Within tech, software to dominate deal flow in 2019

Recently, Carlyle Group Co-CEO Kewsong Lee said tech permeates every investment decision at the firm. “We have a saying at Carlyle: ‘Every deal is a tech deal,’” Lee told the PartnerConnect LP-GP Outlook conference in New York.

Tech is also fast becoming one of the most popular PE-investment targets — and within the category, software will be a prime focus, sources told Buyouts in recent interviews.

The attraction? Software investments provide recurring revenues, significant cash generation and opportunity for consolidation, they said.

Fragmented market

Deal activity will be driven by add-ons and middle-market buyouts, a recent PwC report noted. “The trend is fueling more add-on deals to occupy top-tier funds and will continue to drive higher valuations,” Andrew Cristinzio, partner and PE leader at PwC, wrote in the 2018 Deals Insights report.

The software segment is fragmented, without a real market leader, consisting instead of smaller players competing with each other and larger enterprises.

This gives PE firms the opportunity to acquire businesses from founders and large corporations. 

“We are already seeing a shift from large cap to midcap and, in particular, the sub-$1 billion market is witnessing a relative increase in number of deals,” Roy Kabla, global co-head of tech-media-telecom at Houlihan Lokey, told Buyouts.

Within software, companies focused on security, data and analytics, digital transformation and 5G technology are likely to dominate deal flow in 2019, says Wayne Kawarabayashi, partner and head of M&A at Union Square Advisors.

“You have data breaches like with Walmart, you have problems on social media where people can’t tell what’s fake and what’s real, you have credit card fraud. So securitization of data is becoming increasingly important,” Kawarabayashi said.

Software infrastructure, along with data and technology-enabled services, also brought a lot of interest to Clearlake Capital Group in 2018, said Behdad Eghbali, the firms co-founder and managing partner.

PE and strategics

More and more PE firms and strategics are showing interest in software companies. PE’s share of the software market surged to 20 percent in 2018 from 2 percent in 2001, says Matt Melymuka, co-founder and partner at PeakSpan Capital, a PE firm focused exclusively on growth-stage and enterprise-software companies.

“Historically we saw only business software companies buying software companies,” he said. “Now we have internet companies, telecom companies, private equity firms, and even non-tech companies buying software companies.”

On the TMT side, Kabla sees deal activity ticking up in communication services, digital media and sports, especially in the middle market.

Midcap M&A is likely to stay strong as the large-cap space consolidates, Kabla explained. Some of this vertical consolidation in TMT is forcing large players to build out their platforms quickly with differentiated product and service offerings.

While these platforms can be developed in-house, acquiring middle-market companies can be a more rapid route because smaller companies often have already developed these disruptive offerings, Kabla said.

In 2018, the volume of tech deals rose 55 percent to $532 billion, according to the Technology M&A Outlook 2019 report by Union Square Advisors.

Large deals

Some of 2018’s biggest deals were tech: Blackstone’s acquisition of Refinitiv for $17 billion, Siris Capitals acquisition of Web.com Group for $2 billion, Thoma Bravo’s acquisition of Imperva for $1.8 billion and Vista Equity’s acquisition of Apptio for $1.7 billion, Refinitiv data shows.

Of the 23 largest tech deals in 2018 by value, 16 involved software companies. Investor Group was the most active acquirer, buying nine. Next were Thoma Bravo and Vista, which acquired two each, according to Refinitiv.

Within the broader tech category, the value of IT deals grew 22 percent over the past year, with 862 deals closed, according to PwC.

Last year also saw a record level of tech megadeals. Deals above $1 billion almost doubled in value, to $448 billion. Deals above $5 billion jumped 135 percent in value, PwC reported.

This activity was driven by macro factors including economic growth and lower taxes in the U.S.

At the same time, trade tensions with China, Britain’s pending exit from the European Union, tariffs and rising interest rates are likely to fuel volatility in capital markets.

In volatile markets, take-privates may become more attractive and prominent, Cristinzio wrote.

Macro issues

At the same time, macro issues are also prolonging the deal-making process. The tariff war, for instance, limits China’s ability to invest in the U.S. and vice versa, Kawarabayashi said.

The government shutdown doesn’t play in favor of deal-makers either, slowing down the deal-approval process, Kawarabayashi added. This has been the case with Union Square Advisors, which is awaiting government clearance for one of its deals, Kawarabayashi said.

Some tech areas are more resilient to macro shocks and are likely to see further pickup in investor interest, Clearlake’s Eghbali said.

“[Despite] macro concerns around Fed tightening and higher interest rates, a late cycle and slowing economy, geopolitical risk, and full valuations — software and data services business, that have a defensive moat and are benefiting from macro secular shifts, are a greater area of focus.”

Action Item: Contact Union Square Advisors in New York at +1 212-376-1700.