This article was originally posted on Jan 9th, 2019
Having spent 8 years working with investment banks, I returned to the industry as an M&A advisor earlier last year after receiving my MBA.
In the short span of a little less than a year, I got the opportunity to work on 8 US-based tech M&A deals spanning across various industry verticals ranging from Healthcare IT, Logistics, Marketing Automation, Insurtech, Data Analytics and Digital Media. A few deals were small, a few big, a few fell apart and the rest still in progress. But they had certain things in common and I realized how important and pertinent M&A is, especially in the current times.
1. Tech is eating the world and every sector
Technology is blurring the lines of demarcation among various industries. It is dominating almost every industry that we talk about — be it aviation, manufacturing, food, hospitality, logistics or even industrials. If non-tech companies want to stay ahead of the competition, they have to adopt technology/software into their business. Recent reports from Morrison & Foerster suggest that non-tech buyers have spent over $40B on tech M&A in each of the last three years and I am fairly certain that this number would increase in the coming years. As per the report, strategic acquirers have already paid, cumulatively, more for tech targets ($324 billion) through the third quarter in 2018 than in all of 2017, reversing a two-year decline.
2. Startups becoming a threat and an opportunity early on
We have seen quite often in the past few years, that tech giants gobble up startups early on. With easy access to outside capital than ever before, startups are becoming both a threat and an opportunity for bigger companies. What is called as a ‘kill-zone’ in the industry, as soon as a startup grows and enter this zone, companies such as Google, Facebook, or Amazon either copy them or simply acquire them.
I’ll give an example that I read a while back to elucidate my point. Life on Air had launched a live video streaming app called Meerkat in 2015 and became an overnight success. Soon after, Twitter acquired Periscope to beat Meerkat out of the market. Life on Air shut down Meerkat’s operation and secretly developed another app called Houseparty in 2016 offering group video chats and quickly on-boarded almost a million users on its platform. And as most of you know, Facebook copied and eventually, the engagement metrics on Houseparty platform died. Although startups may have a good product or service and start getting traction, if it is caught in the cross-fire between tech giants, startups are obliterated. Therefore, it may be a good option for startups in the ‘kill-zone’ to consider M&A as an exit strategy at the right time.
With so many major big players planning on IPO in 2019, they will have surplus cash to acquire smaller but well-known companies.
3. Entry in Global Market through cross-border M&A
Despite some tensions between China and US trade tariffs which resulted in fewer deals between companies across the two nations, the overall market looks strong with companies wanting to expand their operations overseas.
I sliced the 2018 M&A data to find four of the top five deals of the year included companies from India, Italy, Israel and Germany. The top on this list is, of course, Walmart’s $16B acquisition of 77% stake in India’s biggest retailer Flipkart. I had written a blog post in August this year explaining my thoughts on the transaction. Although the shift of retailers to online stores had started a few years back, Amazon, Alibaba and now Walmart have emphasized the importance and the associated success it brings for other competitors to follow.
Similarly, there were a few big transactions involving acquisitions of US-based companies. Swiss drugmaker Roche’s US$1.9 billion acquisition of Flatiron Health, Inc. — a specialist in applying big data techniques to the treatment of cancer.
It is not surprising that the US was the top target in terms of the number of cross-border deals and the deal value at 138 deals valued around $22.08B. The UK has the second-largest number of cross-border deals with 79, but India is at the second position in terms of the total deal value at $19.81B
4. Increase the Capacity for growth
About two years ago, an article published in the HBR mentioned how companies should look beyond the obvious M&A reasons and seek to increase the capacity for growth. This is ever more relevant today when the environment is changing at an unpredictable pace and competition is racing ahead at a phenomenal rate. There are several companies in the industry which have been doing good in certain things but not so good in other aspects of the business. These companies through M&A could not only widen the scope of products and service offerings to its existing customer base but also increase the customer base itself. Indirectly, this helps in reducing competition and in turn, increase market share.
Earlier in 2018, Plantronics closed a $2B deal when it acquired Polycom, a unified communications and collaboration provider. With this acquisition, Plantronics moved out of the peripheral business into the communications systems to create the broadest portfolio of communications and collaboration endpoints.
5. Synergy, Synergy and Synergy
This is, probably, the most widely used terminology in M&A which essentially means the whole is greater than the sum of the parts simply put. Synergies refer to the expected cost savings, growth opportunities and other benefits as a result of an M&A. The most common reasons to consider M&A is to realize gains through ‘Economies of Scale’ and ‘Economies of Scope’. There could be both cost synergies and revenue synergies. Because of this, traditionally, strategic acquirers are able to pay a premium and outbid financial sponsors in the bidding process.
6. Liquidity and Dry Powder at astronomical levels
In another blog post dated November 2018, I had presented how a substantial amount of dry powder and favorable debt markets are driving Private Equity deals. The momentum is likely to continue in 2019. It is pertinent to note that Carlyle Group on 7/30/18 announced the final close of its latest (VII) fund of a whopping $18.5B while Blackstone is attempting to raise $20B for its next buyout fund. Dry Powder in the industry is estimated at $1.14 trillion as on September 2018, per Preqin reports. PE firms, therefore, have to utilize this capital somewhere and what better way to do than acquiring firms. Therefore, companies should look for opportunities while liquidity is high and private equity deals are at a very high valuation level.
7. Increase in Confidence Level and Surplus Cash
Domestic policies and recent tax reforms will provide with additional cash flows to facilitate M&A deals in 2019. Increased corporate profits and access to lower cost of debt will encourage middle market companies to invest in acquiring companies. With the number of targets (sellers) remaining more or less constant, there is more competition in this space increasing the valuations as a result. The economic conditions are currently favorable that will persist throughout the first half of 2019.
8. Looming Financial Crisis
If history is any indicator, a peak in M&A activity has always been followed shortly by a recession.
– Before the 1990 recession, M&A was at an all-time high at $558B the previous year
– Right before the dot-com bubble, $3.4 trillion worth of acquisitions took place in 2000.
– Similarly, the market was doing well at $4.1 trillion before the ’08 recession
Ray Dalio, the billionaire investor who predicted the 2008 crisis said in February that a recession is a possibility before the next elections in Nov 2020. Nevertheless, I may add I feel that a recession is due by end of 2019 or early 2020. P/E Ratios are 50% above the historic average and private equity valuations are too high. Although it looks like M&A activity is going to remain strong through most part of 2019, industry rumors and historical data suggest reasons to be concerned about an imminent slowdown. Current credit spreads and yield curve support these assumptions. However, this should be considered with a grain of salt. Most economists are best predictors of the past than the future.
9. Higher Valuation
This relates to the 6thpoint mentioned above in a slightly different way. According to Mergermarket, the year-to-date (YTD) numbers during Q3, increased more than 30% in 2018 compared to 2017. And 2019 could look even better. According to Thomson Reuters, see chart below, worldwide valuation levels in 2018 were highest in over 30 years. Deal values will remain elevated in the coming year. Do I need to say more?
I remain cautiously optimistic about the M&A environment in 2019. In order to respond to the volatility of international politics, companies need to evaluate how they are allocating their capital toward M&A opportunities. Industry convergence will continue in 2019 and considering the imminent recession, 2019 is the best time for an M&A exit.