Will technology lead the M&A rebound?

  • Deal volumes in the technology, media, and telecommunications (TMT) sector fell less than overall global transactions in Q2 2020, slipping 19.7 percent compared to a year ago.
  • Some industries directly impacted by the pandemic – such as aviation or live entertainment – may be slow to recover, but we are already seeing renewed interest in tech assets with applications in the life sciences, industrial, and automotive sectors.
  • Asia-Pacific may be a harbinger of the recovery to come: TMT M&A activity was up 20 percent by volume from Q1 2020.

Technology has been prominent in M&A activity over the past decade. The US$723 billion in TMT deals last year outpaced all other sectors, and TMT has been a top-three sector by value every year since 2010. Explosive growth among large tech players has created super-scale corporations that have the cash to snap up smaller firms in bolt-on acquisitions as they see fit, subject to necessary regulatory clearances.

The tech sector is almost certain to continue leading the way when M&A markets rebound from the slowdown caused by the COVID-19 pandemic.

The digitalization of almost every activity has fostered an arms race that affects most businesses, across almost any sector. Even now, with overall Q2 2020 deal activity at a low ebb, many non-tech companies continue to examine how to leverage technology in the future and take advantage of impending opportunities to add tech capabilities and talent. For many, M&A plans are largely driven by digital strategies.   

However, the picture is far from straightforward. With the pandemic having caused turmoil in the global business environment, volatility in the capital markets, and economic uncertainty, many companies have been conserving cash and focusing on shoring up their balance sheet. As a result some potential buyers of tech assets, particularly those from outside the sector, have put M&A on hold at least temporarily.

And there is a knock-on effect. While large tech companies, and private equity buyers, have plenty of cash for M&A, uncertainty in the wider market complicates valuations, making even these payers more circumspect.

For example, if a large tech company with ample resources is contemplating an acquisition of a growing fintech or digital health business, other potential buyers are likely to include financial services or health care companies. If those companies are focused on maintaining operations, taking advantage of COVID-19 trading conditions, or conserving their balance sheets, they may be less engaged in the M&A market. While that may provide opportunities for the cash rich tech company, it will also generate uncertainty and discourage sellers from engaging as they wait for a stronger market to return. The very fact that the fundamentals of tech are so strong for the medium-term may discourage deals in a weaker market for sellers who can afford to wait.

Tilting the balance within tech

There are other ways in which uncertainty is restraining the tech M&A market. It is still far from clear what course the pandemic may take and how deeply the economy as a whole may be affected. In addition, in many cases, COVID-19 raises new questions about the long-term utility and value of specific assets.

Changes in consumer attitudes and business priorities due to the pandemic have already tilted the balance among different types of tech assets in unexpected ways. Many companies with products or services with health care applications have seen interest increase, and valuations along with it. Businesses and assets related to tech infrastructure, such as data centers, are getting a boost.

On the other hand, the prospects for technology whose value lies in physical retail, hospitality or leisure and entertainment have become less certain. This is not the best time for an app built around improving the experience at the checkout counter of a retail store, for example, or serving advertising to crowds at concerts — given current pandemic-related restrictions.

While the broad outline of these changes is becoming clear, the continuing uncertainty in a world upended by COVID-19 means the shift in the relative attractiveness of different tech assets still has some way to go.  

This leads, of course, to the question of how quickly dealmaking might return, to which the honest answer is that no one knows for sure. One can probably be confident that the nadir in the M&A markets has passed. The global dollar value of Q2 2020 deals across all sectors fell 22.7 percent from the previous quarter and 50.8 percent from a year earlier. Activity in the TMT sector did not fall quite as hard as the market as a whole: the dollar value of TMT deals dropped by 37.3 percent from the prior year. Still, this was the worst quarter for TMT M&A since 2012.

Businesses have adjusted so that, even if the pandemic worsens again in some places, it will be unlikely to disrupt businesses to the extent it did when the virus first spread around the globe earlier in the year. As much as market valuations may still be unsettled, the broad outline of how COVID-19 is affecting various industries, including tech, is beginning to take shape.

Management bandwidth

From March through May of 2020, M&A was depressed not simply because of market conditions. On a very practical level, for many corporate and financial investors alike, management did not have the bandwidth to pursue potential deals. Leadership was, rightfully, focused on keeping employees safe, keeping the business operating amid lockdowns and social distancing, and assessing balance sheet health. As lockdowns ease and businesses adjust, that pressure on management time is starting to ease, creating the space for them to refocus on strategic opportunities.

Given all of these factors, there’s likely to be an uptick in deal activity, and soon. Some parts of the tech sector will move more quickly, while others will lag. M&A activity involving companies with technology related to aviation or live entertainment, for example, may remain frozen. On the other hand, we are already seeing more interest in tech assets with applications in the life sciences, industrial, and even automotive sectors.

Once tech M&A begins to recover, it is likely to move quite quickly. There is a backlog of sellers, including private equity owners who want to monetize some of their holdings. There are also buyers who are motivated to make tech acquisitions — and buyers with cash to get deals done.

Notably, TMT M&A activity was slightly up year-on-year in the Asia-Pacific region, where COVID-19 hit first and where the recovery from initial lockdowns is further along (and more successful in some cases, such as South Korea or Hong Kong). The dollar value of Asia-Pacific TMT deals during the quarter increased by 5.6 percent from a year earlier. There may be other explanations, aside from a post-pandemic recovery in the M&A market. This data may show that more money for acquisitions is staying within the Asia-Pacific region right now, or it could be an artifact of lower deal activity in the region in the comparable 2019 period. Or, it may be a signal of the M&A recovery to come.

All the pieces are in place for the tech sector, sometime soon, again to be a leader in a strong M&A environment — as in years past.   

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