 70% of whom work at companies that have already come public – don't see their ranks being substantially increased in 2019.