Listen: Next in Tech | Episode 131: Mixed up M&A markets

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Eric Hanselman

Welcome to Next, an S&P Global Market Intelligence podcast where the world of emerging tech lives. I'm your host, Eric Hanselman, Chief Analyst for Technology, Media and Telecom at S&P Global Market Intelligence. And today, we're going to be coming back into the merger and acquisition markets, taking a look at what's going on in what has been a really complicated year with analyst, Melissa Incera. Melissa, welcome back to the podcast.

Melissa Incera

Thanks for having me back, Eric.

Eric Hanselman

Well, thanks for coming back. The last time we talked, things were pretty, I guess should we say, unsettled as the market was going forward. But I don't know, I actually had heard people earlier this week talking about normalcy in markets. And maybe we were approaching that. Are we there yet? Is there -- are we getting there? What's the general state of the market?

Melissa Incera

Not quite, I'm afraid. Specifically the tech M&A market. Broadly, we're still down despite the stock market recovery. But to your point, it's growing more nuanced than that. Certainly, we're seeing definitely some significant signs of improvement as the summer goes on.

Eric Hanselman

Well, I mean, one of the things that you said in the past is that this really is a lagging market compared to the traditional stock market. Last time we were talking about valuations, there were still all these inflated expectations as the market was really getting hammered. And maybe that's caught up and we're seeing that lag, as the stock market recovers, similar trends that are starting to follow. Are we heading in that direction?

Melissa Incera

Yes. Yes, I guess, so I can help put where we are into context. The further we get from the pandemic, it's easier to look back, right? And it's increasingly looking like Q1 of this year is going to be where we bottomed out in terms of deal spend in this post-pandemic cycle.

So Q1, our database logged about $49 billion of deal flow, which is the lowest quarterly total since 2012. Or, to put that in another context, if the entirety of the quarterly deal spend was a deal, it would only be about the sixth largest deal in our database. So that's where we started the year. Yes, pretty painful.

Eric Hanselman

Yes. As we've been talking about this spring.

Melissa Incera

Yes, yes, exactly. So now just about exactly halfway through the third quarter, we've already surpassed that deal spend. So there's certainly some heft returning to the market. We're actually starting to see some bigger deals again, with specifically some 10-figure deals done by strategics, which just wasn't happening earlier this year. So there are some sizable gains and some traction coming into the summer.

Eric Hanselman

So -- and the strategics have basically been on the sideline as we're rolling through the beginning of the year. There wasn't much in way of activity there.

Melissa Incera

Exactly. Exactly.

Eric Hanselman

Alongside the strategics, what kind of deals do you see is happening? What's the characterization of where things are and what's taking place?

Melissa Incera

It's a great question. Broadly, we're seeing 3 main types of deals happening at the moment -- consolidation, emerging tech and capitulation-type deals. We'll start with the first, which is the mass bulk of the market at the moment. Because broadly, this is an excellent market for companies of all sizes to buy up market share, technology, competitors, et cetera, particularly because there was such a proliferation of start-ups in the last few years and now venture capital is so hard to come by, as we talked about last time you and I chatted.

So a lot of companies are in dire straits and some of our Voice of the Enterprise data shows that particularly for application software, buyers are going more conservative. They're looking to consolidate their tech stacks. So a lot of these vendors are deciding, hey, we can float better together than we can apart, which is contributing to this massive uptick in this type of deal.

Actually, a lot of -- at least what we see with a lot of bankers, a lot of them are calling this the year of the add-on deal, because there are so many instances of larger start-ups acquiring smaller, and it's happening across virtually every sector.

Eric Hanselman

You were talking about application security in our last episode and application area in general. And as we keep saying, in the security world, there are all of these organizations that are out there that are really sort of more individual pieces of functionality. So it seems like in that market, maybe the sanity of consolidation starts to make sense. You start to bring some of these individual features together in what is now a much more full-fledged product.

But I'm interested about your point about that shift in buyer perspective. Because, yes, that is something we see broadly, which is that buyers are looking to be able to work on platforms. The patience to have lots of individual component pieces that they've got to manage individually is starting to wear a little thin. It seems like that really is pushing that consolidation play.

Melissa Incera

Yes, actually. So that's a perfect segue. So to your point, the conversation of is this a feature, is this a stand-alone platform is super relevant right now, right? Because it's an environment that's not necessarily going to support those stand-alone products for too long. And then secondly -- so you led me into the capitulation type deal.

Eric Hanselman

Which just sounds sad, but this is the reality. And I guess both you and Brenon Daly have been talking over the course of the year about the fact that there are -- there were these lofty expectations. And I guess I alluded to it with the -- my comment about the lagging nature of expectations in venture markets and sort of where founders were and their thoughts about what they really were worth. But when you bring up the term capitulation, I guess we can see where that's going.

Melissa Incera

Yes -- no, and these are not as fun to cover. But this is where we're seeing a lot of selloffs and divestitures as companies are deciding to slim down and focus -- really focus on what they do best, optimize for profitability, et cetera. So it's interesting because we're seeing this year a lot of overturning of really big speculative deals that companies have made in the past.

My favorite this year, Shopify sold off its logistics unit. It spent $2 billion in the last 2 years. So really quick turnover for that one and probably took a massive loss. Twilio has been divesting. I think it divested its IoT business most recently. Google divested its domain business. And these are often very low multiple deals, but they're happening with an increasing frequency as a lot of businesses just look to -- really to optimize and to strengthen core businesses.

Eric Hanselman

Oh, see, I was thinking capitulation was maybe you had founders who are finally seeing that their valuations may be even more rational. But the other aspect of capitulation is actually figuring out what you're going to do as a business and shedding those chunks of the business, which don't make as much sense.

If Shopify was looking to be the next Amazon, running your own logistics environment is probably a sensible way to do it. But if you have realized that maybe that's not what -- but you can't necessarily be everything that Amazon is. Yes, suddenly the light bulb goes on.

Melissa Incera

Yes. And then making this environment even more confusing and contradictory. Then we have the emerging tech deals, where -- these are the hot areas where acquirers are still paying really robust multiples. Generative AI.

Eric Hanselman

Oh, you've said it. You've said it. I was wondering how long we can hold on to the podcast before going to GenAI. But there it is. All right. All right. I suppose we have to, but...

Melissa Incera

We must.

Eric Hanselman

Well, with the furor and the -- just the pervasiveness of every conversation having GenAI in it. We're just about to enter the fall conference season, I know our team has been doing a lot of pre-briefs, and there's just so much generative AI. But it is also driving deals.

Melissa Incera

Yes. And I think toss out some other emerging tech areas, private 5G is another one. AI-enabled security is another one. So these are areas where users are just really eager to get their hands on this tech and start spending in these categories. And it's actually accelerating the M&A curve for a lot of these categories, which is really cool and interesting to watch.

Eric Hanselman

Well, the private 5G one is one of those interesting things that I think a lot of us would have said, "Oh, here it goes. This is going to be amazing." But it's one -- it was a story of an emerging market, of the technology finally maturing enough.

Efforts like Open RAN and a lot of the individual telco equipment manufacturers getting there, but also having this really interesting crop of early-stage participants in this market who are playing as part of this as well. So -- but part of that, the 5G, that's the piece that's near and dear to my heart. But so many different aspects that are going on.

Melissa Incera

Yes. And it's really interesting because in a lot of subsectors, all 3 of these things are happening at the same time, which is why it's so strange and harder to find in the state of the market. So if we look at, for instance, the payment space, we had 4 or 5 months go by without a sizable deal, mostly -- honestly, mostly consolidation type of deals because this sector in the public space was really hard. Valuations were really hard hit.

Eric Hanselman

Yes. But one that had been hot, but then you got like the [ Cardinal's ] been laying off people and there's some pullback and some other things. But yes -- but refocus in that area?

Melissa Incera

Yes. So in July -- so basically nothing for a few months. In July, we hit -- within a 10-day period, we have Visa picking up Pismo at $1 billion valuation, which is presumably a great exit that -- speaking to that emerging tech component. Followed very shortly by Fidelity National, which sold off a majority stake of its own payments unit, Worldpay, at a massive valuation loss. So within a week's time, you see a great exit and one that's a little bit harder to swallow. And...

Eric Hanselman

Huh, both hot and cold.

Melissa Incera

Right.

Eric Hanselman

That is wild, yes. So there's upside in the one and maybe, again, a realization that they weren't heading in directions that made sense for them on the other. Wow. And the pendulum swings back and forth in the same week.

Melissa Incera

Yes, exactly. Exactly. That's the kind of the conundrum we're in right now.

Eric Hanselman

Wow. Interesting. So around that, with so much activity on that end, are there things that aren't taking place? Or are there deals that just aren't going down?

Melissa Incera

Yes, large deals. We're starting to see some, but not remotely on the order of what we were seeing in the last few years. Compared with where the top of the market was last year, just looking at the total value and number of deals over $1 billion, 10-figure deals, we are down year-over-year 2/3 of the number of deals over $1 billion, and we've posted just 1/4 of the value.

Basically, it's just a hard time to make things happen at the moment, especially at the high end of the market. The financing landscape is tough. The regulatory environment is tougher. Buyers have a lot to factor in, especially public buyers where big deals have been quite heavily penalized.

So we've -- actually, we've been seeing a lot of banks and buyers shifting downmarket, where it's a lot easier to get a deal done. And the effect -- the impact of that is that the mid- to low market is actually looking relatively robust. There's not as much spending happening, but there's a ton of deal activity.

Eric Hanselman

That's interesting in that the nature of those deals is changing. One of the things we keep bringing up is the market is adjusting to the fact that you're now actually having to pay for money with interest rates that are up. That in fact, that whole process of the deal itself is shifting. I mean, is this something where you see that the logistics of dealmaking are changing?

Melissa Incera

Yes. So when we talk to bankers, they're super busy right now. They're all working on a ton of deals. They're saying pitches are up. The challenge right now is in the logistics of deal-making, as you say, because there is a lot of skittishness from buyers, particularly, and there's a lot that's just not getting across the finish line. If there's something off, buyers are quick to let go, if there are legal challenges, if something appears as unexpected.

There has been a lot of press about VCs getting into trouble for their lack of due diligence in the last few years. So I don't know if you call it a SoftBank just sued one of its portfolio companies. It's a messaging platform called IRL, in which they invested $150 million at a $1.1 billion valuation. And the company just admitted that 90% of its reported users were fake.

Eric Hanselman

Yes. That's one of those things that -- in the heady days when everybody was moving forward and there was lots of velocity, you could maybe skip over some of those things if, in fact, growth was sort of picking up. But a lot of those things that were used to stimulate growth, if you can't sustain it, now come back to bite you in some pretty significant ways.

And that's -- yes, again, in a challenging market. But it is interesting that when buyers are being that cautious, I mean, it's now moved to not only being cautious, but in SoftBank's situation, that's something where they're really starting to reopen and examine that deal and take a look at, all right, if it's not going the way we expected, what happened.

But it seems like something that maybe is driven by concerns about where the market is. We've gone through this period of everybody figuring that we were going to be heading into a recession. And now the thought is maybe recession-light, maybe soft landing, maybe things are okay.

And in fact, maybe we're seeing some indications that say we're not going to have recession. And all of this uncertainty about where the markets and the economy as a whole is really going. But what you're identifying is that everybody is still not really convinced that we've got a solid base from which to work. Hence, if things go a little sideways, that's just one more thing. It's making people even more nervous.

Melissa Incera

Right. Exactly. To you point, it's definitely a positive thing that there's more due diligence happening. This is definitely a behavior correction.

Eric Hanselman

That's a very polite way to put it.

Melissa Incera

Yes, but it's definitely impacting the way -- even the deals that are in the pipeline, how they're happening, right? We're seeing more deals that involve more contingency type payouts, right? So a rise in earn-outs, a rise in covenants that essentially put more protections in place for the buyers and more guardrails in place for the sellers.

Eric Hanselman

They're going to do earn-outs. They're going to make sure that the deal is contingent upon actually really making money or selling stuff. So, yes.

Melissa Incera

Right. Right.

Eric Hanselman

As you said, healthy corrections.

Melissa Incera

Healthy corrections, right. It's impacting deal flow and that generally deals are just taking longer, they're getting delayed. And we're hearing that there is a large backlog of deals that are either waiting to be announced or waiting for the -- kind of the ideal time, which we don't -- when is that going to be, who knows what the ideal time to green light.

Eric Hanselman

Oh, interesting. So again, it speaks to that hesitancy of people are still a little unsure, but hoping that maybe this goes forward in some way or another. In terms of other parts of the market, we've also talked about -- talking about pendulum swings. Private equity and the kind of thing -- the in and out of the market, levels of activity and those sorts of things. Where is the private equity side of this story playing out? Where do you see that?

Melissa Incera

Yes. Actually, my colleague just wrote a great report about this, so I'm going to give him some credit here. Brenon wrote a report called The End of Private Equity's Golden Era, which is a really great deep dive into the kind of the historical PE buying cycle.

And essentially, what he's saying and the data supports is these acquirers are built to buy, and the rising interest rates have hit them really hard. Fundraising is slowing, as I think we talked about in our last episode, and investors are not as free flowing with cash. This has really dampened the kind of activity we're seeing from PE.

I believe, in Brenon's report, he said inflows, inflows in terms of fundraising are down 20% from 2021. And on top of that, the tech industry is seeing slowing growth rates generally. So it's making the math a lot harder for these buyers. And it's looking like this will be the first year in about a decade that we actually see a decline in spending from PEs as a lot of them reorient themselves.

Eric Hanselman

Interesting. Well, interest and interesting. Well, I think as you brought up, it is that adaptation of the market and especially when PE, in terms of fundraising, was a great opportunity when there were challenges in terms of getting decent returns in other places. But now that people are getting these returns, now that there's maybe a little more belief in the stock market, lots of other ways to be able to get reasonable returns on your investments, they're not the shining stars that they once were.

Melissa Incera

Many of their portfolio companies are getting a bit long in the tooth, right? So you've had this period where they'd spend, spend, spend, and they can't keep buying really without showing returns.

Eric Hanselman

Yes, they've got to get to a point at which they cash out.

Melissa Incera

Exactly.

Eric Hanselman

And at the PE model is that you buy, you hold, you grow value, then you sell and you get a return. But if you've been holding for a really long time, maybe those investors in your funds are starting to get a little itchy for when they're actually going to get some returns on their investments. So an additional complexity.

Melissa Incera

Exactly. Yes. That's exactly right. So we are starting to see a few of them, specifically kind of the leaders in the space, Thoma and Vista are starting to look for exits. And they've done pretty well this year. I think Thoma's exited about $15 billion worth of portfolio companies this year.

Which in comparison to where it was buying last year, I think last year, sum total, it bought about $30 billion worth of tech targets. So 8 months into the year, the fact that it's exited that substantially is pretty impressive, and the valuations have been substantial.

Which actually speaks to the fact that, again, as we've spoken many times about the flight to quality, but the opportunity for businesses that are really well run, that are profitable in this market is actually pretty healthy. It's pretty substantial. Who knows, we could potentially start seeing more exits and more heft at the top of the market driven by these PE exits that, frankly, just have to start happening.

Eric Hanselman

And if you're a company that's behaving well and isn't getting out over your skis or overextended, maybe in fact there are opportunities for you.

Melissa Incera

Yes.

Eric Hanselman

And especially in an area that has been such an active area for tech, private equity has been one of those -- I was going to say bellwether, but with the ups and downs, I guess, we can hardly really call it that. But at least something then is offered an opportunity in terms of so many different tech deals.

But I was wondering, what do you see for the end of the year? Where are we headed as we look towards that fourth quarter? And you see there are some major IPOs that are maybe on there, people keep talking about what's really going to happen with Instacart. Is the IPO market going to come back? Or where are we headed?

Melissa Incera

Yes. Again, I think the hot and cold kind of pattern is going to continue, right? So we might see some IPOs. We might see Arm go -- likely we'll see Arm go. But I don't think that necessarily will bring in -- break down the floodgates in terms of tech IPOs. So I would anticipate we're likely to see the same types of patterns continuing, maybe with some more activity at the top of the market.

Eric Hanselman

Maybe a rebound of some of those big deals that have been holding off.

Melissa Incera

Right.

Eric Hanselman

I guess we'll have to see where things go as the year shakes out.

Melissa Incera

One of the most interesting dynamics that we really haven't paid much lip service to is the fact that there are more buyers than ever in the tech M&A environment. We've seen corp dev operations crop up in businesses smaller than we used to see buying a few years ago.

So there's a lot of demand specifically for high-quality companies. I expect we're going to see deal flow continuing to be really robust. And as we were talking about, just more activity specifically on the high end of the market as buyers become a little bit more comfortable with the current state.

Eric Hanselman

And maybe some of those big deals really start to turn up some of the things that may be have been sitting on the sidelines a little longer. Well, we'll have to see what shakes out in the year ahead. Well, thanks for all this, Melissa. This has been great.

Melissa Incera

Thanks, Eric. It was so much fun.

Eric Hanselman

Well, we've got a lot to look forward to as we roll into the end of the year. But we are at time. That is it for this episode of Next in Tech. Thanks to our audience for staying with us. And thanks to our production team, including Caroline Wright and Ethan Zimman on the marketing and events team; and our agency partner, One Nine.