TMT review Q4 2022

Investors are re-pricing risk in a high inflation, rising interest rate environment – and the largest global tech businesses are trimming headcounts. However, look below the surface and UK M&A deal activity across TMT tells a different story. We tracked 1,125 deals across software, IT services, fintech, and advertising and marketing services - up 1.8% on 2021 and comfortably higher than 2019 levels, and any of the previous three years.

The combined enterprise value of deals (where the value was shared publicly) in 2022 was £53.1 billion, down 8.1% in the final quarter compared to Q3. Larger mega-deals became more challenging as debt-financing costs rose in the final quarter, but still edged past the £53 billion recorded in 2019. So, while some of the froth may have subsided, the M&A market for UK TMT assets has remained robust, particularly in the mid-market, while valuations have, perhaps a little surprisingly, also stayed strong.

This is impressive, given the multiple headwinds which confronted investors in Q4: the continuing war in Ukraine; record inflation; costly debt; changing fiscal policy; and two changes of UK prime minister.

Buy-and-build key to Q4

While some sectors were more subdued – notably broader advertising and marketing services and fintech, where end-consumer market exposure made dealmaking more challenging – the plethora of buy-and-build platforms continued to underpin deal activity, most notably in IT services where there was renewed impetus during the year. The extent to which well-funded platforms with strong balance sheets – whether PE-backed or listed – remain confident in adding to their portfolios, and continue to see value in capability and market extension through M&A, will be a key factor in how 2023 activity levels play out.

Q4 deal volumes pick up tentatively

Our Q3 report identified the first signs of a tapering off in deal activity as a result of the high levels of uncertainty and economic headwinds, after a very strong first half of 2022. It was perhaps surprising therefore to see growth returning to the UK TMT M&A market in Q4, with 273 deals reported, 10% up on Q3 2022 and 3% up on the final quarter of 2021. These are encouraging signs of market momentum going into 2023.

Public market performance

Tech stocks appear to have settled at a ‘new normal’, following a fall from the dizzying highs driven by the COVID-19 bounce and the prolonged period of very cheap debt and positive market sentiment for growth stocks.

Public market performance stabilised in Q4, and while investors in TMT stocks won't have been immune to the widespread negative returns that characterised public markets over the year, this doesn't seem to have impacted M&A deal volumes. The challenge is whether the reset has been enough, and whether it creates value expectation gaps between buyers and sellers that may prove a drag on M&A activity in 2023. Creative and pragmatic deal-making may well be required to bridge the gap and get deals done.

Private vs public market valuations

Private market M&A valuations haven't been subject to the same volatility as has been evident in public markets. Activity levels are dominated by mid-market deal activity, and have perhaps not been subject to quite the same valuation multiple inflation and volatility as has been experienced in publicly traded stocks.

We saw a slight easing back in ARR valuation multiples for private software assets in Q4, while the equivalent metric for IT services businesses actually trended upwards. The continued demand for digital transformation capability was clearly evident. The broader corporate landscape continues to need to invest in technology to deliver both growth and efficiency, while ensuring they are able to operate securely as cyber risk continues to be a core consideration on board agendas. This is creating opportunities for M&A and keeping valuations strong for quality and niche assets in this market.

Private equity – debt costs cause pause

Years of cheap and readily available debt came to something of a shuddering halt in late 2022, as inflation and government instability drove up interest rates. Perhaps as a result, there was a notable step down in the proportion of primary PE deals, which accounted for just 8% of deals compared to 13% in Q3.

We expect this to be temporary. There will be a number of PE deals in Q4 that hit the pause button as investors got to grips with trading performance risk and re-assessed returns and debt liquidity and appetite. We would expect these to progressively flow back into the markets in 2023 as forward macroeconomic visibility improves and debt leverage availability and pricing become clearer.

It will take time for PE to adjust to a world where leverage multiples and the cost of debt are higher. This may actually create an opportunity for strategic trade buyers with solid balance sheets and the ability to execute and integrate swiftly. A particular window of opportunity for listed software businesses perhaps, where PE has really dominated the M&A landscape over recent years.

Q4 notable deals

Building business

In December, business management software specialist The Access Group announced its acquisition of Construction Industry Solutions (COINS), significantly enhancing its presence in the construction vertical. As one of its largest-ever acquisitions, the deal demonstrated both the ability and desire of Access to pursue larger transactions, notwithstanding the current challenges in debt markets for PE-backed consolidators.

Platform for success

In October, Graphite Capital acquired IT-managed services company Digital Space from Horizon Capital in a secondary PE transaction. The reset of the PE clock serves to renew the investment cycle and brings new impetus to pursue bolt-on M&A for Digital Space.

Consumer confidence

In December, FPE Capital continued its strong recent run with another investment from their recently raised third fund, backing 15gifts, a customer experience management SaaS platform. As a b2b guided selling software platform delivering improved conversion rates online for major consumer brands, the transaction illustrated the opportunities that still exist within end consumer spend markets if the proposition is strong enough.

Seven 2023 TMT investment trends

Q4 2022: TMT deal highlights

CSL acquires Caburn

ECI Partners backed CSL acquired Caburn Telecom, a global provider of secure IoT connectivity and SIM management. The acquisition adds expertise and scale to CSL’s offer. Caburn has over one million live IoT connections across a variety of sectors and geographies. Its proprietary platform allows customers to easily manage and monitor their entire SIM base. Our team provided sell-side advisory services.

Air IT acquires Silverbug and Scoria

Managed service provider, Air-IT acquired IT solutions specialists Silverbug and Scoria, bringing further scale in London and the Midlands and enhancing capabilities and skills across a materially larger client base. AIR IT helps UK SMEs grow their business through a range of managed IT services, including IT support, comms, cloud, cyber security, and business intelligence. Our team provided buy-side advisory support.

FPE invests in 15gifts

FPE invested in 15gifts, guided selling software for online retailers which serves almost all UK telco-mobile network operators, and large mobile operators in the US and Europe. Its software combines consumer behavioural psychology with machine learning to humanise online sales journeys and model real-time, data-rich customer profiles. Our team provided sell-side advisory services.

Maven Capital Partners invests in Bud Systems

Maven VCT completed a £3 million VCT investment in Bud Systems, which provides a SaaS platform to apprenticeship and other training organisations to deliver high-quality training while improving the visibility of progress and performance. It also takes care of compliance in an area subject to increasing regulatory obligations. Our team provided sell-side advisory services.

For more insight and guidance, get in touch with Andy Morgan.

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US firms are leading the way in establishing annual recurring revenue (ARR)-based lending in the UK – replicating products established in the states. Institutionally-backed TMT businesses can benefit from debt packages for M&A, growth CAPEX, and providing additional cash runway. It's a less mature market than its US equivalent, but more and more UK-based firms: ranging from private credit funds, alternative lenders and even the high street, have specialist teams and funds dedicated to building it up in the tech sector. Smaller US-based firms are also injecting additional liquidity into the UK market.

Loss-making business funding not yet market orthodoxy

Unlike conventional bank lending, ARR facilities are typically provided to investment-phase businesses forecasting profitability in the next 12-24 months, even if they're currently making a loss.

Lenders structure their facilities against the level of ARR with the majority of the market providing 1-1.5x of ARR in debt facilities. But, it is a new structure and some use an adjusted EBITDA by adding growth-related costs back and looking at a reduced growth case. The potential for borrowers to switch off investment and move into profitability earlier if necessary gives confidence to lenders.

While 1-1.5x is the norm there have been deals at 2x+ ARR with subordinated debt sitting behind the senior facilities. 

The quality of ARR is essential. Lenders focussed on recurring contractual revenue supported by financial due diligence and repeat/re-occurring revenues are viewed less favourably.

Key credit considerations

Equity cornerstone from institutional investors: either venture capital and/or private equity, is necessary to show that the business can be supported alongside the debt provider. Understanding the debt: equity ratio in terms of the business value and how much cash equity has been introduced by the sponsor gives lenders comfort when establishing the debt level. Historic and forecast revenue / ARR growth of 20%+, or CAGR or 30%+. Equity warrants often feature but aren't required and some lenders can structure exit fees instead. The business plan needs to show profitability within 12-24 months where the covenants will switch from growth capital (revenue and liquidity test) to leverage finance (leverage and cashflow generation).

TMT is still attractive to investors 

Despite the challenges in the macro-economy and pressure on valuations, lenders remain positive in the TMT space. Credit processes are more detailed, with scrutiny of business plans and potential risks. But, significant liquidity is still available across banks, challengers, and funds to support transactions, which means the debt markets are very much still open.

For more insight and guidance, get in touch with Adam Hughes. 

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