M & A trends in the TMT industry

The dynamics of the Technology, Media, and Telecoms (TMT) industry allow it to stand out from other sectors despite challenging global economic conditions. 

Whilst high interest rates and energy costs, along with a general cost-of-living crisis, have dampened activity in some sectors. TMT businesses have shown resilience. 

RSM advised on 127 completed TMT transactions across Europe in the 12 months to June 2023, more than any other sector. 

The general positive sentiment towards TMT assets is also due in part to the global drive for digital transformation. Markets and Markets predicts the market will surpass US$3 trillion by 2030, with TMT companies benefitting from this growth. 

Specifically, there are also key advantages for investors in this area. “Software and IT services businesses often have subscription-based revenue models, which provide good security of revenue, often with contract visibility beyond six to 12 months,” says Armand von Alberti, Transaction Advisory Partner at RSM in Germany. 

Investment strategies in the technology industry 

Strategic growth: Buy and build 

Buy and build is an investment strategy well-suited to the technology industry. Companies can build their portfolio of technologies by adding another niche or software product to what they have and then seek to exploit that. 

Lee Castledine, Partner at RSM UK and member of the RSM Global Financial Due Diligence Leadership Team, says, “It may be a small piece of technology, but when you have a large customer base, the cross-sell opportunity can be a very valuable way for acquirers to grow profits, and in turn create business value, quickly and significantly.” 

There can also be cost reduction opportunities as the integration of a product to a portfolio might mean a limited need for incremental overheads resulting in a significant synergy gain from a business combination through those savings. 

An alternative strategy can be for acquirers to purchase businesses that have developed niche technology products but with a historical focus on technical product development rather than commercialisation and expansion of the customer base. The introduction of a focused and dedicated sales force to aggressively market the technology has the potential to accelerate both revenue and profitability to drive business valuation on an upward trajectory. 

The complexity of valuing technology businesses  

Valuing tech assets: A deep dive into revenue dynamics 

Technology assets can be challenging to value, especially in the start-up or hypergrowth phase. The business may be unprofitable at the time of sale and yet have significant potential for future revenue. 

Focus is often directed towards revenue visibility and annual recurring revenues (ARR). Due diligence can be key to testing the robustness of underlying assumptions in this area: 

• Subscription services provide a high-quality and consistent revenue stream, but the precise definition of what constitutes “recurring” revenue is often a focus. Sellers can sometimes argue revenues that are not contractual but have a repeating nature might legitimately be refined as ARR.  
   
• Technology businesses can have multiple revenue streams and sellers in areas such as managed services will want to highlight that an inherent feature of the relationships and customer base will mean additional ad-hoc work will be obtained by virtue of their position within the customers’ business. This work may be less secure than subscription income but can still provide a degree of revenue visibility. “Cybersecurity companies that are embedded with their customers can be viewed as a direct extension of their customers’ cyber support team and with this being such a business-critical area, with a high potential cost of switching provider can lead to higher valuations for such businesses as a result.” says Alex Pike, Partner at RSM UK. 
   
• The dynamics of customer churn are inevitably a key focus – how stable is the customer base and what is required to be replaced each year just so a business can stand still. This leads to a focus on the cost of onboarding new customers and this data can be more challenging to assess fully and transparently. 
   
• A further focus might be on headcount and retention. Who holds the critical business relationships and who are key from a technical software product perspective. Due diligence forms a vital part of assessing the underlying dynamics and resilience of the business model in the technology sector. 

Oliver Smyth, M&A Transaction Services Partner in RSM and Nordics FDD lead, says, “Snowball analysis is critical for breaking down revenue movements like, upsell, down sell, won customers, lost customers, etc. Revenues may be the same year-on-year but that does not provide any deep insight into the underlying activities contributing to that revenue.” 

Due diligence processes can need high-power analysis tools and detailed data analytics work to dig deeply into the underlying business drivers. 

Bridging the valuation gap 

Earn-Outs in tech M&A 

With challenges in pricing, earn-out provisions can become a neat way of bridging the difference between what sellers want and what buyers are prepared to pay. These structure payments are contingent on the future performance of the business and may extend out two or three years linked to a particular performance model, be it revenue, ARR or some form of profitability. Inevitably such structures then require owners to stay with a business for that period to enable them to realise that value. 

The TMT sector is continuing to experience strong levels of M&A activity and is likely to remain an attractive sector. Income visibility and the global drive towards digital transformation are key features that buyers like. Assessing technology businesses can be complex, making an effective due diligence process vital for successful deals. 

If you would like further information about any of these topics, visit our FDD page.