Tech M&A boomed the past five years — but executives need to update their playbook, Bain says

Tech dealmakers have been on a hot streak. But they may need to toss out their old M&A playbooks as the landscape changes, according to a new report from Bain Wednesday.

Heading into 2020, executives are faced with higher valuations, competition from corporate giants names like Intel and Salesforce, and the potential of a recession, according to Bain. Those factors highlight a need for different types of diligence and ways to bring in start-ups that increasingly have different business models than their new parent companies.

“Trends are shifting and they’re shifting quickly,” Adam Haller, partner with Bain & Company’s global M&A technology practice says. “For executives, strategies that made them successful in the past aren’t going to work in the future.”

Tech M&A deal volume has grown 31% annually for the past five years, according to the report. Total deal volume has swelled to more than three times what it was five years ago. And for companies doing larger and more frequent deals, it’s paying off: they delivered returns roughly 3-10 percentage points higher than their less acquisitive counterparts, according to Bain.

The “old strategy” involved buying companies buying competitors to increase their own size in the market. In 2015, half of total tech deals were to increase outright scale. By the end of this year, that total fell to 10%. Ninety percent of companies shifted to “scope” deals in 2019, meaning they are going into entirely new businesses. Tech in particular has really been “widening the aperture,” Haller said.

“They’re acquiring different types of companies than their own with different cultures, different ways of working and new customer segments — these are much riskier deals,” he said.

Part of the rationale for expanding business lines is to gear up for new technologies such as 5G and cloud computing. The emerging technologies are creating demand for new products, better security and more automation, according to Bain. Haller pointed to deals like Intel’s $15.3 billion acquisition of Mobileye and Microsoft’s $26.2 billion purchase of LinkedIn that helped secure access to proprietary data.

Competition from private equity is pushing up valuations, making it harder for standalone buyers to find reasonable deals in the first place. Players like SoftBank, which has partnered with Sprint, or Silver Lake Partners, which partnered with Broadcom, can bring in a company as a strategic deal. That allows the private equity buyer to factor in things like technology or expertise, or a massive customer base that a standalone buyer can’t, and allow them to increase price.

“It puts huge pressure on premiums and prices because you’ve now got a new class of very aggressive competitors there that are in the hunt for for the same assets,” he said. “They’re getting access to synergies that allow them to pay more. So it’s leading to these higher premiums.”

The risk of an economic downturn varies based on who you ask. More than half of the super-rich around the world are already hunkering down for a recession, according to a recent UBS survey. But so-called “Bond King” Jeffrey Gundlach says recession is unlikely as some economic indicators improve. While an economic crisis amplifies the need for diligence to avoid taking excess risk, Haller said it could also be an opportunity for those with cash to spend.

Tech companies weathered the 2008 recession better than the dotcom bubble, largely because they had more cash in reserve. In 1999, the average tech company was sitting on 3% of cash as a percentage of enterprise value. That total was around 10% a decade ago. During the last recession, deal value declined almost 60% but deal volume went up. Heading into the next decade, companies have roughly 10.5% of cash as a percentage of enterprise value.

“For tech M&A, a downturn could actually could present some opportunities,” he said. “We would expect premiums to come down in line with what’s happened in other historical recessions.”