The ‘wealth effect’ in effect

by Brenon Daly

If you’re looking for direction on pricing in the tech M&A market, you might just want to cast a glance at your stock portfolio. When there’s a lot of green there, acquisition valuations tend to be ticking higher, as well. As the equity markets go, so goes the M&A market.

We saw that clearly in the just-completed first quarter, when previously beaten-down stocks surged to their strongest start to a year since 1988. Likewise, according to 451 Research’s M&A KnowledgeBase, acquirers in Q1 paid the second-highest multiples in any quarter since the end of the recession a decade ago. The valuations in the just-closed quarter only trail Q2 2018, when the US equity market was at a similarly lofty level as it is now.

First-quarter deals valued at more than $200m went off at 4.6x trailing sales, according to the M&A KnowledgeBase. That multiple is more than a full turn higher than the quarterly median since 2010, when the equity market was just one-quarter the level it is now. Even looking at the market on a relative basis, stocks are much more expensive now: The price-to-earnings ratio for the S&P 500 Index, for instance, was in the mid-teens at the start of the decade, compared with the low-20s now.

Of course, there’s long been a correlation between M&A valuations and the stock market. In some cases, there’s a direct link. For instance, when acquirers – whether fellow corporate buyers or, increasingly, financial firms – have to pay a premium on already historically high prices to pick up a publicly traded target. During Q1, First Data, Ultimate Software Group and Mellanox Technologies all got acquired at their highest-ever stock price. The M&A KnowledgeBase shows the average valuation for that trio was about 7x trailing sales.

Even beyond that, there’s a softer influence of the ‘wealth effect.’ Without going too deeply into behavioral economics, the wealth effect implies that when people – or companies, which are just collections of people, after all – feel flush, they tend to behave accordingly. Whether picking up a shiny new car or a shiny new startup, buyers that feel well-off tend to shop more – and pay up when they do.

M&A Valuations, 2016-2019
Posted in M&A