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Software, telecom tower companies among Brexit M&A bright spots

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Software, telecom tower companies among Brexit M&A bright spots

The U.K.'s software and telecom infrastructure subsectors are expected to be more insulated than others within the tech, media and telecom industry amid broader macroeconomic uncertainty due to Brexit, M&A experts said.

In certain cases, market conditions are driving buyers to look more closely at U.K. assets, though fears about the impact of Brexit have made some European investors skittish, the experts said. Midmarket software companies stand to benefit, in particular, as supply-chain fears related to trade volatility are not a big concern for cloud-driven enterprises.

"Brexit comes up in conversation [with clients considering a sale], but it's not really a significant issue for a tech company," said William Samengo-Turner, a London-based law partner at Allen & Overy with expertise advising the tech sector.

As the U.K. nears an Oct. 31 Brexit deadline, companies are thinking about access to talent and how to adapt to a new regulatory regime, but these are not the main factors that drive dealmaking, Samengo-Turner said.

Exiting without some sort of trade agreement with the EU is expected to impact supply chains as a new system of tariffs and taxes is established between the U.K. and its trading partners. U.K. Prime Minister Boris Johnson recently proposed an exit agreement, but it remains unclear whether it will be accepted. Johnson said the alternative is for the U.K. to leave the union without a deal.

Amid the uncertainty, deal activity has remained healthy in the software space, which involves companies that typically do not rely on a physical supply chain, noted Chris Brooks, managing director for technology, media and telecom M&A at midmarket investment bank Lincoln International.

"Managed [IT] services, cloud services — there will be a lot of activity this quarter [July-September]," Brooks said. "A lot of those [midsized] assets could have put off a sale to next year, but they haven't."

There were 83 deal announcements for U.K.-based software companies in the just-ended quarter, down from 121 in the prior period, according to data compiled by S&P Global Market Intelligence. Overall, 2019 has seen a higher volume of U.K. software deals than in recent years.

"A lot of the underlying tech trends are far stronger than GDP going up or down a few percentage points," Brooks said, though he acknowledged that the impact of Brexit may be greater on larger, listed firms.

Brooks and Lincoln International colleague Phillip McCreanor, managing director and head of investment banking for the U.K. and the Nordics, have seen the mix of prospective buyers change in recent years as the Brexit debate raged.

"We have seen the volume of European buyers looking at U.K. assets decline," McCreanor said, resulting in a "narrowing" of certain sale processes. Still, fewer buyers have not materially impacted midmarket valuations, Brooks and McCreanor said.

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While Brexit may be giving European buyers pause, U.S. buyers are pursuing U.K. tech deals, perhaps buoyed by the favorable sterling-to-dollar exchange rate, experts said.

U.K.-based companies with global operations could be prime targets in the current environment, said a corporate TMT analyst. Such companies have non-sterling revenue and value outside of the U.K. but appear cheaper due to sterling weakness and a bearish market sentiment.

London-listed and multinational software company Micro Focus International PLC falls into this category, the analyst said. The company said in August it will accelerate a strategic review and will look at its "strategic, operational and financial alternatives." Its sales were impacted by the macro environment, which led customers to delay buying decisions.

Enterprise software company Sage Group PLC is a perpetual target, noted Allen & Overy's Samengo-Turner. The London-listed company has historically attracted interest from U.S. private equity firms. Deutsche Bank analysts wrote in a note last year that they "can see a realistic asset sweating style scenario that might work for a private equity buyer, but we do not see this as a 'slam dunk' investment given the uncertainty and leverage required."

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Regarding confirmed processes, Vodafone Group PLC's plans to spin off its European cell tower portfolio by May 2020 and then either float the TowerCo or dispose of "minority or majority stakes at an individual country level" should not be negatively impacted by Brexit concerns, the experts said. The portfolio includes Cornerstone, a joint venture between U.K. telcos Vodafone and Telefónica SA's O2.

Telecom towers require heavy capital expenditure but benefit from long-term rent agreements, Brooks said. "With investors chasing yield, it's a good time to look at those assets," he said, adding, "I suspect the keenest buyers are infrastructure funds."

Vodafone has retained optionality by saying it will consider a minority or majority sale as well as a listing. This type of process is becoming more common as companies look to minimize risk from market volatility, Samengo-Turner said.

"We're certainly seeing more dual tracks," he said. "But there are several reasons for this, including the EU banking system going up and down, the U.S. trade war, and Brexit. Having more optionality is preferred in this market."