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Thursday, 19 January 2012

Mid-market to drive tech M&A


Matt Turner
19 Jan 2012

Introducing the iPod more than 10 years ago, the late Steve Jobs said of the music market: Its part of everyones life, it is a very large target market, all around the world. It knows no bounds.

Mid-market to drive tech M&A He was talking on October 23, 2001, when, as Apples chief executive, dressed in his trademark jeans and black polo, he introduced the breakthrough MP3 music player to a small audience. Ten years later, the firm has sold several hundred million of the devices and the focus has now moved to new products, such as the iPhone more than 17 million sold in the final three months of last year and the iPad, which sold 11 million in the same period. While Jobs was talking about a new music player, he could have been talking about technology more broadly. The story of the iPod exhibits two fundamental aspects of the sector it is fast moving and pervasive, touching consumers and businesses in multiple, ever-changing ways. In this environment, technology companies, whether they be business to business or business to consumer, are forced to place bets on where a particular market is going, often using mergers and acquisitions as a key tool. Guido Mengelkamp, head of technology investment banking for Europe, Middle East and Africa at Citigroup, said: The nature of technology means that you have to be ready to make large bets, as it is a business driven by the requirement for strategic initiatives. It is a truly global business, and it is short cycled, and CEOs know they could lose their leadership rapidly. Last year, technology was one of the few bright spots for global M&A, with deal volumes

rising 44% to $222.6bn, the highest since 2007, according to Dealogic. The number of $1bnplus deals, at 43, was the joint highest in a decade. Premiums in technology deals were higher than in any other industry group, with an average one-month premium of 35%, the highest for the sector since 2002. Rich rewards For banks at the top of the M&A rankings, the rewards were plentiful. The technology sector generated more in M&A advisory revenue than any other outside of finance, with $1.7bn in fees, ahead of healthcare and oil and gas, according to Dealogic. Bankers are convinced this will increase; while 2011 was a good year, there is still a long way to go to hit the highs of 1999 and 2000, they say. Sam Britton, a managing director at Goldman Sachs, said: While last year felt like a strong year in tech M&A, some of the macro headwinds meant that the market wasnt yet operating at normalised activity levels, and there is plenty of room for growth in 2012. The technology space encompasses a huge number of different sub-sector industries, ranging from IT services to intellectual property; software to semiconductors. As such, bankers warn against industry-wide generalisations but emphasise two general themes: high operational leverage and a global market. The former, with its high level of fixed costs, often means that technology companies produce vast amounts of cash, as once fixed costs are covered, each additional sale goes to the bottom line. This cash is then reinvested in research and development or acquisitions. The latter throws up the possibility of opportunistic dealmaking, as US and Asian buyers circle a European market that has seen valuations depressed by continued uncertainty over sovereign debt. Rob Morgan, technology sector leader in corporate finance at PwC, said: Cash remains king. At a time when debt is hard to raise, those with cash are doing deals and technology companies, particularly at the larger end of the market, have significant cash reserves which they are looking to deploy through M&A. With cash in hand and a strategic imperative for deals, M&A in the technology sector remained robust last year, as the broader market slowed considerably. Economic uncertainty pushed global M&A down 16% in the second half of last year compared with the first half, but M&A in the technology sector rose 11% over the same period, boosted by Hewlett-Packards purchase of Autonomy, Berkshire Hathaways acquisition of a 5.4% stake in IBM, and SAPs acquisition of SuccessFactors. While bankers cite the potential for headline-grabbing activity by IBM and Oracle over the course of this year, most expect the next 12 months to be characterised by smaller deals, with consolidation, mid-market deals and the acquisition of new technology playing a key role in driving activity. Markus Boser, head of technology Emea at JP Morgan in London, said: On the consumer side, technology companies are moving away from specific applications to full ecosystems. Theres similar activity happening with the large enterprise-focused technology conglomerates, which in many cases are broadening their product suite to cover everything from application software to networking. Nonetheless, corporates continue to seek out innovative technologies, leaving room for focused technology start-ups to create a new and better mousetrap.

Ripe for consolidation In the mid-market, bankers cite Europes large, fragmented technology sector as one ripe for consolidation and deal activity, with private equity in particular likely to play a prevalent role. Last year technology was the most targeted sector with buyouts accounting for $37.1bn of deal activity and for exits, with $35.1bn, according to Dealogic. Cyrus Kapadia, deputy head of UK investment banking at Lazard, said: The large midmarket set of European technology companies should provide some interesting targets for buyers both inside Europe as well as the US and Asia. JP Morgans Boser agreed but said that while Asian companies liked the technology and educated workforce on offer in Europe, they were wary of exposure to consumers in the region. He said: There are some interesting opportunities in Europe for Asian buyers and there is an increase in interest, though it remains to be seen whether that will lead to deal activity. Finally, the acquisition of new technology is likely to drive deal activity, with one head of technology investment banking describing a paranoia of missing out on the next market trend among large-cap technology companies. This has helped push multiples as high as 20x Ebitda in some cases, he said. Sophie McGrath, of counsel at law firm Morrison & Foerster, said: Companies focus their R&D on what they think is going to be big in 10 to 15 years, but if you havent got a presence in todays hot sectors, such as mobility or cloud, youve got to go out and buy. These dynamics are set to ensure technology M&A remains robust for the foreseeable future, according to Citigroups Mengelkamp, who said technology M&A was not yet at the peak, but instead only halfway up the slope. As our perception of technology changes, driven by the proliferation of fixed broadband, computing will become more like a utility, he said. The world is becoming more risky, and the technology industry less so. The global economy is increasingly becoming short-cycled, matching the dynamics of the technology industry. The two are meeting in the middle. - Five sub-sectors to watch The technology sector encompasses a large number of different industry sub-sectors, each with their own deal-driving dynamics. Here Financial News outlines five to watch. Software Sam Britton at Goldman Sachs said: Within the sub-sectors, software is traditionally the most important contributor to M&A volume. We see potential for further activity in the market, particularly given the strategic attractiveness of cloud companies. According to one banker, the acquisition of cloud computer company SuccessFactors by Germanys SAP last month acts as a legitimisation of the technology, with further deal activity set to follow. Cybersecurity As increasing amounts of data become available, managing and securing this information is becoming increasingly important. Existing providers are likely to seek acquisitions in a fragmented market. Philip Shepherd, technology sector leader in deal strategy at PwC, said: A good example of this is Intels acquisition of McAfee for $7.8bn [which completed in February 2011]. It highlights the importance of security for large established technology

businesses. Smartphones The proliferation of smartphones has seen a battle emerge for market share, underpinning two strands of M&A: applications and components. These deals range in size from several billion dollars down to tens of millions. In the applications space, Microsoft has rolled out video calling to a number of Android phones following its $8.5bn acquisition of Skype in May last year, while HTC acquired UK mobile video specialist Saffron Media Group for $48m. Matt Cross, technology sector leader in transaction services at PwC, said: While in terms of overall size the UK is a relatively minor player in the global technology market, it is home to a large number of high-quality chip-design companies, including Wolfson, ARM, CSR and Imagination Technologies. We believe that these and other world-class UK technology assets could prove to be attractive acquisition targets in the near future. Semiconductors Last year was a busy one for deal activity in the semiconductors industry, according to bankers, who highlighted Texas Instruments acquisition of National Semiconductors for $6.7bn in April in one of the technology sectors most aggressive deals of the year. Goldmans Britton said: The factors that drove the uptick in deal activity in the semiconductors space in 2011 should continue into the new year. Intellectual property The sector is set to see continued strategic interest, according to bankers, sparked by last Julys sale by Nortel of 6,000 wireless patents worth $4.5bn to a consortium including Apple, Microsoft and RIM.
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