Software M&A Forecasted to Reaccelerate in 2018

While 2017 saw a lull in software M&A, the recently passed Republican tax reform incentivizing cash repatriation, alongside a possible market correction in the new year, could work to boost deal activity, according to a number of analysts on the Street. At the same time, as technological disruption accelerates across industries, companies are increasingly pressured to buy up rivals in efforts to boost their competitive edge.

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“The appetite for technologies like machine learning, robotics, artificial intelligence and advanced analytics is large and growing. We’re seeing some organizations buy smaller tech companies to enable strategic growth and others – typically companies well outside the tech sector – actively looking to converge their businesses with tech companies to achieve marked transformation,” said Deloitte managing partner Russell Thomson in the firm’s 2018 M&A Trends Report.

While the bull market charged ahead in 2017 and tax reform uncertainty loomed, some of the market’s most active buyers, including Microsoft Corp, Oracle Corp, SAP and held off in the face of mounting valuations.

As last year’s stellar returns sent the trading multiples of possible targets higher, with the S&P 500 up 22% in 2017, a possible pullback could present a buying opportunity. Some on the Street expect a rise in interest rates and inflation to present negative headwinds to the high-flying market, allowing for more affordable tech targets, specifically in the industry-specific software space.

“Less multiple expansion, (overseas cash) repatriation and innovation tailwinds could drive a bigger M&A year,” said RBC Capital analysts in a recent research note.

As the GOP tax overhaul is set to slash the corporate tax rate and free up billions in savings for America’s largest tech titans, one possible avenue for spending is M&A activity. While the opportunity to repatriate at a lower rate will provide corporations with funds for bigger and more deals, no sector is sitting on a greater deal of cash overseas than the U.S. tech titans.

This view was reiterated by MoffettNathanson analyst Adam Holt, who adds that while uncertainty over tax reform and growing valuations slowed software industry M&A in 2017, deal activity was again thwarted by private companies, who, finding easy access to capital, were in no rush to sell. He added that the passage of tax reform serves as “kerosene on the fire” in 2018.

Hold expects Microsoft, Oracle, Adobe Systems, VMware and others to dip into their cash mounds and build out their current product suite holes with acquisitions. He sees human relations and payroll software provider Workday, as well as cloud-based intelligent workflow company ServiceNow as prime candidates “wish list” at several potential buyers.

Even, with a forecasted organic revenue growth of over 20% through 2020, is expected to continue its acquisition spree, according to analysts at William Blair. The investment bank’s 2018 outlook report cited “the potential for a mega SaaS tie-up (Salesforce/Workday being the granddaddy of them all).” However, analysts stated that the chances are highest for deal activity to be driven by the on premise vendors such as Microsoft and Oracle, the latter which recently raised $10 billion in the bond market.

As old guard tech giants buy out smaller companies to remain at the helm of the rapidly transforming industry, investors should also expect a slew of new partnerships to form with cloud computing vendors such as market leader Amazon Web Services, Microsoft and Alphabet-owned Google. Recently inked alliances include the AWS-VMware and Google-Salesforce partnerships.

“Our view is that the wave of M&A is slowly beginning to build, and we would expect to continue to see a healthy dose of best-of-breed vendors consolidated into both legacy software vendors like Oracle and SAP, as well as ‘born-in-the-cloud’ vendors like Salesforce and Workday,” said Goldman Sachs analysts in a recent report. The Wall Street bank highlighted possible takeout targets including publicly traded companies Zendesk, Cornerstone OnDemand and HubSpot.