Technology deals insights: Midyear 2020

COVID-19 has had a significant impact on the tech space, accelerating trends that we expect to persist longer term. As a result, we expect many companies will provide more opportunities for employees to work remotely, making tech companies more attractive M&A targets for buyers looking to improve or supplement their existing capabilities.

As companies look to strengthen their market and competitive positioning, it will require rethinking of all aspects of the business from workforce, products and services, end-user experience and how these are all facilitated by a digital platform.

We believe those companies who adopt a structured value creation methodology to identify and articulate the drivers of value created or lost through COVID-19 will be well placed to find opportunity in the tech sector.

We expect FAANGs will emerge stronger from COVID-19 than their less well-capitalized competitors and despite the regulatory scrutiny, we expect them to continue to pursue deals to unlock value and grow through transformative acquisitions. However, fears of increased regulatory scrutiny may block megadeals, with greater focus instead on mid-size assets. More stock-based transactions are likely in the short term as a means to address relative valuation uncertainties and as companies look to preserve cash.

While many enterprise technology companies have benefited from the increasing demand for online and remote capabilities, other sectors within tech will see lower demand as the recession impacts technology spending. Accordingly, tech companies will need to assess workforce levels and non-discretionary spending to maintain operating cash flows and those more significantly impacted may present opportunistic acquisition targets.

We expect to see acquirers take a more deliberate approach to deal-making as the acquisition process transforms in response to COVID-19 and in-person interactions will be replaced with virtual processes to assess talent, evaluate company culture, and execute on a value creation plan. Sellers will need to set up their own virtual process to provide transparency and give buyers comfort in closing the transaction.

We expect the recovery in the financial markets and rising valuations, particularly in technology, to be a strong tailwind for the IPO market. There has been a significant backlog of unicorns waiting to IPO as a result of COVID-19, including Palantir, DoorDash, Robinhood, Databricks, Unity, Tanium, Snowflake, and many others. If favorable market conditions persist, we expect several of these companies to successfully IPO.

While COVID-19 has undoubtedly had a large impact on M&A transactions, we believe many Technology sectors have proved to be resilient and deals will continue to recover through the remainder of 2020.

While we expect all sub-sectors to show improved M&A activity in 2020, each sub-sector’s deals will be driven by unique factors:

Software deal value decreased dramatically in Q2 2020 by 73% quarter over quarter and a decrease of 70% from the first half of 2019 to the first half of 2020. COVID-19 has boosted enterprise SaaS, cloud, and subscription-based models, with a spotlight on deals in the security space, especially identity protection. This has led to higher valuations and the recent opening of the IPO window for fast-growing companies, we expect more IPO activity in this space in the second half of 2020. The increasing valuation premium of cloud companies over other tech sectors may deter acquisitions.

Internet

• Gaming/Social Media/Streaming - Gaming, online social activities, and streaming have seen higher usage as result of COVID-19, with deal activity in these sub-sectors continuing to be strong.
• E-commerce - Many industries are being forced to shift to virtual operations and online platforms, driving an increase in online activities to new industries such as education, while reinforcing the ongoing digitalization of industries such as retail. Brick-and-mortar retailers, many of whom were struggling to address the e-commerce trends before the pandemic, will need to improve their online capabilities as a means to survive.

IT Services deal value has come down in Q2 after two consecutive quarters of increased activity in this space, but generally in line with quarterly averages and almost double for the deal value for the first half of 2019 attributed to Q1’20’s high deal volume. We expect both value and volume to go up in the second half of 2020 as all other sectors view technology as the essential enabler for digital transformation and growth.

Semiconductors deal activity was essentially non-existent in Q2 2020 which resulted in a 93% decrease in deal value comparing the first half of 2020 to the first half of 2019. Chinese companies are looking to develop more homegrown chips in response to a recent tightening of rules by the US intended to restrict the sale of US semiconductors to China’s Huawei. We expect Chinese inbound investment to the US to be slow as US regulators continue to draw a hard line against the acquisition of any key US technology.

Hardware companies have faced supply chain issues internally, and cost cutting has diminished external demand for hardware products. Given lower valuations in the hardware space, we expect the large tech companies will opportunistically expand their product portfolio through acquisitions.