The performance of software M&A in 2020 is indicative of a sector insulated from the worst effects of a pandemic that has bloodied industries dependent on face-to-face interaction.
Dealmaking in the sector dipped in the first half, but the decline was far less pronounced than in the overall M&A market. There were 890 transactions targeting software companies globally in the first six months of 2020, a 23% annual drop from H1 2019. Total value over the same period fell by 29% to US$74.3 billion. This was notably less steep than the 32% fall in value and 53% drop in volume in global M&A—demonstrating the resilience of the sector in the face of the COVID-19 pandemic.
As was the case in other industries, Q2 reflected the effect of the crisis on M&A as deal parties paused live transactions or discontinued negotiations altogether. Of the top 10 deals in H1, only one—the US$1.8 billion sale of Turkey-based mobile game developer Peak Games to Zynga—was announced in Q2. Indeed, the US$19.54 billion in value recorded in Q2 was the lowest quarterly total value since Q2 2013, which registered US$18.2 billion in deal activity.
Banking on software
A number of factors ensured software outperformed the overall market. One is the sheer pervasiveness of technology and the role it plays in ongoing sector convergence. Fintech and the transition towards open banking are prime examples of the role played by this convergence, which underpinned the largest software transaction of H1: Visa acquired Plaid Technologies, a financial technology firm which has developed software to connect apps to bank accounts, for US$5.3 billion. The deal, which is pending regulatory approvals, is just one of many that is reshaping retail banking.
Europe has been a frontrunner in the open banking revolution. EU nations were required to transpose the Payment Services Directive 2 (PSD2) into national law at the beginning of 2018, and compliance with the new rules has been required since September 2019. The directive requires banks to open their customer data to competing operators, specifically to start-ups, to increase competition.
The upshot of PSD2 has been for banks and payment services providers to collaborate with and invest in start-ups to gain access to fast-growing areas of financial services.
Following the adoption of similar frameworks in Hong Kong, Australia, Japan and Brazil, it is now the United States' turn. In August 2019 the US Treasury Department published a report promoting innovation in financial services, setting the recommended ground rules for open banking. Given the country's relatively late pivot towards the open banking model, the Visa-Plaid tie-up is likely to be the first of many more to come in the US market.
In addition to financial services, the ongoing digitalization of industries from healthcare through to automotive has also been responsible for elevated software M&A activity. In March, Veritas Capital agreed to pay US$5 billion to carve out IT services provider and consultancy DXC Technology's US State and Local Health and Human Services unit, a provider of tech to US health programs.
In the same month, a group of investors including Silver Lake Partners, the Canada Pension Plan Investment Board, Fidelity and T. Rowe Price Associates invested US$2.25 billion in a funding round for Waymo, a self-driving car company owned by Google parent Alphabet.
In May, the funding round was increased to US$3 billion. Elsewhere in the space, Intel made the US$900 million acquisition of Moovit, an Israel-based developer of mobility software, which will complement its previous acquisition of Mobileye, a developer of advanced driver-assistance systems which Intel took over in 2017 for US$15 billion.
Convergence is not the only motivating factor at work. The defensive qualities of software make it a sector that sees elevated demand for deals. The immense volatility in stock markets in the first half of 2020—the fastest bear market in history—has made price discovery challenging in many industries.
In many cases, vendors and buyers have simply not been able to agree on price. But in software and in the broader technology space, buyers have generally been more willing to accept higher price multiples, because revenues have withstood and often benefitted from the effects of the crisis as demand for software applications increased amid lockdown measures. High levels of investor interest has narrowed the bid/ask spread in M&A negotiations, increasing the likelihood of deals closing successfully.
If the first two months of the third quarter are anything to go by, software M&A is poised for a successful second half to the year.
So far, there have already been two US$10 billion-plus transactions. The largest of these was telehealth provider Teladoc’s US$15.4 billion bid for digital health platform Livongo, which is pending shareholder and regulatory approvals. The deal comes after a string of smaller acquisitions for both Teladoc and Livongo, and if approved, would be the largest digital health M&A transaction on record.
The second-largest deal announced so far in Q3 was the US$11 billion acquisition of Ellie Mae, a US-based technology provider for the residential mortgage industry, by Intercontinental Exchange (ICE), the owner of the New York Stock Exchange. The deal, which is subject to regulatory approval, would solidify ICE’s position in the mortgage technology space—it had previously acquired Mortgage Electronic Registration Systems in 2016 and Simplifile in 2019. The deal announcement comes little more than a year after seller Thoma Bravo, a PE firm, acquired Ellie Mae for US$3.7 billion in April 2019.
Private equity has a large appetite for software and enterprise software in particular. In the early stages of their development, these companies can scale quickly with little capex investment, making them a draw for VC backers. Further along in the tech companies’ evolution, buyout investors are attracted to the companies’ subscription models. Many software companies benefit from predictable, recurring cash flows that are suited to leveraged buyouts as they can pay down debt efficiently, giving comfort to fund managers and creditors financing these deals.
Another notable Q3 deal was a US$463 million investment into Visma, a Norwegian cloud-based enterprise software provider, by PE firms TPG Capital and Warburg Pincus, plus existing shareholder HgCapital. The transaction, announced in August, values Visma at US$12.2 billion. Hg is a long-time partner to Visma—the London-based buyout firm first invested in the business in 2006, delisting the company from the Oslo Stock Exchange for around US$450 million, before selling a majority stake in the firm to KKR in 2010.
Hg's commitment to this asset and the development of its equity story exemplifies the enduring appeal of the wider software sector. Deals in the space in 2020 have been notable for their presence in what is the most challenging M&A market in at least a decade.
This is not a short-term trend brought about by current adversities. Such deals were already highly attractive long before the crisis. With the rising digitalization of all industries and the reliance of businesses on enterprise resource planning capabilities—especially amid challenging economic conditions—financial sponsors will continue to show strong interest in the sector regardless of how long the pandemic lasts.