Going vertical makes machine learning deal volume horizontal

Mark Fontecchio

by Scott Denne

Last year marked a banner year for machine learning M&A. Purchases of vendors building products around that emerging technology, as well as firms whose offerings enable others to build machine learning products, soared in 2019. Yet the change was more than quantitative. As that new technology pervades older industries, it’s bringing in new acquirers and the rationale behind many machine learning deals has evolved.

According to 451 Research‘s M&A KnowledgeBase, acquisitions of machine learning providers rose 75% to 278 in 2019. In other words, machine learning accounted for one of every 13 tech transactions last year. Within that number, purchases of companies selling into a specific vertical produced the most prominent rise as buyers nabbed 112 vendors building machine learning offerings that address problems within a particular industry, more than double the 53 they bought earlier.

In previous years, many acquirers were content to pick up general-purpose tech and expertise to bolster their machine learning portfolios. Serial shoppers Microsoft, Google, Salesforce and Apple, for instance, each picked up more than 10 businesses in recent years to expand their products’ machine learning functionality. As we previously noted, buyers have already become more discriminating, and more likely to seek tech that fills specific gaps in the product portfolio.

But the application of machine learning to certain markets has not only kept acquirer interest in the burgeoning technology high, it has also brought new buyers into the tech M&A market as staid industries see opportunities and risks that come with the emergence of machine learning. For example, in one of the largest machine learning deals last year, Prudential Financial printed its first tech acquisition with the $2.4bn pickup of Assurance IQ to expand its online sales via software that customizes insurance products around data signals.

As the universe of buyers and the range of rationales for machine learning transactions continues to expand, this technology will likely continue to have an outsize impact on the tech M&A market. At least that’s the take from the 451 Research Tech Banking Outlook, where 91% of bankers surveyed anticipate that machine learning purchases will accelerate in 2020.

Figure 1:

Source: 451 Research’s M&A KnowledgeBase. Includes disclosed and estimated deal values.

Your guidebook for the changing M&A landscape

Mark Fontecchio

by Brenon Daly

For tech M&A, 2019 not only wrapped up a decade, it also ended an era. As we look ahead, it’s becoming increasingly clear that business in the 2020s won’t just be a continuation of the 2010s. To help you navigate the changes, 451 Research has just published its signature 2020 Tech M&A Outlook: Introduction, covering what we see shaping the multibillion-dollar market in the coming years.

And right now, there are some significant shifts in the tech M&A market, wherever you happen to be working. As we highlight in the full report, these once-in-a-generation transitions include:

Longtime corporate acquirers aren’t doing deals like they once did. The decidedly middle-aged mainstays had dominated the tech M&A market since virtually the industry’s first print. But now, the Baby Boom-era vendors are being nudged aside by faster-moving and bigger-buying companies born in the past 20 years or so. Our report looks at which Millennials are driving the trend, and which we think are the next to join M&A’s big leagues.

Broad-market M&A valuations have soared to record levels, roughly doubling over the past decade. And yet, in the all-important matter of pricing, not everything is heading up and to the right. We chart the trends in several key markets, including a historic decoupling of valuations between strategic and financial buyers.

In venture capital, the past decade was dominated by attention to ‘unicorns,’ a term that was coined by a VC in 2013 to describe startups valued at $1bn+. By last year, however, unicorns didn’t look very special. Both acquirers and investors had become increasingly skeptical of money-burning startups. The ‘growth at any cost’ business models that had fueled the 2010s looked unsustainable in the new decade, a change that will have huge implications for startup fundraising as well as exits.

Again, our 2020 Tech M&A Outlook: Introduction is now available to 451 Research clients. Think of it as a guidebook for the changing landscape of the industry.

Figure:
Source: 451 Research’s M&A KnowledgeBase

Thinned-out M&A pipelines

Mark Fontecchio

by Brenon Daly

After tech M&A spending dipped in 2019 from its record level in the previous year, senior tech bankers are bracing for acquisition activity to slow further in 2020. Only slightly more than six of ten (62%) of respondents to the 451 Research Tech Banking Outlook say the value of deals they are working is higher now than it was a year ago. Over the past decade of our survey, an average of 68% of bankers have reported fuller pipelines. The 2020 outlook comes as 2019 posted a roughly 20% year-over-year decline in spending on tech and telecom deals around the globe, according to 451 Research‘s M&A KnowledgeBase. (See the full report.)

More ominously, a recent record one-quarter of respondents (24%) to our survey indicated that the value of deals they are currently working is lower now than it was a year ago. That’s the most-bearish outlook since the recession-scarred year of 2009 and is fully 10 percentage points higher than the average response since the start of the decade. Of course, the tech M&A market has expanded dramatically since emerging from the Credit Crisis. The M&A KnowledgeBase shows that overall spending on tech transactions is running more than three times higher in 2019 than it was a decade ago.

The fact that bankers, who tend to be an optimistic group with a bias toward activity, say their pipelines are thin as they head into 2020 is significant. The reason? Their predictions in previous editions of our Tech Banking Outlook have proven uncannily accurate, particularly on the downside. Since 2010, the level of bankers projecting a decline in the dollar value of their mandates for the coming year has only topped 20% in just three of our surveys (2010, 2013 and 2017).

Each of those years has indeed played out that way, with below-average annual spending on tech deals, according to the M&A KnowledgeBase. Now, we add 2020 to that list as the weakest of the weak forecasts.

For more specifics on the outlook from senior bankers – who, collectively, have had a hand in dozens of deals across a wide swath of the tech landscape – see our full report on our 15th annual Tech Banking Outlook. Highlights include:

How active will private equity (PE) be in 2020? Financial acquirers have been a virtually unstoppable force in the tech M&A market in recent years, accounting for nearly one of every three tech transactions, according to our data. That’s triple the market share they held in 2010. And yet, bankers forecast that the growth for PE isn’t necessarily going to continue in the coming year.

What tech sectors will be the busiest this year? Once again, we have a kind of ‘heat map’ for M&A, based on what bankers tell us they are actually working on. (Crucially, their assessment is based on their pipeline and ongoing workflow, rather than a vague, ‘What’s hot in 2020?’-type question.) See how your M&A priorities line up with the broad-market trends.

Figure:

Source: 451 Research Tech Banking Outlook

A high-water mark in PE deal flow

Mark Fontecchio

by Brenon Daly

High-water marks only become apparent when the waters recede. As time passes, the pinnacle stands out even more because everything that follows comes at a lower level. We see that in deal flow, too.

Consider the take-private of Ultimate Software, which did indeed prove to be the ‘ultimate’ LBO of 2019. No other deal came close to its size ($11bn) or valuation (11x). On average, the tech companies that got erased off US exchanges after the HR software vendor garnered an average valuation of just a smidge more than 3x trailing sales, according to 451 Research‘s M&A KnowledgeBase.

Now, we have an early entry for the singular private equity (PE) transaction of 2020: Insight Partners’ $5bn recapitalization of Veeam. Both in terms of transaction structure and size, it is an outlier. And it will almost certainly remain that way for the full year, even as PE shops likely put up more than 1,000 prints again in 2020.

For starters, financial buyers have only just started shopping in venture portfolios, and are significantly underrepresented there. (Our data shows that PE firms over the two previous years have accounted for just 22% of purchases of venture-backed companies, which is fully 10 percentage points lower than the ‘market share’ they hold across all of tech M&A.) Within that, recaps – or a single financial sponsor replacing a syndicate of investors – are only a tiny slice of those deals.

Of course, Insight was already on Veeam’s syndicate, having invested $500m previously. But in most cases, VC-to-PE deals break down due to unbridgeable valuation gaps. (Oversimplified, the discrepancy goes something like this: VCs tend to value startups aspirationally, while PEs tend to value startups realistically.)

Beyond the unusual transformation of Insight going from minority shareholder to outright owner of Veeam, the transaction is also likely to stand on its own this year because of its size. The M&A KnowledgeBase lists only three tech deals by sponsors over the past year that are larger than the pending recap of the data-protection provider.

And over the course of the past year, PE business has dried up. Spending on transactions by buyout shops dropped 20% in 2019 compared with 2018, while last year also saw the first decline in the number of PE prints in six years. Further, 2020 may slow even more. In our annual survey of senior tech investment bankers, they told us their pipeline for PE work is not as full as their overall pipeline for the coming year. That’s the first time in three years they haven’t been busier with financial acquirers.

VCs finish the old decade with new friends

Mark Fontecchio

by Scott Denne

A late burst of large deals raised last year’s venture capital exit totals to spectacular from subpar as startup investors leaned on new names for exits. In the final six weeks of the year, five of the companies VCs sold were valued at $1bn-plus, after seeing just one such exit per quarter earlier in the year. And although the deal values jumped at the end of the year, VCs, throughout 2018, saw a steady stream of liquidity from vendors that have recently expanded their startup acquisitions.

According to 451 Research’s M&A KnowledgeBase, venture investors sold $40.4bn worth of tech targets in 2020, a dramatic drop from last year’s record $85.6bn but still finishing as the third-highest annual total since the dot-com days. The final weeks made all the difference. The $13bn combined value of just five acquisitions brought the annual total from just below the $28bn of VC exits from a typical year in the 2010s. And that surge came with little help from the buyers that propped up the exit market earlier in the last decade.

Instead, acquirers that have only recently emerged as major sources of liquidity boosted the annual totals. Here’s a sampling:

Just before Thanksgiving, PayPal spent $4bn for Honey, its largest-ever acquisition and only the second time it’s paid 10 figures for a startup (it bought iZettle for $2.2bn in May 2018).

With barely a week to go in the year, F5 Networks paid $1bn for Shape Security, a deal that followed its March purchase of NGINX for $670m, which was previously its largest acquisition.

After printing a pair of nine-figure startup purchases in 2018, Splunk joined the $1bn club, paying slightly more than that for SignalFx, an early-stage cloud performance-monitoring specialist.

By contrast, the companies that, from 2010-18, bought the most startups – Google, Microsoft, Cisco and Oracle – slowed their activity. As a group, those vendors acquire 31 startups in a typical year, our data shows. Last year they purchased just 20, the fewest ever in the decade, and only Google, with eight deals, including its $2.6bn pickup of Looker, was notably active. To put 2019 into context, Microsoft bought as many VC-funded vendors (five) last year as Palo Alto Networks, a security provider that has only inked 12 acquisitions in its entire history.

Figure 1:

Source: 451 Research’s M&A KnowledgeBase. Includes disclosed and estimated values.

A softer software market

Mark Fontecchio

by Scott Denne

The rising tide of 2018’s record software M&A market gave way to a top-heavy 2019 as fewer business application vendors fetched a 10-figure price but a record number nabbed 11 figures. And while the size of the market shrank a bit from last year’s high as both strategics and sponsors slowed their spending, the total stands well above the deal value and volume seen in a typical year. Despite the decrease in overall deal value, acquirers continued to pay premium multiples for those assets they did purchase, something they’re less likely to do in the new year.

According to 451 Research’s M&A KnowledgeBase, acquirers in 2019 bought a record 1,296 application software companies worth $83.2bn, about $12bn less than the previous year. A dramatic drop in transactions valued north of $1bn led the decline in spending. Yet the biggest software deals got bigger. Two acquisitions – Salesforce’s $15.5bn reach for Tableau and Hellman & Friedman’s $11bn Ultimate Software take-private – passed the 11-figure mark in 2019, something that only one other application vendor (Autonomy) had done since the start of the decade.

While only half as many application providers sold for $1bn or more in 2019 as did a year earlier, the 15 transactions that went off in 2019 stand as the second-highest total, according to the M&A KnowledgeBase. In other words, it may be more accurate to view 2019 as an inevitable decline that followed a sudden surge in 2018. In each year since 2010, we’ve consistently recorded about 12 application software deals valued at or above $1bn, meaning that 2019 was notably high, yet well below the 30 we saw in 2018.

And while the number of $1bn software transactions shrank, prices didn’t. The annual median for such deals finished a hair above 7x trailing revenue, the same level as the previous year, our data shows. Who was willing to pay those prices shifted in 2019, however. While private equity firms paid that same multiple in 2018, the median price paid by sponsors to acquire software companies for 10 figures declined a full turn last year. Strategic buyers moved in the other direction, paying a 9.3x median as they continued to pay higher prices in each of the past few years.

Although valuations for application software vendors held up amid a decline in overall spending last year, prices could well begin to fall in 2020. That’s the outlook of respondents to our M&A Leaders survey in October, where they projected a drop in private company valuations at a rate of five to one. Moreover, 2020 starts off with a tougher macro environment than its predecessor. In that same survey, nearly two-thirds of respondents (61%) said that ‘fear of a recession’ could weigh on deal flow in the coming 12 months.

Figure 1:

Source: 451 Research’s M&A KnowledgeBase. Includes disclosed and estimated values.

A shift in the market

Mark Fontecchio

by Brenon Daly

Tech M&A spending in 2019 dropped nearly 20% from the previous year’s record level, as mainstay acquirers stayed away, and an up-and-comer came up short. The combination of the tech industry’s bellwethers not buying and buyout shops slowing their record roll sank the value of tech and telecom acquisitions announced around the world last year to $460bn, according to 451 Research’s M&A KnowledgeBase.

Still, 2019 stands as the fourth-highest annual total since the internet bubble collapsed. The fact that last year hit such heights is rather remarkable, given that it was missing the main engine that has powered tech M&A over the past decades: big-cap acquirers.

As an indication of that, consider that our M&A KnowledgeBase shows that Oracle, Microsoft, IBM and SAP, collectively, did not put up a single billion-dollar print in 2019. It was the first time since 2003 the always-hungry quartet haven’t been in the ‘three comma club.’ Up until last year’s notable absence, the big buyers had been averaging three or four acquisitions between them valued at more than $1bn each year.

Further, our data indicates the ‘first gen’ quartet put up just half the number of overall deals in 2019 that they had been averaging over the past 15 years. It was as if the old guard, having shaped and driven the broader tech M&A market in the 2010s, stepped aside as the curtain came down on the decade. Last year marked the end of an era.

As that transition was playing out in the ranks of the strategic acquirers, the other main buying group was also facing changes of their own. Private equity (PE) firms announced fewer tech transactions in 2019 than they did in 2018, according to our M&A KnowledgeBase. That marked the first decline in deal volume in six years for deep-pocketed financial buyers, which had been the only ‘growth sector’ in the overall tech M&A market for the past few years.

Figure 1
Source: 451 Research’s M&A KnowledgeBase

And the Golden Tombstone goes to…

Mark Fontecchio

by Brenon Daly

For our final M&A Insight of 2019, we’re going to look back on the 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 our other questions to dealmakers, we asked them 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. (Corporate buyers who filled in our 13th annual survey have already received full responses, plus the context for the key forecasts for what’s coming in tech M&A in 2020. 451 Research subscribers will have to wait until the report is published in early January to get the wisdom of the crowds.)

Out of the more than 3,600 tech transactions we have in our 451 Research M&A KnowledgeBase for 2019, our survey respondents handed this year’s Golden Tombstone to Salesforce‘s $15.5bn purchase of data analytics vendor Tableau Software. The deal, which is the year’s largest software transaction and fifth-biggest tech acquisition overall, got twice as many votes as the runner-up – VMware’s $2.1bn reach for security company Carbon Black.

On the other side, we asked which significant tech transaction announced in 2019 they think will struggle to generate the hoped-for returns. Corporate buyers selected Broadcom’s $10.7bn pickup of Symantec’s faded enterprise security business as the most likely blockbuster to bust. The chipmaker-turned-enterprise-software-vendor paid a relatively rich 4.5x trailing sales for a business that hadn’t grown in three years. Plus, there’s the sheer scale of the transaction, which is the largest-ever information security acquisition, equaling an entire year’s worth of spend in the sector in some years.

With that, we will be unplugging for a bit to enjoy the holidays. Our next M&A sendout will be hitting your inbox on Thursday, January 2. In the meantime, we wish all of you peace and happiness for the holiday season, and nothing but accretive transactions in the coming year.

Figure 1
Source: 451 Research Tech Corporate Development Survey

Turn on, tune in, pay up

Mark Fontecchio

by Scott Denne

The few above-market valuations captured by ad-tech companies are increasingly reserved for those vendors remaking the TV advertising market. Although the overall value of acquisitions of ad-tech firms has continued to tumble from the market’s peak in 2015, targets that can help businesses capitalize of the evolving market for TV ads are still able to find buyers at premium prices.

The most recent example comes with The Rubicon Project’s announcement that it will spend nearly half of its equity to purchase Telaria, a maker of software for managing sales of digital video ads. Although both companies operate ad exchanges and publisher-facing ad software, Telaria was built around video, with a focus on connected TV advertising. Rubicon, on the other hand, was built for display ads, later expanding into mobile and online video. Its acquisition of Telaria values the target at 4.4x trailing revenue, while Rubicon itself, a larger and faster-growing company, commands just 2x on the NYSE. (We’ll have a detailed report on this deal later today for subscribers to 451 Research’s Market Insight service).

Telaria isn’t the only ad-tech vendor fetching a premium because of its connected TV capabilities. In its sale to Roku, DataXu nabbed a higher multiple than most of its peers as Roku sought a way to expand its reach in connected TV ads (subscribers to 451 Research’s M&A KnowledgeBase can see our estimates of that multiple here). And LiveRamp, seeking to expand its identity graph into television, paid $150m for Data Plus Math, a vendor with just 25 employees.

These transactions, and the accompanying valuations, come as TV viewing (the largest nondigital ad market) repositions from over the air to over the internet. The pace of this shift can be seen in 451 Research’s VoCUL: Communications & Media surveys. In the space of a single quarter, the rate of respondents telling us they use a streaming video device (Roku, Apple TV, etc.) to watch video every day rose to 26% from 21%. Similarly, those telling us they do the same on a videogame console jumped to 17% from 11% from our first–quarter to second–quarter survey.

Figure 1: Ad-tech M&A
Source: 451 Research’s M&A KnowledgeBase

More public private equity

Mark Fontecchio

by Scott Denne

Although the volume of overall tech acquisitions by private equity (PE) firms has declined a bit from last year’s record, the number of take-privates continues to increase. The latest of such deals is Francisco Partners and Elliott Management’s $4.3bn purchase of LogMeIn – a typical take-private from what’s becoming an atypical source.

According to 451 Research‘s M&A KnowledgeBase, buyout shops have erased 42 tech vendors from public markets this year, the second-most of any annual total and seven more than they bought in 2018. In acquiring those companies, they’ve spent $74bn, the second-highest annual outlay for such transactions. (The highest came in 2016, the year that Dell, a Silver Lake portfolio company, shelled out $63bn for EMC.)

In some ways, LogMeIn is a typical LBO – it’s a large, profitable public company that’s struggling to put up growth. Garnering a 3.4x trailing revenue multiple on the sale, its valuation sits right in line with the annual median for take-privates this year. But unlike LogMeIn, fewer vendors are coming off the major US exchanges.

As sponsors are spending more than usual on take-privates, they’re having to go further afield to do it. For just the second time in the decade, PE firms are purchasing fewer companies that trade on the Nasdaq or NYSE exchanges than public companies that trade elsewhere.