INTRODUCTION: HINTS OF LIFE IN THE TECH SECTOR GIVE REASONS FOR OPTIMISM
By its very nature, M&A is fraught with risk -- even in the best of economic times. It is not surprising, therefore, that corporations put their M&A initiatives on hold during the first quarter of 2009 while waiting for the turbulent economic conditions to calm down. While the overall number of deals is down 9% from last quarter, it is an improvement from the 23% drop from Q3 2008 to Q4 2008.1 This leveling off of the decline in deal activity, as well as large deals in early Q2 (Oracle's $5.6 billion acquisition of Sun Microsystems, Fidelity's $4.4 billion purchase of Metavante, and eBay's $995 million acquisition of Gmarket), suggest we may have reached the bottom of the tech M&A drought in Q1. Indeed, several indications in the broader technology market provide reason for hope. For example:
Frozen credit markets show signs of the first thaw. It appears that sweeping attempts by the federal government to get the credit markets moving again are beginning to see some results. As the New York Times reported in early April, investors have started to display some willingness to take on risk again, and companies with good credit histories are borrowing in the bond markets.2 According to Bloomberg research, asset-backed securities issuance volume in March 2009 jumped to $10.7 billion, near September 2008 levels, following five months of much lower volumes.
Technology stocks are strong compared with other sectors. The tech-heavy NASDAQ Composite outperformed the Dow Jones Industrial Average and the S&P 500 in Q1 2009 and over the past 12 months (see Figure 1 and Figure 2). The NASDAQ finished Q1 up 16% from its November 2008 trough.3
Anecdotal evidence suggests financial strength among many private companies. Based on Updata's discussions with numerous private IT companies, which often don't receive as much news coverage as their public counterparts, it appears that many vendors had surprisingly resilient top-line performance in Q1 and show strong pipelines. Credit contraction and a weak equity market remain a concern, however.
Public performance points to bottoming. While performance remains mixed, more public bellwethers have pointed to an end (or near-end) to declines. A good example is Intel, which posted lower profit and sales in Q1, but also beat Wall Street estimates. In announcing its results, Intel's CEO also called a bottom for the PC industry. While not suggesting a rapid bounce-back, such "green shoots" seem to be becoming more prevalent.
Areas With Potential For IT M&A Transaction Activity
Unlike in the last recession, technology is on the whole faring better than other sectors during this economic downturn. We see potential for booming deal activity in 2009 in these areas:
Mobile technology. Mobile devices continue to rapidly replace traditional wireline phones. According to market research firm IDC, wireless phones will replace wireline phones for one quarter of the US population in 2009 alone.4 What's more, the NPD Group reported that nearly 25% of all mobile phones sold in the last three months of 2008 were smart-phones, pointing to continued rapid growth ahead in the use of mobile devices for computing and Internet functions.5 With the continued development and adoption of advanced mobile technology in a virtuous cycle (witness iPhone), and the explosion of content optimized for PDAs, the mobile technology space is an area to watch in 2009. Areas of interest include mobile applications, enterprise device management, mobile entertainment (note the transformation of handheld game units made by Nintendo and Sony into Internet communication and portable movie devices), and mobile advertising technologies. With regard to the latter, eMarketer projects that mobile advertising will be a $3.3 billion market by 2013.6
Green technology. Cost savings is a major concern for business executives in these recessionary times. Environmental consciousness often coincides with long-term cost consciousness as many "green" technologies ultimately effect lower utility bills. President Obama's commitment to environmental sustainability will provide further incentive for investments in the green technology space. Areas of particular interest include data center management (energy and performance optimization) and consulting services.
Industry-specific technology. Certain verticals and sectors are proving themselves more recession-resilient than others. With the federal government expected to inject massive sums of money into certain initiatives, technologies relevant to healthcare management and environmental sustainability, for example, will be in demand. The federal government itself will be a very powerful IT customer in the coming quarters in areas including cyber-security and mobile communications. In the private sector, technologies that reduce complexities associated with regulatory compliance should enjoy a boost. IT for managing healthcare delivery also stands to benefit; executives in this sector actually plan to increase their spending in 2009.7
Overall Market Observations
Updata has observed the following trends taking place in the overall technology M&A landscape:
Proven business models more important than ever. Would-be targets are being valued by profitability metrics (typically EBITDA) more than ever before. As one large strategic buyer told us: "The bar [for overall due diligence] is five times higher than it was a year ago." The majority of buyers expect an acquisition target to be profitable, not on a pro forma or going-forward basis, but on a stand-alone basis prior to the date of closing. Dilutive deals are much less attractive. Although the gap is narrowing, large bid-ask spreads are usually the result of buyers bidding based on EBITDA multiples and sellers looking for a multiple of revenue. As the saying goes: "Buyers usually look to the past while sellers like to look to the future."
M&A precedent transactions are taking a backseat in valuation discussions. M&A valuation discussions are based increasingly on public comparable trading information, rather than M&A precedent transactions. The reason is that buyers generally see deal multiples from prior to September 2008 as irrelevant, and there have been fewer transactions with announced multiples since then. Public trading comps are therefore viewed by buyers as one of the only valuation criteria that is current. This can create significant gaps in valuation expectations where sellers are looking at deal multiples nine to 18 months old, which in "normal" times might be considered relatively recent.
Creative financing and acquisition structures are becoming more common. We are observing more M&A discussions where buyers are offering private company stock as consideration and where sellers, including financial sponsors who would not normally accept such a consideration, are actually contemplating it. Additionally, the use of seller financing is on the rise. We are also seeing more proposed minority investments, joint ventures, offers to buy out isolated shareholders who need liquidity, and other "non-traditional" deals.
The dearth of the mega deal is paving the way for mid-market transactions. While Q1 did not see gargantuan M&A deals of HP/EDS proportions, the current market landscape seems favorable for mid-market (valued at less than $200 million) deals (see Figure 3). Over the last 12 months, of all the deals tracked by Updata, the vast majority were valued at less than $200 million. Additionally, we have seen significant private-private deal activity in recent months, including almost a half-dozen private-to-private IT security deals.
Bottom-line focus is reducing R&D investment, which may benefit M&A. There is tension these days within public IT firms between showing growth and showing profitability. Shareholders are demanding more of the latter, thereby reducing development investments that reduce profits in the short term but improve growth longer term. As a result, many IT vendors need to rely more on acquisitions of technology IP-rich companies in coming quarters to quickly pick up capabilities they normally might have developed internally. This may help drive a slingshot recovery in M&A.
Figure 3 Selected Mid-Market Transactions
SECTOR ANALYSES
Updata has identified several areas within our tracked IT sectors that are defying the odds and buoying the tech sector. See Figure 4 below for stock performances for Q1 2009 by Updata sector versus the NASDAQ composite.
Figure 4 IT Sector Stock Chart Versus NASDAQ -- YTD Ended March 31, 2009
Following are sub-views of each of our tracked sectors, as well as some magnified trends within each:
INFRASTRUCTURE SOFTWARE
Infrastructure software deal activity has rebounded somewhat in recent quarters. In both Q3 and Q4 2008, infrastructure software deals made up about 6% of the total deals tracked by Updata Advisors. But in Q1 2009, that percentage rose to 8%. The total number of infrastructure deals is also up 20% from 10 in Q4 to 12 in Q1. Significant deals include Informatica's $40 million acquisition of Applimation in February and the acquisition of Mazu Networks by Riverbed Technology for $47 million. Additionally, Updata Advisors announced one transaction in the infrastructure software space: Yosemite's acquisition by Barracuda Technologies. Updata represented Yosemite in this transaction (see Figure 5). Updata has observed the following trends in infrastructure software:
Cloud computing is nascent, but enticing. The economic downturn is forcing enterprise executives to seek new ways to reduce and better manage costs. Cloud computing models are still developing, but the promise of flexibility and cost savings have and will continue to attract a lot of attention from enterprise customers and IT service providers. Venture capital continues to pour into cloud-specific companies, such as cloud storage developer Nirvanix which recently raised $6 million in venture funding.8
Activity is brewing in the data center market. There has been a hotbed of activity around data centers in Q1, most notably with Cisco announcing its entrance into the market. Eager to take a piece of the pie from the data center heavyweights (IBM, HP), Cisco launched a line of blade servers in March. Automation and virtualization in the data center spaces still command a significant portion of infrastructure deals; examples include Virtual Blocks' acquisition by CBTS and Q-layer's acquisition by Sun Microsystems.
Storage continues to be a hot infrastructure software space. For the past couple of quarters, storage deals have dominated. Q1 2009 has been no different. Examples of Q1 storage deals include Quest Software's acquisition of MonoSphere's technology assets and Barracuda's acquisition of Yosemite Technologies.
Enterprise application software deals have been taking an increasingly larger share of the M&A deal pie over the past couple of quarters as measured by deal numbers. In Q1 2008, deals in the EA space made up 21% of all deals tracked by Updata, but in Q1 of this year, they made up 27%. Deal volume only dropped about 2% from Q4 2008 (with 43 deals) to Q1 2009 (with 42 deals). Significant deals include Autonomy's acquisition of Interwoven for $590 million and the acquisition of VeriSign's communication services group by TNS for $230 million (see Figure 6). Updata has observed the following trends in enterprise application software:
Vertical applications are meeting a need not addressed by packaged horizontal apps. In specific vertical industries, such as healthcare for example, IT executives are investing in more industry-specific applications than ever.9 Deals in the enterprise application space that involve targets that specialize in vertical-specific applications are keeping pace with this demand. AFS Technologies acquired ERP vendor to the meat and seafood industries Interactive Management Systems, and drug safety/risk management solutions provider Relsys International was acquired by Oracle (both deals were announced in March). We are also seeing more activity percolating around the government vertical as larger IT vendors strategize on how to capture a portion of the economic stimulus pie. One interesting sector that could result M&A activity is in the government procurement IT arena.
Human Capital Management (HCM) and workforce management markets continue to consolidate. In a recessionary, high unemployment environment, enterprise solutions that focus on recruiting and talent management are naturally (although perhaps temporarily) less critical. Over the long haul, there is no question as to their strategic importance. Further, there continue to be too many small players in this fragmented sector. As a result, we are seeing ongoing consolidation in the space. As HCM "suite" providers emerge, consolidators become more active as valuations become more attractive, and marginal players are left with little choice other than seeking a suitor. In January, Xactly bought on-demand sales compensation vendor Centive and Aspect acquired workforce performance management solutions provider AIM Technologies. With the ranks of Federal employees growing at an unprecedented rate, we also are aware of HCM providers focused on the Government sector that are faring well and garnering some attention.
BI and CPM remain active sub-sectors, especially SaaS solutions. More than ever in this economic climate, companies are seeking to gain a competitive edge via business intelligence (BI) and corporate performance management (CPM) solutions that leverage all available enterprise data to identify operational weak links and areas for efficiency improvement. We continue to learn of numerous start-ups and growth stage companies pursuing various aspects of business analytics; buyer interest in this area remains strong. Typically, these BI and CPM start-ups are SaaS-based as companies that leverage the traditional licensed software model have, for the most part, been consolidated. The race is on to see who the winners will be in the SaaS BI and CPM markets. Along the way, there will likely be several acquisitions by larger players looking to get their hands on interesting but affordable technologies to fill product gaps.
Including the April 1st announcement that Fidelity National agreed to acquire Metavante, the first 90 days of 2009 saw the financial technology (Fin-Tech) sector outpacing all other IT sectors tracked by Updata (see Table 2 at the end of this report). The Metavante deal at $4.4 billion plus the Fifth Third Processing Solutions deal at $2.4 billion and the thinkorswim deal at $630 million combined for a total of $7.5 billion in aggregate deal value and generated plenty of excitement in the Fin-Tech sector. Interestingly, Kevin T. Kabat, Fifth Third's CEO, noted that their transaction "...is expected to generate meaningful additions to our tangible common equity and Tier 1 capital ratios." We can't help but wonder if more banks aren't lining up asset sales of their captive Fin-Tech businesses as a means to bolster Tier 1 capital. Recall that Citigroup sold its Global Services business to Tata Consulting in Q4 2008 for $505 million. One of the key reasons banks are compelled to monetize their Fin-Tech assets is that they typically trade at M&A values well in excess of their book value. Realizing the gain on a sale provides much needed tangible equity for the bank.
Aside from these three large deals, a number of other Fin-Tech deals were announced in the first quarter, some of which are outlined in Figure 7 below. Overall enterprise value for these deals was $3.1 billion (excluding the Metavante deal announced on April 1, 2009) or a decline of 37% compared to Q12008. The number of deals (19) announced in Q12009, however, improved from 17 in Q12008. Of the Fin-Tech deals tracked in Q12009, two-thirds were in the payment processing subsector; risk management and bank software and services deals comprised the balance. We believe this heavy weighting in the payment processing subsector is consistent with several factors weighing on the overall Fin-Tech sector:
Slowing transaction growth is increasing the attractiveness of consolidation. Because transaction processing businesses benefit from economies of scale, there is a general trend for processors to combine and gain operating leverage. With the payment processing sector slowing (i.e., NACHA reports that ACH transaction volume slowed to a 6.9% growth rate in 2008 from a 13.2% growth rate in 2007), the larger consolidators will become more aggressive acquirers as they seek to maintain their revenue growth goals. Smaller processors will take advantage of the consolidation pressures and seek out attractive deals.
Mobile payment and alternative payment technology companies have fewer funding options. Many of these young technology companies are facing a challenging capital raising environment for either debt or equity capital. Positive cash flow is virtually a "must-have" for raising new growth equity making it increasingly likely that payment technology companies, many of which are "pre-" positive cash flow, will be forced to seek an M&A exit to a strategic buyer. Fortunately, the large, well-capitalized strategic buyers remain interested in new payment technology as a way to stay in front of an ever changing technology curve. However, we don't expect valuations for such deals to rival the frothy levels seen in the last two years for deals like Qualcomm/Firethorn or VeriSign/3united Mobile Solutions.
Services business models are holding up better than product models in the FI market. Throughout the first quarter, we continued to see evidence that service providers to the financial institutions (FI) market (those that rely on OPEX funding) were under less pressure than vendors that sell software/products to the FIs (vendors that rely on CAPEX funding). While pricing pressure remains intense among the service and their FI customers, the service-based vendors appear to be less vulnerable to capital project delays which are afflicting many of their FI software counterparts. This has the effect of tempering M&A activity for software-focused Fin-Tech companies because quarterly results are highly uncertain, which makes it difficult to successfully navigate a four- to six-month M&A process.
New regulation will help lift the Fin-Tech sector later in 2009 and 2010. New banking regulation will emerge in the coming months defining for the banking industry (and other financial services industry participants), where capital will be deployed in order to comply with these new rules. As Fin-Tech vendors develop solutions to meet these new requirements, we look for the software providers to turn more bullish. Risk management solutions, and in particular, anti-fraud solutions will continue to proliferate in the financial services market. These solutions will continually evolve to keep pace with ever-changing technology, new forms of online banking, and new payment capabilities such as mobile banking. Relative to other Fin-Tech areas, the risk management sector is well-positioned for continued innovation, strong revenue growth, and strategic M&A as large Fin-Tech providers seek to acquire technology that can be sold through their channels.
Continued interest from offshore IT providers in Fin-Tech BPO companies. This trend has driven a number of Fin-Tech deals in the past 18 months and we expect to see it continue. Notably, HCL recently acquired two Fin-Tech services companies (Capitalstream and Liberata Financial Services) and Headstrong recently acquired Lydian Data Services and iX Partners. We believe other offshore service providers remain keenly interested in making US-based Fin-Tech acquisitions, particularly in the BPO and/or infrastructure services areas.
Security M&A activity levels in Q1 2009 showed a basis for cautious optimism, but remained weak by historical standards. The number of security deals announced in the quarter increased 25% over Q4 2008 to 10, but remained 47% down over prior-year Q1. Overall transaction volume similarly remained low, at less than $300 million, about half the prior-year quarter. While valuations reported on announced deals were also at historic lows (affected in part by companies forced to sell), we feel that the sector has troughed and will rebound, perhaps sharply, as early as late 2009/first-half 2010. One reason is that enterprise customers will need to increase security spending beyond historical norms to compensate for spending deferrals during 2008-2009. Additionally, major technology shifts underway -- notably the rapid move to cloud computing, enterprise 2.0, and mobile computing -- are widening customers' perceived safety gap.
Significant transactions in the IT security space in Q1 included Vector Capital's acquisition of public Aladdin Knowledge Systems for $161 million (EV/TTM revenue multiple of 1.4x), and the acquisition of public Certicom by Research in Motion for $73 million (EV/TTM revenue multiple of 3.6x). Additionally, Updata announced two security deals in Q1: Orchestria's acquisition by CA, and Securevision's acquisition by ParetoLogic. Updata represented the seller in both transactions (see Figure 8). Security observations of note include:
Acquisitions of public targets are on the rise. Three public security acquisitions were announced in the first quarter; Aladdin, Certicom, and HiFn. (The acquisition of a fourth public company, Entrust, was announced early in Q2.) This higher-than-average public takeout activity, plus the fact that two of the three deals announced Q1 were unsolicited, suggests a market bottom as buyers anticipating higher future acquisition prices make their move. There are several other notable aspects to these deals. First, two of the deals involved private buyers -- Safenet/Vector for Aladdin and Thoma Bravo for Entrust. Second, the targets had significant proprietary technology that helped drive interest; particularly in Certicom's case where VeriSign and Research in Motion bid the valuation up 40% and 100%, respectively, from RIM's initial bid.
Five of the 10 security deals announced in Q1 involved private buyers. As we predicted, the decline in public valuations has made share exchanges and private-private mergers more attractive, and we expect to see a rise in private buyer deals in coming months, particularly where targets are not profitable and lack access to capital.
Consolidation of security functions into IT infrastructure management continues. Q1 acquisitions by CA which bought Orchestria (Updata represented Orchestria) in the data loss prevention space, and by Novell which bought Fortefi in the privileged user management space, highlight continued consolidation of security functions into public infrastructure suites. Our contacts at large public companies suggest ongoing interest and efforts in acquiring additive security functionality, so we expect the relative dearth of traditional public buyers in Q1 will not be repeated in Q2 this year.
Digital home managed services is a promising growth market. As home networks become more sophisticated, users seek easy-to-use yet comprehensive security solutions that increasingly mimic workplace network security. An attractive way to provide this is via Internet service providers (ISP). According to the research firm Parks Associates, at-home digital managed services represent a more than $2 billion market when security is included with online storage and other services online.10 As an example, Radialpoint, an acquisitive vendor in this space, received a $98 million investment from TA Associates in late 2008.11 We expect to see further activity in managed security services for the home market during the year.
Rapidly growing e-commerce volumes drive demand for Web assurance solutions. According to a recent Nielsen study, more than three quarters of those using the web in the US shop online.12 E-customers require identity theft protection, vendor validation, secure payments, anti-malware, and privacy assurance. McAfee, eBay, and others are investing actively in building out the infrastructure for a full-cycle secure e-commerce "stack" offering. Competition should heat up in this area, driving further activity in coming months.
Areas of likely acquisition activity this year include: next-generation intrusion/malware detection, embedded security, identity management, virtual environment intrusion prevention, internal fraud monitoring, secure web gateway, and application and database security. While venture investment levels remain lower than in recent years, emerging subsectors are expected to help drive investment volume. These include some of the above areas, plus new-media security (e.g., digital billboards), convergence security (e.g., smart-locks), and mobile transaction (e.g., pay-by-PDA) security.
Declines in financial sector spending are not permanent, and will be largely offset by other verticals. While the financial industry has cut back spending in most IT areas, analysts believe that security spending growth will return as banks deal with new regulatory and restructuring/merger challenges. Helping pick up the demand slack in the meantime will be small- to medium-sized businesses (SMBs), which are expected to spend more in security as regulations, competitive considerations, and cost reductions lower the size threshold for investment. The Obama administration's plan to place greater emphasis on cyber-security across government agencies and in delivery of government services is also providing a boost to spending.
Figure 8 Selected IT Security Transactions
IT SERVICES
IT Services M&A, while down 7% in terms of deal numbers (Updata tracked 50 in Q1, down from 54 Q4 2008), remains reasonably active. Pockets of particular strength include expansion of multi-shore delivery capabilities through M&A, and acquisition of expertise in verticals such as healthcare, life sciences, data center operations, and the federal government. We have found that even in tough macroeconomic environments, services firms are able to adapt their business models to maintain profitability and retain key talent. Witness the ability of legally bankrupt BearingPoint not only to continue ongoing operations, but actually to win large deals in the midst of its travails, and you get a good sense of this sector's resiliency. Attractive aggregations of specialized, billable talent drove PricewaterhouseCoopers' and Deloitte's interest in BearingPoint, along with several other deals highlighted below (see Figure 9).
While India remains an attractive location for IT services outsourcing, talented resources across a number of geographies attract IT executives looking to cut costs and add capabilities. In fact, IT outsourcing is the one area where Forrester Research predicts growth in spending this year.13 A relevant example highlighting India's continued importance is Xerox's recent announcement that it has signed a six-year, $100 million outsourcing contract with HCL Technologies to manage Xerox's data centers.14 Equally interesting is ACS's acquisition of offshore BPO talent in our own hemisphere through Caribbean-based e-Services Group.
Healthcare IT is poised to boom in 2009. Healthcare is benefiting from a host of spending and demand drivers, including federal government initiatives, an aging population, and a desperate need to deploy efficiency-enhancing technologies across the patient, provider, and payer spectrum. Examples of specialty consulting deals in healthcare in Q1 include Navigant Consulting's acquisition of the Bard Group and Gemstar Group's purchase of Calyx Partners; both deals were announced on January 12.
The federal government is still a very important IT services customer. We expect acquisitions of IT services companies that cater to the public sector to remain robust throughout 2009. These span both defense and civilian work, although defense and intelligence work performed by security-cleared consultants remains in hot M&A demand. Services deals in the government sector include Deloitte's acquisition of BearingPoint's public services business and ManTech's acquisition of DDK Technology Group. Both targets focus exclusively on the public sector.
Training and educational services are proving attractive. We have seen an increased level of interest and activity among companies that specialize in IT-enabled training and education services for enterprises and professionals. This is driven to a large extent by enterprises -- and employee/professionals -- retooling and sharpening skills to remain competitive as the global economy undergoes massive shifts. According to IDC, worldwide IT-enabled training and educational services spending will be $28 billion in 2013.15 An interesting transaction in this space in Q1 was eLearning company REDTRAY's acquisition of Academy Internet in February.
Figure 9 Selected IT Services Transactions
INTERNET
Internet M&A activity levels in Q1 2009 declined sharply, as both buyers and sellers have been adversely affected by the slowdown in online ad spending and the broader economy. Last quarter, a mere 10 deals were announced in the sector (including digital advertising, social media, online destinations), as compared with 33 deals in Q4 2008 and 35 in Q1 2008. Overall transaction volume was also reduced to historic lows of less than an estimated $300 million, well below the prior-year quarter. Although valuations were not disclosed on most Internet transactions announced in the quarter, anecdotally they have been lower as larger buyers have made offers reflecting the slower growth environment and their reduced valuations. Significant Q1 deals in the Internet sector included Lionsgate's acquisition of TV Guide Network and Guide Online for $255 million, announced in January (see Figure 10). In our view, while prior market headiness may not return anytime soon, a decent M&A market based on reasonable growth expectations should return to the sector by early 2010. Observations of note include:
Internet sector continues to enjoy uniquely powerful secular growth drivers. Sector recovery is a question of when, not whether. Despite economic challenges, vast and growing numbers of people worldwide continue to spend more time and money online, and do more online. In fact, Internet services of all types are benefitting as more cost-effective alternatives to traditional ways of doing business. As an example, in their recent Directions conference, IDC predicted that cloud computing will vastly change the existing IT landscape in a mere five years, driven in large part by the greater savings and efficiency in-the-clouds solutions offer versus the traditional customer premise-based IT model.
Ongoing battles will rage among Internet behemoths for primacy. Competition in key Internet areas of search, collaboration, security, e-commerce, online entertainment, and mobile services will drive a strong M&A market for some time, and will strengthen public valuations as the pieces are put into place. In the mobile market, for example, the iPhone has just scratched the surface of opportunities to leverage the power of mobile computing. Eventually, enterprise mobile computing will become its own "stack" with attendant applications, infrastructure, and services that are just beginning to be built. On the consumer side, location-based services, e-payments and entertainment will drive significant investment and M&A activity.
Home networking is poised for high growth. Large IT vendors including Cisco, Microsoft, and Symantec are increasing efforts at selling more to the home IT market, where spending is projected to rise faster than overall tech spending. Cisco¡¦s acquisition of Pure Digital is an example of this and we expect more targeting of consumer technology vendors from the large enterprise players. Demand drivers include blurring lines between home and workplace Internet and PC use, and increasing home user access to -- and familiarity with -- broadband, networking equipment, and various IP-enabled devices and services.
Social media is changing the face of search. Tremendous traffic and engagement enjoyed by such sites as Facebook -- second in unique visitors only to Google, and growing faster -- and Wikipedia, highlight that web-based networking and collaboration will change the traditional search model for referring traffic. As these super sites increasingly become the launch points for more web users, while offering more opportunities for engagement, Google, Yahoo!, and MSN will need to adapt. This will drive interesting deal-making in the quarters ahead.
Online advertising spending growth is down this year, but will continue to outgrow traditional media. While 2009 is proving to be a difficult year for online media as spending has declined and CPMs (cost per thousand impressions) have compressed, analysts predict that online advertising spending will bounce back before most other tech sectors because it is so closely tied to economic activity (i.e., as people spend more, businesses will advertise more). Online advertising also benefits from the fact it is playing catch up with time spent online and thus taking share. eMarketer predicts online advertising will reach 15% of total advertising spending in 2013, up from 9% in 2008, as spending continues to catch up with time spent online.16 IP-enabled outdoor digital and video game advertising are two high-growth sub-sectors with the potential to be quite large in a few years. As more viewers become comfortable with digital streaming, ad spending in this area will grow as well. Tolerance for ad content in streaming broadcasts has increased to 80% in 2008 from 67% in 2006, according to Knowledge Networks.17
Media conglomerates will continue investing and buying to increase revenue contribution from online activities. A key M&A driver will be the continued moves into new media by traditional media companies that have healthy balance sheets and scale but need to maintain growth by following their audience online. These include NewsCorp, Disney, and communications giants like AT&T and Verizon.
Figure 10 Selected Internet Transactions
DATA TABLES
Table 1 M&A Quarterly Analysis For Deals Tracked By Updata -- Overall
Table 2 Q1 2009 M&A Quarterly Analysis For Deals Tracked By Updata -- By Sector
Table 3 Selected Private Equity Transactions
CONCLUSION
While there is no denying the challenging state of the macroeconomic environment, signs in Q1 suggest that there is reason to be cautiously optimistic that the next few quarters will show an upswing in technology demand and M&A deal activity. Tech companies that have lower-than-average debt levels and are flush with cash are beginning to test the M&A waters once again.
Early Q2, for example, has already shown some very encouraging signs such as the announcement of several large deals such as Oracle's acquisition of Sun Microsystems for $5.6 billion, Fidelity's acquisition of Metavante Technologies for $4.4 billion, and eBay's acquisition of Gmarket for $995 million. In comparison, all of Q1 saw just one transaction with an enterprise value of more than $1 billion.
Another indication that the technology market is looking up is that three successful technology companies went public in early April: Changeyou.com, Bridgepoint, and Rosetta Stone. Bridgepoint and Rosetta Stone are eLearning companies and Changeyou.com is a Chinese online game developer. This ended a tech-IPO drought which began when Grand Canyon Education (another eLearning company) went public in November 2008 and Rackspace Hosting went public in August 2008.
In addition, financial performance of public IT bellwethers, while still somewhat of a mixed bag, has improved. To date, several public IT companies (such as Amazon.com, IBM, and Apple) have reported quarterly results that either met or exceeded analyst expectations. Absence of visibility had been a major cause of valuation and activity declines in late 2008. Improved performances overall are reflected in the fact that the average technology mutual fund is up 12.8% this year through the end of Q1 versus a 4.9% loss for S&P 500-stock index funds, according to Lipper.18 As companies sense a bottom in the stock market and become less risk averse, they will opportunistically return to their M&A initiatives which had been in their pipeline for the past three months.
While recovery may not be uniform across sectors and will take time, these initial signs suggest that Q2 may be the beginning of a return to normalcy.
