Digital disruption

There were plenty of compelling reasons to turn to M&A in 2017

In 2017 the number of TMT transactions globally rose, up by 3% on the same period last year. With many firms waking up to the threats of digital disruption and with new technologies such as Artificial Intelligence (AI) and the Internet of Things (IoT) still in their relative infancy, there were plenty of compelling reasons to turn to M&A.

An interesting trend last year was that companies largely shunned all stock mergers, as aptly demonstrated by the collapse of talks between Sprint and T-Mobile. The year marked a period where levels of cash on the balance sheet were at a post-recession high, meaning all cash deals were king.

The market capitalisation of the five big technology companies has doubled in the last three years to €2.6tn, but 2017 was the year that they faced a major backlash. Under a climate of discontent at the income inequality that ultimately buoyed populist movements such as Brexit and the election of Donald Trump, Silicon Valley came under attack. From accusations that social media platforms aided the Islamic State and fixed democratic elections to criticisms of sexual harassment and tax avoidance, attacks came from all sides.

Governments around the world started to take notice. For instance social media platforms were hauled to US congressional hearings, and both the European Union and the US have proposed legislation that looks to increasingly hold the tech giants to account. Some ultra conservatives have even gone so far as to suggest that digital platforms should be reclassified as utility companies and broken up. Silicon Valley is no longer untouchable.

Market data

The average size of a TMT transaction with a disclosed value increased by €4.6m compared to 2016. However, a particularly notable trend in 2017 was a fall in the number of deals above the €4bn threshold. Uncertainty over the economic climate in the US and Europe has led many firms to focus on making smaller acquisitions rather than pursuing mega mergers, which ultimately carry less risk.

Media transactions dominated the top ten again in 2017, this time with a focus on television. Disney announced its planned acquisition of the film and television arm of 21st Century Fox for €44.5bn, whilst Discovery Communications bought Scripps Network for €12.4bn. As traditional television and movie distribution models are increasingly disrupted by digital services, the idea that bigger is better seems to be winning.

Verizon also acquired media giant Yahoo for €3.8bn in 2017. This valuation was a long way away from the heady heights of its €42bn valuation in 2008 and a telling reminder that a lot can happen in a decade in the technology industry.

Elsewhere, Intel made the largest investment in a self-driving car firm to date, when it acquired Mobileye for €14bn. The acquisition turns the firm into a major player in the driverless car battle alongside competitors such as Uber, Apple and Google.

The software giants on the other hand largely focused on smaller tuck-in acquisitions. Many legacy players have already significantly invested in transitioning their businesses to cloud models, such as Oracle’s acquisition of SaaS ERP specialist Netsuite. Consequently over the past year the focus has been on building rather than transforming their offering.

Meanwhile North American and European targets increased their stranglehold over TMT M&A representing 69.9% of the market between them. The number of transactions featuring an Asia Pacific target dipped by 1.5%. Targets from the rest of the world also dropped by 0.8%.

With western economies maturing and the vast majority of the global middle class now sitting in emerging markets, it is perhaps surprising that we have not seen more TMT acquisitions within regions such as Africa and South America. Yet with many emerging economies still languishing at the bottom of the World Bank’s ease of doing business rankings, it seems international investors are still dissuaded by political and economic risks, along with challenging regulatory environments and operating conditions.

IPO levels remain low

There were a higher number of IPOs in 2017 at 24, compared to the previous year. Yet despite Snapchat’s much anticipated stock market debut it was still the second lowest number since 2009. With greater access to private equity funding than ever before, many firms have continued to shun the public markets.

As for those that did go public there were some notable success stories. Demonstrating that competing against Amazon is not always impossible, shares in Roku, a competitor to the US giant’s Fire TV, have surged more than 200% since its stock market debut in September. Equally, e-commerce company Stitch-Fix’s shares have also grown 57% since it listed in November.

Yet although there were a number of winners, there were also some notable losers. Meal kit delivery producer Blue Apron’s shares have fallen 62% since its debut in June on the back of intense competition from Amazon. As for Snapchat’s much-hyped debut its shares have performed poorly, but saw a slight rise in early 2018 on the back of improved fourth quarter figures.

Private equity and TMT are still a perfect match

As in previous years it looks like there will continue to be a frenetic level of private equity investment in 2018.

China became a particular hotspot in 2017 with the value and volume of private equity investment reaching a new high. Larger deals were also up 50% in 2017 as funds looked to find the new breed of unicorns. However, the level of first round investments was still at historically low levels. This suggests that investors have become more cautious towards start-ups and a wait-and-see attitude has replaced the more gung-ho approach of previous years.

Elsewhere, despite some of the political uncertainties around Brexit, the UK still remained a hotspot for private equity transactions from both domestic and international investors. FinTech firms proved to be particularly popular as the UK continues to produce innovative companies in the sub-sector. For instance online only bank Atom received €113m in a new round of investment, and peer to peer lending platforms Funding Circle and Zopa also both participated in new rounds of funding led by international investors.

Software assets across Europe are also still commanding double digit multiples from private equity houses. Firms that serve industries such as construction, which have traditionally been late adopters of technology, have proved particularly attractive. For instance, Clearwater International advised Eque2, which provides construction contract management software, on its management buyout by LDC. Elsewhere Battery Ventures invested in Newforma, a US project information specialist, whilst TA Associates invested in thinkproject!, a provider of BIM software.

B2B IT services and hosting continue to remain hot property throughout Europe. Clearwater International advised Ireland’s largest managed IT services firm Version 1 on its MBO backed by Volpi Capital, while the largest European transaction in the sector was executed by BC Partners which paid Go Daddy €386m for German hosting specialist PlusServer.

Buy-and-build models are particularly prevalent as investors see it as the most obvious way to gain scale quickly in a fragmented marketplace. UK private equity portfolio companies Node4, Pulsant and Metronet all made further acquisitions in 2017.

Conversely, strategic buyers still remain the most likely source of exit for businesses in the media and marketing services environment as purchasers are able to structure their deals with an attractive level of earn-out. However, Equistone Private Equity’s investment in technology-led marketing services provider Inspired Thinking Group, on which Clearwater International advised the buyer, demonstrates an increasing appetite for marketing businesses with tangible IP.

Future prospects

Looking ahead as new high profile data leaks continue to hit headlines, and amidst a political climate dominated by accusations of election hackings and cybercrime, internet security specialists will continue to be sought after assets. Expect to see more deals like Microsoft’s €84m purchase of Hexadite.

Meanwhile 2017 saw €18bn invested in M&A in AI, 26 times more than in 2015. Whether the current tech giants remain supreme depends largely on the future of AI. If real world data remains essential then they are currently in pole position. Yet in another possibility, where simulation is key and machines teach themselves using synthetic data, their power is blunted. The race is now on as we start to get a clearer picture of how it unfolds in 2018.

And what of the overall future of technology’s superpowers in Silicon Valley? Whilst they may be facing a backlash, it is worth noting that Amazon, Microsoft and Alphabet’s shares rose to all-time highs last year. Furthermore there seems to be no evidence of consumers voting with their feet, as aptly demonstrated by the queues for Apple’s latest iPhone X. Tech giants may in the future face heightened scrutiny and greater regulation, but it is too early to write them off just yet.

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