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M&A in the UK tech sector: Buoyant or a bubble ready to burst?

2015 has already been a bumper year for tech M&A, at a worldwide level and in the UK mid-market (under £100m). Yet for every article and report bullishly forecasting a continuation of the strong level of activity we’ve enjoyed over the last few years, there’s another predicting a bubble about to burst.

Global M&A deals have reached a record high this year. However, in Q3 2015 there was an increase of just 5.6% compared with the same period 12 months ago, the slowest growth rate for almost three years.

Some see this as a sign of weakening confidence, pointing to concerns in the US and Asia-Pacific over a China-driven global downturn, worries over Greece’s position in the Eurozone and general nervousness in the face of tumbling oil prices.  

Whilst market volatility and the slowing of overseas economies can have a significant effect on huge cross-border acquisitions, or billion-dollar energy and utility deals, the technology market can be comparatively insulated.M&A is almost a natural by-product of the constantly-evolving, constantly-disruptive tech sector. As new technology develops, it generates new platforms, new processes, new business models and a whole lot of data; all of which in turn generate the need for better technology to link these elements together. Innovation begets disruption; disruption begets consolidation; consolidation begets innovation. Lather, rinse and repeat.

Established businesses in the tech space are having to become accustomed to competing with newcomers and startups, and so the need to differentiate becomes more important. M&A can provide a solution, and – typically - mid-market M&A deals in the tech sector are driven by more than just a desire for growth.

Smaller strategic acquisitions can bring new talent, new products, access to new intellectual property, new ways of operating and increased cost savings. Acquisition risk can be minimalised much more effectively than with major transformational global deals in more traditional sectors.

At this level, integration is swifter and typically easier to manage. Earn-outs, which are ostensibly a way to bridge a valuation gap, but in practice can turn out to be little more than a way of deferring an argument about price, can be tailored to metrics and conditions which are more predictable.

As a firm, we’ve worked through the dot com bust and the five years of the Great Recession, so we’re wary of being hubristic. We’ve all seen where over-confidence and over-hyped valuations can lead, and it’s not particularly pleasant.

However, commentary equating today’s M&A activity to the M&A market of 2000 – the previous peak in terms of M&A value, and the start of a three-year economic decline - is not comparing like with like. At the turn of the 21st century, around half of the buyers in global M&A deals paid for their acquisitions in shares, enabling valuations to spiral without the reigning effect of being tied to a hard cash price. Recent figures show that full equity deals only account for around 10% of today’s M&A market.    

Whilst we may see a decline in the number of global mega-deals over the next 12-18 months, it doesn’t take much to maintain buoyancy in the UK tech mid-market.

The latest announcements from the Bank of England suggest that interest rates will remain static for the foreseeable future and are unlikely to rise above the “emergency” 0.5% rate until well into 2016.

A combination of continuing low interest rates and the abundance of cash on corporate balance sheets of tech-hungry acquirers (together with continued disruption by technology across all business sectors) means that high levels of UK tech M&A could well continue into 2016 and beyond.

For further information, please contact Andy Moseby.

This article first appeared in Business Zone.