In Ernest Hemingway’s The Sun Also Rises, a character famously describes how he went bankrupt.
“Gradually, then suddenly.”
M&A markets tend to work similarly in the other direction when they are rebounding from a steep dislocation.
In the wake of the 2001 downturn, M&A deal volume recovered incrementally through 2004 until it exploded upward in 2005. Something similar happened in the years after the 2008-2009 great financial crisis, with a few years of moderate recovery followed by significant legs up in 2014 and 2015.
As 2024 begins, tech dealmaking continues to recover gradually – a trend that may endure for months or potentially longer – but be ready for it to shift suddenly.
2023 was a banner year for public equities, with the NASDAQ up over 40% in 2023, but valuations remain well off the stratospheric pre-downturn levels in January 2022. In Software, NTM EBITDA multiples peaked for application software companies at almost 40x in late 2021 vs. ~22x today, while infrastructure software approached 25x and has now settled at around 20x. Internet multiples experienced even more dramatic contractions, with e-commerce NTM revenue multiples 75% below levels observed in early 2021.
But today’s valuations are reasonable relative to history and the headwinds dampening transaction activity in tech markets are dissipating. Inflation is moderating, the Fed is forecasting as many as three rate cuts in 2024, and the bid-ask chasm separating buyers from sellers since 2022 is finally narrowing.
Then there’s the growing enthusiasm for all things AI. If you listened to an S&P 500 earnings call this past quarter, you heard three times as many mentions of “artificial intelligence” as you did the same time a year ago. And while it’s still too early to identify the big winners from AI beyond the chip and processing companies that are providing the picks and shovels for the AI buildout, it’s not too early to identify the key themes and trends that are likely to define tech sector dealmaking in 2024. Investors have an enormous demand for liquidity entering this year and that will inevitably catalyze activity. Here are just a few trends we have our eyes on:
- A Singular Opportunity for Strategics: With interest rates at multi-year highs and tighter leverage limits, strategic buyers have a notable cost of capital advantage over private equity firms. A PE firm getting financing today can expect to pay 2-3 percentage points more than they did in 2020-2022, which will may increasingly price them out of transactions above a certain size.
Strategics also have a chance to take advantage of compelling assets that are either trading at low valuations or prized assets that enable them to press a competitive advantage in the coming market cycle. A great example of the latter is Cisco’s announced acquisition of Splunk in September, an all-cash transaction that values the cybersecurity firm at ~$26B. In hindsight, market participants may look at this deal as one that encouraged other strategic buyers to test the transaction waters, especially given the fact that we know of several other large deals that are also on the verge of an announcement.
- An Altered Playing Field for PE Buyers: Although PE firms face a more challenging credit environment, it’s important to remind ourselves that the last 15 years represented a vacation from interest rate history. Today’s rates are about the same as they were in the two decades leading up to the 2008-2009 great financial crisis and there are signs the market is adjusting to this “old” normal: M&A and LBO activity reached a 17-month high in September. Globally, there is some $3 trillion in capital that’s committed by LPs but undrawn, representing a significant amount of dry powder that will have to be put to work. In addition, there continues to be a huge liquidity disconnect between the money LPs need and what GPs are distributing. When you combine this with fact that GPs have finite investment periods during which they can deploy capital, you have the recipe for a significant burst of investment activity.
In 2024, we expect to see more investments made across the capital structure including a growing proportion that involve co-control or minority investments, as well as more flexibility in a deal’s governance and liquidity provisions. Firms will also need to leverage informational advantages wherever they can as the formal process to sell strong assets is often increasingly over before it starts. This trend was apparent in recent take-privates in the software industry, as the last ten deals commenced with specific inbound interest which led to an auction won in almost every case by the initial bidder.
- Venture Will Be Patient … Up to a Point: The recent IPO drought was even deeper than during and after the 2008 crisis: There were only five total technology IPOs across 2022 and 2023. These droughts don’t last forever, and equity market momentum may start to pry open the IPO window in 2024. However, we expect the overall IPO market to remain muted throughout the year.
Whenever the IPO market does open back up, expect to see most IPO candidates sharing a well-defined profile: significant scale, strong revenue growth, profitability, market leadership and often the presence of an anchor investor that serves as a validator for a company’s prospects.
For those portfolio companies that don’t have the possibility of a near term IPO exit, venture firms are likely to be more willing to engage in M&A at reasonable valuations now that there is less resistance to marking down assets.
- Cross-Border M&A Will Be an Important Part of the Recovery: For most of the last two decades, cross border deals accounted for around 10-15% of total global M&A. But cross border activity has plummeted since 2022, and the accounted for less than 5% of total activity in the most recent quarter. Although the U.S. has historically taken the lead in reviving deal activity in the wake of downturns, we expect cross border activity to return closer to its recent historical averages, providing a meaningful boost for overall global M&A.
These trends all add up to a bifurcated market emerging in 2024, where good companies selling at fairer valuations will have plenty of suitors. However, dealmaking in this dynamic market will require more work, which of course is why Jefferies is here. In this depressed deal environment, we are one of only two global investment banks that is growing our market share and we are continuing to invest significantly in our TMT practice to be well-positioned when activity inevitably increases.
The recovery may be going slower than many would like, but if history is any guide, it can accelerate faster than many may think. When it does, we’ll be ready and looking to serve our clients with the best possible advice and execution resources.
Jason Greenberg is Co-Head of Global Tech, Media and Telecom Investment Banking at Jefferies. Previously, he was Head of Global Tech Advisory at Jefferies. Prior to joining Jefferies in 2014, Jason was at Credit Suisse where he led Software Investment Banking after previously having served as head of Communications M&A. Prior to joining Credit Suisse, Jason was a founding member of the CSFB Technology Group and DMG Technology Groups, where he helped lead their respective efforts in software and communications M&A. Jason has over 30 years of investment banking experience and has advised on hundreds of M&A assignments worth more than $250bn, including acquisitions, divestitures, joint ventures, hostile takeovers, takeover defenses, leveraged buyouts, financings, stock buybacks, spinoffs and leveraged recapitalizations.
Cameron Lester is Global Co-Head of Technology, Media and Telecom Investment Banking at Jefferies. He was most recently Head of Global Internet Investment Banking at Credit Suisse. Prior to returning to investment banking, Cameron was Co-Founder and General Partner at Azure Capital Partners for fifteen years, specialized in Internet, software and related infrastructure technologies. Prior to Azure, he served as a Managing Director and the Group Head of the Software Investment Banking Group at Credit Suisse First Boston Technology Group. Prior to CSFB, Cameron served as the Group Head of the Software Investment Banking Group at Deutsche Bank. He received an MBA in Finance from the University of Pennsylvania's Wharton School and a BA in Economics from the University of Virginia.