2873: Understanding M&A Trends With Ernst & Young

[00:00:00] Are we on the brink of a significant transformation across the tech landscape? A transformation

[00:00:07] driven by mergers and acquisitions? Well in today's episode of Tech Talks Daily,

[00:00:14] we're going to delve into the vibrant world of Tech M&A. We're going to be guided

[00:00:19] by the insights of my friend James from Ernest Young today and James brings to the table

[00:00:25] a deep understanding of the current trends and future outlook of tech M&A because as the

[00:00:31] tech sector rebound strongly in the latter half of last year. We're seeing that trend

[00:00:37] continuing this year so I want to explore the dynamics that led to this resurgence. And

[00:00:42] also what does it signal for the future? From the strategic importance of being proactive

[00:00:48] in deal making to leveraging M&A for integrated growth. James will share his expert perspectives

[00:00:55] today on how companies are navigating this complex terrain of tech investments and of

[00:01:01] course the continuous evolution that is being driven by both artificial intelligence

[00:01:05] and cyber security. We've got so much to talk about today.

[00:01:09] But before we get today's guests on, it's time for a quick shout out to the sponsors

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[00:01:56] and now let's get today's guests on. Buckle up and hold on tight as I beam your

[00:02:02] ears all the way to California in the US where James is waiting to join us today.

[00:02:09] So a massive warm welcome to the show James. Can you tell everyone listening a little bit

[00:02:14] who you are and what you do? Great pleasure to be here. I'm a partner at Erson Young.

[00:02:19] I'm our America's Technology Media Entertainment and Telecommunications Sector Leader for our

[00:02:25] Strategy and Transaction Practice. But outside of that role, my day-to-day responsibilities

[00:02:30] are really centered around advising my technology clients as they embark on M&A transactions

[00:02:36] both by side and sell side. Also spend a significant amount of my time helping public

[00:02:41] and private companies define, analyze, validate and externally report software top line metrics

[00:02:47] such as annual current revenue and net retention rates. Well it's a pleasure to have you on the

[00:02:53] podcast today. There's so much I want to talk about and so much else as excited about getting

[00:02:59] you on the podcast about today as well. So to kick things off and to set the scene,

[00:03:04] can you start by giving us an overview of why technology was named the EYM&A Sector of the

[00:03:10] Year 2023 last year, especially considering the sector's performance, fluctuations throughout

[00:03:16] the year. Anything you can share around that? Sure. So we're coming up on the 12-month anniversary

[00:03:22] of the financial panic here in Silicon Valley where I'm based and we really saw technology

[00:03:27] M&A hit a pause really following that period in that March, April, May period. But the

[00:03:33] second half of 2023, we really saw the beginnings of a comeback and that resulted in technology

[00:03:38] being the most active sector for the year even after that slowed down and representing almost 25%

[00:03:43] of all M&A activity. And what we expected to see was that M&A activity carry forward into 2024

[00:03:50] and that's exactly what's happened. And I think we saw deal values just last month in February

[00:03:55] be up almost two times in February 2024 versus February 2023.

[00:04:01] And you mentioned that surge towards the back end of last year. I've gone to ask,

[00:04:05] what factors do you think contributed to that rebound and how do these trends compare to,

[00:04:10] let's say pre-pandemic levels? Sure. So let's take aside the magnificent seven companies.

[00:04:18] The public market ARR or next 12-month revenue multiples, they really drop significantly

[00:04:24] starting in late 2022. And those lower valuations really maintained throughout 2023.

[00:04:32] And since they were stabilized over 12 months, what we actually saw is a number of the smaller

[00:04:37] software public companies become more accepting of their new valuation multiples. They started

[00:04:42] to entertain take private transactions to really go refocus on their cost structure and then

[00:04:47] go refocus on growth. And that was a really big driver is take private transactions in the

[00:04:54] back half of 2023. We also, a lot of people call 2023 the year of efficiency. And we saw a lot of

[00:05:01] our clients go and perform a robust portfolio analysis on products and business units, especially

[00:05:08] a lot of them would say they had acquired and really at behest of sometimes active

[00:05:12] shareholders. And as they went through that analysis, they started to realize their

[00:05:16] certain products or business units not core to their future product roadmaps or not aligned

[00:05:21] with what they were focused on from a cash efficient growth perspective. And that really

[00:05:26] resulted in uptick in public company car valve transactions in the back half of 2023

[00:05:30] that actually helped enable some of that growth in M&A that we saw. And then finally,

[00:05:37] it's hard to talk about M&A if you don't talk about AI and just all the excitement and

[00:05:42] momentum driven by chat GBT. And as you'll see in our CEO poll survey found that 100%

[00:05:49] every executive that we surveyed, they're making or planning to make significant investments in

[00:05:53] GIN AI. And as many companies when it looked internally, I noticed they lacked the talent

[00:05:58] or the technology to enable GIN AI capabilities into their products and operations. What we've

[00:06:05] seen is a really big uptick in tech and talent transactions centered around AI.

[00:06:10] And I'm glad you mentioned AI there because when we're talking about

[00:06:14] pre pandemic levels and comparing with the big boom towards the back end of 2023,

[00:06:19] the big factor that we've got to mention is AI everywhere went completely nuts for it there,

[00:06:25] especially driven by chat GBT and so many other different factors. And AI has been a pivotal

[00:06:31] driver in transforming things like productivity and market entry strategies for so many different

[00:06:37] companies in just about every sector you can think of too. But can you elaborate on how AI

[00:06:42] how AI's role in tech MNA has also evolved and the impact it's had on that sector's growth?

[00:06:49] Sure. So Bill, on our last response, just from an MNA acquiring perspective,

[00:06:55] yes, for clients are viewing AI as a product feature, and they're therefore looking at

[00:07:00] acquiring tech and talent to enable their product formats. And that's simply the MNA

[00:07:04] activity that we're seeing just overall from an investment perspective. But AI were broadly

[00:07:10] what we're seeing every transaction we're working on whether it's an AI related business or not

[00:07:16] is AI's top of mind and a priority validation number one. And from a commercial perspective,

[00:07:23] during diligence buyers are now really trying to understand well how can JIN AI help them or

[00:07:28] this target company to stand differentiate or accelerate their growth in the marketplace?

[00:07:33] And then from a technical perspective buyers were forming diligence on the AI

[00:07:37] capabilities of the target software. What's the data quality? What's the security around that data

[00:07:43] and the governance around it? And then also assessing the culture and the people within

[00:07:48] the R&D organization and do they have the right people with the right AI skills to deliver

[00:07:53] against their planned combined product formats in the future, which obviously will include an AI

[00:07:58] feature. And then I think what's the biggest evolution and that's especially for our private

[00:08:02] equity firms is they're looking at AI and wondering well is this going to kill this target

[00:08:08] company we're looking at? Will it kill their primary product offering or the market advantage they

[00:08:12] currently have? Because people are trying to look out okay three to five years out,

[00:08:16] you know how will AI impact this market or this product? And that's definitely transformed

[00:08:22] the way that people approach MNA and the sector from just what we're looking at just even two

[00:08:27] years ago. And the last few weeks as I've been scrolling down my news feed on my phone and there's

[00:08:33] so many private equity firms ramping up their investments in tech. I'm curious you're right

[00:08:39] in the eye of the storm here, what shifts are you observing in things like market valuation

[00:08:44] and investment strategies? Anything that you're seeing here? Yeah so maybe take a step back

[00:08:50] and then get to where we are today. And there's no doubt versus the peak sort of Zerbera,

[00:08:56] PE MNA activity significantly decreased from the first half of 2022. And we started to see our

[00:09:02] clients much more disciplined around their investments with higher interest rates. And

[00:09:07] when MNA was slower, what we saw our clients focus on in the back half of 2022 and early 2023

[00:09:14] was really on improving the cost structure and the cash flows of their portfolio companies.

[00:09:18] But now we are starting to see bills getting done and they tend to be take private transactions.

[00:09:24] And it's mainly because the public software in SaaS multiples, you know, we spoke about previously

[00:09:30] they've retreated and that allowed at those lower public valuations, it allows the sponsors,

[00:09:36] their lenders and investors to get comfortable faster with the valuation of those companies.

[00:09:41] But in the private market, we still haven't seen that acceptance of the lower valuations by

[00:09:45] the sellers. And I think that's why we continue to see a headwind for PE MNA activity more broadly,

[00:09:51] but you're probably still seeing some of the headlines on some of the take private transactions.

[00:09:55] So what we are seeing when PE is interested, it's actually when it's the higher quality assets

[00:10:01] sitting in the market and that could be a take private, it could be a public company carve out

[00:10:05] transaction or even in the PE back portfolio company. And those quality assets come to

[00:10:11] market, we're actually still seeing AR multiples and above those mid single digits and still seeing

[00:10:16] a decent multiple on those. But outside of those quality assets and those public assets, there's

[00:10:22] still an evaluation gap in the private company buyers and sellers and what they're willing to accept.

[00:10:28] And I'd say we're starting to see more activity, we're starting to see private equity firms start

[00:10:33] sell side processes. But most of that activity that we're seeing right now,

[00:10:36] it's still taking a longer period of time to launch or to close because there's valuation gaps

[00:10:42] or there continues to be concerns about the top line growth profile. That's a lot of these

[00:10:47] software and SaaS companies, because it's been 12 months of decreasing net retention rates

[00:10:52] and investors are trying to really get their head around is 115 the new 130 of net retention

[00:10:57] rates. And another huge topic of course all around the world that is up there with AI is

[00:11:04] cybersecurity continues to be a major focus for executives and business leaders in every industry

[00:11:10] too. So how is the emphasis on cybersecurity shaping M&A strategies and deal making in the tech

[00:11:17] sector? Is there equally a lot of buzz around this too? There is, yeah, I've been doing this for 50

[00:11:22] plus years. And the one consistent theme is the cyber threat landscape continues to expand

[00:11:28] and customers continue to buy more cybersecurity products. And as long as there's customer

[00:11:32] demand, cybersecurity will always continue to be the first or second most active M&A sub sector.

[00:11:38] It has been for 15 years and expected to be for the foreseeable future. And that's both for strategic

[00:11:43] buyers and P sponsors. What we're currently seeing is a continued emphasis by the larger public

[00:11:50] technology incumbents to build out their platforms. And they're using M&A as a way to add new

[00:11:55] products and enhance their offerings. And this is especially true around cloud security

[00:12:00] and protecting data across cloud based services, third party APIs and obviously gen AI applications.

[00:12:07] And then what's also actually pretty interesting right now is we're seeing a bunch of next gen

[00:12:11] cybersecurity companies, some of which may even be P back, they're going after these older

[00:12:17] cybersecurity companies was low to negative top line growth, we've not really been able to

[00:12:22] make the shift to the cloud or to a subscription model. And they're using this as an opportunity

[00:12:27] to acquire an enterprise customer base at a fairly reasonable valuation level.

[00:12:32] I'd say that's sort of the trends we're seeing right now with cybersecurity.

[00:12:35] And although there is a lot of excitement in the industry at the moment, I think it's also

[00:12:39] important to highlight that there's a certain amount of uncertainty all around the world here

[00:12:44] in 2024. So considering the geopolitical and economic headwinds that faced in 2023

[00:12:51] and again continuing in 2024, what are the anticipated challenges and opportunities for

[00:12:57] tech and M&A activities throughout this year? And maybe into next year too.

[00:13:03] Sure. So let's move into the headwinds and those 2023 headwinds, they're still here in 2024,

[00:13:09] where we definitely have two major wars. We have continued tensions with the world's

[00:13:14] largest economies. And then there's some pretty large presidential elections occurring

[00:13:18] this year, including in the US. And all three of those have the potential to create risk and

[00:13:24] uncertainty. And that's always a negative for M&A when you have uncertainty and risk.

[00:13:30] On the macro side, inflation stabilized, but it's not coming down as quickly as people

[00:13:35] expected. And now we're starting to see people price in three rate cuts versus four,

[00:13:40] at least here in the US. And if we have continued delays and rate cuts,

[00:13:43] I do think that could be a headwind down the road for M&A. And then finally,

[00:13:50] antitrust and the regulatory environment. And in my career, this is the most active I've ever seen

[00:13:55] it. And I think we'll continue as a result to see a void in large transformational deals by

[00:13:59] the mega cab technology companies. You know, we're talking with clients and they're not

[00:14:03] only right now trying to assess whether or not a deal can get approved early on.

[00:14:08] They're really concerned with the length of time it may take just to get the approval.

[00:14:12] And then their risk, when something goes out for 12, 15, 18 months, the risk it has not only

[00:14:17] to their business, but also to the target's business as those longer reviews occur.

[00:14:22] But on the positive side, you know, a couple drivers I think will be a tell when for M&A is

[00:14:30] there's a backlog and a bunch of private companies who haven't raised capital in over 12

[00:14:34] months. And they're going to have to raise capital again at some point soon.

[00:14:37] And right now, we're looking at a depressed IPO market. And it doesn't appear that the VCs are

[00:14:43] going to be re-upping with those companies. So our view is we expect that to drive a lot of M&A

[00:14:50] in the back half of 2024 as a lot of these companies use M&A as an exit

[00:14:55] versus trying to go and do another capital raise. And then what gets me most excited

[00:15:01] is a lot of people call 2023 the year of efficiency. And companies spend a lot of

[00:15:04] time cleaning up their cost structures and their balance sheets. But my clients now are speaking

[00:15:09] to me about growth again. And within the technology sector, one of the biggest historical

[00:15:14] drivers of growth has always been through M&A. So people are starting to think, okay,

[00:15:19] we've cleaned everything up, let's move towards growth. And a lot of that will result in

[00:15:23] M&A, which makes us pretty bullish on 2024. And another question I have to ask you is around

[00:15:30] the 2022 Chips and Science Act. And now that's boys to impact the tech sector significantly.

[00:15:36] And Chips stands for creating helpful incentives to produce semiconductors for anybody listening

[00:15:42] that hates me talking in accurate names. I think it's an important topic because for so long,

[00:15:48] there was I think it was 64% of the world's semiconductors that we all take for granted

[00:15:52] and rely on came from one area, which was Taiwan. So how do you see this act influencing

[00:15:59] strategic acquisitions underboard attack M&A landscape throughout this year?

[00:16:04] Well, I think the Chips Act should push semiconductor companies to make more strategic

[00:16:08] acquisitions to enhance not only their domestic manufacturing capabilities in the US,

[00:16:13] but also diversify their supply chains. You know, I spoke about the geopolitical and

[00:16:18] antitrust environment. And I think that's going to make it really challenging for semiconductor

[00:16:22] companies to perform M&A. So what we actually think is more likely is I think we'll see more

[00:16:28] joint ventures, partnerships, partnerships and alliances by the semiconductor companies,

[00:16:34] both here in the US and internationally to go after these government subsidies.

[00:16:38] So while we don't expect it to be M&A, we do expect a bunch of activity

[00:16:43] and alliances and partnerships to be built to go after those funds.

[00:16:46] But I would say, related to that infrastructure layer with the interest in Gen AI by companies

[00:16:53] and governments, one area where we are starting to see significant activity, both M&A and investment,

[00:17:00] is in the build out of data center capabilities to meet the current AI needs.

[00:17:04] And while Chips are a huge enabler of Gen AI, so are data centers. And we expect to see

[00:17:09] more government funding as well to go support data center acquisition

[00:17:13] and build down the US. And we think that will drive much more M&A activity than more

[00:17:18] semiconductor themselves acquiring and integrating one another.

[00:17:23] And finally, with one eye towards the future, and I know the speed of technological change

[00:17:28] at the moment makes it almost impossible to make predictions. But from your vantage point here,

[00:17:33] what are the key sectors or technologies within tech M&A that companies should

[00:17:38] be watching closely for this year, especially considering the continued quest for Gen AI

[00:17:43] capabilities and market adjustments? There's a lot going on right now, isn't there?

[00:17:48] There is. There is a lot. And I would definitely say AI, tech and talent deals, and cybersecurity

[00:17:55] will definitely be the leading sectors just like they were in 2023. But along those same lines,

[00:18:02] we're actually seeing analytics and data management software continue to be in demand

[00:18:06] as companies look for ways to manage, host and consume these large datasets that they're

[00:18:10] using for their internal business purposes or definitely for AI use cases. So data analytics,

[00:18:15] management software, we expect it to continue to be hot. And then within the US, you have an aging

[00:18:21] population. And I'll never bet against vertical software, healthcare software M&A as healthcare

[00:18:27] is essential regardless of the economic environment. So we expect to see continued activity there.

[00:18:32] And so similarly, the government both federal and local, they have aging infrastructure,

[00:18:37] they have old systems and software processes. And actually think one thing to keep an eye on

[00:18:42] is I think we'll start to see more vertical software companies focused on developing products

[00:18:47] specific for government use cases. And I think we'll see more of that activity in 2024.

[00:18:53] And then we did talk about the Chips Act and semiconductors. And while semiconductor M&A has

[00:18:58] been slow, one area that's been hot, and I expect to remain hot is on the software used

[00:19:04] to design and analyze chips and electronic systems. As more companies like to design their own chips

[00:19:10] across and systems across different industry groups, I think the attractiveness of chip design,

[00:19:16] analysis and simulation software really will mean remain high and expect even more M&A in

[00:19:22] that sector going into 2024. And of course you are working in an incredibly fast moving

[00:19:28] industry. And on behalf of every business leader listening all around the world, there's

[00:19:32] I think we all collectively feel this pressure on being a state of continuous learning. So I've

[00:19:38] got to ask someone that's keeping up with so many of these trends, where or how do you

[00:19:43] self-educate? Any tips or anything you can share on that? Are you keep up speed with these trends?

[00:19:48] The only way I think he will make your work because this technology sector just moves so quickly

[00:19:53] and I think it's very challenging to keep up. So what I try to do is wake up early in the

[00:19:58] morning. I'm like a 5am type person. I block off my first 1-2 hours each morning and I try to

[00:20:03] read industry publications, listen to podcasts or read analyst reports. And what I found and just

[00:20:10] because I love the sector X and like sub stacks tend to be great avenues to find really unique

[00:20:15] voices. And then those individuals recommend other individuals and then my reading list

[00:20:20] just continues to expand and expand. And that's sort of what I do on each morning as I

[00:20:24] start the day. And I actually maintain my own reading list not only for myself but for my

[00:20:29] colleagues who are part of my sector. I think we're up to like 15 non-traditional media sources

[00:20:34] that we go and use for content. And as most of your listeners probably know,

[00:20:38] like Ben Thompson is your techie. He's the OG. He started all of this and he's phenomenal.

[00:20:44] But there's a few other sources like clouded judgment by Jam and Ball. I think Meritik

[00:20:49] Capital's software polls that they put out monthly and the Pragmatic engineer. When those emails come

[00:20:55] in, I quickly read them. I think they're great. And then I think from a podcast, we obviously

[00:21:01] have your podcast and you know there's also BG Square which is the new Bill Gurley-Braggersner

[00:21:08] podcast as well. I think they do a great job. Fantastic advice. I'm just a little relieved

[00:21:14] that you didn't say that you had some kind of Mark Wahlberg style regime when you said

[00:21:18] we're going to put five. I mean not the 3AM guy work out, I mean bad for seven o'clock,

[00:21:22] anything like that. It's more of a coffee and reading for me. Yeah, not the Mark Wahlberg work.

[00:21:29] Obviously when we've mentioned the TechEbenei Outlook report there and we've talked a lot about the

[00:21:35] world you're in and the Ernest Young website is a huge website. Is there any way in particular

[00:21:40] you would like to point anyone listening wanting to find out more about the report or some

[00:21:43] of the topics we talked about today? Yeah, so on our homepage, TMT is a sector. Go there. We have

[00:21:50] some great thought leadership whether you're in technology, mini-entertainment or telecommunications.

[00:21:55] Please go there. We post new materials each week. And then I also post on my LinkedIn,

[00:22:00] so James Brundage on the LinkedIn website and feel free to go there and I actually

[00:22:06] post a lot of our materials there as well. Well, we covered so much in a short amount

[00:22:11] of time there from some of the catalysts of the Ebenei world continuing demand for GNAI,

[00:22:16] of course, PE firms starting to increase investment and they've got cybersecurity.

[00:22:21] Then we've got the TechEbenei Edwin's geopolitical ongoing regulation, higher cost of financing.

[00:22:26] I do urge anyone listening to check out the area of the website. I'll put a link on there so

[00:22:32] it's nice and easy for everyone to find you. But more on everything just thank you for coming

[00:22:35] on and sharing your insights today. Much appreciate it. Thanks, Neil. I really appreciate it.

[00:22:40] Once again, a huge thank you to James for sharing his insights today and

[00:22:44] the big takeaway for me is that it's clear that the TechEbenei landscape

[00:22:48] is teaming with both challenges and opportunities. And the proactive stance of companies coupled

[00:22:55] with the strategic investments in AI and cybersecurity, they all point to a dynamic

[00:23:00] future for TechEbenei. However, that journey is indeed fraught with geopolitical tensions,

[00:23:06] regulatory hurdles and the ever-present challenge of financing.

[00:23:12] But as we do collectively look towards a robust 2024 for TechEbenei, I think the insights shared

[00:23:19] today by James offer a comprehensive understanding of the forces shaping the future of technology

[00:23:25] investments. But of course, what does that mean for the broader tech ecosystem

[00:23:30] and for businesses looking to navigate these turbulent and maybe even uncharted digital waters?

[00:23:38] Well, this is where I'd love to hear your thoughts on how these trends might impact

[00:23:42] your own strategies and ask you to share your perspectives with me. Join the conversation.

[00:23:47] You've heard from me. You've heard from James today. But I'd love to hear your thoughts

[00:23:51] and you can do that by emailing me techblogwriteroutlook.com, Twitter, Instagram, LinkedIn,

[00:23:57] just add me or see Hughes. Don't just hit connect. Send me a direct message. Tell me you've listened

[00:24:02] to the episode and share your thoughts. It could be something completely different. Maybe you

[00:24:07] thought we missed something today, but you are so important in helping us continue to

[00:24:13] explore this ever-evolving landscape of technology and business. So I'll put a copy of the

[00:24:18] report that we referenced over on my website techblogwriter.co.uk. If you go to podcasts,

[00:24:25] you'll see nearly 3,000 interviews with business leaders around the world.

[00:24:30] Straight away upon listening to this, you should be able to find a blog post

[00:24:34] and I'll link to the report that we referenced as well.

[00:24:37] But I'm afraid that's it. We're out of time today. Tomorrow will be a completely different

[00:24:42] topic around how technology is transforming our life, our work and even world. So I

[00:24:48] hope you'll join me again tomorrow for another conversation and maybe we can learn a thing

[00:24:53] or two together. That's the plan, but thank you for listening as always and until next time,

[00:25:00] don't be a stranger.