Expect Tech Mergers to Increase

I first started calling for a re-emergence of Tech M&A in late March (March 24th to be exact) and we’ve seen this thesis play out in spades thus far in the 2Q. I listened to The 451 Group’s M&A call Thursday and here are some interesting stats along with my sense of where we go from here.

The month of April was the biggest month in terms of deal activity since June 2008 and April activity outpaced the prior 4 months – combined. In April, there was more than $20Bn dollars of deal flow versus roughly $16 billion the prior four months.

Thus far in the 2Q09, there have been 612 deals for a total value of roughly $43Bn versus 646 deals done in 1Q09 for a measly $9Bn. Clearly the big deal is back and while the first quarter was the first quarter in years to not have a $1Bn dollar deal, we’ve had 8 thus far in the June quarter (including eBay (EBAY)/Gmarket, Oracle (ORCL)/Sun (JAVA) and now Data Domain (DDUP)).

Deal valuations have compressed in a meaningful way (1.8x Price/TTM Sales in 1H08 versus ~1x Price/TTM Sales in YTD1H09) – but the floor’s been set and we are off to the races. Median valuations in the 1Q09 were 0.9x Price/TTM sales versus 1.2x this quarter thus far.

As I see it, this is just beginning. First, it is interesting to note that we have a bar-bell of sorts unfolding. We have sales of distressed assets (JAVA) and deals of high-quality growth companies (DDUP) – so buyers have a breath of appetites. What’s more, some of these deals have been game changing (i.e.: Oracle/JAVA) and this puts further pressure on the sector to consolidate. Whether it started with EMC’s purchase of VMW (as some have argued) or Cisco’s (CSCO) move into servers, status quo doesn’t cut it any longer and both vertical and horizontal consolidation will unfold over the coming quarters and years. Tech companies with liquid balance sheets and a desire to thrive in the next cycle are going to continue to look for IP to acquire, distressed assets and/or potentially game changing deals.

I’ve discussed the below before, but as a reminder - some of my favorite Tech Spec names include:

Palm (PALM): The smart phone and mobility secular tailwind is massive and global and software will be a key differentiator. PALM owns its operating system, has core software competencies, dedicated developer following and differentiated product. This is an asset that can’t be duplicated overnight, if at all – so it is clearly an attractive takeout candidate from that standpoint. The Pre is just the beginning of PALM’s return to relevancy. The company boasts a solid management team. Short interest is massive (less relevant for this discussion, but at 29% worth noting). With an Enterprise Value of roughly $2.4 Billion, the EV/Total Addressable Market (TAM) is compelling.

Red Hat (RHT): Open-source and cloud compute are share gainers within the Enterprise compute market. RHT boasts a compelling position within the Linux/open-source community and will prove a key enabler of cloud compute. With roughly $3.50 per share of cash on its balance sheet – this is a profitable and strategic asset. Importantly, the Oracle/JAVA transaction serves as a wake-up call to the industry – both in terms of a shifting competitive landscape as well as the relevance of strategically-oriented outflank-initiatives. If IBM doesn’t snap-up RHT, someone else will.

BMC Software (BMC): BMC represents another strategically placed, relevant Enterprise software vendor that should benefit from the Oracle/Sun Microsystems transaction. The company’s portfolio of products and toolsets are differentiated, competitive and relevant. Great margins, $4.00+ of net cash and a “not too tough to swallow” valuation land BMC squarely in the Two-Banger bucket.

Electronic Arts (ERTS): Solid portfolio of first-party properties (great content) and seculars which are misunderstood. While investors are focused on “this cycle is over”, management teams with a long-duration will quantify the value of the content and appreciate that the industry seculars are changing in positive ways (shift to mass-market increases TAM and shift to console-less improves economics). ERTS has a solid balance sheet with net cash, compelling margin potential and digestible valuation.

Atmel (ATML): Strategically well-positioned semi company with a clean balance sheet and market share gaining products and technologies. Microchip (MCHP) and On Semiconductor (ONNN) wanted to buy Atmel for $2.3Bn in October of 2008 – current market cap is under $1.8Bn. The cycle is just beginning; buy low.

Disclosure: Long ERTS.

Comments

[BeachRider:]

VMWare has certainly been a roller-coaster for EMC. It competes with Microsoft on MS's home-turf, so investors have been very fidgety. Palm could be at a local high-point, so an acquisition would need to take that into account. Red Hat has been on the M/A chart for so long, it seems like no one really wants to own them. BMC has been tracking that life-cycle that so many have followed before. If it follows their pattern, it won't be sold until it is on some kind of down-tick. This might be similar for ERTS. There can't be a lot of buyers for ATML, so the opportunity would have to be special.

Jun 23 08:29 AM