by Brenon Daly
Deals in which one private equity (PE) firm sells a company to another PE outfit are sometimes referred to as ‘paper trades.’ These transactions have become increasingly popular in recent years as yet another way for buyout shops to put their record levels of cash to work. By our count, secondary transactions currently account for almost one out of every five deals that PE firms announce, roughly triple their share at the start of the decade.
However, there’s a price for that popularity: the paper is getting a lot more expensive. PE firms paid an average of 4.5x trailing sales for tech vendors owned by fellow buyout shops since the start of 2018, according to 451 Research’s M&A KnowledgeBase. That’s 50% higher than the average PE-to-PE valuation from 2010-17.
There are a lot of reasons for the increase, not least of which is that overall valuations for the broader tech M&A market have been ticking higher, too. But that doesn’t fully explain it.
The M&A KnowledgeBase shows that the average multiple for tech deals since January 1, 2018 with buyout firms on both sides is nearly a full turn higher than the average multiple paid by PE shops to tech providers in that same period. Recent secondaries that secured price-to-sales multiples in the high single digits include Mailgun, Quickbase and the significant minority stake of Kaseya, according to our understanding.
So why do paper trades go off at a premium? Part of it is explained by the view that companies in a PE portfolio have largely been cleaned up, operationally. They are something of a ‘known quantity,’ which takes at least some of the risk out of the purchase.
From there, it’s just a short step for the new buyout owners to one of their favored activities: optimizing the businesses for cash flow. That financial focus, which is undeniably supported by the broad economic growth and continued increases in tech spending, has contributed to the current cycle of ‘pay big now, find a bigger buyer later.’ But if the economy turns, PE firms may well find that high-priced secondaries are one of the first types of deals to disappear, leaving them holding some very expensive paper.
Contact: Brenon Daly
Although private equity (PE) is often portrayed as heartless and hardened dealmakers, it turns out the group is actually quite sensitive. We don’t necessarily mean emotionally sensitive but rather economically sensitive. This hyperactive group of acquirers is far more attuned to interest rates, credit availability and other economic factors than rival corporate buyers. What happens outside buyout firms goes a long way toward shaping what goes on inside.
We’re seeing that right now in the tech M&A market. The just-enacted sweeping overhaul to the US tax code has changed some of the key calculations that buyout shops have to make before they can put their unprecedented pile of cash to work in tech deals. Under the new tax regime, PE firms are facing higher costs and potentially longer holding periods – both of which would weigh on returns. (Buyout shops are getting hit with numerous changes, the most significant of which is that they are now only able to deduct a portion of the interest payments for the debt they use to acquire companies.)
The tax changes, which were negotiated and passed in the final few months of last year, knocked PE almost completely out of the market during that time. Through the first three quarters of 2017, buyout shops were clipping along at an average of about $10bn in spending each month, according to 451 Research’s M&A KnowledgeBase. However, spending plummeted to just $7bn for the entire fourth quarter. The aggregate value of deals in December – the month when the new tax code was approved – didn’t even reach a half-billion dollars, the lowest monthly total since early 2014.
Of course, this is only the most-recent case of macroeconomic conditions shaping PE activity. A far more vivid example of that came a decade ago, when the mortgage crisis effectively killed the first wave of tech buyouts. As we noted last summer on that unhappy anniversary, the last four crisis-shadowed months of 2007 accounted for just $7bn of the then-record $106bn in PE spending that year. The PE industry took until 2015 to reclaim the level of spending it put up in 2007, according to the M&A KnowledgeBase.
No one is suggesting the changes from the tax code will be anywhere as severe as the disappearance of credit, which is what we saw in the recession a decade ago. This time it’s more of a recalibration than a retreat.
Contact: Brenon Daly
As the World Economic Forum opens its doors today, we expect even more backslapping and bonhomie than usual among the business leaders, politicians and other TED-types that flock to the annual gathering in Davos, Switzerland. What’s got them all so excited? Well, unlike recent years at the conference, there are some pretty favorable winds blowing across the globe these days.
Stock markets around the world are at all-time highs, economic growth is accelerating and even fractious political rifts have been mended (at least temporarily) so governments can get on with the business of business. (Germany appears to be finally on track to forming a governing coalition, after last September’s election left the economic powerhouse of Europe without a government for the first time since World War II. On a smaller scale, US President Donald Trump jetted over to the Swiss mountains after Congress resolved for the moment a stalemate that had shut down the government of the world’s largest economy for a few days.) Not for nothing is the theme to this year’s gathering: ‘Creating a Shared Future in a Fractured World.’
Of course, it’s a lot easier to get along when everyone is making money. And right now, people are making money because of the world economy rather than despite it, as has been the case for the most part since the end of the recession. In past years at Davos, economic growth and confidence had been elusive, or at least not evenly distributed. This year, in both the formal presentations and the hallway chatter, there’s a bullishness that’s been missing recently.
As an indication that business around the world is picking up, consider that one in six respondents to a recent 451 Research Voice of the Connected User Landscape said their companies are bumping up Q1 sales projections because of the global economy. That’s twice as many businesspeople as said the macro-economy is putting a crimp in their sales pipeline. For comparison, around the time of Davos last year, slightly more respondents to our survey said the world economy was dampening their sales outlook than boosting it.
Contact: Brenon Daly
As we look back on 2017 and ahead to 2018, 451 Research has published its annual forecast for tech M&A, highlighting the trends that we expect to shape deal flow and the markets that we think will see much of the activity. The 2018 Tech M&A Outlook – Introduction serves as an overview of the broad M&A market, setting the stage for the upcoming publication of our comprehensive report that features analysis and predictions for eight specific IT markets on what deals are likely in 2018.
The full report, which we think of as an ‘M&A playbook’ for the enterprise IT market, has insightful forecasts for activity in application software, information security, mobility and other key sectors. The 80-plus-page 2018 Tech M&A Outlook report will be published at the end of January. It will be available at no additional cost for subscribers to 451 Research’s M&A KnowledgeBase Professional and Premium products, and will be available for purchase for 451 Research clients and others that don’t subscribe to our M&A KnowledgeBase products. (If you’re interested in purchasing the full 80-plus-page report, contact your account manager or click here.)
In the meantime, our introduction provides insights on some of the overall dealmaking trends that are also likely to shape activity and valuations in sector-specific transactions. Key highlights in our overview of the broader M&A market include:
- After tech M&A spending in both 2015 and 2016 topped a half-trillion dollars, what happened that knocked the value of deals in 2017 down to just $325bn?
- Many of the tech industry’s biggest buyers printed only half as many deals as they have in recent years. Is that the new pace of M&A at these serial acquirers, or will they rev up again in 2018?
- The pending tax overhaul will likely add billions of dollars to the treasuries at major tech vendors. Why don’t we think that will necessarily lead to more M&A? If they don’t spend it on deals, what are tech companies going to do with the windfall?
- Which tech markets are expected to see the biggest flow of M&A dollars in the coming year? Enterprise security tops the forecast once again, but what about emerging cross-sector themes such as machine learning and the Internet of Things?
- How did private equity (PE) move from operating on the fringes of the tech industry to become the buyer of record? PE firms accounted for an unprecedented one out of every four tech transactions last year. Why do we think their share of the market will only increase?
- VC portfolios are stuffed, as the number of exits in 2017 slumped to its lowest level since the recession. What challenges loom for startups and the broader entrepreneurial community without the return of billions of dollars from those investments?
- For startups, will venture capital be flowing freely in 2018? Or will the polarized VC market (fewer rounds, but bigger rounds) continue this year?
- Despite nearly ideal stock market conditions, why don’t we expect much acceleration in the tech IPO market in 2018? What needs to happen – to both supply and demand – for the number of new offerings to take off?
For answers to these questions – as well as other factors that will influence dealmaking in 2018 – see our just-published 2018 Tech M&A Outlook – Introduction.
Contact: Brenon Daly
If you have a hard time thinking of a truly blockbuster tech deal last year, you’re not alone. Even people who buy companies for a living struggled to single out any 2017 transaction.
As we do every year, we asked in our 451 Research Corporate Development Outlook Survey for dealmakers to look at the handiwork of their peers around the tech industry and select what they thought was the most significant transaction of the year. Survey respondents work at tech companies of all varieties, but regardless of their industry, the majority of their picks each year usually settle on one or two high-profile deals.
That wasn’t at all the case for our most recent survey. For starters, the pool of 2017 nominees was unprecedentedly broad and shallow. Corporate buyers put forward a record 12 separate transactions for the deal of the year.
From that long list, however, we don’t actually have a winner. Or rather, we have three winners. For the first time in more than a decade of giving out our Golden Tombstone award, we have a tie. Fittingly enough for the diffuse deals that characterized last year, we have a tie between three transactions: Intel’s $15.3bn reach for Mobileye, Cisco outbidding the public market for AppDynamics and Broadcom’s unsolicited bid for Qualcomm. We’re still working on cutting the Golden Tombstone into three pieces so each of the winners can have their own chunk of M&A immortality.
Contact: Brenon Daly
Despite all the ‘fire and fury’ around President Donald Trump, when it comes to tech deals, the president is good for business. At least that’s the view of a majority of buyers at some of the largest and most-active companies in the market.
By a more than two-to-one margin, respondents to the 451 Research Tech Corporate Development Outlook Survey said the Trump White House will help spur M&A in 2018. Specifically, 59% said the current administration will ‘stimulate’ dealmaking this year, compared with just 23% saying it will ‘inhibit’ dealmaking.
Somewhat surprisingly, the nearly six out of 10 respondents who forecast a ‘Trump bump’ in the tech M&A market is 10 percentage points higher than our previous survey. The increase over the past year in Trump’s standing among dealmakers stands in sharp contrast to the president’s overall popularity, which has dropped to record lows over that same time. Since Trump took over as CEO of America, the percentage of people who disapprove of the president has steadily risen from 41% to 55%, according to Nate Silver’s FiveThirtyEight, which calculates the figure based on a weighted blend of numerous polls.
Even with the divergent views about the White House, corporate acquirers mostly told us the overall economic picture isn’t really snagging deals these days. See the full 451 Research Tech Corporate Development Outlook Survey for more insights from many of the main buyers in the tech M&A market.
Contact: Brenon Daly
Despite a lackluster year for tech M&A in 2017, corporate acquirers overwhelmingly forecast that their companies will be looking to shop again this year. More than six out of 10 (62%) respondents to the annual 451 Research Tech Corporate Development Outlook Survey indicated that their firms would be more active with acquisitions in 2018. That was the most-bullish outlook since the end of the recent recession, coming in more than three times higher than the 18% of corporate buyers who expect their companies to step out of the market. (To see the full 451 Research report, click here.)
The company-specific outlook, which came from major acquirers across the tech landscape, is far more buoyant than their view of the broader M&A market, however. Looking ahead at the overall dealmaking environment for corporate buyers, only slightly more than four out of 10 respondents (43%) said it would be more favorable in 2018 than it was in 2017. On the other side, fully one-quarter (25%) predicted that general tech M&A conditions would deteriorate this year.
Although the broad-market outlook – with slightly more than four out of 10 respondents projecting an improved M&A environment in the coming year – ticked higher from last year’s survey, it is still lower than the two surveys before that, when tech acquisition activity did indeed hit multiyear highs. In those two previous 451 Research Tech Corporate Development Outlook Surveys, slightly more than half of the respondents forecast a favorable environment for their fellow strategic buyers. In both 2015 and 2016, spending on tech deals topped $500bn for the first time since the internet bubble burst, according to 451 Research’s M&A KnowledgeBase.
To see what else corporate acquirers told us about their financial rivals (PE firms), valuations and even what President Donald Trump is doing to the business of M&A, click here.
Contact: Brenon Daly
As tech companies said goodbye to 2017, most of them did so with fond memories of the past year. Public companies nearly all saw steady gains on Wall Street, with more than a few hitting record highs. Record amounts of venture money flowed to startups, while more-established companies looked ahead to their already-stuffed treasuries getting even fuller when the benefits of the recently passed tax program kick in. And probably most importantly, customers are saying they are ready to spend on tech like they haven’t been since the recent recession.
In a November 2017 survey by 451 Research’s Voice of the Connected User Landscape, fully 50% of the 872 respondents said their company is giving a ‘green light’ for IT spending. That was the highest reading since 2007, and 13 basis points higher than the average survey response for the month of November for the previous five years. During that 2012-16 period, in fact, respondents unanimously said their companies were more likely to cut their IT spending than increase it.
All in all, the end of last year was a good time for publicly traded tech companies to do business. And they did, except in one crucial area: M&A. Tech acquirers announced one-quarter fewer deals in Q4 2017 compared with the final quarter of the previous three years, according to 451 Research’s M&A KnowledgeBase. Meanwhile, spending on tech and telco acquisitions in the October-December period slumped to the lowest quarterly level since Q2 2013.
Historically, there has been a relatively tight correlation between overall IT budgets, company valuations and M&A activity. To some degree, activity in all three of those markets is determined by a single shared characteristic (confidence), so it follows that there would be some interdependence in the trio. And yet, as we step from 2017 to 2018, that connection appears to be breaking down. Tech companies are enjoying record levels of confidence from customers and investors, yet are rather timid when it comes to shopping.
Contact: Brenon Daly
A number of the mainstay acquirers that had helped boost the tech M&A market to recent record levels stepped out of the market in 2017, clipping spending on deals by more than one-third compared with 2016 and 2015. The value of tech and telco acquisitions around the globe in the just-completed year slumped to $325bn, after topping a half-trillion dollars in each of the two previous years, according to 451 Research’s M&A KnowledgeBase. Last year’s M&A spending ranks as the lowest in four years.
The primary reason for the drop in 2017 is that tech giants – the companies that had set the tone in the overall M&A market over the past decade – didn’t shop like they once did. For instance, Oracle and SAP have, collectively, announced 16 acquisitions valued at more than $1bn since 2010, according to our M&A KnowledgeBase. However, only one of those deals printed last year. (More broadly, Oracle took an uncharacteristically long eight-month hiatus from deal-making in 2017. The prolonged absence of corporate acquirers such as Oracle was one of the primary contributors to last year’s overall M&A volume slumping to a four-year low, according to our count.)
Also weighing a bit on 2017’s totals is that free-spending Chinese buyers, who had turned tech into a favorite shopping ground, all but disappeared from the top end of the market last year. Our M&A KnowledgeBase lists just one $1bn-plus acquisition by a China-based buyer in 2017, down from nine transactions in 2016 and seven in 2015. Currency restrictions imposed by China’s authorities in early 2017 drastically reduced the ability of Chinese companies to put money to work outside their country. Also, the simmering trade fight and sparring over currency policy between Beijing and Washington DC slowed M&A between the world’s two largest economies.
On the other hand, last year saw the full emergence of a new, powerful – and largely underappreciated – force in the tech M&A market: private equity (PE). As corporate acquirers retreated, financial acquirers accelerated. PE firms announced a record 876 transactions last year, more than twice the number they did just a half-decade ago, according to 451 Research’s M&A KnowledgeBase. Deal volume, which has increased for five consecutive years, jumped nearly 25% in 2017 from 2016, even as the number of overall tech acquisitions posted a mid-teens decline year on year.
Contact: Brenon Daly
Looking to put its mountainous cash holdings to work, private equity (PE) has become a velocity play. Deal-hungry financial acquirers have scaled back the size of the checks they write, but have compensated for that by writing a lot more checks.
This year, for instance, buyout shops have put up twice as many $1bn+ tech transactions as they did during the pre-credit crisis peak, but only half as many big ones. As PE firms lower their sights, their current overall M&A spending is coming up well short of the amount they threw around in the previous generation.
To understand this shift in price preference, it’s useful to compare PE dealmaking at the top end of the market in 2017, which will see an overall record number of sponsor-backed transactions, with the previous high-water year for PE spending in 2007. This year, 451 Research’s M&A KnowledgeBase has recorded 24 acquisitions by PE firms valued at $1bn or more, with total spending on those deals of $69bn. In contrast, 2007 saw fewer than half that number of billion-dollar transactions (11 vs. 24), but spending on those big-ticket deals was one-quarter higher ($85bn vs. $69bn).
A decade ago, buyout shops were looking to bag elephants. The prices of the two largest transactions in 2007 were both a full $10bn higher than this year’s biggest PE print, according to the M&A KnowledgeBase. (And for the record, this year’s sole buyout blockbuster – the late-September PE-led $17.9bn purchase of Toshiba’s flash memory business – looks more like the consortium deals we saw last decade than the PE transactions we’ve seen recently.)
For the most part, however, those blockbuster deals from last decade, with their 11-digit price tags, haven’t delivered the hoped-for returns. PE firms are now hoping that by going small, they can get a bigger bang.