M&A volumes in the technology, media and telecommunications sector have shown a strong resurgence over the last 18 months. The latest figures for the first half of 2014 demonstrate a continuation of this trend, with deal values totalling $373.1 billion (£233 billion), a substantial increase from U$172.7 billion for the same period last year.
What is driving this growth? There are a number of factors, generally a combination of technological change and economic recovery.
Economic recovery has undoubtedly driven a substantial improvement in outlook, as well as giving acquirers increased firepower, whether in the form of highly priced shares to use as acquisition currency; stronger balance sheets from increased profits and cash flows; or greater availability of both equity and debt finance.
Many publicly quoted companies in the sector have seen sustained increases in their ratings as sentiment has improved, pushing up metrics which are commonly used to determine sector valuations. These factors in turn have driven up the prices of assets – which has tempted more company owners to put their businesses up for sale or re-financing, thus creating the conditions for further M&A.
In my opinion, the most significant underlying driver behind the current M&A boom in the TMT sector is still the proliferation, increasing reliability, and decreasing cost of the internet. The more ubiquitous, efficient, reliable and cheap it becomes, the faster it drives both economic and technological change. The internet is still driving many of the most obvious sub-themes within the TMT space.
Examples include the transition to the cloud; the “internet of things”; e-commerce and internet-based marketing, as well as the related sciences involved in monitoring, analysing and refining the online marketing process; and the proliferation of large volumes of data being created and transmitted, requiring ever more demand for datacentre, hosting and storage technologies.
The transition to the cloud
Many businesses, large and small, are now aware of the huge benefits that cloud computing can offer, such as reduced up-front cost from not having to buy, maintain and upgrade hardware, the greater efficiency in upgrading and distributing new versions of software and the benefits of being part of an integrated ecosystem of online software solutions.
As a result, most providers of software are involved, to varying degrees, in transitioning their businesses to the cloud. In some sectors, for example CRM, HCM and accounting, particularly at the SME end of the market, the transition is well advanced, with big winners such as Salesforce, Workday, Netsuite and Xero flaunting significantly higher valuations than some of their less fleet-footed competitors.
Xero is arguably the best example, raising around $200m from the VC market at a valuation of over 40 times revenues. However, the transition to the cloud has been slower in some other sectors and market segments.
Some companies, often those with large, complex ERP requirements, have been slower to transition, for a number of reasons.
First, the transition can be painful and expensive if it involves re-purposing large amounts of existing data and scrapping embedded investment in existing hardware or internal know-how. Also, it is not necessarily cheaper, over the medium term, to move to a cloud-based solution if that also involves committing to a typical SaaS business model; the net present value of a stream of SaaS licence and managed hosting payments might be considerably greater than the apparently larger, but less recurring, cost of buying and installing your own hardware and buying a perpetual licence for the software that runs on it.
If you are the CFO of a large, cash-rich company, you might prefer to deploy the cash up front via the more traditional “perpetual licence” model. In some sectors, such as defence and some areas of financial services and healthcare, the sensitivity of the underlying data has made some customers think twice about moving to a cloud model. In general, however, the transition to the cloud is continuing to gather speed and probably has a considerable way to run.
The growth in cloud computing is also driving growth in the underlying services required to host and deliver these online solutions, namely the datacentre and hosting markets. This has been a highly favoured area of investment for private equity firms and has driven significant M&A volumes.
In the UK, for example, several private equity-backed consolidators such as Pulsant, Six Degrees, Adapt and Claranet have carried out multiple acquisitions, with Pulsant also recently being sold in a secondary transaction at a valuation of an estimated 11 times EBITDA.
The approach to Iomart by Host Europe shows that consolidation in this sector is set to continue as operators seek to generate economies of scale, acquire customers to fill existing datacentre capacity and build higher added value managed services offerings. This will become increasingly necessary in order to justify pricing their services at a premium to Google and Amazon’s massive, but commoditised, offerings.
The 'internet of things'
This term describes the technology of equipping hitherto “dumb” items (industrial machinery and vehicles, fridges, domestic heating systems, vending systems, cars) with sensors and communications systems – usually internet based, but increasingly also mobile – that enable them to report regularly or even constantly on their current condition. This trend is at a relatively early stage of its development and its relevance and durability is as yet unproven.
However, there are few concrete examples of successful business models based on this concept (unless you count the acquisition of Nest earlier in the year by Google at a mind-boggling valuation). The idea is that, in due course, these interconnected devices will generate large volumes of useful data which will drive operating efficiencies. Such data will also lend itself to predictive analysis enabling companies such as Google, as well as many others such as insurance companies and utilities, to market more effectively.
E-commerce and internet-based marketing
To the man in the street, one of the most obvious effects of the internet over the last decade has been on shopping. This has driven the emergence of vast generalists like Amazon at one end of the scale, to specialist or niche sellers, such as Wiggle in cycling, at the other. This in turn has driven a large number of M&A transactions.
At Altium, for example, we have advised on over 100 e-commerce and internet transactions across Europe over the last five years. These have included companies selling apparel, both fashion (Dress-for-less) or sporting (Blue Tomato, ActivInstinct); computer products for gaming enthusiasts (Caseking); and travel (Blacklane Limousines, Icelolly).
An example of technological change driving M&A in a specific market is in the area of online printing, where the internet has transformed the business of selling personalised cards and other merchandise (pixartprinting, Onlineprinters and albumprinter).
One of the fastest growing tech sectors, which is again driving substantial M&A volumes, is that of internet marketing technologies. One of the reasons that the internet is such an effective marketing medium is that it lends itself to measurement and analysis. For all companies (not just e-commerce vendors) who market to, or transact with, their customers over the internet, it has become increasingly important to understand who your customer is, what their interests are and how best to interact with them and tailor your offering to their needs.
Economic sentiment and its effect on valuations can be unpredictable. However, fundamentals appear to be sound, as companies remain profitable, cash generative and willing to expand IT budgets once more. In addition, businesses and financial investors have material cash resources which can be deployed for M&A and debt is freely available on attractive terms.
Public market valuations remain strong currently but can turn quickly. Some companies which have floated in the recent past amid very strong investor sentiment, and have thereby achieved extremely high multiples at IPO, have since underperformed and suffered significant share price falls as a result. It appears that public company investors are once again becoming increasingly discerning and, while high quality businesses will continue to prosper, shareholders expect high valuations to be justified by commensurate financial performance.
However, the underlying technological trends driving M&A show no signs of abating. Although internet penetration, the adoption of cloud and SaaS technologies and the volume of goods and services transacted online are higher than ever, substantial scope remains for further growth in these areas.
Overall, valuations in the technology sector remain high and the fundamental drivers of M&A are strong. We believe there will be continuing appetite from financial buyers, trade buyers and the public markets for good technology businesses, and ongoing interest from company owners in exploring options to capitalise on very favourable conditions for M&A.