Tech M&A Dips in Q2 as Buyers Move on from Growth Deals at Growth Prices

The summer holiday came early to the tech M&A market. Dealmakers around the globe announced nearly 15% fewer tech and telecom acquisitions in Q2 than in recent quarters, according to 451 Research's M&A KnowledgeBase. And they didn't spend much on the deals that they did get done. Our data shows the aggregate value of tech transactions announced in the April-June period slumped to the lowest quarterly level in a year and a half.

Altogether, the M&A KnowledgeBase shows Q2 spending of $113bn on just 815 tech deals. The slump in Q2 activity comes as strategic acquirers continue their extended hiatus in the market they once dominated. (The number of tech transactions announced by corporate buyers has dropped almost uninterruptedly since mid-2015, according to our numbers.) In the first six months of this year, for instance, tech bellwethers such as Oracle and IBM, which had averaged one purchase per month in their M&A heyday, have each put up just one print.

But now, add to that an uncharacteristic slowdown in the Q2 tech deals by the other main buying group, private equity (PE) firms, which had been the sole ‘growth market’ in tech M&A recently. PE shops have doubled their number of tech acquisitions in the past five years, but in Q2, they posted a second consecutive year-on-year quarterly decline in deal volume. Spending dropped even sharper, with the value of PE deals in Q2 coming in at just half the level of the year-ago quarter. (We look at the trends in the tech buyout market more fully later in this report.)

Looking inside the recent deal flow, there has been a notable shift in M&A activity that has helped drive many of the record number of $1bn+ acquisitions in 2018. The M&A KnowledgeBase recorded 108 tech transactions last year valued at over $1bn. (For perspective, that works out to more than two blockbuster deals announced every week in 2018.) In contrast, buyers this year are scaling back their significant acquisitions. So far in 2019, we have recorded just 39 big-ticket transactions, putting us on pace to record nearly 30% fewer $1bn+ deals this year than last year.

To oversimplify the seismic shift in tech M&A, we would characterize last year's activity at the top end of the market as expansion-minded, while this year's deals appear much more driven by consolidation. Along with that shift in acquisition strategy, the markets that are seeing the most action have changed. This year, big prints are piling up in old-line, mature tech sectors such as semiconductors and electronic payment processing rather than some of the more growth-oriented segments that saw heavy traffic in 2018.

For instance, corporate buyers hadn't announced a single software transaction valued in the billions of dollars this year until three weeks before the end of Q2. The drought was snapped by a pair of quick-fire analytics deals by Google and Salesforce. But still, the two big enterprise software transactions so far in 2019 is a notable step down from the same period last year, when broad-market software vendors announced five billion-dollar deals.

Noteworthy transactions announced since April include:

• Salesforce printed its largest acquisition to date, roughly equal to the combined amount it handed out in its next eight largest deals. The $15.1bn in stock it paid for Tableau values the analytics provider at 12x trailing revenue.
• Continuing the recent consolidation of the semiconductor industry, Infineon paid $9.1bn for Cypress Semiconductor. The deal is three times bigger than any single transaction the German chipmaker has ever done.
• The newly appointed head of Google Cloud looked to M&A in a big way to help close the gap on other public cloud suppliers. Google handed over $2.6bn for data visualization vendor Looker.
• Siris Capital Group continued its effort to erase mature tech companies off US public exchanges. It paid $1.7bn for 30-year-old Electronics for Imaging in a deal that valued EFI at just 1.4x trailing sales, the second-lowest valuation Siris has paid in any of its take-privates.

As acquirers of all stripes have shifted their focus from rapidly expanding markets such as software to more mature and slower-growing areas of IT, valuations have followed suit. As one representative transaction from the quarter, consider Extreme Networks' consolidation of Aerohive Networks in late June. Net of cash and debt, Extreme is paying $210m for Aerohive, or just 1.4x sales at the networking gear provider. The target's sales have been flat for the past three years, and even with a premium, it is being valued lower in the takeout than it was valued on its own three months earlier.

More broadly, at the top end of the market, the M&A KnowledgeBase shows acquirers are paying, on average, at least a half turn less this year than they did last year. The 5.7x trailing sales that strategic buyers paid in their 50 largest transactions announced so far in 2019 and the 4.2x trailing sales paid by sponsors are both down from last year, but still above the prevailing multiples since the start of the decade. We would also note that the US equity index closed out Q2 at record levels, having tacked on a mid-single-digit percentage gain since last summer.

Probably the most significant change in the overall tech M&A market so far this year has come with financial acquirers lowering their sights. It used to be buyout shops, which are sitting on record amounts of cash, that looked to bag elephants, regardless of the strategy they were employing. Private equity (PE) firms would top already-high stock prices in take-privates, or pay historically rich prices in secondaries, justified – at least partly, in their view – by ambitious growth and cash-flow assumptions for the target company.

Those trends in the buyout industry hit their high-water mark in terms of overweening financial confidence with the $11bn LBO of Ultimate Software. PE firm Hellman & Friedman led the mammoth deal, which valued Ultimate at 10x trailing sales and, unusually, included other investment shops to help pay for it. The transaction is the largest-ever software take-private, according to our data, and the valuation matched the highest-ever multiple paid in the nearly 40 software vendors erased from US exchanges for over $1bn by PE firms.

Although the take-private of Ultimate was announced only in February, it almost looks like it belongs to an entirely different era. Now, PE shops appear to be moving down-market in their big purchases, as well as focusing more on bolt-on acquisitions than big platform purchases. With just two quarters of declining buyout activity, we don't want to make too much of this trend. But it's still worth nothing that, at least early on, the buyout barons appear to have slowed their roll through tech M&A, a change that could remove billions of acquisition dollars from the market.

This year's shift by PE firms to the midmarket and below is already showing up in the M&A KnowledgeBase. At the midyear point, our numbers show buyout shops are on pace to ink one-third fewer billion-dollar deals in 2019 than they did in 2018. Assuming the current rate of big-ticket transactions holds through the end of the year, PE firms would announce just 22 tech acquisitions valued in the billions of dollars, the fewest since 2015.

And yet, even as they put up significantly fewer billion-dollar deals, buyout shops are doing almost as many transactions overall as they have in history. Between direct investments by the firms and bolt-ons by their existing portfolio companies, financial acquirers are on pace to almost match last year's record of more than 1,100 announced transactions, which is twice the number of deals they announced just in 2014

That's not to say PE firms have suddenly discovered financial discipline, paying only austere prices in their transactions. Consider these deals from the past quarter:

• Insight Venture Partners paid a double-digit multiple to take a majority stake in threat intelligence startup Recorded Future, which we estimate was growing revenue at a 50%+ clip. (Subscribers to the M&A KnowledgeBase can see our record on the transaction, which includes our proprietary estimates for Recorded Future's 2018 and 2019 revenue.)
• In its first acquisition since going private late last year with Vista Equity Partners, Apptio paid what we understand to be a healthy price for Cloudability. (Subscribers to the M&A KnowledgeBase can see our estimates for the price and valuation of that deal.)

Lastly, as we turn briefly to the other exit (IPOs), we finally had something to write about in Q2. That wasn't the case in the opening quarter of 2019, when not a single enterprise-focused tech vendor went public. (The opening months of this year were dominated by talk and trading of new listings from several high-profile consumer tech providers. Although these names may have been popular with users, they didn't prove popular with investors. Lyft remains underwater from its offering, while Uber spent all but the two final days of Q2 below its offer price.)

No such bearishness greeted the B2B companies that debuted in Q2. All six of the vendors that came to market in late spring and early summer this year did so at a double-digit price-to-sales multiple. Collectively, the six B2B firms that debuted in 2019 were valued at more than $60bn, as of the end of Q2. For comparison, the 10 enterprise tech companies that went public in the first half of 2018 created slightly more than $40bn of market value at the end of Q2 2018.

451 Research will have an in-depth report tomorrow on the stunningly rich valautions being awarded across the board to IPOs so far this year. The report will also look ahead at which startups from our coverage areas might be aiming to cash in on Wall Street's lucrative interest in enterprise tech right now.