Listen: Next in Tech | Episode 51: Booming M&A in Tech

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Eric Hanselman

Welcome to Next in Tech, an S&P Global Market Intelligence podcast where the world of emerging tech lives. I'm your host, Eric Hanselman, Principal Research Analyst for the 451 Research arm of S&P Global Market Intelligence.

And today, we will be discussing the 2022 M&A outlook with our returning guest, Brenon Daly, who's Research Director for our team. Brenon, welcome back to the podcast.

Brenon Daly

Thank you, Eric. It's great to be here. It feels like so long ago that we were still -- back the last time I as on, we were still talking about tech M&A spending in the hundreds of billions of dollars. Now we're talking about it in the trillions of dollars.

Eric Hanselman

Only hundreds of billions. Who knew?

Brenon Daly

Measly, yes. So yes, a lot to talk about.

Eric Hanselman

Well, to your point, what a wild ride at the end of the year of really phenomenal in terms of the level of activity, but you've got a lot of data on that.

Brenon Daly

Yes. It seems like sort of the takeaway from 2021 as we look back before we look ahead. But from last year, it seemed like almost any deal that could get imagined or any deal that could ever get done, got done last year.

And a couple of quick points on that. When you think about sort of the tech industry, think about the large sort of household names, the acquirers that we sort of look to, to set the tone in the overall market, right, because M&A, like any market, starts at the top. And so here, I'd point to in the past year alone, 3 of the largest tech acquirers have announced their largest acquisitions.

So think about Microsoft, Oracle, Intuit, right? All well-established M&A programs, all been around for decades, all have done hundreds of deals. And yet last year, each of them announcing the largest acquisition, all of which was somewhat related to the pandemic. And certainly, the purchases that they did picked up new relevance in the pandemic. And that's certainly a theme that drove not just those blockbuster transactions but activity throughout all of technology.

Eric Hanselman

Wow. So thinking about sectors and buyers, you're talking about some of the corporate acquirers who are out there. What were those sectors and the buyers that drove that activity?

Brenon Daly

I think a lot of what you saw in the M&A market is kind of mirrored in what you saw in the equity market, right? Those -- both of those markets are historically correlated. They tend to move in concert with one another. And certainly, there has been a long-standing sort of lockstep movement along with that.

So when you think about 2021, remember the sort of pandemic plays on Wall Street. Think about Zoom or Netflix or Peloton for that matter, all well-established companies that got a boost in -- during the pandemic because of the changes in their respective industries. So when we couldn't go out to movies, we wanted to stream more. So Netflix saw a bump in their subscriber growth. We wanted to keep active when our gyms were closed, so Peloton started -- couldn't make enough bikes, couldn't get enough bikes to its customers.

And obviously, we've seen a little bit of that come off as life has normalized a little bit, but all of the drivers that influence the stock market performance also came through in the M&A market. And think about those large transactions that I talked about earlier around Microsoft, Oracle and Intuit, again, 3 of the largest companies, all doing their largest acquisitions in the past 12 months.

So Microsoft's deal, obviously, Activision Blizzard, $76 billion. Yes, $76 billion, 3x the size of any transaction they've ever announced. And what was it? It was a video game company. Video game -- again, we couldn't get out to the cinema. We couldn't get out to the theater. We couldn't get out and go do whatever we wanted to do outside or at least not regularly. And so a lot more gaming, and Microsoft making a big bet on $76 billion bet on that area.

Think about Oracle, right? There are a few industries that were more disrupted by the pandemic, both from the initial outbreak and continuing today than health care. Think about the way we used to go to a doctor's office kind of take a number and so almost like a butcher shop, wait for our number to be called and then service. Now we're doing all of that online, most of it, anyway. And we've had this movement away from doctors records being stored locally. Now they're moving up to the cloud, and that was Oracle, again, $30 billion deal for Cerner, playing very much into that drive towards digitizing health care, right?

That was what was behind that or even Intuit. Retail, obviously, upended during the pandemic with closed stores and more commerce moving online. Well, if your customers are moving online, you have to be able to reach them online, and that's what was behind Intuit spending $12 billion for Mailchimp, the company behind MailChimp, again, a marketing automation vendor, just a way to be relevant in this new way we're shopping.

So again, all of those strategies, all of those transactions were the result of how the pandemic changed the way we lived and worked.

Eric Hanselman

We've certainly seen that in a lot of our discussions around the influence on tech activity as well. In the larger market, these deals clearly represent what are those broader themes, but we've seen those also happen in direct tech impacts, remote work, a lot of the shifts and transitions that are taking place there. All of the things that are happening in terms of security consolidation, which we've talked about a lot, those are areas that have been driven by a lot of these thoughts about really the fact that these conditions and capabilities are going to be long-term shifts. So wow, real significant forces.

Brenon Daly

Yes. And as it changes the way we work, right, it changes the tools and technology that we rely on. Think about -- you mentioned earlier information security, right? Last year, breakout year, spending on information security transactions. Just within that sector, in 2021 totaled the 4 previous years combined. So we saw 4 of the 5 largest information security transactions of the past 2 decades all announced in 2021.

And they went off at exceptional valuations. On average -- according to our 451 Research M&A knowledge base, on average, information security transactions were getting 10x trailing sales. That's about twice the market multiple, suggesting that, that premium is built in because we have fundamentally changed the way we do business and information security. And you've had on Dan Kennedy in the past talking about the budget growth, right? We...

Eric Hanselman

He actually immediately precedes us. So our listeners have actually gotten that up close and personal about, yes, Dan's numbers about that continued level of spend. And guess what, you see it in deals.

Brenon Daly

Yes. And when there's budget dollars available, vendors are going to look to expand their offering to soak up some more of those budget dollars. And so that's information security, but that is one market. If we look just more broadly at software in general, we start to think about how much our business has changed.

A couple of quick examples, right? Overall, in software application for 2021, 2.5x the previous record in terms of M&A spending just within the software industry. And again, point to some of those blockbuster transactions, whether it was Oracle or Intuit or Microsoft, Square doing transactions, Buy Now Pay Later. So changing the nature, digitizing a lot of our businesses where we saw retail is just not the same as it once was.

We look back in 2021 and just as a quick example of how the pandemic shifted strategies for companies, for vendors, right? And any strategic shift brings with it sort of 2 considerations, right? If you have a new demand, how are you going to meet that demand? Well, pretty much you have 2 choices: you can either buy something or you can build something.

Last year, credit market was in -- about as receptive as we've ever seen it, right? Stock prices were about as high as we've ever seen them. Treasuries were about as full as they've ever been across all of technology. So when you put all of that together and then you run from a sort of corporate strategy seat, when you run the buy build discussion or the calculation internally and you know that this is a window of opportunity, right? The pandemic with all of the changes and all of the disruptions has created a window of opportunity.

So you have a company like Microsoft that is now growing faster coming out of the pandemic than it was going in. Going into the pandemic, it was about a 13 -- call it, 12%, 13%, 14% grower, so low teens. In its most recent quarter, it's talking about 19%, almost 20% growth. So we've gone -- and this is off of tens of billions of dollar revenue base. So we've gone from a low-teens grower to a high-teens grower.

Similarly, look at the renaissance that IBM has had, right? They did 14 acquisitions last year, IBM, which had been basically out of the market since it bought Red Hat 3 years ago. That 14 deals that we tracked in our M&A knowledge base was the highest total for IBM in more than 6 years.

Eric Hanselman

Well, we're just off the most recent SpaceX launch. And if we compare that, we've got -- what do you need for the rocket? Fuel, you need oxidizer, and you need a source of ignition. So to your point, we've got high markets, cheap credit of full treasure chests, boom, launch.

Brenon Daly

Exactly. And companies for -- at a record level did exactly that. Last year, 300 companies used at least some of their stock to cover acquisitions last year. That was the highest since the great financial crisis more than a decade ago. So they looked around, saw this exceptionally high valuation that they were being awarded and turned around and used that as M&A currency to great effect.

That's one of the key drivers, which, as we begin to sort of transition and look ahead, that's a change here basically since November, right? And we're seeing some of those valuations come down, come down very sharply, which is having a direct impact not only on Wall Street but also here in, again, historically correlated tech M&A market.

Eric Hanselman

And not a great day for Facebook. So...

Brenon Daly

Or PayPal.

Eric Hanselman

Oh, yes.

Brenon Daly

And again, those are companies that stand to benefit from the new way we do business. And yet, right, not all growth is distributed equally. And so again, think of the telegraph, the market signals around tech M&A from some of these huge declines in company's evaluation, right? They're not going to be willing to necessarily spend the money. They're not going to be willing to price assets, to go out and buy, pay 10, 15, 20x trailing sales for some of these start-ups that they would have willingly done when they were riding high last year, last summer. Now it's a different calculation.

Eric Hanselman

Well -- and the expectation is that credit is going to be tighter at the same time. What's the extent you see that really guiding expectations about 2022?

Brenon Daly

Certainly, 2022 is a different year than 2021. It's not simply the years rolling over, like more change than just the calendar. Think about the S&P IT index. So this is a basket of IT stocks broadly diversified, right? Peak to trough, it was down more than 20% just from October. So this is a huge slide in valuation. And again, that not only takes away the currency, which acquirers were relying on to record levels in 2021, but it also shakes the confidence. And those are the 2 key components of any successful consummation of a transaction, right? You have to have the will to buy something and the means to pay for it. And right now, both of those have taken a hit.

Now, tech names, by and large, have rebounded a little bit off the bottom, but we're still talking about a double-digit decline, right around 10%. And again, this benchmark index from where it was just a month or 2 ago. So that valuation compression is beginning to trickle through here to the M&A market. We've already seen just in January when I ran the numbers, prevailing multiples so far this year is about 5x trailing sales. And you think, well, that's great. That's certainly above where they were 2 years ago when -- pre-pandemic, you were talking about basically 3x trailing sales was a pretty conventional valuation multiple. Again, that's an all-in looking at all sectors of technology but just basically think 3x trailing sales.

Now we're up to 5x trailing sales. Sounds great, except when you think back to summer, Q2 and Q3 prevailing market multiple was 6x trailing sales. So we've given up an entire turn in valuation multiple. That's a huge degrade when you think about how companies are planning to pay for all of these.

To your point, the stock is no longer the currency it once was. $1 of equity just doesn't go as far as it once did. The credit market, undeniably tighter than it's going to be, probably 3 rate raises this year here in the U.S. And that has more to do with the macroeconomy, of course, right, with inflation at a 40-year high here in the U.S., 30-year high in the U.K.

So the Fed's going to be spurned in action like that, and there is going to be a reciprocating slowdown, a corresponding slowdown in the credit market. That is going to obviously weigh more heavily on financial acquirers, so private equity firms, and just to understand what a force that the -- with private equity has become in the M&A market overall.

A couple of quick stats on that. Last year, private equity firms and their portfolio companies announced almost 1,500 transactions. That was more than 1 out of every 3 tech deals had a financial sponsor behind it.

Eric Hanselman

No longer the shy people at the dance.

Brenon Daly

And certainly not doing deals the way we conventionally think about it. They're no longer sort of bottom-feeding, buying in out-of-favor technology companies and stripping them, running for them for cash. The old sort of playbook, that's no longer what they -- how they do business in technology industry. They're buying growth assets at top-dollar valuations, with the expectation is that they can then flip those at an even higher valuation.

Thoma Bravo paid 10x trailing sales from Medallia, 10 almost 11x trailing sales for Proofpoint, right? That was a $12 billion take private. Clearlake paid its highest-ever to take private multiple. So they are buying at the top of the market, again, with the expectation to generate a return, right? Their capital, the cost of financing those deals is going to increase, which is going to put their return threshold even higher.

So they're buying it at an all-time high. And the deal is about to get more expensive. That's going to put pressure on returns. And so deals are going to face -- private equity deals are going to face a lot more scrutiny than they did certainly in 2021. Again, as we begin to look out for this year, the balance of this year, we're seeing downward pressure in both strategic and financial acquirers.

Eric Hanselman

So if we take a look at the year ahead, the things are weighing a little more heavily. But I want to touch on the M&A outlook survey and -- because you also run the survey that's taking a look at interests from the financial community. They were all pretty positive, though, right?

Brenon Daly

They were. And honestly, I mean, for a cynical person like myself, I was astounded and not just because of the sentiment, which we'll get to, but mostly because, if you think about sort of traditional conventional market, right, there's a phenomenon of cyclicality, the sort of reversion to the mean. And we've seen that year after year. Our data goes back 20 years, so we have basically 3 M&A cycles, complete M&A cycles that have played out over that time.

And if we look back to the previous high watermarks for each year, right, so when M&A has set new records, the subsequent year has always been a down year, anywhere from 20% to 40% decline in spending. So a substantial sort of drop from this high watermark. So the waters recede as you might expect.

But according to -- again, this was our survey. So this is -- we've surveyed some of the largest tech companies and both the acquirers and their advisers, so investment bankers, senior-level investment bankers and a lot of the corporate development executives who are hands-on on all of these transactions. We've surveyed them for about 15 years. And this year, we surveyed basically the end of 2021, get their take looking ahead, sort of look inside your pipeline, tell us how busy you expect to be, with what and all of the sort of outlook questions.

And I guess, the takeaway there is 2/3 of them, 2/3 of the respondents to our survey, the M&A outlook survey, forecast spending would either hold steady or increase here in 2022. Now again, context is everything. Remember, we're coming off an unprecedented year in terms of spending where the previous record, right, we shattered it last year, doubled up on our previous record in 2021. And yet, looking ahead, right, our advisers and the acquirers are indicating there's going to be more of the same here in 2022.

And just to bring it all kind of current, I ran the January totals for some year-to-date, right, and the January spend was the highest monthly spend that we've ever had in the 20 years of the 451 Research M&A knowledge base, so...

Eric Hanselman

Wow. So these folks are at the top of the wave.

Brenon Daly

So we are sprinting out of the blocks, certainly, for 2022. However, I think there's a lot more -- a lot of challenges that I think are ultimately going to slow the pace of M&A in 2022 throughout the year, right? We've got Fed increases. We've got inflation that is a serious macroeconomic problem that is going to have a derivative impact in the tech industry specifically. So I think there's a lot lined up against tech M&A. Think it will still be a banner year, probably not to where we got to last year, but it will still on a historic basis, right? It will still be certainly among the top-spending years simply because there's so much capital to be put to work out there.

Eric Hanselman

But it sounds like the wave is going to break at some point. But the trick is, for those who are good enough to ride it all the way to the beach, still some room to go.

Brenon Daly

Still deals to be done and certainly still money to be spent. And that's the key. I mean any time you look at a growth industry, right, in M&A and by extension, the tech overall, are both growth industries, you're going to have sort of up and to the right activity.

That said, it's not always a straight line up and to the right. And I think that's what we'll see for the balance of 2022. It's a little bit of puts and takes as kind of we find our footing after this unprecedented spending spree in 2021, and 2022 probably nets out a little bit above average, historical average. So not a bad year.

Eric Hanselman

As the saying goes, though, past performance is not a guarantee of future returns. So...

Brenon Daly

Absolutely.

Eric Hanselman

Well, Brenon, thank you so much for the update. We'll see how the year rolls out. So maybe we should check back in with you as we start rolling a little further along and see where this wave does break.

Brenon Daly

All right. Well, thanks. It's great to be back here. We'll do it again soon.

Eric Hanselman

And that is it for this episode of Next in Tech. Thanks to our audience for staying with us. And I hope that you'll join us for our next episode where we'll be taking a look at the macroeconomic outlooks for all the voice that can use our landscape data with Mike Nacarino will be coming up next. So I hope you'll join us then because there is always something Next in Tech.