Australian tech market deals forecast to surge, presenting great opportunities for start-ups.
Despite the COVID pandemic, the past financial year has seen increasing activity within the local digital economy.
Besides more SMEs becoming increasingly digital, the pace of mergers and acquisitions (M&A) within the sector shows no signs of slowing down.
We have never had such a strong pipeline of deals and every day we are seeing more opportunities, including for SMEs and emerging companies.
“Today’s digital economy leaders need to be faster moving and more agile than ever before.”
We see six key themes driving the M&A market for the remainder of 2021 and into 2022 as lockdowns gradually wind back:
1. Valuations for tech companies at record levels
Investors are paying a premium for growth – even if it comes from M&A. This is encouraging large private and listed companies to acquire smaller and emerging companies in anticipation of a valuation arbitrage. Large software companies that traditionally traded at six- to eight-times revenue have seen their valuation multiples trend upwards over the past two years and it is not uncommon for software as a service (SaaS) companies growing at 20 per cent plus a year to be valued at above 15-times forward revenue.
2. Increased demand from global buyers
The relatively small size of the Australian market also leads many Australian technology companies to focus on international markets at an earlier stage than their competitors in the US and UK. This global focus makes these Australian-based companies attractive to large global strategics and international technology investors. Australia has a strong reputation for producing world-class technology companies. In addition, many of these companies have been bootstrapped, making them more efficient than their international competitors that have been built with external capital.
3. The rise of alternative debt funding
There has been a significant increase in the number of venture and mezzanine debt funds in the Australian market. A number of these funds will even lend to companies that are loss-making if they can see a path to break-even and the business has strong recurring revenues. Many of these lenders will also fund M&A transactions with less restrictive covenants than offered by traditional lenders.
4. Organic growth is challenging and expensive
In many sectors it has become increasingly difficult to grow organically, especially by entering new markets and for businesses such as enterprise software and IT services. This trend has partially been driven by COVID, which has disrupted traditional face-to-face sales processes and slowed decision making.
The shortage of talent is also a key factor limiting the growth of many digital economy businesses. The opportunity cost from labour shortages is pushing boards to consider more favourably acquiring businesses that have good quality teams and high levels of automation.
5. Private equity is embracing the digital economy
The emergence of tech-focused private equity had driven a wave of deal-making. It is becoming increasingly common for these funds to outbid strategics for high-quality businesses, including emerging companies.
Private equity portfolio companies typically regard M&A as a key growth strategy. They tend to move faster and often more decisively than strategic acquirers. Low interest rates and tech-friendly lenders are also fuelling a wave of leveraged buyouts and portfolio company M&A with debt covenants often linked to annualised recurring revenue rather than EBITDA (earnings before interest, taxes, depreciation and amortisation).
6. Sellers are embracing a strong market to cash-out
The volume of unsolicited inbound interest and reports of record high prices are prompting founders and boards to consider selling earlier than may otherwise have been the case.
Founders and boards are also finding it increasingly difficult to scale their businesses due to the shortage and cost of talent and the challenges posed by COVID.
The strongest M&A markets we are currently seeing are in the fintech and enterprise software sectors. There is huge demand for companies that sell to a global market and are growing rapidly.
We are also seeing a significant amount of M&A activity in the IT and telco sectors, where listed players are often trading on multiples well above ten times EBITDA and they can repeatedly buy good-quality smaller businesses for five or six times EBITDA. We have advised on and witnessed over 40 deals in this sector over the last few years and we continue to experience strong interest from buyers for the companies we are selling.
Companies like Unity, Spirit Technologies, Tesserent, 5G Networks, Over the Wire and RXP (itself now rolled up by Capgemini) have been incredibly active. Competing for this consolidation are PE backed companies like Nexon, backed by EQT and CyberCX, backed by BGH, which have rolled up more than a dozen players in the communications and IT services sectors.
These well-funded players are outbidding larger strategics – the competition is fierce.
In the current market, listed and private equity backed companies were being rewarded for scale – so the faster they are able to acquire, the more accretive the potential value. There comes a point, though, when the market wants to see they have been able to integrate their acquisitions and promised synergies are being realised.
Growing Australia’s technology industry
Australia’s technology industry currently contributes around 6.6 per cent of GDP and employs over half a million people. However, technology firms in the US represent four times the share of those in Australia, highlighting the potential for growth in the domestic market.
Today’s digital economy leaders need to be faster moving and more agile than ever before.
Emerging companies need to ensure they can deliver, and deliver at scale, in order to compete with global companies that are looking to claim a slice of the expanding Australian market.
An emerging Aussie success story
TASK Software is a great example of an emerging Australian business that is beating some of the world’s largest enterprise software companies to supply its point-of-sale software to major brands like Starbucks and Crown Casinos.
TASK had been inundated with inbound interest from financial and strategic buyers but its recent deal with Plexure allowed the team to continue to build the business as part of a larger ASX-listed story.
This article first appeared in issue 34 of the Inside Small Business quarterly magazine