UK technology businesses have never been in so much demand. M&A activity in the sector hit record highs last year and valuations spiked sharply higher, as highlighted in research by ICON Corporate Finance. And while there’s the perennial concern about the UK’s perceived failure to build businesses on the scale of the US tech giants, the quality of British technology companies is attracting an increasingly global cast of suitors.
“We had to check the figures because the year’s frenzied dealmaking, increased volumes and valuations were eye-watering,” says Brian Parker, ICON’s head of M&A, of the firm’s recently published UK Technology M&A Snapshot.
Indeed, the figures speak for themselves: there were 1,070 deals for UK technology companies announced during the course of 2021 – a 44% increase on the previous year. That total was, by some distance, an all-time high. By comparison, 2019, the last full year of pre-pandemic dealmaking, saw 895 transactions announced.
Unlike many other sectors of the economy, the COVID-19 crisis has given large parts of the technology industry a positive boost. Alan Bristow, CEO of ICON – a longstanding member of the Corporate Finance Faculty – explains: “Digital transformation is the underlying theme driving rapid change across every sector. The market for tech companies was getting stronger and stronger even before the pandemic, but the way in which the crisis has accelerated digitalisation in areas such as e-commerce, fintech, logistics and healthtech has driven tech M&A forward even more rapidly.”
Competition for these businesses is stiffer than ever. Corporate buyers, racing to acquire new digital competencies, are finding themselves in battle with private equity and VC investors awash with capital and desperate for sources of potential return against a backdrop of near-zero interest rates (for now).
At a global level, private equity firms were estimated to be sitting on between $1.8trn and $2.3trn worth of dry powder by the end of last year, according to Preqin and S&P Global respectively. That firepower certainly made itself felt last year. Private equity- and VC-backed acquirers announced 507 deals during 2021, accounting for 47% of all M&A activity in the UK technology sector. These investors embarked on a spree of buy-and-build deals, so their share of the M&A marketplace tripled compared with the previous year.
Another factor in the intense competition for the UK’s best technology businesses is the growing attention of international buyers. There was a time when M&A in the sector was largely a domestic affair, but – as highlighted in the February 2022 issue of Corporate Financier – those days are gone. Last year, overseas acquirers accounted for almost half of tech dealmaking, up from less than a third six years ago.
In fact, overseas acquirers – all from the US – accounted for eight of the 10 largest deals last year, although the largest transaction of all, the £4.2bn purchase of Mimecast, was led by the British private equity giant Permira.
High-profile, cross-border deals included e-commerce giant Etsy’s £1.1bn purchase of the second-hand clothing platform Depop, and financial services group JPMorgan Chase’s £700m acquisition of ‘robo-advice’ company Nutmeg.
By contrast, domestic acquirers were more likely to be involved in smaller transactions, although many of these dealmakers made multiple acquisitions during 2021.
Among corporate buyers, the IT services provider Babble Cloud – as featured in Corporate Financier’s survey of the UK’s most acquisitive companies (March 2021) – made no fewer than nine acquisitions last year as it sought to build a nationwide network. Backed by private equity firm Graphite Capital, Babble almost doubled its customer numbers through deal activity last year. In the software sub-sector, Access and ClearCourse each made six acquisitions.
Similarly, five private equity investors accounted for 50 deals between them, with LDC, Inflexion, Hg, August Equity and BlackRock each announcing 10 tech transactions.
More smaller deals
Overall, this proliferation of buy-and-build investment strategies meant that smaller deals increased in number particularly sharply last year, with buyers more likely to focus on early-stage, less mature targets. There were only 38 deals valued at more than £100m over the course of 2021.
“Everyone’s hunting the unicorns,” says ICON’s Bristow, of the desire to invest early in a start-up that will achieve a $1bn valuation in as short a time as possible. “As a result, while investors are doing their diligence carefully and the bar to securing investment remains high, once a business meets those fast-growth KPIs, it can raise significant sums at pace.”
Prices for the best businesses are rising accordingly. While valuations vary enormously across the sector (see box, ‘Record valuations’), the median business was sold at 2.5x revenue last year, or 23x EBIT (earnings before interest and tax). Both those figures were at a record high. The ICON research estimates that valuations have now doubled over the past 10 years.
The question now is whether such heightened levels of activity and pricing can be sustained over the months to come. At the macro level, the war in Ukraine and wider geo-political tension in Eastern Europe, the shift to tighter monetary policy and the volatility seen in listed technology stocks during the early part of the year all look worrying.
In addition, there’s concern in some quarters about the impact of the UK’s new National Security & Investment Act (NSIA), which requires the parties in some strategically important M&A deals to notify regulators when talks begin. Technology companies may increasingly be caught by this regulation. Nvidia’s blockbuster takeover of Arm Holdings was abandoned in February, partly because of such anxiety. By the end of 2022, there will be greater visibility of the impact of the NSIA.
Bristow expects the impact of the legislation to be relatively limited – and, more broadly, he’s confident that valuations will hold up. “We may struggle to match the pace of last year, but the market is going to be very active again,” he predicts. “Valuations are sustainable – there’s been a marked step-up in the baseline, so the starting point for every negotiation is much higher.
That positive view is shared by his colleague, Brian Parker: “Deal activity is unprecedented. After a fast start to 2022, we see no signs of this slowing down. The market is extraordinarily resilient – now is a great time to be the owner of a UK technology company looking at exit options.”
Sectors in demand
Certain areas of the UK technology sector are running particularly hot. “The demand for data and analytics tools is enormous in every industry, so there’s huge demand for businesses with deep tech,” says ICON’s CEO Alan Bristow (pictured). “That’s also focusing M&A and investor interest on artificial intelligence and machine learning because these are the super-smart technologies needed to process the massive volumes of data and make it useful.”
Crowdstrike’s £274m purchase of Humio – completed at a whopping valuation of 34x revenue – was one high-profile data deal in 2021. Humio’s data and analytics platform will enhance Crowdstrike’s cyber security proposition.
Indeed, security is another highly active area of the market, with Permira’s take-private bid for email security specialist Mimecast last year almost four times bigger than any other deal in ICON’s research. “The pandemic has focused attention on cyber security,” points out Bristow. “With ever more of our lives conducted digitally, the need for protection cuts across every industry.”
Valuations of UK technology companies hit new records last year – but it would be a mistake to generalise about the sector. In fact, pricing varies hugely depending on the nature of the target’s business.
The average technology transaction last year was priced at 2.5x revenue and 23x EBIT. But valuations in certain areas spiked much higher. In the fintech sub-sector, for example, JPMorgan Chase’s purchase of Nutmeg was priced at 35x revenue.
One factor is visibility, particularly as investors seek to understand what normal looks like in the wake of the COVID-19 pandemic, which has disrupted the market and made comparisons more difficult. That supports pricing in the software-as-a-service market, where customers subscribe to a service for fixed periods, offering much greater certainty about forward-looking revenues. In less predictable areas of the technology sector, investors may not be prepared to pay so much.
Equally, pricing tends to be less elevated in sub-sectors where deep tech is less prominent. In the communications and managed services sub-sector, for example, some deals last year were conducted on single-digit multiples – even as low as 1x revenue in certain cases.
Technology business founders need more than simply a successful business model to attract suitors and maximise price – investors and acquirers are also looking for well-run companies with strong management and leadership, says ICON’s Alan Bristow.
“Governance is a crucial part of building value,” he argues. “To grow the business and to attract investment, you need the right management structure and systems in place – and you need it as early as possible.”
He highlights the importance of tapping the UK’s rich ecosystem of non-executive directors, to share their experience of what it takes to build successful – and sustainable – businesses. Business angels, who often take early-stage stakes in growing businesses, can also provide invaluable support.
One question for founders will be when to think about exiting. The willingness of founders to sell up early has sometimes been criticised by those who wonder why technology companies in the UK rarely grow to match the scale of the US tech sector giants. But scaling a business requires a different set of skills to getting it off the ground in the first place.
These criticisms, argues Bristow, often reflect a lack of awareness of the strength of the UK tech sector, rather than the reality. “As a nation, we’re very poor at getting the message across about the success of our world-class tech businesses,” he says. “These businesses are not being talked about, but the M&A statistics show just how highly they are regarded.”