sector deal review: technology

Sector Deal review: Technology

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DEAL rounDtAbLE DISCuSSIonSponsored by RR Donnelley

the daily deal m o n d ay S e p t e m b e r 9 2 0 1 3

W hile interest in new fields such as mobile, cloud computing and big data

is shaking up the technology sector, lack of confidence in the general economic outlook has helped to put a damper on mergers and acquisitions in the sector so far this year, according to a panel of seasoned M&A experts.

The outlook for technology M&A deals was the focus of a July 17 webinar presented by The Deal and RR Donnelley. entitled “Sector Deal Review: Technology,” the discussion featured a distinguished panel of experts, including Jeffrey liu, senior managing director and U.S. group head for technology at ernst & young capital Advisors, Ashley larson, a principal at egis capital Partners, and Sean V. Madnani, senior managing director and partner at Blackstone group, where he is head of West coast and Asia technology M&A advisory. Mark Aiello, vice president of sales and operations at RR Donnelley Venue Data Room, moderated the panel discussion.

The discussion took place against the background of disappointing second quarter M&A numbers. While global M&A reached $490 billion in the quarter, up about 3% over the first quarter, that was still down 10% from the same period in 2012.

Despite the general slowdown in overall activity, there were some bright spots in the tech area. Bain capital led a consortium of private equity buyers to make a $6.9 billion bid to take BMc Software private, chip-maker ASMl holding purchased cymer for $3.7 billion, and Priceline’s $1.8 billion acquisition of Kayak Software. even in europe, where deal making has been slow because of the ongoing economic malaise there, the M&A market was brightened by nokia’s $2.2 billion purchase of Siemen’s stake in their networking joint venture.

“While the global economy is inching back to recovery, I think the attitude of strate-gics is to continue to wait and see how the recovery and U.S. monetary policy will play out in the second half,” said ernst & young’s liu. he added that the technol-ogy sector was at a key inflection point in a number of areas such as the trend towards

mobility, cloud computing and changes in content, all of which are creating a dilemma for corporations that are reluctant to make a purchase at a moment of economic weakness.

Madnani agreed with liu’s conclusions. “having confidence in the general economy, in some of these emerging tech trends and then the confidence to act on some of these trends, is really lacking in the corpo-rate sector right now,’ Madnani said.

larson added that recent big initial public offerings for RetailMenot Inc., a provider of online coupons, which raised $191 mil-lion in July, and King.com, the company that makes candy crush Saga, a popular Facebook puzzle game, illustrated that buy-ers are now competing against the capital markets for quality properties.

larson also said that she expected to see an increasing number of divestitures as companies focus on noncore assets and need to reinvent themselves. She men-tioned nokia’s deal with Siemens as an example; she added that hewlett-Packard, which she said has been saddled with too many recent acquisitions, is more likely to be on the divestiture side going forward.

liu said that many tech companies are focusing on divestitures and carve outs for the first time, where a parent company sells a minority stake in a subsidiary, rather than on acquisitions to grow their businesses. “There is a lot of pressure to become more focused and streamlined and not be so fully integrated that there is a loss of focus of customer needs,” he said. “There is a very interesting behavioral shift taking place for these companies to undertake carve outs and divestitures.”

Madnani said one driver of divestitures was the upward trajectory of equity markets recently. Poor performing companies are really noticeable in this context, so activist investors are forcing companies “to figure out where value is and correct the behavior that is depressing stock prices.”

larson pointed out that the large volume of divestitures was opening the tech sector to

private equity sponsors, who have histori-cally not been that active. Madnani agreed, saying that private equity was increasingly interested in assets, “especially with very robust debt markets willing to fund some of these acquisitions.” he said most sponsor activity in the first half was focused on exits.

Madnani warned that the rapid run up in valuations was having a dampening effect on private equity involvement in the market. “however, we’re at a point where valua-tions have run up pretty significantly, and so the math no longer works to achieve the returns that private equity firms historically have required,” he said. “We’re seeing private equity firms, even though they have committed funds, not able to deploy those funds in a way that would achieve the historical rate of return.”

liu said that strategic investors appeared to be adopting a new blueprint in which they become vertically integrated companies rather than “really broad horizontal solution sellers.” he said this was evident in recent acquisitions involving cloud computing platforms, social media and customer-relationship software.

he added that the majority of strategic ac-quisitions in the past 12 to 18 months have been in web services, cloud computing and Software as a Service, or so-called SaaS, which is software delivered over the internet


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and constantly updated, as compared with earlier generations of shrink-wrapped soft-ware packages which are installed on local computer networks and involved much higher up-front investments.

Madnani agreed and noted that there has been a leap forward in software-defined networks, where traditional hardware functions are being replaced by software functionality. “Buyers are more focused on moving up the stack into more value-added services or software,” Madnani said.

Asked by Aiello to talk about tech M&A by geographic region, the panel agreed that europe was still in the doldrums despite the success of the nokia-Siemens deal, but Asia was described as being very robust.

“We’re seeing a lot of outbound activ-ity from Japan and Korea into the United States,” Madnani said. “A lot of that is being driven by the need for growth outside their domestic markets.”

liu added that there was a lot of activity in Korea and Japan involving IT service firms, which he said were benefitting from some of the changes in cloud computing, and consumer electronics firms that are considering ways to grow their core assets in optics and video. “We’re seeing a lot of interest from Japanese and Korean com-panies in U.S. targets,” liu said. “It actually

made sense from a currency standpoint as well.”

Madnani added that he expected to see more and more cross-border M&A deals coming out of latin America. he mentioned in particular Brazil, which because of the upcoming Soccer World cup and the 2016 summer olympics, made investing in infrastructure more important than it is in other areas of the world such as the United States. For example, he noted that Brazil would likely be investing in facial recognition software and other biometrics as part of the investment in high tech security measures for Brazil’s major upcoming events.

larson said that Brazil’s telecom infrastruc-ture wasn’t yet fully developed, prompting liu to predict said that there would likely be major investments in internet capability in the near future in Brazil.

liu added that it was possible that global incumbents in IT services could start buy-ing local assets in latin America, includ-ing companies that have developed local teams, specialized local processes and local know how.

Aiello noted that at $66 billion, global tech deals were down 24% year over year, but he quoted ernst & young data as show-ing that in the U.S., tech deal values have actually risen by 30%. he asked members

of the panel about their perception of valua-tions in the current environment.

liu commented that inorganic growth was a fundamental weapon in any growing tech company’s arsenal, which he said has resulted in companies making very targeted and precise technology add-ons. Some of these deals have exceeded $1 billion in the last couple of quarters. “For success-ful incumbent companies, it’s imperative to continue to buy and that’s created a foun-dational level of M&A activity, which is even more apparent when the rest of the sector has really slowed down.”

Madnani said that there has been a divi-sion in the tech arena between companies that are in hot areas such as security web content and others that are in lower growth areas. Security companies are command-ing double-digit multiples of earnings before interest, taxes, depreciation and amortiza-tion (ebitda), and in some cases, double-digit multiples of revenues.

larson said she had seen recent deals for virtual storage companies at 20 times ebitda and for companies offering SaaS multiples of five times ebitda.

The eagerness to do deals in some tech areas, however, has not reduced the time to completion in most cases. “The gesta-tion period of a deal actually materializing is


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much longer than it has been historically,” said Madnani. “It’s taking much longer for buyers to get comfortable about the assets they are looking to buy and it’s taking sellers time to feel comfortable that they’re getting true value for their business.”

Madnani also mentioned that the complex-ity of deals has increased, such as carve-outs that take place across borders. he said the increase in time for completion of deals could be one reason why the overall number of deals has declined.

“I think you’ve seen timelines expand by 50% to get to signing,” liu said. he added that was because boards of directors and management of companies are retroac-tively scrutinizing deals they have already done, trying to evaluate how they have fared. “getting your hands around the financials and the forecasts are becom-ing an increasingly lengthy part of due diligence,” he said.

Madnani said that one complication of estimating valuations is that many new companies have multiple revenue models. he cited the example of linkedin.com, “where there are two or three ways that a platform can make money and people are willing to pay more for that.”

Another important consideration Madnani mentioned was protecting the revenue downside. he cited the importance of SaaS, software companies usually sell on a monthly or annual basis, which he said “has become increasingly more important to companies and investors because these plays protect your investment and make sure you maximize it.”

Aiello asked the panel which tech sec-tors they thought had the most promise. A number of panelists made the point that a lot of the new technologies, such as big data, involve different methodologies and that it might take some time for one or two big players to emerge from a crowded field. Until then it would be hard to make acquisi-tions, he said.

liu said he expected ecosystems to de-velop around mobile devices offering things like security and storage management in the same way the server environment once developed around Pcs. “no real winners have emerged yet,” liu said. “once you see a certain scale reached, you’ll start to see more acquisitions.”

larson said she was particularly excited about the ability of video analytics to drive operational improvements within busi-

nesses. Fast food chains might use them to make sure floors are being washed on schedule or that an employee has correctly rung up a meal. “We are seeing a lot of dollars behind such solutions because they add to the bottom line,” she said.

liu agreed and said one major area of investment was in big data analytics based on cameras in industrial complexes and on factory floors, where data extracted from the video can be analyzed to improve efficiency and security. Another growth area was machine-to-machine data, where sensors send information automatically over the Internet to computer-driven consoles that use software with algorithms designed to analyze the data.

Asked about the importance of cloud services, liu said he was already seeing evidence that mid-sized companies are tak-ing advantage of massive cloud solutions offered by firms like Amazon to integrate vertically to offer services that are narrowly specialized not only in terms of function but also geography, such as a company that processes health insurance claims only for the southwest of the United States. he expected this to be only one of the major growth areas about to emerge in the tech arena. n



sector deal review: technology

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