Tech M&A market fragile as strategic buyers step back from dealmaking

In the first six months of 2024, the tech M&A market took two steps forward in the first quarter, only to take one step back in the second.

After a promising start to the year, driven by a spike in deals by strategic buyers, the past three months have been relatively underwhelming. Total tech deal value dropped to $86.50 billion, down from $130.00 billion in the first quarter, according to data from the S&P Global Market Intelligence 451 Research M&A KnowledgeBase. While the second quarter total was up from a year earlier, deal activity remains mired somewhere between the COVID-19 pandemic boom and the post-interest rate hike bust.

"Fragile is how I would describe the tech M&A market," said Greg Bedrosian, co-founder and CEO of tech-focused investment bank Drake Star Partners, in an interview with S&P Global Market Intelligence. "Deals are getting done, but there is still, on the buyer side, not a lot of tolerance for missing projections."

A return of PE

One major difference between the first and second quarters of this year was an uptick in deals involving private equity buyers. The second quarter represented a rare period when private equity firms outpaced strategic buyers, thanks to a few large PE-driven deals.

Of the 20 largest deals in the second quarter, PE firms lodged more than half, according to data from 451 Research M&A KnowledgeBase. Permira Advisers Ltd., Thoma Bravo LP and Advent International LP have been among the most active PE buyers.

Strategic buyers, meanwhile, pulled back somewhat after an active first quarter.

Valuation shifts

One aspect of the M&A market that investment bankers noted is a large valuation difference between the haves and have-nots.

Growth rates for software companies, for instance, have fallen dramatically since the pandemic, and they do not seem to have hit a bottom. Revenue growth for the top US and European software companies is running about half what it was during the pandemic, when the median was about 26%, according to S&P Global Market Intelligence data.

This has taken a toll on the M&A market. Software companies posting revenue growth of more than 20% to 25% and that are profitable are getting rich multiples comparable to those seen during the pandemic when there was a rush toward digitization, investment bankers say. Companies with slower rates of growth are getting much weaker multiples, often resulting in no deals.

"Low-digit growers in 2024 are struggling to get the valuation multiples sellers expected during the pandemic in 2021 and 2022. That has had a chilling effect on M&A deal activity," said Mehdi Khodadad, co-leader of law firm Sidley Austin's global private equity practice, in an interview with Market Intelligence.

"The M&A valuations for rule of 40 companies have been exceptionally strong," Ben Howe, founder of boutique investment bank AGC Partners, told Market Intelligence. "If you start to come off that, the differential in valuations is quite staggering." Rule of 40 is a principle that says a software company's profit margin and revenue growth should equal or be higher than 40% to be sustainable.

Security surge

Tech companies that meet this rule are scattered across myriad categories, including fintech, payments and vertical software. Cybersecurity companies have seen some of the most valuable deals.

In May, Akamai Technologies Inc. agreed to acquire application programming interface security company Noname Gate Inc. for $450 million, representing a revenue multiple of more than 11x. That same month, Thoma Bravo-backed Venafi Inc. agreed to be acquired by CyberArk Software Ltd. for $1.54 billion, representing a revenue multiple of more than 10. More recently, multiple press outlets reported that Alphabet Inc. is seeking to bolster its nascent cybersecurity capabilities with the acquisition of Wiz Inc. for $23 billion, implying a 2023 revenue multiple of more than 65x.

A sustained boost in activity still seems unlikely for the remainder of the year, investment bankers say, though they are hopeful M&A activity will recover more strongly in 2025. If the Federal Reserve cuts interest rates, the gap between buyer and seller expectations could be bridged.