After cresting all-time highs in 2021, the first quarter of this year has served as something of a reality check for technology, media and telecommunications (TMT) dealmaking. It may be a dip, or it may be the start of a serious sector correction. Listed stocks in the sector are seeing what looks like the start of a substantial revaluation.
According to Refinitiv, the global TMT sector delivered a record $1.72trn worth of deals in 2021, almost double the previous year’s total of $961bn. This remarkable run, however, has been checked so far in 2022. Global TMT deal value from the start of this year to 19 April is down 15.4% year on year. Deal volume in the sector is also down 17.9% year on year.
In addition to navigating the effect of rising interest rates, stubbornly high inflation and Russia’s renewed invasion of Ukraine on M&A activity generally, TMT dealmakers also have to readjust to post-lockdown markets. The NASDAQ Composite index, as an indicator, has fallen almost 30% since the start of the year. With so many other industries forced to put the shutters up during lockdowns, TMT assets saw red-hot M&A demand. As economies have reopened, however, investors have again been allocating capital across a broader spread of sectors.
Resilience needed
For all the recent headwinds the TMT industry has faced, dealmakers are sanguine about the drop in deals in 2022.
Anna Faelten, an EY partner who specialises in the sector, says that after an exceptional 2021, it would have been unusual for TMT to sustain last year’s levels. TMT deal activity is nevertheless still underpinned by positive long-term fundamentals.
“Companies in every industry are having to ‘tech up’ as all aspects of doing business are digitised. With technology developing so fast, M&A has become a must-have tool for corporates to develop and maintain technology capability. This is a long-term trend that has created a whole new buyer pool for TMT assets.”
Indeed, corporates have proved to be willing to pay generous multiples for targets that will both increase their technology service offering and their geographical reach.
Telefonica Tech, a Spain-based IT Services group, for example, paid an earnings before interest, taxes, depreciation and amortisation multiple of 13.7 times in its £175m acquisition of data analytics group Incremental, according to Grant Thornton’s Q1 2022 Technology Insight. The deal expands Telefonica Tech’s position in the UK market, as well as its provision of Microsoft technology services.
Andy Morgan, UK head of TMT M&A at Grant Thornton, says that alongside the strong demand from corporates looking for deal targets that will enhance internal digital capabilities, private equity buyers have sharpened their TMT investment theses and have been aggressive in many areas.
“Private equity has always been a strong presence in areas like business software and managed services. But we also noted private equity’s growing presence in areas such as consulting, data businesses, B2B communications, cloud services, cyber security and tech-enabled services across vertical markets.
“TMT continues to offer private equity buyers compelling opportunities to create value through consolidation, buy-and-build and digitalisation investment strategies.”
Recent transactions include Apax agreeing a £600m deal to acquire technology-led risk management and compliance solutions platform Alcumus from Inflexion.
Split market
Alfonso Marone, KPMG’s UK head of TMT deal advisory and strategy, argues that it’s important not to extrapolate stock market corrections involving high-profile US companies and technology indexes to what is going on in private M&A markets. Technology businesses that thrived through COVID-19, including Peloton, Zoom and Netflix, have all suffered double-digit share price declines as markets have recalibrated. Unicorn start-ups that listed at high valuations have also seen their share prices buffeted.
By contrast, profitable companies in business software, tech-enabled services and broadband infrastructure, with sticky, recurring revenues, have remained in high demand.
Marone comments: “Yes, we’ve seen the public markets valuations of some TMT companies fall by between 30% and 70%, but this correction has largely involved high-growth companies that floated last year at valuations based on future earnings growth rather than profitability and cash generation. TMT companies with steady cash flows have continued to trade strongly, with much more limited impact on share prices.”
Deals involving companies in cash-generative TMT verticals so far this year have included Partners Group acquiring enterprise resource planning software developer Forterro from Battery Ventures for €1bn and B2B telecoms player Daisy Group acquiring business broadband, phone and card payment provider XLN in a deal said to be worth around £210m.
Morgan says that although buyers are taking more time to scrutinise deals, this has had little effect on pricing or demand for high-quality assets. “There’s much more focus on inflation, talent and supply-chain considerations in due diligence, but overall there’s still a high degree of confidence that high-quality TMT assets will deliver future growth and are worth paying top dollar for.”
Still a seller’s market
Although the TMT deal market is unlikely to reach the peaks achieved in 2020 and 2021, and buyers are becoming increasingly picky about the TMT deal targets they are willing to pursue, the sector’s prospects for now still appear bright for the next 12-18 months.
Marone says sellers continue to “exceed their pricing expectations and secure double-digit multiples for TMT assets”.
One area to monitor over the next three to five years will be whether private equity investors in the current vintage benefit from the same growth in multiples that have been observed over the past decade, Marone adds. But in the current market, he says: “TMT deal activity remains robust and has proven more resilient than M&A in other sectors.”
Faelten says even after the drop in deals in Q1 2022, TMT M&A activity is still well ahead of pre-pandemic levels. “This is still a seller’s market. Demand for technology and technology-enabled businesses and services is not going away.”
Holding winning cards
Rather than exiting profitable TMT assets within the typical five-year time frame, private equity firms are opting to retain stakes held in prized TMT portfolio companies for longer.
“Private equity firms that hold good TMT assets, have a strong management team and still have visibility on the buy-and-build runway and growth trajectory are increasingly comfortable with sticking with those assets,” according to Andy Morgan of Grant Thornton.
In order to facilitate these longer holds, private equity firms are either pursuing fund-to-fund deals, setting up continuation funds or simply retaining or selling down minority stakes as other private equity firms invest.
Nordic Capital, for example, invested (an undisclosed amount) in healthcare software-as-a-service platform RLDatix alongside incumbent private equity investors Five Arrows Growth Capital and TA Associates in January.
The deal saw Nordic take a minority stake in the company, with Five Arrows and TA Associates retaining their majority shareholding in the business. TA first invested in the business, then known as Datix, in May 2018, buying a stake from Five Arrows. Arma Partners was adviser to Datix.
Five Arrows first invested in the company back in 2013 and has now held a stake in the company for close to 10 years.
When you’re on to a good thing in the TMT sector, why let it go?
Building TMT specialism
Deloitte runs an annual Fast 50 awards programme, which focuses on the tech and media sectors. “Through more than 100 interviews with Fast 50 applicants, and more than 10 deals completed in the sector in 2021, we gained a great insight into what is driving growth for the very best tech and media companies in the UK,” says Chris Graves, the firm’s TMT sector lead in the UK. He cites capital efficiency, innovative approaches to talent and an early focus on the US market as being particularly key.
Kiren Asad, a director in Deloitte’s TMT M&A team, explains: “We see a range of strategics and financial investors pursuing new M&A strategies to capture these opportunities, acquiring the improved business models that have emerged during the COVID-19 pandemic. Corporates also place high importance on bringing in the different talent and cultures these firms have.”
Recent deals advised on by Deloitte’s TMT M&A team include:
- advising the shareholders and management team of social media content provider Jungle Creations on investment from Livingbridge Private Equity;
- advising Kin+Carta on four disposals in the marketing services subsector; and
- advising Vespa Capital on its sale of BioPhorum, which provides a subscription-based, independent collaboration platform for the biopharmaceutical industry, to Five Arrows Growth Capital.
“Since we started [the awards] in 2019, we’ve witnessed the TMT sector soar to new heights, with software businesses almost doubling median revenue multiples, with AI, collaboration tools, digital media and health tech all attracting massive investment,” says Asad, who won the prize for the best student to pass ICAEW’s Corporate Finance diploma in December 2015 and who is now a key member of Deloitte’s growing TMT M&A team.