Welcome to the latest edition of technology insights, our round-up of mid-market M&A deals in the UK technology space, covering IT services, software, fintech and advertising.
This report covers the fourth quarter of 2020, an interesting period for deals as the market continued to build on the resilience shown in Q3.
Q4 enjoyed a significant step up in closed deals, as market confidence strengthened on positive vaccine news, and extended government support programmes continued to pump record levels of liquidity into the economy.
While there was an element of catch up in deal-making, the appetite for technology assets has been built on the back of resilient trading performance, demonstrating the strength of underlying business models.
At a headline level, there were 258 announced deals in Q4 2020, an increase of 49% from Q3 2020, and a small increase from Q4 2019. At one level, Q4 represents something of a return to normality, with a sharp increase from Q3 and growth from the same period last year.
Software sector accelerates
Software remained a bright spot within the technology arena, accounting for 128 (61%) of transactions in Q4 2020, spanning a broad range of subsectors and acquirer types, including strategic trade, private equity (PE) and PE-backed trade.
Robust activity in software continues to illustrate the underlying attractiveness of software for dealmakers, with recurring revenue models, high degrees of scalability and a large, addressable market driven by the continued acceleration of transition to the cloud.
Other sectors also performed well. IT services accounted for 78 deals (30%). The speed of adoption of digital-first business models created huge opportunities for managed services and consulting-led partners, alongside the inevitable impetus provided by increased mobile working.
Fintech continued to see some interesting transactions, as regulatory drivers and the continued emergence of more agile, consumer-oriented financial services solutions drove activity. With 19 deals (7%), volume was more subdued but the drivers for consolidation in this market remain strong, which leads us to expect increased activity in 2021.
Looking at some of our own transactions in Q4, they are strongly reflective of these trends. We were delighted to advise the shareholders of iSAMS (management information systems for schools) on their sale to Hg Capital and ICG backed Iris Software and VIPR (an insuretech platform) on their transaction with Tenzing Private Equity.
Moving into 2021, the deal pipeline for Q1 across the market should underpin a strong start to the year, as vendors look to transact ahead of any potential changes in capital gains tax in March. The impact of the latest lockdown is far less pronounced this time around from a deal perspective. The technology sector has been able to find ways to get comfortable on key diligence and transaction issues without the need for extensive physical face time or international site visits.
While the economic recovery and outlook remain fragile, we think 2021 is shaping up to be a banner year for technology transactions, with IPO market activity resurgent, highly liquid balance sheets of corporate acquirers, and the deep pockets of private equity and debt funds looking to deploy capital in the sector.
Technology sector overview
There were 258 announced1 transactions in Q4 2020, an increase of 49% from Q3 2020 and almost 1% from Q4 2019. The fourth quarter of 2020 represents a relatively normal M&A volume, and the only quarter in 2020 to post an increase from the same period last year.
Source: Capital IQ, Mergermarket, Megabuyte, Grant Thornton Research
Disclosed total deal value rebounded more strongly, reaching £18 billion in Q4, up from £7.6 billion in Q3, the highest quarterly performance over the last 2 years. Most of this uplift was accounted for by a single deal: the Special Purpose Acquisition Company-driven (SPAC) acquisition of Paysafe for £6.7 billion, illustrating continued industry consolidation within the merchant-acquirer space.
Other megadeals in Q4 included:
Jacob’s acquisition of PA Consulting (digital transformation - for £1.8 billion)
TalkTalk’s sale to Toscafund/Penta (telecoms – for £2 billion)
CDK’s carve-out of its UK-based international division (automotive dealership software – for £1.1 billion).
However, the technology, media and telecom (TMT) M&A environment in the UK remains predominantly mid-market. Activity in Q4 was characterised by a broad spectrum of different acquirer and deal types:
Cisco announced the acquisition of listed CPaaS provider IMImobile for £540m (equating to 3.3x trailing EV/ Revenue / 3.2x forward). The acquisition is expected to enhance Cisco’s ability to offer more compelling contact centre experiences for its clients. Public market listed assets are increasingly coming on the radar for M&A, so we can expect to increase activity in this arena in 2021.
Capita continued its restructuring programme with the sale of its Education Software Services division to Montagu Private Equity for £400m (equating to 4.2x revenue or 8.2x EBITDA), combining it with an investment in ParentPay. This well-trained divestment process has triggered a flurry of activity in the EdTech market.
Insurance software provider SSP announced it was to be acquired by Canadian listed Constellation Software through its Volaris division, for an estimated £200m. SSP was formerly a portfolio company of Lloyds Development Capital and SEP.
Significant technology acquisitions
Looking at the most-active UK acquirers in the last quarter, the following led in terms of volume, with four acquisitions each:
Aqualine backed ClearCourse (CRM and membership software consolidator)
August Equity backed new buy and build platform Air-IT (IT managed services)
TA Associates/Hg Capital-backed Access Group (enterprise software)
Other significant acquirers include:
Wireless Logic (three acquisitions to add to the Montagu Private Equity-backed m2m platform, including the transformative deal with Arkessa)
Civica (also three acquisitions for the Partners Group-backed public sector software consolidator)
Notably, all the leading acquirers are PE-backed ‘platform’ businesses, illustrating the key role PE capital plays in the UK mid-market.
Valuations continue upward march
In terms of valuation, the mean EV/revenue for the Q4 reached 3.8x – a sharp increase from the low point at the end of Q1. – evidence again of investor appetite for TMT businesses.
There is talk of a resurgent 'Tech Bubble'. However, whilst deal multiples may have shifted up a turn by the weight of money chasing the high recurring revenue and high growth assets, it is not a rising tide that lifts all ships. There is a flight to quality and scale.
Average UK TMT EV/Revenue multiple by quarter
Source: Capital IQ, Mergermarket, Megabuyte, Grant Thornton Research
We have seen little evidence that sellers have needed to adjust pricing expectations due to the pandemic. For businesses that have traded well through the COVID-19 period, high levels of available liquidity have created an environment where multiple exit options are possible. Many are capitalising on the opportunity to crystallise some equity value and mitigate the risk of future capital tax rises. Whilst there's no rush, many are considering their options and looking seriously at what is possible.
Capital markets view
Looking at listed businesses, which still provide the best real-time view into valuation and sentiment, the technology-heavy NASDAQ index increased in price faster than the global MSCI index (which is more weighted to the total economy).
While the demarcation between a technology business and what is not has increasingly blurred, there remains an investor preference for the technology sector. Looking at trends from the beginning of the year, the NASDAQ index is up 42%, whereas the MSCI World is up 13%.
Valuation multiple expansion is part of the driver of the explanation. The implied valuation (in terms of TTM enterprise value/revenue) of leading global equities within our four sub-sectors of interest is shown below:
Source: Capital IQ
Fintech and software businesses receive the highest valuation, on average, reflecting their strong growth prospects and scalable propositions. It is notable that over the 12 months every subsector either matches or exceeds its average multiple for the beginning of the year.
Did the sector merit a fundamental re-rating? Perhaps – for a long time, there have been comments about some of the differential market multiples for technology assets between the US and the UK. However, there is undoubtedly some effect from the weight of capital looking for robust earnings, cash generation and growth.
Beyond technology, the choice for investors has appeared limited and fraught with downside risk. Lockdown was the first real test for many technology-led business models since 2008/9: given that most have not only survived, but thrived, some multiple expansion is expected due to greater investor recognition of the durability of these businesses.
Looking at performance on an actual price basis shows a similar picture:
Source: Capital IQ
Notably, this performance by subsector is reflective of the upgrades in broker forecasts for listed technology assets. On average, brokers have significantly increased their target prices for TMT businesses in 2020, suggesting that the run-up in valuation is not just underpinned by enthusiasm:
Average increase/decrease COVID-19 situation in target security price from 1/1/20 to 31/12/20
Advertising and marketing services
Source: Capital IQ
In summary, 2020 has proved to be a far more resilient year for M&A than most envisaged in the depths of the first UK lockdown in May 2020. The technology sector has been the shining light in the resurgence in deal-making in the second half of 2020. The bounce has been impressive, but will it be sustained?
Q1 2021 will likely see elevated transaction volumes as sellers pre-empt potential changes in future capital gains tax regimes – but the outlook for the rest of the year also feels strong.
The UK vaccine rollout continues apace. While the journey will not be linear, the route towards a broader recovery in economic activity will be supported by record levels of government support and infrastructure programmes. Technology will remain at the forefront of the recovery. However, management teams and investors will need to hold their nerve and show tremendous flexibility and agility to ride the wave. The evidence of 2020 shows they are well equipped to do that.
To discuss deals within the technology sector further, contact Andy Morgan.
1 All deal activity is based on the deal's announced date and includes deals with a UK target or deals with a UK domiciled acquirer. Deal activity excludes growth capital transactions.
2 Deal values are mainly sourced from corporate websites. However, if no press release is available, they are sourced from deal databases, including Capital IQ, Megabuyte and Mergermarket, or press commentary released at the deal's time. Deal values may subsequently be amended as the acquirer releases further detail.