How economic and technological factors are driving a major year for tech acquisitions
In late March, Salesforce announced that it planned to pay $6.5 billion for API vendor MuleSoft. It was just the most recent indication that 2018 is likely to be a bumper year for technology mergers and acquisitions. Last year, tech M&A deals amounted to $8.6 billion, according to research firm Evercore ICI. The prevailing sense among industry insiders is that M&A activity in New York’s Silicon Alley and across the country is not likely to slow down in 2018; in fact, as technology continues to evolve and as the implications of the new tax bill play out, this year may be one for the record books.
Contributing factors: technology and the tax bill
There are a number of factors driving the rise in M&A activity. The new tax bill, formally known as the Tax Cut and Jobs Act, resulted in the largest reduction in the corporate tax rate in U.S. history. The TCJA also incentivizes the repatriation of funds that have previously been held offshore.“A lot of cash is coming back on shore—as much as $1.5 trillion,” notes Ben Boissevain, managing director of Ascento Capital, a New York based M&A advisory and consulting firm. “And a portion of that will certainly go into M&A.”
Jennifer Fitzgerald, co-founder and CEO of PolicyGenius, a New York-based insurance technology firm, agrees that signs point to an active year for mergers in the New York area. “Our sector has seen billions in venture capital over the past few years,” she says. “And after venture comes M&A.”
The rapid evolution of technology is a major contributor to rising M&A volume. Both tech and non-tech companies are increasingly aware that there may be opportunities in emerging sectors such as augmented/virtual reality, artificial intelligence, big data and blockchain. “We’re seeing a lot of acqui-hires in those areas,” Boissevain says, referring to the practice of bringing on the team of the firm you’re acquiring.
“The overall sentiment I’m hearing from the big VCs is that Fortune 500 companies have largely taken a wait-and-see approach to the new tech start-ups,” Fitzgerald said. Given that new technologies are becoming increasingly central to major companies’ future plans, she says, “now is seeming like a good time for them to come in.”
Recent examples include Wal-Mart’s acquisition of start-up Spatialand to bolster its virtual commerce efforts and Nike’s purchase of New York- and Philadelphia-based consumer data analytics firm Zodiac as part of its strategy to enhance analytics capabilities and connect one-on-one with consumers.
Most M&A activity is based on strategic, not financial concerns, Fitzgerald points out. Recently, many of those deals have involved companies being valued at very high multiples. “There’s confidence at the board level justifying those incredibly high multiples,” Boissevain said. “They understand that they need the technology—they can’t stay still.”
Sectors to watch
With the rapid growth of technology, certain sectors are crowded with competitors; those are the areas where M&A activity is likely to result in rapid consolidation. “When you consider enterprise software, particularly the subset of network security, I think you’re going to see a natural process where there’s winners and losers emerging,” Boissevain said. “The customers of these vendors don’t want to buy 20 different pieces of software; they want to buy five.”
Investors have seen newer sectors as opportunities for investment. “New venture money flowing into a sector is a good leading indicator of the health of that part of the market,” Fitzgerald said. “It’s still early days for our sector, insurance technology, and there hasn’t been a lot of M&A yet. But we think it’s coming.”
Closing deals in a frothy environment
When it comes to closing deals in the current high-volume, high-valuation environment, it’s important not to get too carried away. “You can’t forget to do your due diligence and make sure you’ve got all your ducks in a row,” Fitzgerald warns. “IP, corporate governance—you’ve got to have all that squared away before you go too far down the road.”
Both the buy- and sell-sides can benefit from increased competition. Boissevain recommends that sellers reach out to a number of targets and ask them all to submit their bids on a specific date in order to increase competition. The auction process tends to result in higher valuations and higher close rates. “Even on the buy-side, having a few targets in mind helps create optionality,” he said.
At the same time, be careful not to get too carried away by news of high-multiple deals across the industry, which can lead to unrealistic expectations on both sides of the table. “Because it’s so frothy out there, it’s important to have a discussion about ballpark expectations of valuation early on,” Boissevain counsels. “If the buy-side is not planning on paying more than 4x, and the sell-side is counting on 16x, no deal is going to happen, because expectations are too far apart.”