M&A – What’s the Rush?
2010 so far has seen a formidable increase in merger and acquisition activity in general, and in the tech industry in particular: HP is on a veritable shopping spree, picking up Palm, 3Com, 3PAR, Fortify, Stratavia, and ArcSight. IBM picked up Sterling Commerce, Unica, and Netezza. Oracle bought Sun Microsystems. Intel pockets Infineon’s Wireless Solutions Business as well as McAfee. Google is continuing to show a ferocious appetite with 23 acquisitions through late September. Even long-time M&A spectator SAP has jumped into the fray with the purchase of Sybase. Beside these big deals, there is a host of smaller mergers and acquisitions across the technology spa
So what’s the rush?
1. Cheap Cash – Lots of It
Current cash balances of companies in the S&P 500 index equal a record 11.6% of those companies’ market value, about twice the level for the period 1980 to 2007. With profits up and credit markets more or less up and running at record low interest rates, that stock pile of dry powder is poised to increase. And a good use of that cash is to lock in future growth by buying targets with existing revenues and a strong market positions.
2. Organic Growth Prospects Limited
However one slices it, the current economic outlook is still rather limited. The CEO Economic Outlook Index declined in the third quarter 2010 to 86 from 95 one quarter ago. That doesn’t necessarily mean that we’re headed for a second recession, but it does limit everyone’s enthusiasm to go out and spend their way to fuel more growth. Organic growth options for companies are limited; so why not buy some revenues and profits.
These arguments may support why a buyer would be interested in buying its way out of sluggish growth, but why is it equally interesting for smaller companies to sell at this point?
3. Survival of the Fittest
In such an environment of limited growth outlook, competition intensifies. Economies of scale take precedent, and smaller players are feeling the squeeze. Larger companies can bundle product offerings and cross-subsidize technologies to gain market share. If you can’t beat’em, join’em.
4. It’s Cheap out there
Companies are still relatively cheap. Or at least they’re not expensive. The trailing S&P500 P/E ratio is about 15x, below the long-term average P/E of 16.4x. Not rock bottom, but certainly not “frothy”. For technology companies, where development time is money, buy versus build often tips towards “buying” time, revenue, and profits.
5. Reality Sets in
There is always a time in a technology start-up when it becomes clear that it’s the elusive home-run, an “also-ran”, or a flop. In times of abundant venture funding, a lot of the “also-ran” companies will get the time and money to reach some level of maturity, a better exit environment, or a second chance to “re-invent” themselves. But lately, funding sentiment has turned, and VCs attitudes feel like they are back to the gloomy days of 2008. After five quarters on the upswing, the Silicon Valley Venture Capitalist Confidence Index turned negative in the second quarter of 2010, and according to PWC’s MoneyTree report, VC financing in the third quarter was down more than 30% to about $4.8 billion from the second quarter. It may get better, but it will take a while. Such a restrictive financing environment makes maintaining the “also-rans” more difficult and VCs will start to take some of their chips off the table. If the valuation isn’t going anywhere, it’s better to do a deal sooner rather than later.
6. Back to the Core
Boom-time-diversification’s ugly cousin comes to visit during periods of crisis and slow growth. “Back to the core business” becomes the new company motto, and non-core and underperforming business units are sold. Of course one company’s side show is another company’s main attraction: a lingering economy fosters the reallocation of assets to their best use.
The current wave of M&A will likely persist. There are plenty of merger opportunities where a combination of two strong companies makes perfect sense. There are countless “also-ran” businesses, where the timing of a transaction depends on the patience of the investor. And until we see the tide change to “diversification acquisitions”, there is an abundance of non-core opportunities to be had.
Gunther Hofmann is a Vice President of The Brenner Group and has done extensive work in valuations, M&A, venture capital, and corporate finance with significant international experience in small firms as well as global corporations. Gunther earned a Masters Degree in Electrical Engineering and Business Administration from Darmstadt University of Technology in Germany, and was a Visiting Scholar at UC Berkeley. He is a holder of the Chartered Financial Analyst designation, and a member of the National Association of Certified Valuation Analysts. Gunther is Chairman of the Software/IT Industry Group of the German American Business Association (GABA).
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