Managing Director & Senior Partner
The volume and value of technology-driven deals have approached their current heights only once before—in 2000, right before the dot-com collapse. But then the value of tech M&A plunged from more than $900 billion to less than $300 billion in 2001 and to less than $100 billion in 2003.
Since 2012, the tech deal market has rebounded, with growth in volume and value significantly outpacing the overall M&A market. Deals in tech, including digital, totaled more than $700 billion in value in 2016, representing almost 30% of the entire M&A market. (See Exhibit 1 and the related article from The 2017 M&A Report, “The Technology Takeover.”)
Today’s tech M&A market is very different from its dot-com predecessor. Back in 2000, internet companies went public or were sold despite having no revenue or even, in many cases, a working business model. Today, top tech companies are profitable, and business models are market tested, if not fully mature. Even younger startups, which have yet to pass the profitability threshold, have clear business plans and timetables.
In order to investigate the resurgent tech M&A market, BCG developed a classification taxonomy for tech deals on the basis of the nine high-tech trends shown in Exhibit 2. Our goal was to develop a working definition of a “technology target” that goes beyond broad Standard Industrial Classification–based definitions to include companies that have some form of technology as an essential attribute or part of their business model. To do this, we developed a lexicon of more than 450 technology business terms (“software as a service,” for example) that we used to screen companies and transactions for inclusion. Data from the resulting database of more than 43,000 high-tech deals over the past 20 years illustrates the difference between target companies during the era of the dot-com bubble and the more recent past. For example, the average age of a target company in 2000 was 6 years, while in 2016, it was 14 years; median revenues in 2000 were $83 million, compared with $206 million in 2016; and only 53% of all tech targets had positive EBIT in 2000, compared with approximately 65% in 2016. Buyers now are also much more knowledgeable about how they plan to make use of new technologies in their own operations and business portfolios.
Given the size and prominence of the M&A tech market today, it’s surprising how little about its supporting trends and dynamics has been explored in any depth. For example, which companies, exactly, are the most active buyers, and which technologies are they after? What are current valuation levels in tech M&A, how do they compare with the broader market, and to what extent are they justified? Is the formation of another tech bubble a possibility? At the individual company level, of course, the critical question is, How do buyers, especially buyers from outside the tech sector, make tech deals work? This article provides some answers.
Two tech M&A market segments are emerging, each with its own dynamics. They are distinguished by size of the deal.
The total number of tech deals has been growing at a rate of 9% per year since 2012. Large-cap tech deals (more than $500 million) have shown the strongest volume growth (more than 13% per year), and they are the main driver of aggregate deal values, which have increased 27% per year during this period, from $278 billion to $717 billion. (See Exhibit 3.)
The absolute tech deal value in any given year is driven by a few multibillion-dollar transactions. In 2016, for example, 91 deals—each valued at $1 billion or more—generated approximately 80% of total tech M&A value. The two largest deals, SoftBank Group’s acquisition of ARM Holdings ($31.6 billion) and Microsoft’s purchase of LinkedIn ($26.2 billion), made up 8% of the total market. In the large-cap marketplace, there is a trend toward rising overall valuation levels as competition increases for large-scale, must-have assets and as more traditional buyers, backed by substantial M&A bankrolls, seek technological innovations.
At the same time, there is also a highly active marketplace for small acquisitions. More than 80% of the volume of tech M&A is made up of transactions valued at $100 million or less. Moreover, there were another 6,000 deals in 2016 in which the value was not disclosed. As our colleagues pointed out earlier this year with respect to “deep tech” (new technologies that advance scientific and technological frontiers), many startups seek corporate support early in their existence for a variety of reasons, and one form that such support can take is acquisition. (See “A Framework for Deep-Tech Collaboration,” BCG article, April 2017.)
While companies may decide to participate in this market for any number of reasons, one oft-cited motivation is the need to close innovation gaps because they have fallen behind in their own R&D. Our data suggests exactly the opposite. The more innovative companies are the ones that undertake more tech acquisitions. Acquirers, in both the tech and the nontech sectors, that primarily buy nontech targets have a median R&D-to-sales ratio of 1.2%. Companies that focus on tech acquisitions have a median R&D-to-sales ratio of 5.5%. A more detailed analysis by industry segment confirms that the more a company spends on R&D, the more likely it is to be an active acquirer of tech targets.
The biggest factor driving tech M&A is the increasing role and prominence of buyers in nontech sectors. Digital and advanced technologies have disrupted multiple industries, and they are making their influence felt across most others. Time to market and reaching critical mass are key considerations, and companies often don’t have the time—or the talent—to build the capabilities they need themselves. The automotive and financial services sectors are two prime examples: when it comes to M&A, the deals in both today have as much to do with software and technology as they do with powertrains and money. Little surprise, then, that every industry in our database showed a significant increase in the share of tech targets since 2012 as companies increasingly turned to M&A to acquire new capabilities and close innovation gaps. The share of nontech-sector acquirers has grown by 9 percentage points since 2012 to encompass about 70% of all tech transactions. (See Exhibit 4.)
The industries with the largest share of tech deals include private equity and venture capital, financial services, industrial goods, consumer goods, and retail and health care (which are close to a tie for fifth place). Almost one-third of all private equity and venture capital deals in 2016 involved tech targets. This might be expected for venture capital firms, but a similar trend is developing for private equity overall as financial sponsors increasingly look for technology companies as both standalone acquisitions and add-ons to strengthen portfolio companies.
Major private equity deals in 2016 included Apollo Global Management’s acquisition of cloud computing services company Rackspace for $4.3 billion; Thoma Bravo’s purchase of Qlik Technologies, a software and analytics company, for $3.0 billion; and Swedish private equity player EQT’s acquisition of Press Ganey Holdings, a health care software company, for $2.4 billion. Private equity transactions tend to involve software more than hardware targets, and many have concentrated on the mobile technologies, app development, social collaboration, big data, and cloud-based services segments. (See Cracking the Code in Private Equity Software Deals, BCG Focus, May 2017.)
In financial services, close to one-fifth of all deals involved tech companies. Major transactions included LendingTree’s $130 million purchase of Iron Horse Holdings, which operates the CompareCards consumer credit-card comparison platform; Standard Chartered Bank Principal Finance Real Estate’s pending $73 million acquisition of Chayora Holdings, a data center developer and operator; and Crawford & Co.’s purchase for $36 million of WeGoLook, an online and mobile collaborative economy platform.
In the industrial goods sector, 14% of all deals had tech targets. Among automotive companies, one-quarter of all deals in 2016 were tech focused, reflecting the rising importance of connected cars and new mobility trends, including autonomous driving. For example, General Motors paid $1 billion for Cruise Automation and invested $500 million in Lyft.
The tech targets of today are operating in an environment that’s very different from the one that existed during the first wave of the digital revolution, and the technology trends have shifted substantially. For example, digital technologies are just beginning to reshape the health care sector, and data and analytics will only increase in importance across all industries. Many established players will need to acquire new technologies and skills to stay current or move ahead. In the wake of recent high-profile cybersecurity incidents, we may see more M&A activity in the infrastructure and security category.
As noted above, our data indicates that nine trends are driving market growth. Three of the biggest are the following.
Industry 4.0. Advanced manufacturing accounted for more than 600 transactions in 2016 as companies snapped up a variety of technologies, including robots, factory automation, 3D printing, and the Internet of Things. Industry 4.0 deals have been growing at a rate of almost 20% per year for the past three years as more traditional companies seek to position themselves for the manufacturing environment of the future. One example is Siemens’s $4.5 billion acquisition of Mentor Graphics, a US-based automation software specialist, which is intended to complement Siemens’s existing capabilities in mechanics and software with advanced technology for the design, testing, and simulation of electrical and electronic systems. Technologies such as these are hard to come by; the biggest constraint on Industry 4.0 M&A growth may be the availability of attractive targets.
Cloud Computing and Cloud-Based Solutions. The cloud—along with all the capabilities that it enables, such as software-, platform-, and infrastructure-as-a-service—remains a driving force of the digital revolution. Little surprise that it attracts a lot of acquisition interest. Cloud-based deals have increased by approximately 30% per year since 2013. Cloud players are in high demand by both established tech giants (Oracle’s $9.3 billion acquisition of NetSuite is one example) and private equity firms (Vista Equity Partners’ $153 million acquisition of GovDelivery).
Mobile Tech and Software Application Providers. Three types of buyers are the principal hunters of these targets. First and foremost, buyers from the tech sector seek to unlock value by increasing their share of wallet through cross-selling and expansion into new customer segments and regions. Among the almost 250 acquisitions in this category is Microsoft’s purchase of LinkedIn, which pushed the average deal value to $535 million. In fact, most 2016 deals were significantly smaller, such as Comverse’s acquisition of Acision UK Limited for $136 million. (Acision, now known as Mavenir, was a provider of seamless mobile messaging solutions to service providers and telecom operators.) Second, nontech-sector buyers are searching for new product features and functionality improvements for their core products (think auto OEMs and connected cars). Third, investors, especially private equity firms, are attracted by the favorable economics of software companies, which have highly scalable products, low deployment costs, and generous profit margins.
Buyers in nontech sectors often have difficulty justifying the valuation multiples of tech industry targets—and for good reason: current valuation multiples are high and getting higher. From 2013 to 2016, median EV/sales multiples for tech targets rose from 2.1 to almost 3.0, about a 50% increase. Acquisition multiples for individual tech stars can easily reach 6 to 8 times sales or even more.
The key factors determining multiples are the target company’s growth rate, gross margin (especially for software firms), and industry segment. Software companies frequently achieve gross margins of 80% of sales or more because of their low cost of goods sold. As a result, these companies easily realize EBIT margins of 25% or more once their revenues surpass the basic costs of R&D, talent, and marketing. Acquirers pay dearly for such levels of profitability. That said, our analysis did not reveal clear-cut evidence that positive EBIT is a major driver of acquisition value (many highly valued targets have yet to achieve profitability on an EBIT basis), indicating that acquirers tend to focus more on gross margins than on bottom-line profitability.
Industry segments are important. From 2013 through 2016, gaming and fintech deals had the highest median valuation multiples, exceeding 3.0 times sales. Typical sector multiples for software-focused firms (including cloud and big-data companies) have ranged between 2.4 and 2.8 times sales. Median Industry 4.0 multiples are lower because many of these transactions involve hardware companies that typically have lower margins than their software counterparts. (See Exhibit 5.)
In hindsight, the inflation of the new-economy bubble from 1998 through 2001 is clear. Median EV/EBIT multiples for tech targets exceeded 25 at times then, almost 50% higher than nontech multiples at the peak and twice the long-term historical spread between tech and nontech multiples of about 5 points.
Today, while EV/EBIT multiples involving tech targets are again at lofty levels—and well above long-term averages—nontech transaction multiples have risen by similar amounts. Common factors that drive all valuation multiples include the continuing availability of cheap financing and the need for many acquirers to buy growth in an otherwise low-growth environment. We see high valuation levels as a current fact across the full M&A market rather than as a sign of an industry-centric tech bubble ahead.
There are, of course, exceptions and outliers. A few tech companies possess what many would-be buyers regard as must-have assets. Bidding wars for these companies can lead to significantly inflated acquisition multiples when it comes to large-scale transactions, such as those of more than $250 million and, particularly, those greater than $1 billion. For instance, Salesforce.com ultimately acquired Demandware following a rumored bidding contest involving several other suitors, which caused Salesforce.com to raise its initial offer by 36%, to $2.8 billion, to get the deal done. Similarly, a German auto OEM consortium consisting of Mercedes-Benz, Audi, and BMW encountered fierce competition from such global tech giants as Uber, Tencent, and Baidu in the bidding for Nokia’s mapping unit, which the auto OEMs won at a price of about €2.8 billion. For these types of deals, median EV/sales premiums of almost 80% and EV/EBIT premiums of 50% are not uncommon when compared with transactions of less than $250 million. (See Exhibit 7.)
Tech M&A is expensive. Does buying tech firms add value? If so, how do successful acquirers get their money’s worth? We address these questions in the related article from the 2017 M&A report, “The 2017 M&A Report: Doing Tech Deals Right”