Economic recovery drives global tech investment

Stephen Georgiadis discusses current tech sector investment trends and the funding options open to businesses

M&A volumes in the technology, media and telecommunications sector have shown a strong resurgence over the past 18 months. The latest figures for the first half of 2014 demonstrate a continuation of this trend, with deal values totalling $373.1bn (£233bn), a substantial increase from $172.7bn for the same period last year.

Economic recovery has been followed by a substantial improvement in outlook. Acquirers are benefiting from vastly increased firepower in the form of highly priced shares to use as acquisition currency; stronger balance sheets from increased profits and cashflows; and greater availability of both equity and debt finance.

Many businesses large and small are now aware of the huge benefits that cloud computing can offer, such as reduced upfront cost from not having to buy, maintain and upgrade hardware; the greater efficiency in upgrading and distributing new versions of software; and the benefits of being part of an integrated ecosystem of online software solutions.

As a result, most providers of software are involved to varying degrees in transitioning their businesses to the cloud. In some sectors, for example CRM, HCM and accounting, particularly at the SMB end of the market, the transition is well advanced.

Big winners such as Salesforce, Workday, Netsuite and Xero are flaunting significantly higher valuations than some of their less fleet-footed competitors.

However, some companies, often those with large, complex ERP requirements, have been slower to transition, for a number of reasons. First, the transition can be painful and expensive if it involves repurposing large amounts of existing data and scrapping embedded investment in existing hardware or internal know-how.

In addition, it is not necessarily cheaper over the medium term to move to a cloud-based solution if that also involves committing to a multi-year, recurring SaaS-type contract.

The growth in cloud computing is also driving growth in the underlying infrastructure and services required to host and deliver these online solutions, namely the datacentre and hosting markets. This has been a highly favoured area of investment for private equity firms and has driven significant M&A volumes.

In the UK, for example, several private equity-backed consolidators such as Pulsant, Six Degrees, Adapt and Claranet have carried out multiple acquisitions, with Pulsant also recently being sold in a secondary transaction at a valuation of an estimated 11 times EBITDA.

This term describes the technology of equipping hitherto "dumb" items – industrial machinery and vehicles, fridges, domestic heating systems, vending systems, cars – with sensors and communications systems that enable them to report regularly or even continuously on their current condition.

This trend is at a relatively early stage of its development and its relevance and durability is as yet unproven.

However, there are presently few concrete examples of successful business models based on this concept. The idea is that in due course, these interconnected devices will generate large volumes of useful data which will drive operating efficiencies.

Such data will also lend itself to predictive analysis enabling companies such as Google, as well as many others such as insurance companies and utilities, to market themselves more effectively.

To the man or woman in the street, one of the most obvious effects of the internet over the past decade has been on shopping. This has driven the emergence of vast generalists such as Amazon at one end of the scale, to specialist or niche sellers, such as Wiggle in cycling, at the other.

This in turn has driven a large number of M&A transactions.

One of the fastest-growing tech sectors, which is again driving substantial M&A volumes, is internet marketing technologies. For all companies, not just e-commerce vendors, that market to or transact with their customers over the internet, it has become increasingly important to understand who your customer is, what his or her interests are and how best to interact and tailor your offering accordingly.

Economic sentiment and its effect on valuations can be unpredictable. However, the fundamentals appear to be sound today as companies remain profitable, cash generative and willing to expand IT budgets once more.

In addition, businesses and financial investors have material cash resources which can be deployed for M&A activities, and credit is readily available on attractive terms.

Public market valuations currently remain strong, but can shrink quickly. Some companies floated in the recent past amid very strong investor sentiment, thereby achieving extremely high multiples, have since underperformed and suffered significant falls in their share prices as a result.

It appears that public company investors are once again becoming increasingly discerning and, while high-quality businesses will continue to prosper, shareholders expect high valuations to be justified by commensurate financial performance.

However, the underlying technological trends driving M&A show no signs of abating. Although internet penetration, the adoption of cloud and SaaS technologies, and the volume of goods and services transacted online are higher than ever, substantial scope remains for further growth in these areas.

Stephen Georgiadis is managing director and head of UK technology at Altium