Trends driving the tech M&A surge

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Trends driving the tech M&A surge

The technology sector is experiencing a surge in merger and acquisition (M&A) activity.

That's thanks to the global recovery from the COVID-19 pandemic now being well underway and the low interest rate environment continuing to provide a ready supply of cheap capital. 

Australia’s technology industry currently contributes around 6.6% of GDP and employs over half a million people. However, technology firms in the US represent four times the share of those in Australia, highlighting the potential for growth in the domestic market.

Today’s digital economy leaders needed to be faster moving and more agile than ever before.

Emerging companies need to ensure they can deliver, and deliver at scale, in order to compete with global companies that are looking to claim a slice of the expanding Australian market.

As corporate advisers to the digital economy, we have never seen such a strong pipeline of deals and every day we are seeing more opportunities, including for SMEs and emerging companies.

Looking forward, we see a number of key themes continuing to drive M&A activity for the tech sector, which we outline in more detail here.

Record valuations - Investors are paying a premium for growth – even if it comes from M&A. This is encouraging large private and listed companies to acquire smaller and emerging companies in anticipation of a valuation arbitrage.

Large software companies that traditionally traded at 6x to 8x revenue have seen their valuation multiples trend upwards over the past two years and it is not uncommon for software as a service (SaaS) companies growing at 20% plus a year to be valued at above 15x forward revenue.

Increased demand from global buyers - The relatively small size of the Australian market also leads many Australian technology companies to focus on international markets at an earlier stage than their competitors in the US and UK. This global focus makes these Australian-based companies attractive to large global strategics and international technology investors.

Australia has a strong reputation for producing world-class technology companies. In addition, many of these companies have been bootstrapped, making them more efficient than their international competitors that have been built with external capital.

The rise of alternative debt funding - There has been a significant increase in the number of venture and mezzanine debt funds in the Australian market. A number of these funds will even lend to companies that are loss making if they can see a path to break-even and the business has strong recurring revenues.  Many of these lenders will also fund M&A transactions with less restrictive covenants than offered by traditional lenders.

Inorganic growth - In many sectors it has become increasingly difficult to grow organically, especially by entering new markets and for businesses such as enterprise software and IT services. This trend has partially been driven by COVID-19 which has disrupted traditional face-to-face sales processes and slowed decision making.

The shortage of talent is also a key factor limiting the growth of many digital economy businesses. The opportunity cost from labour shortages is pushing boards to consider more favourably acquiring businesses that have good quality teams and high levels of automation.

Private equity entrants - The emergence of tech-focused private equity had driven a wave of deal-making. It is becoming increasingly common for these funds to outbid strategics for high-quality businesses, including emerging companies.

Private equity portfolio companies typically regard M&A as a key growth strategy. They tend to move faster and often more decisively than strategic acquirers. Low interest rates and tech-friendly lenders are also fuelling a wave of leveraged buyouts and portfolio company M&A with debt covenants often linked to annualised recurring revenue rather than EBITDA.

Earlier - The volume of unsolicited inbound interest and reports of record high prices are prompting founders and boards to consider selling earlier than may otherwise have been the case.

Founders and boards are also finding it increasingly difficult to scale their businesses due to the shortage and cost of talent and the challenges posed by COVID-19.

The strongest M&A markets we are currently seeing are in the fintech and enterprise software sectors. There is huge demand for companies that sell to a global market and are growing rapidly.

We are also seeing a significant amount of M&A activity in the IT and telco sectors. especially where listed players are often trading on multiples well above 10x EBITDA and they can repeatedly buy good-quality smaller businesses for 5-6x EBITDA.  We have advised on and witnessed over 40 deals in this sector over the last few years and we continue to experience strong interest from buyers for the companies we are selling.

Companies like Unity, Spirit Technologies, Tesserent, 5G Networks, Overthewire and RXP (itself now rolled up by Capgemini) have been incredibly active. Competing for this consolidation are PE backed companies like Nexon, backed by EQT and Cyber CX, backed by BGH, which have rolled up more than a dozen players in the communications and IT services sectors. These well-funded players are outbidding larger strategics – the competition is fierce.

Mark Nesbitt and Hugh Richards are co-founders and principals of Latimer Partners.

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