After the M&A Frenzy: What's Next?
Leveraged buyouts and strategic acquisitions have set new records. What will happen to these assets - and to software M&A - when the economy slows?
By Ken Bender, Software Equity Group, LLC
Nov. 06, 2007
We have no crystal ball, but Software Equity Group has a decent track record forecasting the software industry's economic expansion, consolidation and contraction over the past fifteen years.
We believe the U.S. economy, despite the Fed's best efforts, will finally fall victim to the housing bust, tight credit and skyrocketing oil prices. Economists expect the GDP will slow to 1.6% in Q4 and may well contract further in 2008 until there is a modest negative decline for two consecutive quarters, the economic definition of a recession. The current expectation is any recession will be moderate and will last some 12 to 24 months.
Nevertheless, such a contraction will likely create a new M&A environment for software industry entrepreneurs and investors.
The Return of a Recession
What will be the likely impact of a mild recession on the software industry? Enterprise customers will markedly reduce their IT capital spending, as they have in prior downturns. Consequently, software company growth will slow, and investors will increasingly turn their attention to profitability and net income. It's almost a law of nature.
Larger software companies, in response, will turn their attention to cost-cutting, re-examining spending priorities, paring headcount, and enhancing the productivity of those who remain. We anticipate many of these larger companies will take a product line approach to cost-cutting, scrutinizing each product line, and assessing product line-specific revenue, expense, market leverage and, most importantly, return on investment. Particular attention will be paid to products acquired during the M&A frenzy of the past few years.
After conducting these product line, operational and financial reviews, we fully expect a good number of public software companies will shed non-performing and incongruent product lines and business units in an effort to cut development, support and marketing costs. In fact, SEG has established a new division to assist in the profitable disposition of these assets.
The Impact on Private Equity
Private equity firms will be even more diligent and disciplined in assessing their portfolios of software companies acquired and taken private in the past three years. Overall, private equity accounted for 25% of all North American M&A activity in 2006, and within the tech sector $44B was spent on buyouts last year.
By June 2007, private equity had already exceeded the 2006 total, with transaction valuations averaging approximately 10x TTM EBITDA. Many of these companies - with revenues in the hundreds of millions - or billions - of dollars - were acquired to serve as platforms for add-on acquisitions and accelerated revenue growth in hopes of an IPO three to five years out. (For a complete look at the latest data on software finance, download Software Equity Group's Q3 2007 Quarterly Report .)
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We believe the U.S. economy, despite the Fed's best efforts, will finally fall victim to the housing bust, tight credit and skyrocketing oil prices. Economists expect the GDP will slow to 1.6% in Q4 and may well contract further in 2008 until there is a modest negative decline for two consecutive quarters, the economic definition of a recession. The current expectation is any recession will be moderate and will last some 12 to 24 months.
Nevertheless, such a contraction will likely create a new M&A environment for software industry entrepreneurs and investors.
The Return of a Recession
What will be the likely impact of a mild recession on the software industry? Enterprise customers will markedly reduce their IT capital spending, as they have in prior downturns. Consequently, software company growth will slow, and investors will increasingly turn their attention to profitability and net income. It's almost a law of nature.
Larger software companies, in response, will turn their attention to cost-cutting, re-examining spending priorities, paring headcount, and enhancing the productivity of those who remain. We anticipate many of these larger companies will take a product line approach to cost-cutting, scrutinizing each product line, and assessing product line-specific revenue, expense, market leverage and, most importantly, return on investment. Particular attention will be paid to products acquired during the M&A frenzy of the past few years.
After conducting these product line, operational and financial reviews, we fully expect a good number of public software companies will shed non-performing and incongruent product lines and business units in an effort to cut development, support and marketing costs. In fact, SEG has established a new division to assist in the profitable disposition of these assets.
The Impact on Private Equity
Private equity firms will be even more diligent and disciplined in assessing their portfolios of software companies acquired and taken private in the past three years. Overall, private equity accounted for 25% of all North American M&A activity in 2006, and within the tech sector $44B was spent on buyouts last year.
By June 2007, private equity had already exceeded the 2006 total, with transaction valuations averaging approximately 10x TTM EBITDA. Many of these companies - with revenues in the hundreds of millions - or billions - of dollars - were acquired to serve as platforms for add-on acquisitions and accelerated revenue growth in hopes of an IPO three to five years out. (For a complete look at the latest data on software finance, download Software Equity Group's Q3 2007 Quarterly Report .)
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