There are several factors enabling tech to resist current pressures: from the accelerating digital transformation wave and high cash conversion of much of the sector to resistance to inflation. In our Q2 2022 TMT review you'll get full details on this, as well as briefings on the four trends you need to look out for in the next few months. Another key development is the widening range of stakeholders prioritising ESG. Tech companies need to be mindful of its relevance to cost, revenue, and reputation.
In Q2 2022 disclosed deal value was £14.4 billion, up 35% on Q2 2021 (£10.7 billion) and 29% when compared to the previous quarter (£11.1 billion).
Deal values are sourced from corporate websites, deal databases (including Capital IQ, Megabuyte and Mergermarket), or from press commentary released at the time of the deal. Deal values may be amended as further detail is released by the acquirer.
The figure was bolstered significantly by The Access Group securing further investment from existing investors Hg and TA Associates, and incoming institutional investor GIC, which was done at a mid-20x EBITDA multiple, valuing the company at £9.2 billion.This highlights the continued strong appetite and valuation environment for private equity-backed, profitable and cash generating software businesses, notwithstanding tightening debt markets.
As we've seen before, valuations have held strong for assets which are cash-generative and demonstrate consistent growth over three years, have visible recurring revenues, opportunities for cross-selling, and provide a strong buy and build platform.
Though tech is not immune to the inflationary pressure of rising energy, wage costs and increasing interest rates - driving continued talent shortages, overhead pressure and supply chain challenges in certain parts of the market - in many cases it's more resilient to inflation than most other sectors.
High-margin models can absorb rising costs, while the customer base of the increasingly prevalent subscription-revenue models is becoming conditioned to annual price increases. The business critical nature of most B2B SaaS models will likely remain robust and attract capital compared to consumer-facing tech models, which are more exposed to inflationary pressures and customer demand softness.
Ironically, an inflationary environment can strengthen the investment case for technology which increases clients’ productivity and reduces costs.
Compared to its peers, tech is not a highly-leveraged sector. The cash-generative nature of many businesses within the sector makes them an attractive M&A target amid rising interest rates.
However, this is less true of early-stage companies and emerging SaaS models, which typically require growth capital. This is where the pressure on funding cycles is being felt with many management teams reassessing their cost base to extend their funding runway and shorten their path to profitability and cash generation. These are more likely to feel the macro-economic heat in the coming months, though we can expect the winners to come out stronger.
The MSCI and NASDAQ are down 20% and 15% respectively for the year ending 30 June 2022, with continued volatility and weakness over Q2. Capital-market sentiment has continued to move away from growth stocks, driven by global macroeconomic factors and more aggressive interest rate policy as central banks try to get high inflation under control.
In terms of sub-sectors, fintech suffered a sharp decline and is down 26%. Advertising, IT services, and software fared slightly better, dropping by 10%, 14%, and 21%, respectively.
Tech stocks’ recent underwhelming performance has not dampened appetite for technology M&A. It must also be set against the context of a remarkably strong bull-run over a sustained period in recent years.
Buyers are seeking deals based on strong fundamentals and strategy, which can help offset (or at least withstand) the macro-challenges that have pushed capital market investors towards more defensive stocks.
The weakening of capital market valuations creates buying opportunities for some. Optum UK’s £1.24 billion acquisition of UK healthcare technology provider EMIS is a good example of strategic trade with strong balance sheets and liquidity seeing buying opportunities. The deal represented a 49% premium to EMIS’s share price but adds scale, a strong market position in the UK healthcare eco-system and a highly profitable and cash generative asset to Optum UK.
We've also seen the return of the public to private transaction with PE-investors seeing value in listed technology stocks. The £1.1 billion recommended offer by Hg for regulatory and compliance software consolidator Ideagen plc being the stand-out deal. We may well see more over the remainder of 2022 if valuation softness in capital markets continues into Q3 and Q4.
We saw several dual-track processes in Q2 amid strong competition between trade and private equity. Trade was responsible for 164 deals (54%), PE-backed trade for 105 deals (34%), and PE stand alone accounting for 38 deals (12%).
We’ve seen a growing trend of maturing UK buy and build platforms expanding their horizons outside of the domestic market.
In April, UK business messaging platform Commify entered the US market through its acquisition of CDYNE Corporation. Commify already has a proven acquisition model in Europe, and it's now looking to copy this over to the fragmented and high-growth US market. We provided due diligence services.
Other overseas moves include business management software firm The Access Group acquiring Australian volunteer management software firm DutySheet, while Iris Software has continued its push into the US with multiple acquisitions over the last 12 months.
In April, HSBC issued its first sustainability-linked loan (SLL) to a tech company, Maintel Holdings (on its website Maintel states that it is committed to science-based targets aligned with 1.5 °C). We're seeing more tech players benefit from this type of loan which offers favourable interest rates in exchange for good ESG practice.
We're seeing increasing interest in TMT companies that help their clients achieve governance targets related to compliance.
In April, professional services and technology group Davies acquired Worksmart, which helps organisations to track and manage regulatory processes. We provided buy-side advisory services.
Likewise in June, Ideagen’s shareholders accepted a 350p-per-share offer from private equity group Hg valuing the company at £1.1 billion.
The adage that the smartest person in the room is the one with the data, could as easily read, the richest person in the room…We're seeing an increasing number of deals focusing on sector-specific data specialists.
In April, Allfunds Group swiftly followed up its euro 145 million acquisition of WebFG from Bridgepoint by acquiring InstiHub, which provides market insights and pricing data to the delegated fund industry. We provided sell-side advisory services.
Finally, when shares in big consumer-facing names, such as Netflix or Meta, are falling, it's easy to forget the workhorses of the tech sector. These are the software, services, and IT companies that satisfy the continuing demand for digital transformation and compliance. It's these that will continue to underpin M&A activity if economic and market conditions face a tougher outlook over the next 6-18 months.
ESG matters to a range of stakeholders. However, the fundamentals of corporate valuation haven't shifted and through the way in which ESG impacts their behaviours, it can flow through into a corporate valuation.
ESG can be a product differentiator, improving revenues through increased demand and prices. For example:
Value can also be created through developing products and services to enable others to meet their ESG goals. Examples of where this occurred includes:
And ESG can also bring a positive impact on cost. Employees increasingly focus on more than pay when deciding on employers, particularly in this tightening labour market. Inclusion and diversity initiatives, pay equality, and ESG impacts attracting and retaining talent and lower costs associated with acquiring it, but also bring in fresh perspectives.
A focus on ESG can facilitate lending, often at a lower cost. Lenders, with their own net-zero targets, are incorporating ESG metrics into their decision making.
We recently surveyed more than 40 UK-based lenders (from large clearing banks to alternative lenders) and found that 57% have an ESG-lending strategy; 85% said that a firm’s ESG status or its ability to transition to net-zero influenced the credit risk assessment.
A recent Bank of America report cited that a poor ESG score is a predictor of bankruptcy. Although that might be because those facing bankruptcy have less time to dedicate to ESG – we always need to be cautious of inferring causality.
Firms need to be aware of this direction of travel. Borrowers aren't expected to achieve net zero overnight, but lenders are increasingly looking for firms to have a roadmap in place to improve their ESG credentials – then they'll be willing to fund this transition. Will firms who don't put such a roadmap in place still enjoy the same access to capital in five years?
There can also be more serious consequences for violations in areas related to ESG. For example, in 2019 Facebook agreed to pay a USD 5 billion fine to the US Federal Trade Commission for privacy breaches. And there've been numerous other fines related to misreporting information.
You may wonder if there's an additional premium for 'being good' or a discount for 'being bad' that's factored into shareholder value?
A shortage of ESG investments relative to demand have driven up their price – this premium may be expected to dissipate as more firms improve their ESG credentials.
Beyond that, a reputational impact may be incorporated into value calculation. This can be positive – an expectation that companies with positive ESG credentials will perform well. However, it may also be negative.
We used an econometric technique, known as an events study, to compare actual returns following adverse ESG findings with expected returns in the counterfactual scenario where no wrongdoing took place. Using data from 24 UK-based PLCs that had adverse regulatory findings between 2004 and 2013, and were able to show the share price loss is disproportionately large when compared with the magnitude of any fines.
The impact of fines were equal to 0.05% of market cap on average, compared to the average value of reputational losses, which equalled 5.5% market cap. This equates to £1.15 billion worth of value loss for the average FTSE 100 firm. We've since extended this analysis to look at specific breaches that occurred in relation to ESG matters. As might be expected, the impact on the share price is greatest where there's a customer feedback loop and customers are able to "punish" the firm by switching to an alternative supplier or stopping purchasing the product entirely.
In cases where customers (at the business or retail level) are unable to vote with their feed and switch suppliers then the impact is likely to be lower. TMT products tend to be essential in nature and so any punishment is likely to occur by switching suppliers, which may potentially be constrained by the use of long term contracts or a limited number of alternative suppliers.
Our analysis also showed that the reputational damage of ESG breaches is also likely to impact over a longer time frame and result in a change to the long run growth rate of the share price as well as a one off drop that is typically associated with reputational matters.
The impact of undertaking ESG activities extends beyond regulatory compliance and has the potential to impact revenues, costs and company valuation. Increasingly a firm’s ESG activities will be of interest to a wider range of stakeholders as they become aware of the broader risks and benefits associated with a firm’s ESG strategy.