January 22, 2013
Interviewed by: David Snow
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Technology M&A and the Private Equity Opportunity

Jeffrey Liu of EY Capital Advisors gives an overview of M&A trends in the technology space. He describes why mid-sized technology companies can no longer be “all things to all people,” spurring the need to divest, possibly in partnership with PE firms.

Jeffrey Liu of EY Capital Advisors gives an overview of M&A trends in the technology space. He describes why mid-sized technology companies can no longer be “all things to all people,” spurring the need to divest, possibly in partnership with PE firms.

Privcap: What are some trends along the spectrum of technology companies, from the most mature down to the startup scene?

Jeffrey Liu, EY: A few things are happening, I think these days in particular. You certainly have seen a more intense trend over the last five years. And that is that in order to be large and of scale, it’s certainly helpful to be multi product area. You’ve seen big software companies, big integrated vendors that have software and hardware, survive in that configuration. At the other end of the scale, because of technology like the cloud, big data, mobile, there’s also room for fast growers that are focused on very innovative, specific technologies.

The toughest area is in the middle, where you’ve had companies either try to fall into either category– to be all things to all people, as you say, a large, integrated vendor, but never really exceeding a mid cap or small large cap size. Or companies in the middle that have tried to continue to be innovative at the expense of margin, having to put more in R&D in order to stay competitive across multiple fronts.

And I think in the last few years in particular, that’s become a traditional private equity target ground. Where you’ve seen companies that have had to divest of nonperforming consolidated divisions just because they haven’t reached a big enough scale to make them operate efficiently. You’ve seen companies that have really had to reinvest into their R&D structure in different ways to make sure that the margins that they’re earning are more competitive with the rest of their industry class.

And that’s garnered a lot of opportunity for traditional private equity firms. It’s also, I think, recently created a lot of activist activity. Which to me, is often a sign, at the extreme end, that there’s really some intense transformative change that needs to happen in an industry.

Privcap: How does the cash flow of more mature companies inform the private equity opportunity?

Liu: Again, if you’re a reasonably successful technology company, you’re typically throwing off a lot of cash. And I think when you match that with almost a philosophical bias that a lot of technology management teams have had. Traditionally, to have multiple quarters or even a year’s worth of sales in cash on their balance sheet. Plus the fact that, because of globalization, there’s a lot of cash that’s outside of the US that can’t be repatriated in tax-efficient ways.

You end up having companies that appear to have a lot of excess cash on their balance sheet. And those are typically either activist targets, where there’s a lot of urging for return of cash to shareholders either in dividends or repurchases. Or they become good private equity targets. Because there’s cash on the balance sheet to actually fund either leverage buyouts or transformative acquisitions. There are ways that that excess cash is recognized by Wall Street or private equity, and maybe put to action through external pressure on management teams.

Privcap: What is happening among publicly traded tech companies that is important for PE investors to undertand?

Liu: It’s an interesting time in technology. I think you do see a lot of consolidation in companies at the top end of the market to continue to create scale. You also have some very important, I think even more transformative, technology trends than the internet days of the ’90s or early 2000s. And those are in cloud, data and analytics, mobility. So you have kind of a multi-dimensional growth area in terms of these technologies.

You also have a lot of M&A activity happening. On the M&A activity side, through acquisitions, there are often some divestitures. Because there still is an imperative to have a core set of competencies. So oftentimes, some of these companies are being bought, but also shedding certain divisions. Those often are good private equity targets.

Some of the mid cap companies that I described, that aren’t necessarily meeting a good shareholder return threshold, are often being taken private or being considered as private equity opportunities to make them a little bit more efficient. Again, sometimes to divest non-core assets that have been acquired over the years in an attempt at consolidation.

Those, I think, are a very rich area or category of private equity targets. And there are some good exits, ultimately, because these companies still, I think, are on the path of being consolidated. They just may need a little bit of private time to get their products, divisions, margins in order.

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