For the past two years, global software M&A has been on a winning streak, but things began to shift in the second half of 2022, as valuations began to drop, driving down deal values.
The pandemic sent valuations of technology assets to heady heights, as investors sought to capitalize on a rapid global online shift in everything from remote working to streaming entertainment. Valuations have since reversed that trend, in some cases heading below their pre-pandemic levels, which has contributed to the recent divergence between deal volume and values compared with the pre-pandemic period. The NASDAQ-100 Technology Sector Index, for example, was down almost 40% year-on-year by the end of 2022, versus approximately 17% for the S&P 500, as inflation and monetary tightening took center stage and investors rotated away from tech and into energy, healthcare and other defensive plays.
And yet, even with a material decline in total deal value in H2, there were still 5,703 transactions globally in the sector in 2022, up 4% year-on-year on what was already a record-breaking 2021.
The first quarter of 2023 continued to show a healthy trend in deal activity for the sector, with a quarterly uptick in global dealmaking. Between January and March, there were 1,143 deals, a quarterly gain of 12% on Q4 2022. Overall deal count remains significantly above levels seen pre-pandemic, before fiscal and monetary stimulus lifted markets. It’s a similar picture on the value side, with US$81.9 billion in software deals—up 15% quarter-on-quarter.
The PE software play slows down
While the market remains active, today’s software M&A market is quite different from that of 2021-2022. There is a lack of mega deals driving value as buyers’ risk appetites have shrunk. There have been no transactions of the magnitude of Microsoft/Activision (US$68.7 billion) or Broadcom/VMware (US$61 billion), both of which were announced in the first half of 2022. The closest in scale to these was Adobe’s US$20 billion bid for cloud-based design and prototyping tool Figma in September 2022. In Q1 2023, the largest deal announced to date, valued at US$12.5 billion, is the acquisition of software firm Qualtrics International by PE firm Silver Lake Partners and Canada Pension Plan Investment Board.
PE buyers were out in full force in 2022, seizing the opportunity to buy prized assets from cooled-off stock markets. There was a record 2,278 buyouts of software companies in 2022, a 12% year-on-year increase. The deals were worth a total of US$253.4 billion—down on 2021, but still higher in buyout deal value than any other annual total on Mergermarket record.
PE transactions in the sector slowed down somewhat in Q1 2023, with 537 deals worth US$49.9 billion—down 30% and 51%, respectively, year-on-year—but it’s worth noting that nine of the top-ten M&A deals in the sector were by PE firms, as they continued to take advantage of lower valuations.
In addition to the Qualtrics International transaction, Silver Lake Partners was also involved in the second-largest PE software deal this quarter. The firm—along with a large group of investors that includes venture capital firm AH Capital Management and sovereign wealth fund Temasek Holdings—acquired a 13% stake in Stripe, the fintech software company engaged with payment processing solutions. The deal was valued at US$6.5 billion based on the valuation of US$50 billion.
Sticky sales
A major draw of the software sector is high-potential enterprise products and services. Sales are sticky and therefore predictable, benefitting from subscription plans often for mission-critical cloud enterprise tools that are embedded into workflows. There is huge potential for upselling additional plugins and modules, and this can all be achieved with relatively low fixed software development costs. Investors can therefore get a lot of bang for their buck when investing primary capital into these businesses from the scalable annual recurring revenues they can bring in, if their product resonates with the market.
These trends, combined with a growing interest in take-private transactions, produced an increase in these deals starting in 2022, as private buyers took advantage of dislocations in the public markets, and this has continued in 2023. Take-privates of software firms produced US$28.4 billion in deals in Q1 2023, up 4% year-on-year, and six of the top-10 software deals during this period have been take-privates (including the largest PE deal of the quarter, Qualtrics International), according to Mergermarket.
Other deals topping the take-private list include the acquisition of P&C insurance software company Duck Creek Technologies by Vista Equity Partners in March, in a deal worth US$2.6 billion, Francisco Partners’ purchase of SaaS analytics platform Sumo Logic for US$1.7 billion and Symphony Technology Group’s acquisition of Momentive, the maker of SurveyMonkey, in an all-cash deal that values the company at approximately US$1.5 billion.
In addition, ClearLake Capital made an unsolicited offer in March 2023 to acquire a majority stake in Blackbaud, a firm that provides software and related services to non-profit organizations. The deal, valued at approximately US$3.8 billion, was rejected unanimously by Blackbaud’s board of directors, but discussions are ongoing.
The rebound in software deal activity in Q1, while positive, does not signal a return to last year’s heights any time soon. Growth is expected to slow and rising financing costs are a pressure point for large leveraged buyout activity, which is true across the sectors being targeted by sponsors.
However, even with disinflation seemingly picking up, the impact of the past two years of inflation is still being felt and recent interest rate rises in the US, the UK and the EU are only adding to the pressure for companies hoping to cut costs. Business input costs and working capital requirements remain high. This situation may benefit some enterprise software providers, where the main pitch is to reduce overhead, streamline efficiencies and boost productivity—boxes that every company wants to tick right now. The narrative has shifted from connectivity in a digitalizing world to enhancing resilience amid rising macro pressures. Software has never been more relevant.
