M&As in Tech.

M&As in Tech.

General Perspective.

What are M&As?

The term mergers and acquisitions (M&A) refers to the consolidation of companies or their major business assets through financial transactions between companies. A company may purchase and absorb another company outright, merge with it to create a new company, acquire some or all of its major assets, make a tender offer(a bid to purchase some or all of the shareholders’ stock in a corporation common in public companies) for its stock, or stage a hostile takeover(occurs when a company or individual attempts to gain control over a target company by sidestepping their management and board of directors. That’s what makes the takeover hostile — merging with or acquiring a company against the wishes of that company’s management).

In an acquisition, one company purchases another outright.A merger is the combination of two firms, which subsequently form a new legal entity under the banner of one corporate name.

Acquisition: When one company takes over another and establishes itself as the new owner, the purchase is called an acquisition. Unfriendly or hostile takeover deals, in which target companies do not wish to be purchased, are always regarded as acquisitions. In a simple acquisition, the acquiring company obtains the majority stake in the acquired firm, which does not change its name or alter its organizational structure.

Merger: On the other hand, a merger describes two firms, of approximately the same size, that join forces to move forward as a single new entity, rather than remain separately owned and operated.A purchase deal will also be called a merger when both CEOs agree that joining together is in the best interest of both of their companies. In a merger, the board of directors of two companies approve the combination and seek shareholders’ approval.This will mean merging of brands and company structures to conform to the new company identity and business case.

A deal can be classified as a merger or an acquisition based on whether the acquisition is friendly or hostile and how it is announced. In other words, the difference lies in how the deal is communicated to the target company’s board of directors, employees, and shareholders.

Other examples of M&As include;

Consolidations.Involves creation of a new company by combining core businesses and abandoning the old corporate structures. Stockholders of both companies must approve the consolidation, and subsequent to the approval, receive common equity shares in the new firm. 

Tender Offers. In a tender offer, one company offers to purchase the outstanding stock of the other firm at a specific price rather than the market price. The acquiring company communicates the offer directly to the other company’s shareholders, bypassing the management and board of directors.

Acquisition of Assets. In an acquisition of assets, one company directly acquires the assets of another company. The company whose assets are being acquired must obtain approval from its shareholders. The purchase of assets is typical during insolvency proceedings, wherein other companies bid for various assets of the Insolvent company, which is liquidated upon the final transfer of assets to the acquiring firms.

Management Acquisitions. In a management acquisition, also known as a management-led buyout (MBO, a company’s executives purchase a controlling stake in another company, taking it private. These former executives often partner with a financier or former corporate officers in an effort to help fund a transaction. Such M&A transactions are typically financed disproportionately with debt, and the majority of shareholders must approve it. 

How Mergers Are Structured:- 

Mergers can be structured in a number of different ways, based on the relationship between the two companies involved in the deal:

Horizontal mergers: Two companies that are in direct competition and share the same product lines and markets.

A Vertical Merger: A customer and company or a supplier and company. Think of an ice cream maker merging with a cone supplier.

Congeneric Mergers: Two businesses that serve the same consumer base in different ways, such as a TV manufacturer and a cable company.

Market-extension merger: Two companies that sell the same products in different markets.

Product-extension merger: Two companies selling different but related products in the same market.

Conglomeration: Two companies that have no common business areas.

Mergers may also be distinguished by following two financing methods, each with its own ramifications for investors.

Purchase Mergers: As the name suggests, this kind of merger occurs when one company purchases another company. The purchase is made with cash or through the issue of some kind of debt instrument. The sale is taxable, which attracts the acquiring companies, who enjoy the tax benefits. Acquired assets can be written up to the actual purchase price, and the difference between the book value (For value investors, book value is the sum of the amounts of all the line items in the shareholders’ equity section on a company’s balance sheet. You can also calculate book value by subtracting a business’s total liabilities from its total assets) and the purchase price of the assets can depreciate annually, reducing taxes payable by the acquiring company.

Consolidation Mergers: With this merger, a brand new company is formed, and both companies are bought and combined under the new entity. The tax terms are the same as those of a purchase merger.

Other important flow of activities to take note of in an M&A M&A transaction.

How Acquisitions Are Financed: A company can buy another company with cash, stock, assumption of debt, or a combination of some or all of the three. In smaller deals, it is also common for one company to acquire all of another company’s assets. Company X buys all of Company Y’s assets for cash, which means that Company Y will have only cash (and debt, if any). Of course, Company Y becomes merely a shell and will eventually liquidate or enter other areas of business.

Another acquisition deal known as a reverse merger enables a private company to become publicly listed in a relatively short time period. Reverse mergers occur when a private company that has strong prospects and is eager to acquire financing buys a publicly listed shell company with no legitimate business operations and limited assets. The private company reverses merges into the public company, and together they become an entirely new public corporation with tradable shares.

How Mergers and Acquisitions are Valued:- 

Both companies involved on either side of an M&A deal will value the target company differently. The seller will obviously value the company at the highest price possible, while the buyer will attempt to buy it for the lowest price possible. Fortunately, a company can be objectively valued by studying comparable companies in an industry, and by relying on the following metrics.

Price-to-Earnings Ratio (P/E Ratio):With the use of a price-to-earnings ratio(P/E ratio), an acquiring company makes an offer that is a multiple of the earnings of the target company. Examining the P/E for all the stocks within the same industry group will give the acquiring company good guidance for what the target’s P/E multiple should be.

Enterprise-Value-to-Sales Ratio (EV/Sales): With an enterprise-value- to-sales ratio (EV/sales), the acquiring company makes an offer as a multiple of the revenues while being aware of the price-to-sales (P/S ratio) of other companies in the industry.

Discounted Cash Flow (DCF): A key valuation tool in M&A, a discounted cash flow (DFC)analysis determines a company’s current value, according to its estimated future cash flows. Forecasted free cash flows (net income + depreciation/amortization (capital expenditures) change in working capital) are discounted to a present value using the company’s weighted average cost of capital (WACC) . Admittedly, DCF is tricky to get right, but few tools can rival this valuation method.

Replacement Cost: In a few cases, acquisitions are based on the cost of replacing the target company. For simplicity’s sake, suppose the value of a company is simply the sum of all its equipment and staffing costs. The acquiring company can literally order the target to sell at that price, or it will create a competitor for the same cost.

Naturally, it takes a long time to assemble good management, acquire property, and purchase the right equipment. This method of establishing a price certainly wouldn’t make much sense in a service industry wherein the key assets (people and ideas) are hard to value and develop.

What are M&As in Technology?

Generally, Tech M&As would follow under the category of Technology Media and Telecommunications (TMT). The technology industry is known for its dynamic and ever evolving landscape. In this digital age, mergers and acquisitions (M&A) play a crucial role in shaping the industry’s future. As businesses seek to stay competitive and innovate, they turn to M&A as a strategic tool.

Technology innovation still roars ahead at its rapid pace, with artificial intelligence (AI) reaching an inflection point in 2023, which raises the stakes for companies to expand and reinvent their offerings as data becomes the new business currency. And despite the AI-dominated headlines, cybersecurity, the metaverse, the intelligent edge(the analysis of data and development of solutions at the site where the data is generated which helps reduce latency/delay, costs, and security risks, thus making the associated business more efficient), and other disruptive trends also are creating a need for companies to innovate or else risk being left behind. For many in the industry, it’s time to reset and reinvent via M&A.

Now, those that get M&A deals through will also need to focus on bringing the product portfolios together, which will be increasingly essential to achieving longer-term value from the deal. And that will be even more critical for success among the growing number of acquisitions for which AI is a key part of the deal thesis. The deal multiples are higher, the technology is comparatively unproven, and the value comes from unifying data sets and reinventing offerings to capture new opportunities for product or service differentiation. Companies need to plan their long-term strategy for putting those technologies together to power the AI use case or create a bigger and better data set.

The difficulties in achieving revenue synergies in Tech M&As will most likely come from failure to integrate the product portfolio as the most common reason why companies were unable to capture revenue synergies. While many dealmakers have perfected their ability to estimate near-term revenue synergies, they often have massive plugs in the model for these vital longer-term product synergies, with little view into how to actually achieve them. They now need to devote equal energy to product integration, the longest term (and therefore the least certain) of all synergy drivers. That means strategically bringing offers together, developing differentiated new customer value propositions, and building integrations or unified platforms that, in turn, enable the longer-term revenue synergies.

Why is this so hard to unlock a successful Tech M&A transaction? Research has produced these three common oversights.

The first hurdle involves keeping customer intimacy top of mind throughout the deal cycle. In diligence, companies typically don’t use a deep customer lens when developing the combined offers and use cases. Then, post-announcement, there’s a lack of proactive customer communication about the combined company vision—something that can result in competitive reversals and churn. Companies need to perform diligence with the objective of learning what customers actually want (joint offers or compelling use cases, for example) before defining a high-level roadmap of priorities and related investments for potential synergy product offers. This needs to be nailed down before closing the deal. And companies need to make it a must-have deliverable on day one to communicate the near-term and long-term priorities externally. The sooner they can make commitments, the sooner they can fend off competitors who are trying to sow uncertainty into the minds of customers.

The second challenge centers on the need to align and motivate key talent. A product vision and strategy require agreements across stakeholders from different functions within both organizations. That’s difficult to manage in the early days. But mismanaging this process can cause critical leadership to depart, jeopardizing the integration. Building early alignment on the end product vision and what it will take to get there (again, grounded in a compelling “better together” customer value proposition) can inspire talent.The best companies pull forward strategic product planning with a dedicated cross-functional team as part of the integration management office. They help clarify the early development work needed to support day-one joint offers as well as the long pole development that underpins broader platform plays to hit the ground running. Product planning teams must move in lockstep with go-to-market (GTM) planning teams to ensure that future products/bundles are priced and packaged to resonate in the market and that sales teams are retrained and the technical support is in place to sell the new joint value proposition (VP).

As a big part of the talent equation, the best acquirers take a tailored approach for different technical talent populations, using both financial and nonfinancial levers. They host joint sessions with key product leaders, clearly and quickly answering the “what’s in it for me” basics and addressing the inevitable “elephant in the room” issue about how teams will come together to support the longer-term product strategy and vision. Also important is tailoring the cultural integration approach to specific talent subcultures.

Finally, technology company acquirers face the challenge of refocusing their energy and investment on creating long-term value. Amid competing priorities and operational fire drills (pointless, unproductive, useless, or chaotic activity), it’s easy to deprioritize the critical decisions and investments that will spur long-term value. Without a clear integration thesis, organizational energy and corresponding investments may be misplaced. This is unsurprising. There are competing priorities: How much do we invest in the base business, and how much do we invest to generate the true synergies that are the basis of the deal? Achieving both requires a systematic and data-driven approach—something that’s much easier to say than do. At the best companies, every investment dollar follows strategy. That means establishing clarity on R&D spending—namely, ring-fencing incremental investments, defining criteria for evaluating synergy investment opportunities, and establishing a centralized mechanism for strategically allocating funds based on business cases.

My take to success in Tech M&A.

From all the above, it is clear that the biggest hurdle in Tech M&As is product synergies which are often hypothesized but not valued, therefore they don’t get the investment rigor and focus needed to make them a reality. It gets even harder when you think of the different technological integrations, their short-mid-term pivots in light of new technologies that might reshape or phase out an existing technology once and for all. Bringing product portfolios together will be more important to achieving longer-term value from Tech M&A deals. Too many companies stumble in their product integration planning. In conclusion, best acquirers do these three things right to put themselves on the best path to success from the onset.

Where are the business opportunities for Tech Lawyers & RMA in the M&As in Tech or TMT in general?

According to a 2024 PWC report on TMTs, a new record was set for M&A activity in TMT in the first half of 2023, with around 8,500 deals announced, 100 more than the previous record of 8,400 deals that was established in the first half of 2021. However, the second half of the year was a different story, with deal volumes declining by 31% from the first half of the year to less than 6,000 deals. For 2023 as a whole, deal volumes ended the year down 1% on the prior year. Deal values decreased by 44% in 2023 compared to the prior year, primarily because of a combination of smaller deals and lower valuations.

Furthermore, the number of TMT megadeals dropped from 42 in 2021 to 24 in 2022 and just 11 in 2023.

PWC predict and expect the following areas to be hot spots of M&A activity in 2024:

Software-as-an-opportunity: Software continues to attract investor interest because of the nature of its subscription-based business models, particularly from PE players, which now account for approximately two-thirds of all software deals. With more predictable recurring revenues and cash flows, the software sector will continue to appeal to investors in the current lower-growth environment. As a result, we expect software to continue to dominate technology dealmaking activity in 2024.

• PE continues to shape the software M&A landscape: Private equity remains a driving force in software M&A, shaping approximately two-thirds of software deals in 2023. Silver Lake’s acquisitions of Qualtrics and Software AG, Blackstone’s investment in Civica and other investments underscore the sustained interest, with PE firms attracted to the resilience and growth potential of software companies.

• Software vendors acquire new capabilities and enter new markets: Software vendors are expected to continue their acquisitive strategies in 2024, seeking new capabilities and market entry plays. Buy-and-build platforms have continued to execute bolt-on acquisitions in 2023, and we expect this trend to continue in 2024. With the focus on cost reduction and investments in AI, corporate acquirer megadeals have been subdued in 2023 with the notable exception of Cisco’s US$28bn announced acquisition of Splunk in September 2023.

IT services

• Pockets of growth in IT services: Many organizations have been delaying the implementation of new IT programs due to the uncertain macroeconomic outlook, presenting a more challenging outlook for the IT services market in 2024 and in turn hampering M&A. IT service management, cybersecurity and DevOps are expected to outperform, and we expect to see M&A activity in these segments as a result.

• Generative AI’s impact on IT services: Gen AI will have a multifaceted impact on IT services. On the one hand, it presents an opportunity to improve productivity in delivery, which in turn will improve competitiveness and margins. On the other hand, it is challenging current business models—for example, in software testing. While gen AI is attracting a lot of investment buzz, we believe many dealmakers may be reluctant to invest in the space before the impact of gen AI is more certain.

Semiconductors(Semiconductors are materials which have a conductivity between conductors (generally metals) and nonconductors or insulators (such as most ceramics) While semiconductor products are vital for computing, telecommunications, military systems, utilities, health care, and transportation, there are few industries that don’t rely on integrated circuits to some extent).

• Regulatory complexities and geopolitics shape semiconductor M&A: Regulatory challenges will continue to play a significant role in shaping semiconductor M&A for 2024. The fallout from regulatory hurdles—notably seen in Nvidia’s attempted acquisition of ARM and Sai MicroElectronics’ proposed purchase of Elmos Semiconductor—underscores the complex global dynamics at play. We anticipate continued regulatory scrutiny, particularly in the context of geopolitical tensions, influencing deal structures and limiting cross-border megadeals.
• Semiconductors focus on supply chain resilience and portfolio strategy: Chip shortages, particularly of chips that are used in AI applications, and disruptions in the global supply chain have driven a focus on supply chain resilience, which will likely see organic investment prioritized over M&A. We expect large, diversified semiconductor companies to evaluate their portfolios and potentially divest operations. For example, Intel has announced its intent to separate its Programmable Solutions Group (PSG) with a view to conducting an IPO in the future.

Telecoms consolidate and Netco models re-emerge: Telecom market structures continue to be transformed by consolidation and the re-emergence of the Netco model—where companies own and operate the network infrastructure and lease it to telcos and service providers—as a means to realize synergies, mutualise costs and attract alternative capital. We expect to see these trends play out across both fixed and mobile segments, particularly in Europe, where key players have struggled to generate appropriate returns on capital. This represents a significant opportunity for strategic investors, private equity and infrastructure capital.

Streaming consolidation: With the end of the US writers’ and actors’ strikes, streaming services face less ambiguity about costs going forward and more predictability in production processes. This enables these players to better model and analyze their ongoing operations. Additionally, improved access to data provides streaming companies with enhanced visibility into consumer preferences such as the number of platforms to which consumers are willing to subscribe, penetration in major markets and content preferences driving consumer behavior. We believe the ecosystem is ripe for consolidation and expect some streamers in the market to look for strategic partners in the next six to 12 months.

The technology sector accounted for 85% of TMT deal volumes in 2023, and with more than 12,000 deals in the sector in the past two years, is a significant component of the overall global M&A market. With ongoing trends of digitalisation and technological disruption, we expect the technology sector will remain a bright spot for M&A in 2024 and beyond.

In 2023, the software subsector accounted for almost three-quarters of technology deal volumes, with almost 9,000 deals. This was 2% higher than in 2022. The next most active sub sector was IT services, with almost 2,000 deals in 2023, followed—at some distance—by semiconductors and equipment with just over 600 deals.

In terms of deal values, software accounted for two-thirds of technology deal values in 2023, down from almost three-quarters the prior year, primarily because of a decline in the number of megadeals and lower valuations. In 2023 the largest technology deal announced was a software deal—Cisco’s approximately US$28bn proposed acquisition of Splunk.

Regulatory headwinds.

Some of the biggest M&A headlines in 2023 have centered on regulatory scrutiny as regulators across the globe continue to investigate and take action. Several TMT deals have received tough scrutiny, particularly from US, UK and EU regulators concerned about Big Tech acquisitions that boost the market power of dominant companies or involve start-ups seen as nascent rivals. Although some large deals have failed to obtain regulatory approvals, others have succeeded. For example, Meta closed on its US$400m acquisition of Within Unlimited, taking more than a year to secure necessary approvals to move forward with the deal. Similarly, Microsoft worked through the regulatory process to gain approval for its US$68.7bn acquisition of Activision Blizzard. Regulators in the EU recently introduced a Digital Markets Act which aims to curtail the power of Big Tech and anti-competitive behavior. The EU regulators also ordered Google to sell part of its ad-tech business. In 2024, we expect continued regulatory pressure will dampen enthusiasm for M&A and extend the time it takes to close larger deals.

Tech Law Division,

RmLawAfrica

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