2019 Tech M&A Outlook: Introduction

Mark Fontecchio

by Brenon Daly

Each January, we look back on deal flow over the previous year and look ahead at what we expect in the coming year. Our Tech M&A Outlook: Introduction provides a broad overview of acquisition activity in the tech market and the trends that shaped – and will shape – the multibillion-dollar tech M&A market. A few of the insights from the report include:

Both strategic and financial acquirers printed a record number of billion-dollar deals in 2018, with their combined pace topping two big-ticket transactions announced every week last year, according to 451 Research’s M&A KnowledgeBase. Microsoft, Salesforce, SAP, Adobe and IBM all inked billion-dollar acquisitions last year, after not one of the tech giants announced a blockbuster print in 2017.

With its broad applicability for buyers across the tech landscape, machine learning (ML) cemented its standing as the fastest-growing trend in the tech M&A market. The number of deals has increased roughly 50% every year since the start of the decade, our data shows. And no slowdown is expected in 2019, since bankers told us they have more ML transactions in their pipelines than anything else.

VC has turned into an industry characterized by ‘fewer, but bigger.’ That’s true in funding as well as exits. The M&A KnowledgeBase tallied the sale of just 603 startups in 2018, the second-fewest exits in the past half-decade. Proceeds from those deals, however, smashed all records. Last year’s total of $83bn in announced or estimated deal value almost eclipsed the total for the three previous years combined.

Additionally, we look at the prevailing trends in M&A pricing; the unprecedented activity of private equity that’s reshaping the tech landscape; and what the outlook is for the other exit, IPOs.

The overview serves as an introduction to our full, 100-page report that covers the outlook for M&A activity in six key enterprise IT markets, including application software, IoT and cloud. The full report, which will be available next week, is included in all subscriptions to 451 Research’s M&A KnowledgeBase, and is also available for purchase.

Viacom orbits around online video and ad targeting with Pluto TV purchase

Mark Fontecchio

by Mark Fontecchio, Scott Denne

With the $340m pickup of Pluto TV, Viacom broadcasts its desire to provide more online video and gain insights about the viewers who watch it. The target offers an ad-supported streaming service with more than 100 channels and claims over 12 million monthly active users. That media content and viewership data could help Viacom as it pushes into streaming video in search of higher ad rates through granular audience targeting.

The $13bn media giant dipped into streaming video M&A with the $17m acquisition of AwesomenessTV in July. Today’s larger deal signals Viacom’s appetite for more digital-first and digital-native content. Price isn’t the only dramatic difference between today’s transaction and that earlier buy. With Pluto TV, Viacom gets a fully backed streaming service that hosts both scheduled content and on-demand videos on a variety of channels, rather than a single channel or studio. Reaching for Pluto also gives Viacom access to millions of users, many of them younger viewers who don’t consume much traditional television. That amount of proprietary audience and viewership data can be immensely valuable, as the company recently cited increased ad rates due to improved ad targeting.

Surveys show that more people are signing up for online video services, often at the expense of traditional TV. According to 451 Research’s Voice of the Connected User Landscape, roughly one-fifth of consumers have either dropped traditional cable and satellite TV providers or have never subscribed to them in the first place. The same survey found that 57% of consumers now pay for at least one online video service.

According to 451 Research’s M&A KnowledgeBase, media firms have infrequently acquired software and internet businesses, having only printed about 20 deals in each of the past two years. Still, we anticipate that more broadcasters and studios will expand their acquisitions of video services or underlying technology as they seek ways to generate a direct link to their audiences to offset declining TV viewership and massive investments in original, niche content from Amazon and Netflix.

An unexpected exit from Sand Hill Road

Mark Fontecchio

by Brenon Daly

There’s a new exit off Sand Hill Road that’s proving increasingly popular for startups. Rather than following the well-worn path that leads into another venture portfolio, startups are taking an unexpected turn into private equity (PE) holdings at a record rate. For the first time in history, a VC-backed startup in 2018 was more likely to sell to a PE buyer than a fellow VC-backed company, according to 451 Research’s M&A KnowledgeBase.

Last year was 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. But with ever-increasing amounts of cash to put to work, PE firms have started reaching into VC portfolios much more frequently and aggressively.

The M&A KnowledgeBase shows that buyout shops, 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 startups, or buying out an existing syndicate of venture investors.

Altogether, PE firms have doubled the number of VC-backed deals over the past three years. That buying group has increased its startup purchases every single year since 2015, while the number of VC-to-VC transactions has fallen every single year during that period.

Those diverging fortunes have pushed buyout shops’ share of VC exits to an unprecedented 23% in 2018, up from roughly 10% at the start of the current decade, according to the M&A KnowledgeBase. So for a startup looking to sell itself in the coming year, it’s probably more likely to go to a company owned by Silver Lake rather than Greylock, or KKR rather than NEA.

Pricing pressure

Mark Fontecchio

by Brenon Daly

No matter where shoppers looked last year, the tech M&A market was a pricey place to be. Unprecedented valuations are one of the main reasons why overall acquisition spending basically matched the highest level since the dot-com collapse. 451 Research’s M&A KnowledgeBase recorded $573bn worth of deals in 2018, nearly equaling 2015’s record but on 20% fewer transactions.

Drawing on the M&A KnowledgeBase, we see that ‘valuation inflation’ played out in deals across the entire tech landscape:

At the top end of the market, both corporate and financial acquirers in 2018 paid multiples that were a full turn higher than either group has paid for their big prints since the recession. Our data shows that in the 50 largest transactions done by each of the buying groups, private equity shops paid 5x trailing sales while strategic acquirers paid 6.3x trailing sales.

Turning to the VC market, startups that exited last year did so at relatively rich prices. On a median basis, startups sold for 5.8x trailing sales in 2018, almost one-third richer than the 4.5x multiple recorded in the M&A KnowledgeBase since the start of the decade.

As my colleague Scott Denne recently noted, software buyers paid a median 7.6x trailing sales in the record number of $1bn-plus deals they inked last year. They had never paid more than 5x sales in any year since the recession, our data shows.

However, the astonishingly rich multiples paid in last year’s deal flow may well stand as the high-water mark. At least that’s the prevailing view of senior investment bankers we surveyed. In a December survey, a record number of respondents to the 451 Research Tech Banking Outlook Survey predicted tech transactions going off at lower M&A multiples in 2019. (See our full report on the survey.)

Fully two-thirds of senior bankers (68%) forecast discounting in deals in the coming year, more than twice the number of bears in the two previous years of surveys. Just 4% anticipate M&A pricing ticking higher in 2019.

Software buyers surge

Mark Fontecchio

by Scott Denne

In 2018, it seemed that anyone who could buy a software company did. The reemergence of software M&A’s regular strategic acquirers, along with a continuing surge in private equity (PE) deals and a jolt from young public software companies, pushed the market for application software acquisitions well past its 2016 record.

According to 451 Research’s M&A KnowledgeBase, acquirers picked up 1,191 application software companies worth a combined $90.5bn. This marks the first time we’ve recorded more than 1,100 software companies sold in a single year, and represents a 42% increase over the previous record (from 2016) for total value of acquisitions in the category.

While there were certainly outstanding deals – SAP’s $8bn purchase of Qualtrics being the largest – it was the volume of acquirers willing to make big purchases that drove the year’s total to its heights. Since the end of the dot-com bubble, there have only been two years that have had more than 10 application software deals to print at or above $1bn, and never more than 14. This year, buyers announced 28 of them.

SAP bookended the year with a pair of such transactions: the $2.4bn acquisition of Callidus Cloud and the $8bn purchase of Qualtrics in November. Prior to that, you have to go all the way back to SAP’s 2014 acquisition of Concur for its last 10-figure deal. It wasn’t the only one of its peers to return to market in a big way this year. Adobe printed two $1bn application software deals (Magento and Marketo) – its first since 2009. At the same time, Cloudera, Twilio and Workday all printed their first-ever 10-figure deals.

Vertical software targets – companies building software for specific markets, such as construction, pharmaceuticals, education and government – took an outsized share ($30.4bn) of the annual total. Those targets continued to be a private-equity favorite, while attracting interest from companies outside the software industry. Roche, the pharma giant, opened the year with a $1.9bn purchase of electronic health records company Flatiron Health, while industrial conglomerate 3M closed the year with a $1bn acquisition of clinical documentation software developer M*Modal.

Even amid the return of the old strategics and the emergence of new cohorts of software buyers, PE continued to influence the software M&A market. More than one in three (37%) application software acquisitions was made by either a PE firm or a PE portfolio company, up from 33% in 2017 – the highest level up to that point. Still, the reemergence of strategic acquirers helped push up prices on those deals. The median multiple paid by a PE firm for a software company last year came in at 4.1x trailing revenue, clocking in above 4x for the first time on record.

Across the software market, rising multiples spurred the growth in deal value. Buyers paid a median 7.6x trailing revenue across $1bn-plus deals in the category last year, compared with each of the four preceding years, where median multiples on such deals fluctuated between 3.9x and 4.8x.

Hosting M&A dips in 2018 as big players slow activity

Mark Fontecchio

Following two years of outsized spending, hosted services providers took a breather in 2018. M&A activity in the sector decreased across the board, as deal volume, aggregate spending and valuations all dropped, driven by a pullback among the largest hosting and multi-tenant datacenter (MTDC) providers. We expect the biggest buyers to return to heavier spending in 2019, fueled by the increasing need for infrastructure to support workloads in the cloud.

Despite a 23% drop in volume and 40% reduction in spending, hosted services M&A clocked its fourth consecutive year of more than $10bn in total value with $10.7bn. In the decade leading up to 2015, expenditures surpassed that benchmark just twice. And yet, the steep drop last year was jarring. According to 451 Research’s M&A KnowledgeBase, valuations also dropped – the median multiple on enterprise value to trailing revenue fell last year to 2.7x from 3.6x in 2017.

While overall tech M&A saw larger enterprises buying again, hosted services witnessed the opposite, with Digital Realty Trust and Equinix stepping back. From 2015 to 2017, those two buyers combined for about five acquisitions and $6bn in spending each year. In 2018, they inked two deals among them for less than half that typical amount. Digital Realty cited its muted share price as a reason for stepping back – both it and Equinix started 2018 with a dip, followed by a summer recovery and then ending the year down alongside the general markets.

Still, even with the decreased spending, Digital Realty Trust and Equinix inked two of the year’s most notable hosting deals. Digital’s $1.8bn purchase of Ascenty gives it a strong foothold in Latin America, while Equinix’s $800m pickup of Infomart Dallas highlights the company’s continued efforts to extend its interconnection reach. Setting aside those two buyers, both financial and strategic acquirers each reduced spending more than 20%.

Exacerbating the decline, hosted services companies are less likely to buy their peers, and have increasingly looked to other markets for growth, particularly managed services, while they aim to move up the stack as their customers increasingly opt for cloud over datacenter deployments. In 2018, hosted services companies purchased 19 IT services and outsourcing business, compared to 13 in 2017. In that vein, we saw deals such as Rackspace buying Salesforce cloud integrator RelationEdge, and eHosting acquiring Microsoft cloud MSP LiveRoute.

More deals to be done

Mark Fontecchio

by Brenon Daly

Even after strategic acquirers led the tech M&A market to a near-record level in 2018, they still plan to step up their shopping in 2019. More than half the respondents to the annual 451 Research Tech Corporate Development Outlook predicted that their companies 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.

The bullishness comes after many of the mainstay acquirers placed an unprecedented number of big bets in 2018. Corporate acquirers announced a record 74 transactions valued at more than $1bn in 2018 – double their number of big prints annually at the start of the decade, according to 451 Research’s M&A KnowledgeBase. Big-name buyers such as Microsoft, SAP, Adobe, Cisco Systems and IBM all put up single prints valued in the billions of dollars last year.

However, the folks who do the buying at tech companies did see some clouds on the horizon. Nearly four in 10 corporate acquirers (39%) told us that the deteriorating economic picture around the globe created a ‘pain point’ for deals they worked on in 2018. That was almost twice the number of respondents who said their work didn’t get snagged by any of the broad market concerns.

Subscribers can see our full report on the annual 451 Research Tech Corporate Development Outlook, which drew responses from some of the tech industry’s biggest buyers on what they see coming in 2019.

Cloudy days ahead boost infrastructure management M&A

Mark Fontecchio

by Scott Denne

The overwhelming shift toward cloud environments, mixed with reliable cash flow from pre-cloud companies, has taken M&A to unseen levels in a normally sleepy corner of the tech M&A market. IT infrastructure management vendors, those companies that make the software to monitor, manage and automate IT environments, fetched 10x the total value that such deals see in a typical year. The surge comes as legacy IT companies reach the inescapable conclusion that the cloud – from SaaS to IaaS – has forever changed IT.

According to 451 Research’s M&A KnowledgeBase, companies developing infrastructure management technology sold for a combined $94.4bn in 2018. To say that’s a record doesn’t suffice. Last year’s total came in six times higher than the previous annual high. Put another way, the total deal value for the sector was more than the combined total of the nine preceding years, which includes the previous sector record set in 2016.

In a market that typically sees 125-150 deals annually, a single transaction often skews the year’s total deal value. Certainly, IBM had such an impact with its $33.4bn acquisition of Red Hat last year. But it wasn’t a single outlier that made last year unique. It was an abundance of such deals. Since the dot-com crash, just eight infrastructure management companies have sold for more than $5bn, and five of them were sold last year. Both the largest (IBM’s Red Hat) and second-largest (Broadcom’s proposed $18bn purchase of CA Technologies) infrastructure management acquisitions were announced in 2018.

The growing dominance of Amazon and Microsoft Azure in the cloud market catalyzed the Red Hat deal. IBM inked the largest software acquisition of all time to carve itself an opportunity, as IT environments and applications spread among different cloud services. A similar rationale drove Salesforce’s $6.6bn purchase of MuleSoft – the largest ever done by that buyer – aiming to give the SaaS giant a stake in helping businesses integrate SaaS, hosted and on-premises applications.

451 Research’s Voice of the Enterprise surveys show how fast this future will arrive. In our Digital Pulse: Vendor Evaluations report, 44% of respondents told us that most of their IT workloads reside in traditional, on-premises infrastructure. Yet only 16% of them expect that will be the case in two years, as respondents spread their workloads across SaaS, on-premises private clouds, hosted private clouds and IaaS – each of which saw 15-20% predicting those deployment options would be home to the majority of their workloads.

And the Golden Tombstone goes to…

Mark Fontecchio

by Brenon Daly

For our final M&A Insight of 2018, we’re going to look back on the astonishing year of dealmaking in the tech industry. Or rather, we’re going to have the pros do it, and tell us what stood out for them.

In our just-closed 451 Research Tech Corporate Development Outlook survey, among other questions we asked 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. They had plenty to consider from 2018. 451 Research’s M&A KnowledgeBase lists a record 105 transactions valued at more than $1bn from this year, which is twice the number announced at the start of the decade.

Without further ado, this year’s Golden Tombstone goes to IBM’s record-breaking purchase of Red Hat. The deal represents the largest software transaction in history, nearly twice the size of the second-biggest purchase. In the voting by some of the tech industry’s most seasoned dealmakers, IBM’s big bet slightly edged out Microsoft’s reach for GitHub.

That’s the good news for Big Blue. Taking a bit of luster off the coveted trophy is the fact that corporate buyers also selected IBM’s record-breaking pickup of Red Hat as the high-profile deal announced this year that’s most likely to struggle to generate the hoped-for returns.

The dual-placing for the blockbuster transaction probably isn’t unexpected, given its unprecedented scale. But the bears on the deal are overrepresented. IBM’s acquisition of Red Hat got almost three times the number of votes as second-place Broadcom-CA.

Those who ‘shorted’ IBM’s massive deal noted the vast cultural divide between buttoned-up Big Blue and the more freewheeling open source company. Also, IBM has been in the midst of a protracted decline in its business. In fact, since IBM picked up its previous Golden Tombstone award for the June 2013 purchase of SoftLayer, shares of Big Blue have shed 40% of their value.

VCs piling up chip deals

Mark Fontecchio

This year’s surging M&A market has brought relief to a tech sector that’s long struggled to find exits. With today’s announcement that Cisco is acquiring venture-backed Luxtera for $660m, venture capitalists have realized more value from their semiconductor investments than any time since 2013. In a reflection of the broader market, the return of strategic acquirers has boosted the sales of chip startups.

As 2018 heads toward a close, buyers have spent a collective $1.4bn on purchasing semiconductor startups from venture portfolios, compared with just $1.8bn in the three previous years combined. The acquisition of Luxtera goes a long way toward boosting this total. According to 451 Research’s M&A KnowledgeBase, the deal is the largest purchase of a VC-backed chipmaker since the dot-com bubble burst. (Neither that record nor the annual totals include acquisitions of public companies that previously raised venture capital.)

That Luxtera’s exit marks a record speaks as much to the dearth of liquidity for chip startups as it does to the target’s accomplishments. In the face of rising development costs, VCs have long shied away from chip investments and acquirers have come to depend on product development more than M&A for incremental improvements. Most of the dealmaking among semiconductor vendors in recent years has been large consolidations, rather than midmarket acquisitions.

Still, there’s been some relief from the paucity of exits this year. Prior to Luxtera, Cisco, a frequent buyer of software vendors in recent months, hadn’t acquired a semiconductor business in nearly three years. The same goes for Skyworks, which provided VCs with the third-largest exit in the category when it shelled out $405m for Avnera in August – it was the acquirer’s first purchase in more than 30 months. And Intel picked up a pair of chip startups this year after a 16-month hiatus from semiconductor M&A.