Sector focus: TMT
The sky’s the limit for TMT – or so it seems. With tech multiples now at record highs, Clearwater International partners Nathaniel Cooper and Per Surland explain where the attractions lie and what the future could have in store.
TMT has recorded more deals than any other sector
Technology continues to enthral private equity investors. Over the past 12 months, TMT has recorded more deals than any other sector (358) and clocked up the second-highest aggregate deal value (€51bn). TMT’s Q3 multiples – 14.3x LTM and 19.1x on the current quarter – are the highest on record.
The stellar performance of TMT has deep roots. Since traversing the 10x threshold back in Q2 2016, average multiples for the sector have never fallen back. In fact, TMT is the only sector where the deal multiple has remained consistently above 10x over the past five years.
The tech's factor
So, what makes TMT so attractive – and why are deal multiples now so high? Abundant dry powder aside, there are two major drivers in play.
First, TMT offers classically attractive business models. “Software as a Service (SaaS) and subscription-based data services are examples: they’re asset light, predictable and offer high cash flow with gross margins over 80%,” says Clearwater International partner Nathaniel Cooper. “Once you’ve built the capability, you can sell it many times over. Private equity loves this model, and the appeal is clear, particularly when things are getting hot in terms of valuations.”
Survival means investing in both consumer-facing and back-end infrastructure that is digital
The second big driver is the need for businesses to build resiliency – particularly in the wake of COVID. “The pandemic accelerated digital behaviour – and no matter what happens in the economy, corporates need to get their hands on the best technology to futureproof their businesses,” says Cooper. “Survival means investing in both consumer-facing and back-end infrastructure that is digital. This includes marketing, because now you’ve got to find your customers online. This is a ten or 20-year growth trajectory and there is no turning back from this.”
Competition for deals is intense – there just aren’t enough targets for PE to deploy all of its capital. One consequence of this is the trend towards investors looking at tech businesses that are project-based rather than powered by recurring revenues. Some of these businesses are growing at 40-50%- plus per year and can attract multiples in the high teens.
Related to this are super-hot subsectors such as fintech, where TMT and financial services converge. “Tech players are looking to tap into a trillions-dollar market that’s already there,” Cooper says. “Clearwater recently did a great growth round for nudge, which combines financial services and employee financial wellness. This traded at a 10x revenue multiple.”
Some of these businesses are growing at 40-50%- plus per year
Digital infrastructure remains patchy. In Germany, for instance, digital networks lag behind the rest of Europe, something that made home schooling and remote working tough during COVID. There is clearly headroom to build-out networks in some geographies. But even in regions with good digital infrastructure, such as the Nordics, the clamour for digital transformation is huge and growing.
Making the transition
The energy transition is an increasingly important digital driver, says Clearwater International partner Per Surland: “Legally-binding emissions targets mean that electrical power is going to become more important. Deeper and more pervasive electrification will depend on digitalisation.” Fibre and 5G are part of the story, but so are software applications and services. “These underpin everything from vehicle charging to balancing power grids and enabling communications between market actors. The ability to manage energy flows across the grid will become critical as power storage and conversion technologies – such as power-to-x-become prevalent. All of this will hinge on digital technology,” predicts Surland.
Legally-binding emissions targets mean that electrical power is going to become more important
Aside from SaaS, fintech and grid tech, several other TMT niches are gaining strong interest. The digital marketplace subsector is one of these and growth is huge. Digital marketplaces aggregate supply and demand, allowing sellers of products and services to find customers more efficiently. Clearwater recently advised sneaker marketplace NAKED Copenhagen on its sale to Groupe Courir and is currently advising on similar UK-based transactions.
Data aggregation and analysis continues to attract PE buyers. “Digital solutions around last-mile logistics is another hotspot,” observes Surland. “This is about e-commerce enablement: building the systems and processes to get goods to consumers. Clearwater recently advised both on Webshipper’s sale to nShift and Reconomy Group’s acquisition of Reverse Logistics.”
Turning to buy-side strategies, Cooper notes that PE is doing much more thesis investing: “If they’ve done the work on a sector – maybe tried to buy something and failed – they want to leverage that knowledge to acquire something similar. Simultaneous bolt-ons are another trend: these help to justify high deal multiples, so when you look at your post bolt-on, post synergy multiple, it’s not necessarily 20x.”
Looking ahead, buyers need to think laterally about future value creation to justify high multiples. Overpaying by three multiples doesn’t matter if you are growing at 50% a year because at the end of your five-year hold period, you’re going to be looking good. At the same time, PE players are keeping a weather eye on the interest rate environment. “Right now, the market is pricing in moderate rate increases,” says Surland. “But sustained high rates would clearly weigh on the value of future cash flows and therefore valuations.”