The Buyers Speak: Software Equity Group’s 2011 M&A Survey

The following excerpt is from Software Equity Group’s 2010 Software Industry Equity Report

In early January 2011, Software Equity Group conducted its third annual Software Company Buyer Survey to provide our readers a better understanding of 2011’s software M&A ecosystem and buyer thinking. We polled 176 of the largest software companies in the world, both public and private, and received an excellent response. Collectively, the respondents to our 2011 survey spent well over $13.9 billion on software acquisitions in 2010, and their plans and playbook will heavily influence the software M&A ecosystem in the year ahead.

Unsurprisingly, 83% of our respondents bought at least one software company in 2010 and stayed close to home. Buyers remained focused on strategic transactions that leveraged and enhanced their core businesses, acquiring tuck-ins and eschewing bargain shopping and unsought opportunities. Their M&A behavior in this regard was consistent with their responses to our 2010 survey, and reflected the economic uncertainty that persisted through much of 2010.

What lies ahead? The number of software M&A transactions will almost certainly grow this year, as 93% of respondents stated they plan to acquire at least one software company in 2011 and 51% stated they plan to acquire three or more software companies in 2011. Indeed, 17% of respondents stated they plan to acquire six companies in 2011, up from only 6% in 2010.

And what’s motivating these buyers? Buyers are laser focused on improving their products and broadening their current offering. Product enhancements – to plug holes, add incremental functionality, competitively differentiate and improve the user experience – was ranked by 40% of respondents as their most important M&A objective in 2011, and by an additional 27% as their second highest priority. Broadening their current offering – adding new product categories, entering new markets and expanding territories – was named the most important M&A objective by 30% of respondents, and as their second priority by an additional 40%. Financial benefits and market share as primary motives were seen as considerably less important. By contrast, in 2010, buyers were almost equally divided amongst financial objectives, product enhancement, market expansion and market share.

Software M&A spending will likely be robust in 2011, with 54% of respondents expecting to spend at least $100 million on software acquisitions this year. Valuations should also see an uptick. 60% of respondents expect to pay at least 10% more in 2011 for a company very similar to one acquired in 2010.

While SaaS providers have been on many large software company radar screens for the past three years, it hasn’t been an M&A spending priority for most. Until now. 30% of the buyers in our 2011 survey believe that it is “very important” that a target be all or sustainably SaaS/subscription based, a remarkable increase from just 13% in the 2010 survey. In fact, only 17% felt that SaaS was “unimportant” in 2011, a stunning decline from the 47% who expressed disinterest in 2010. It’s unclear whether big software company interest in acquiring SaaS providers has suddenly peaked because of the attraction of subscription based revenue, or because of market demand. Likely, it’s some of both.

What do buyers consider most important when selecting and valuing an acquisition target today? Since most buyers in 2011 are seeking to enhance and extend their own offerings, it’s of little surprise an overwhelming 63% of 2011’s Survey respondents deem the target’s products and technology platform the most important factors in deciding whether, and for how much, to extend an offer. The target’s profitability and growth, to the dismay of many private software company founders, is relatively unimportant to the overwhelming majority of our 2011 Survey respondents.

A notably greater number of buyers this year ranked the caliber of the target’s management team and operations to be the most important factor in deciding whether, and for how much, to extend an offer. It’s almost certainly because buyers today deem continuity, orderly transition and phased management withdrawal essential to the success of the transaction post-closing.

As our founder, Ken Bender, wrote in the editorial column of our 3Q10 Quarterly Report, the buyer mindset today has changed since the Great Recession. Our 2011 survey results back him up. M&A decision making has shifted from top down to consensus according to 60% of buyers responding to our survey; 72% say they’re doing much more analysis today of the market opportunity, go forward strategy and target synergies; and 84% of respondents indicated they conduct much more pre-LOI due diligence on a target’s financials, products and operations.

Despite this unprecedented degree of due diligence by buyers, we’ve observed a higher mortality rate in the past two years of software M&A transactions under LOIs that never closed, and decided to ask why.

Our 2011 Survey makes clear the exit valuation gulf between buyers and sellers is wide, and often gets wider during due diligence. A whopping 41% of our respondents told us that unrealistic valuation expectations were the single greatest reason why a deal under LOI failed to consummate. This response should be read in conjunction with responses to another of our questions regarding those post-LOI events that most imperiled the closing of a transaction.

According to the buyers we surveyed, the closing of a deal under LOI is most imperiled by the renegotiation of the proposed purchase price due to matters uncovered or clarified during due diligence. These can cover the gamut of missed revenue or EBITDA forecasts, uncollected sales taxes, missed product release dates, open source languages embedded without appropriate license, deceased third party developers who didn’t sign work made for hire agreements, customer attrition beyond what was indicated during pre-LOI discussions… it’s a long list, and buyers today do not react kindly. Often they see the value of the company as being less than originally bid, and reduce their offer. The targets, in turn, are often outraged for being “nickel and dimed”, especially when they’re so “strategic” to the buyer. More often than not, that’s the reason behind the “unrealistic exit valuation” response given by so many of the buyers we surveyed when asked, “What’s the most common reason an acquisition fails to consummate once you enter due diligence?”

It’s clear from the results of our 2011 Survey that buyers in 2011 will be more acquisitive; will pay modestly more; will be product and technology focused; will be process and consensus driven; and will closely scrutinize the target prior to closing to reduce risk and enhance the likelihood of realizing the expected return. Thus far, as we go to press, that certainly appears to be the case. We’ll detail that more in our 1Q11 Quarterly Report.

Software M&A Deal Volume and Spending

The following excerpt is from Software Equity Group’s 2010 Software Industry Equity Report.

Software M&A transactions accounted for 11.7% of all U.S. M&A activity in 2010, down from 13.3% in 2009. There were 1,586 mergers and acquisitions worth $51.9 billion in the U.S. Software sector in 2010, compared to 1,329 transactions aggregating $27.4 billion in 2009 (Figures 37 and 38).

1Q10 began on a positive note with 431 transactions, the fourth consecutive quarter of increased software M&A deal volume. Unfortunately, that level of activity was not reached again in 2010, as software M&A deal volume declined 12% to 385 transactions in the second quarter, rebounded a bit in Q3, then fell off again in the final quarter (Figure 39). Year-over-year, each quarter in 2010 posted an increase over 2009, assuming 4Q10’s 368 software transactions (vs. 372 in 4Q09) will increase by 10-15 deals in our final tally.

Overall, 2010’s software deal total was healthy in comparison to transaction volumes over the past decade. Note to our readers: The deal and dollar volumes in Figures 37 and 38 have been updated from our previously published quarterly reports due to transactions newly reported or deleted (i.e., scrapped deals) after our publication dates.

Based upon our 2011 buyer survey results and our conversations with a broad array of public software company corporate development heads and private equity firm managing directors, we anticipate a modest increase in software M&A transaction volume in 2011. Asked how many software companies they anticipate acquiring in 2011, 20% said six or more; 31% said three to five, and 41% stated they plan to buy one to two this year (please see Survey results). Overall, responses to our 2011 Survey indicate software M&A deal volume will rise approximately 12% to 1,775 this year, driven primarily by buyers seeking product enhancements, extensions and competitive differentiation. =

2010’s total software M&A spend was 90% greater than 2009’s, although deal volume increased only 16%. It would be erroneous to conclude, however, that the average deal size increased dramatically in 2010 because valuations were markedly higher or many larger companies were acquired. Major fluctuations in software M&A spending each quarter are typically the consequence of a relatively small number of software industry mega-deals (transactions with enterprise values greater than $500 million). Of 2010’s $51.9 billion total software M&A outlay, $26.3 billion was spent on 17 mega-deals. By comparison, 2009’s $27.4 billion total software M&A outlay included $9.6 billion spent on seven mega-deals, while 2008’s $56.2 billion total price tag included $32.6 billion on 21 mega-deals.

SEG Releases the 2011 Buyer Survey and 2010 M&A Review

Software Equity Group’s 2011 M&A Buyer Survey and 2010 Annual Software Industry Equity Report is now available for download. Our comprehensive, 84 page, annual report provides insight, data, and information about software industry mergers & acquisitions, initial public offerings, venture capital investments, public software company financial and stock market performance, and software industry market trends available nowhere else.

Think you know what’s in store for software M&A in 2011? Think again. We surveyed 176 of the largest software companies in the world to gain insight into their acquisition strategies for 2011. The detailed answers from many of the movers and shakers in the software industry will surprise you.

Software Equity Group’s research reports are now read and relied upon by more than twenty thousand software industry senior executives, entrepreneurs, venture capitalists and private equity investors and professional advisors in 64 countries across the globe. Shouldn’t you know what they know?

You can obtain a complimentary Executive Summary which provides some highlights from the report.  The cost of the complete Software Industry Equity Report is $595.  If you have any difficulty completing the purchase of your report, please contact Kelly LaMarca at klamarca@softwareequity.com or 858-509-2800.