Technology bucks M&A trends
- Subtitle: Industry Spotlight
While mergers and acquisitions may have slowed down across industries, in the tech sector it’s just part of doing business. Thanks to a highly competitive, fast-paced, ever-changing industry, combined with disruptive technology, intellectual property and patents, M&A is always an option for Canadian tech firms.
But an uncertain economy, as well as an increasing divergence between buyers and sellers over valuation, is a concern for dealmakers. Deals are still happening, though — perhaps just a little differently than a few years ago.
Tech M&A got off to a mixed start this year, according to Ernst & Young’s Global technology M&A update. Aggregate deal value of global tech M&A fell 12 per cent year-over-year to US$25.1 billion in the first quarter of this year, which was only half the value decline of M&A in all industries.
“The volume of transactions is up slightly from the prior year, yet deal value is down rather significantly,” says Tony Ianni, president of Ernst & Young Orenda Corporate Finance. But tech-sector M&A is faring much better than M&A in general; private equity deal values for technology climbed 171 per cent year-over-year in the first quarter, despite falling significantly in all industries.
Ernst & Young expects that macroeconomic pressures will hold global tech M&A activity to flat or slow growth in 2012, but disruptive “mega-trends” will drive more strategic transactions. These megatrends include smart mobility, software as a service (SaaS), big data analytics, online video and social networking.
It found the biggest increases in transaction volume during the first quarter came from deals targeting online video technology and SaaS companies, which also generated the largest deals by dollar value. Similar deal volume strength was seen in mobile applications, health care information technology, advertising and marketing technologies, patents, social networking, and big data analytics deals.
The economic environment in Canada is also much more positive than in most other markets, says Ianni. The fundamentals are strong for M&A, he says, with corporate cash on the balance sheet, moderately rising confidence, and a narrowing evaluation gap between buyers and sellers.
But, says Ianni, there’s a new cautious investor in the marketplace. People want to talk, but then hear bad news out of Greece, Spain or Italy and it slows right down again. “Sellers recognize they want to maximize value but minimize closing risk,” he says. “The worst thing you can do is go out in the marketplace and then have a failed deal, because that will translate into reduced valuation down the road.”
These economic conditions are influencing the way deals are done. We’re seeing more preemptive approaches compared to pre-recession levels, says Craig Hanna, vice president at PricewaterhouseCoopers. “Previously if you were selling a business you’d talk to 100 different parties and get a competitive auction going. Now one in three deals are preemptive, meaning buyers seek out a seller on a one-to-one basis.”
Buyers are more conservative and selective in this environment. They’re looking for technology that fills a gap in their portfolio, for a patent (to use offensively or defensively), to expand geographically, to acquire talent or even to acquire a customer base.
With so many collaboration tools now available, where a company’s workforce is located is far less of an issue, says Hanna. U.S.-based Salesforce, for example, acquired social performance platform Rypple in Toronto and then invested in the team here, rather than exporting it south of the border.
“It’s not something where there’s a broad universe of potential buyers — it’s driving more targeted M&A that has great value to one or two buyers,” says Hanna. “They know it and pay premiums to preemptively do deals.”
There are standard ways to value a manufacturing or resource company with hard assets. But in the tech world, values range widely, and we’ve seen huge premiums paid for niche or market-leading technologies.
What might be surprising is who these buyers are. According to PwC, close to 50 per cent of deals involving a Canadian buyer in 2011 and the first half of 2012 targeted other Canadian businesses, while 35 per cent were acquisitions of U.S. companies. The remainder targeted businesses in the European area, Australia/New Zealand, and Asia.
“The buyer might be someone across the street from you,” says Hanna. This ties back to a high propensity for deals to fail as they go through due diligence, and is one reason why Canadian companies are successful at acquiring other Canadian companies — there’s a familiarity with the market.
But quality of engineering, products and solutions, as well as a strong workforce for creating globally competitive businesses, are attractive to buyers from the U.S. and around the world. As a result, we’re seeing a lot of smaller (and less headline-grabbing) deals taking place, particularly around IT outsourcing and consulting.
A survey earlier this year by global law firm Morrison & Foerster LLP and tech market intelligence firm 451 Research found that tech companies in the U.S. also seem to be focused on deals closer to home — a surprise, amidst talk of capturing China and other foreign markets. There, more than 60 per cent of respondents said their potential acquisition targets are largely or wholly U.S.-based. Only 12 per cent says their M&A activity is either mostly or entirely occurring outside the U.S.
Their biggest concern in pursuing cross-border acquisitions is integration risks with foreign firms. Other factors include concerns over transaction risk and lack of visibility into overseas markets.
However, over the past year we’ve also seen some big deals: IBM acquired Platform Computing, Rogers bought Blink Communications and Microsoft sold its core wireless patent portfolio to MOSAID Technologies — to name a few.
Cheryl Foy, who has served as general counsel for ViXS Systems Inc. for the past year, hasn’t seen much M&A activity in her latest role. But she’s seen plenty in her 12 years working in the semiconductor industry; one company she worked for, Tundra Semiconductor, was acquired by a U.S. firm. Over the years she says she’s seen a move toward consolidation in the semiconductor sector — and every time the economy suffers it seems to be more pronounced.
Tech M&A hasn’t gone away, says Chris Hewat, a partner in the Toronto office of Blake Cassels & Graydon LLP. For a number of Canadian companies, it’s a regular part of their ongoing business strategy. And private financing available for smaller companies is also recovering.
But financing is still limited compared to the U.S. “The relative lack of private capital is still driving smaller private companies into the hands of the bigger companies,” says Hewat. “They’re not able to stay the course and grow their own company.”
But SaaS — which is not a new technology, but rather a delivery method that is replacing the old licensing model for software — is driving economies of scale that allow smaller companies to compete with much larger ones.
That is one of many factors driving M&A in the tech sector. Aside from disruptive technologies, Canadian tech firms have looked either in the U.S. or further abroad at acquisition targets because of the relative strength of the Canadian dollar.
We’re also seeing a continued focus on intellectual property and patents, says Frank Arnone, a partner in the Toronto office of Blakes. Ownership of patents in a particular area — without preference to a particular use or technology — is an attractive feature for technology buyers, he said, as opposed to a “true” M&A where a buyer is focused on an acquisition target’s IP.
“If you have a strong patent portfolio and are attacked for infringement, you have an ability to defend yourself in part by finding infringement of your patents by the plaintiff,” says Hewat. These disputes often get settled through cross-licensing arrangements where each of the parties provides rights to use their patents to the other. “If you don’t have a strong portfolio in the first place, you have nothing to offer up.”
Indeed, the Ernst & Young report notes that the increasing importance of IP caused transactions targeting patents to grow in the first quarter of this year.
There are a lot of subtleties that come into play in the tech sector that you wouldn’t see in other industries, says Hewat. A buyer might be acquiring a product, but it’s also acquiring the people who design, develop, and commercialize that product. It might also be acquiring that company’s customer base.
Successful buyers are heavily focused on integration, including how they integrate the acquired company into their corporate culture, says Hewat. The involvement of senior HR on the buyer’s side is typical in a tech M&A.
“There is more of a need in a lot of tech acquisitions to be more strategic than financial,” says Arnone. “The math is more complicated.” Are you complementing your product line or are you replacing what you already have? Are you going to cannibalize your sales? Are there customers who are going to be affected or motivated to leave because of whom the buyer is?
“Your ultimate asset is your workforce,” says Chad Bayne, a partner with Osler Hoskin & Harcourt LLP. “It’s very unique to the technology field.” But, he adds, acquiring a company just for its talent is not as in vogue as it was a few years ago.
Ernst & Young notes that social networking transactions, for example, have changed in character, as post-IPO companies appear more focused on acquiring strategic mobile technologies instead of talent acquisitions or geographic expansion as they previously were.
While there’s a lot of talk about Facebook and Pinterest, the reality is that businesses are paying for enterprise tools, says Bayne. Salesforce has transformed itself — through strategic acquisitions — to a company focused on social media for the enterprise. And HootSuite was originally a dashboard for social media targeted at consumers; now it’s transformed into an enterprise company.
At the end of the day that’s where you make money, because that’s where you can charge licensing and support fees. “Apple has sort of bucked that trend (in the consumer space), but how many Apples are out there?” says Bayne. “It’s a rare phenomenon.”
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