Tech Focus: How will US tech M&A unfold as recession looms?

Data InsightDealspeak 5 December

Tech Focus: How will US tech M&A unfold as recession looms?

Even as rising interest rates have hit technology valuations hardest, dealmaking in the US tech sector has remained surprisingly robust in 2022.

US-based tech M&A  – totaling USD 560.3bn in the year to date – is at its second highest level ever, according to Dealogic. Down 30% compared to 2021’s record year, it has contracted less than overall M&A, which plunged 44% to USD 1.435trn over the same period.

But there are caveats. Much of tech M&A happened early in the year before markets soured. Since June it has weakened considerably. Eight of the year’s top 10 tech deals took place in the first five months of the year, before the full extent of the Federal Reserve’s hawkish commitment to squashing inflation had become fully clear.

Tech firms are no longer thinking about transformational deals, but have frozen hiring and instituted layoffs in a bid to conserve cash and turn profitable. “There’s a hesitancy to do M&A,” says one advisor to the tech industry.

State of play

Private equity, which holds roughly USD 1.2trn in dry powder, continues its dominance. Buyouts of US-based tech firms have hit the second-highest level ever – USD 125.4bn in YTD 2022 – down 23% from the same period last year. Exits at PE-backed tech firms totaled USD 171.3bn in YTD 2022, down only 5.6% from last year.

“Sponsor-to-sponsor trades in the mid-market involving profitable, growing tech companies are getting done,” says one dealmaker.

Yet tech buyouts have plunged as the drumbeat of recession gets louder. They shrank to USD 22.3bn in 3Q22, less than half the prior quarter’s total, as institutional loan issuance dried up. Banks – fearful of the kind of losses they suffered financing Citrix’s buyout, agreed in January before markets soured – have largely stopped underwriting. Direct lending by PE firms has filled some of the void.

In the risk-off environment, tech firms are looking at smaller product or talent acquisitions. Bigger deals to capture revenue or market share are off the table. Adobe’s USD 20bn splurge on Figma in September was an anomaly, not indicative of corporate dealmaking hunger. The software company lost a Figma-sized chunk of its market cap in the days following that announcement.

A persistent valuation gap has also gummed up dealmaking, with sellers slow to adjust to the dramatic downturn in asset prices. That gap seems to be narrowing. Valuation expectations have come down sufficiently for one software company to consider restarting its acquisition hunt. “They still need to drop some more before we pull the trigger,” its CFO says.

Where to from here?

Given the stark drop in valuations, companies won’t sell unless they have to. Instead, tech firms could opt for PIPEs (private investment in public equity) – just as some did early in the pandemic – giving sponsors a minority stake rather than selling outright.

Defensible sectors – such as cybersecurity, regulatory technology, government IT, and healthcare software – will continue to attract M&A interest, says a second dealmaker. His investment bank has been filling out its tech practice to manage a strong pipeline of deals that are expected to transact in 1Q23 and 2Q23.

Private equity groups are actively running the rule over several de-SPAC’d companies trading well below their listing price, other dealmakers say.

For now, “A ton of leveraged buyouts are on hold,” says the first dealmaker. “Everything over USD 3bn is going to be tough.”

One way to spread risk is for several PE firms to participate in the same deal. That has led to the highest level of club deals in 15 years, says a third dealmaker.

“There’s a lot of dry powder in PE coffers. There are very strong balance sheets in the corporate arena. That capital from both sources will tend to be deployed.”

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