Virtually no one is immune to the dynamic forces of the worldwide financial meltdown. The current crisis has taken its toll on M&A, although much less so than the utter collapse of the IPO market and the broad freeze of private equity and venture financing.
Published on Feb. 24, 2009
After two record-breaking years, M&A activity fell almost one-third in 2008, putting the year on par with 2005. The chilling impact of the credit meltdown and resulting recession is reflected in public equity values, off 40-50 percent in many sectors, and that has caused a similar chill in valuations of both public and private sellers in M&A transactions. Corum research indicates that transaction values for software companies during the 4Q of 2008 declined 40 percent vs. the prior year, although with significant variance across industry sectors.
Strategic buyers still lead the way on snapping up key technology sector acquisitions, recognising the benefits of acquiring not only technology, but also the highly valued customers, recurring revenue base, domain expertise, human resource talent and brand of the seller.
Depressed valuations
Given the death of available credit and wary institutional investors, financial buyers, especially private equity funds, are much less active. Without the benefit of leverage it becomes increasingly difficult for the funds to generate the kinds of returns their investors demand. This further depresses valuations because without leverage PE firms are less competitive with strategic buyers.
New venture financing has also ground to a halt, as many VCs rush to prop up portfolio companies hit hard by the downturn and angels fear to tread. Without additional financing, for many smaller firms an acquisition by a better funded buyer is a matter of survival.
Deal mortality has increased, in part due to financing that fell apart such as the Bell Canada/Ontario Teachers Pension and Take Two/EA, JDA/i2, Elliot/Epicor deals. In fact, at well over 1,000, the total number of deals scrapped in 2008 is the highest in 10 years. We expect that more deals will fall apart as this unsettled market finds a bottom and begins its slow recovery. Until then, volatility will continue to wreak havoc.
Vanishing IPOs
IPO activity has almost totally vanished, with the average return on those that did go public in negative figures. Investors are rushing for a safe harbor and eschewing the risk of freshly minted companies. The lack of IPO activity has its adverse impact on M&A. A strong IPO market creates upward competitive pressure on valuations, and IPO proceeds have historically been a funding source for strategic acquisitions.
M&A has always been the primary and is now almost the exclusive option for shareholders seeking a liquidity event. For the many buyers with cash, opportunities abound. Valuations are lower, sellers are more reasonable, and buyers will likely find fewer competitive bidders compared to 12 months ago Nonetheless, for sellers, this is an excellent time to test the market for M&A. Some may argue that with valuations broadly down, it would be a good time to wait. However, everything is down and it may be the perfect time to rethink your investment strategy and, unless your company has enough cash to last at least two years, you might not make it through the downturn.
Reflecting back to the dot-com collapse, weve all witnessed companies that delayed going to market, only to find that the opportunity to sell never returned. Technology and market shifts pulled the rug from under many tech competitors. Active engagement in an M&A process can generate tremendous value from the industry research and market exposure that result from the effort. With an ever-changing competitive landscape and consolidation in all sectors, there may never be a better time to align with a larger partner who has the financials resources, brand, distribution and expertise to assure the success of your vision long term.
There will be many more challenges to running a software / IT business during the next several years. If you lack the financial resources to make it for the next 24 months on your own, you may have little choice but to find a larger partner now.