While COVID-19 is a black swan event and is not considered to be the new norm, its implications will carry some lasting effects as companies adapt and embrace the digital frontier. The global pandemic has forced many companies to shift to alternative methods in order to continue operating. As non-essential businesses ceased physical operations, the adapting global workforce embraced digitalization accelerating demand in cybersecurity, telecommunications, and IT services. An MIT survey study finds that nearly 50% of the workforce are working remotely as of May (1). This monumental shift towards work-from-home (WFH) pressures businesses to modernize their IT infrastructure and develop/acquire new solutions in order to ensure a smooth and safe transition.
Although the current environment has highlighted the advantages for IT solutions and digital applications, 2020 will still come with its share of challenges. According to Deloitte, IT spending for the year is expected to drop about 3% from 2019 levels. This is likely correlated to the number of businesses that failed or cut costs in order to stay afloat. As a result of uncertainty and low confidence, we did see a relative dip in M&A deal volume (-15%) and value (-2%) when comparing 2020 to 2019 Q1. In comparison, the global M&A market saw declines of over -35% in both volume and value (2) which indicates that the technology-focused sector is more resilient to these types of crises. As visibility for the post-COVID business practices remains muddled, the only certainty is that the workplace culture has changed. Investors seeking to stay ahead of the competition have begun initial diligence to prospect the right company for acquisition.
How Corporations and Private Equity’s Value Perception of Technology changed
The figure above indicates that PEGs and Strategic acquirers are being more aggressive towards tech valuations over the last 7 years.
The average price/sales multiple in 2012 was below 3x and by 2019, we’re seeing strategic acquirers push the envelope of valuation with a >7x multiple of sales.
We expect to see that uptick in value progress as the economy moves past this downturn and continues adopting these services.
While the pandemic served as a catalyst for adopting technology, the IT industry has done considerably well over recent years. Prior to COVID-19, acceptance of cloud based services and increased data security regulations spurred growth for the IT services space with an estimated annual growth rate of 8.4% until 2025 (3). In conjunction, the Global Cybersecurity market is forecast to grow annually 14.5% over the next 4 years (4).
Acquirers took advantage of this market’s potential as we saw a 12% increase in M&A transactions in Q1 2019 (5), where companies are using the “buy rather than build” approach. Companies would rather acquire than set up a department from the ground up. Additionally, video conferencing and cloud services that provide remote access are proving to be a productive and cost-efficient tool. Large blue chip corporations such as LinkedIn and Twitter have already announced WFH as a permanent part of their work culture moving forward, and countless other firms have followed suit.
The work-from-home paradigm shift brings value to IT services and cloud computing as many companies seek to off-load internal IT departments, eliminating the costs of maintaining data centers and managing a whole department. This move creates an opportunity for those in the technology-driven space since Private Equity groups and strategic acquirers are looking for well-positioned platform investments and add-ons. As more sectors begin reopening, we anticipate PEGs to become more aggressive in regards to acquisitions and valuations as they hold on to nearly $1.4 trillion in dry powder –money waiting to be deployed.
To get ahead of the curve, investors are poised to acquire now. If you’re looking to gauge the value of your business for a potential transaction, please contact any member of the Plethora team and we can help you explore the next steps. With so much dry powder waiting to be invested, and limited ready sellers, the theory of supply and demand tells us that now is the best time to start the process. With the M&A process taking about 6-9 months, maximize the value of your business by taking advantage of the market before it gets saturated.
Footnotes:
- National Bureau of Economic Research
- Mergermarket
- Grand View Research
- Market Research Engine
- Capital IQ
AUG
2020