THE QUESTIONS ENTREPRENEURS ARE ASKING: WHERE IS THE MARKET GOING?
Only a fool tries to time the market. But only a fool ignores the importance of market timing. I know many entrepreneurs who tried to sell too late – but not many who sold too early. If you are a hammer, everything looks like a nail. Who can you trust in this hall of mirrors? Kidding aside, we are frequently asked by entrepreneurs, “where is the market going,” or “how long will the strong tech M&A market continue?”
Last week Geekwire asked us to comment on Amazon’s 7x drop in M&A in 2016. This gave us a good reason to dig into the data and form some opinions about the current health of the market, and to make a few predictions for 2017.
First, let’s be cognizant that the financial press focus on the big deal, whereas over 90% of tech M&A deals are under $100 million. For example, Fortune covered the wave of broken deals in 2016, but their lens was focused on huge, cross-border M&A across all industries These mega deals are more impacted by regulatory changes and political changes than the mid-market tech M&A deals we focus on.
Second, we were reminded that the media tracks announced transactions, which are typically initiated 3 to 6 months before they are announced. Announced deals are therefore a trailing indicator of the health of the market.
Third, we are seeing a lot of companies coming to market. After reviewing our communications with mid-market companies and private equity firms, we saw the sheer volume of outbound PE inquiries distorting the apparent health of the M&A market, and perhaps played a role in this trend. More obvious is the valuation environment; a lot of good companies want to take advantage of high valuations.
Let’s address these point individually.
Over 90% of Tech M&A deals are under $100 million. How often are these smaller transactions reported in the Wall Street Journal? Only when a buyer (or attention-seeking exec employed by the buyer) spends a lot of money on a PR firm. The financial media provide great coverage on big deals and big trends, but to get a sense of what is happening in the mid-market for tech M&A, we need to go to different sources.
For great mid-market coverage we like CBINSIGHTS, 451GROUP, Geekwire, TechCrunch, and too many high-quality tech business blogs to name individually. We also find, as Todd Bishop at Geekwire confirmed, that public company filings often include disclosures that don’t appear anywhere else.
If we look at the appropriate data for mid-market tech M&A, what does it tell us? First, that acquisitions by traditional technology acquirers did peak in 2013 and 2014, but that industrials, private equity, and new international buyers – in particular from China – have picked up the slack and helped maintain a robust deal flow.
The good news: Non-traditional buyers of tech companies (Carriers, industrials, fashion, etc.) will continue to bolster M&A activity.
The bad news: international activity has already slowed due to Brexit, uncertainty over the new Republican administration, and a marked slowdown in successful M&a attempts out of China.
Announced deals are a trailing indicator. There is no reliable, independent measure of how aggressively acquirers are initiating deals at any specific point in time. Anecdotally, we are finding a lot of acquirers distracted by in-process M&A, so our sense is that a lot is happening right now. We are talking with growth equity targets that are aligning their M&A strategy with series B or C funding rounds. We are also seeing a lot of confidence and latitude among product managers and Corporate Development teams, which creates the kind of confidence necessary for a healthy M&A market.
Market Saturation Risk. We track approximately 130 financial sponsors that are active in mid-market M&A. We see the same firms contacting our clients – sometimes all of them. We see mid-tier PE firms with 30 MBAs in a boiler room, calling against a list of 8,000 companies, having 2,000 conversations resulting in 150 meetings, 45 LOIs and 15 closed deals. We see other PE firms contracting with buyside representatives to reach out to similar lists. The net result is that CEOs feel inundated by interest, and are sometimes drawn into a process without understanding that interest from 100 PE firms is the same as interest from 1 PE firm; they are all targeting the same profile. They are all calling the universe of companies in order to update their CRM systems so they won’t miss anything. Naturally it is more complicated than that; some want high-growth with a healthy burn, some want profitable slow growth, others are seeking highly profitable companies and don’t care about growth. But the fact is, being called by a PE firm does not indicate interest on the part of that PE firm in investing in your company. It just means they are keeping their database up to date.
Investment bankers are pouring gas on the same fire. I have four clients that have been called on by the same firm in the bay area, and it got to the point where I started to receive resumes from their people, because our name kept coming up. But as with the financial sponsors, interest from a banker doesn’t mean that your company can be sold for a valuation that meets your requirements.
In our conversations with CEOs they often remark on how the cadence of inbound inquiries have increased in the last six months. We ask them how many of those inquiries came from strategics, or came in the form of a partner-level introduction through a mutual acquaintance. Don’t be distracted by the PE frenzy. One of our clients accepted lunch with a PE firm during a recent tech conference and, as our client put it, “as soon as I told him our revenue he developed a lot more interest in his salad than our conversation.”
Valuations are good. The public markets are strong. The Unicorns have, for the most part, survived their down rounds. Companies looking to take advantage of high valuations are preparing to go to market, or are already in the market. It will be very crowded out there in 2017. More sellers does not create more buyers.
Back to our core thesis: the volume of inbound inquiries is not a reliable indicator of the health of the M&A market, and if you are going to put your company in play, be very careful to differentiate yourself so you don’t get lost in the crowd.
In Summary,
1) To assess the health of the M&A market for your own company, check deal activity on tech blogs, CBINSIGHTS, 451 Group and other similar resources, and don’t rely solely on the financial press.
2) Remember that announced deals are a trailing indicator, and that a more meaningful predictor of your own opportunity are a) the confidence level and b) the stock market performance of your potential buyers.
3) You are probably getting approached regularly. Put all of the generic PE inquires in one bucket and consider them to be a single knock on the door. Every inquiry by a strategic counts. Every thoughtful approach at the partner level from a PE firm counts. And if you do go to market, remember how important it will be to stand out in the growing crowd.