US-Based Software M&A: 2011 - Not what we’ve been expecting

Software is one of those classic scope:scale M&A sectors, where big players with tons of cash buy up little guys to address known customer demand (product scope), or increase efficiencies for existing offerings (cost cuts and economies of scale).

Surprisingly, after a big volume quarter in Spring 2010 ($16B)… the number of software deals has actually declined for three successive quarters… back down to 2008-2009 levels of about 200 deals/quarter.

Usually, a big M&A quarter with big deals, instigates shake-out and re-alignment within competitive product markets… deals drive deals. It hasn’t happened this time, even in the context of an economic recovery, strong acquiror earnings, and a rising equity market.

Our view is that paradoxically, these same factors are keeping a lid on deal-making.

Priority number #1 for the large software acquirors is delivering on earnings. They have aggressively cut headcount and discretionary spending… lessons learned in 2001-2002 bursting of the Internet bubble. M&A transactions have restructuring charges and front end-loaded investments. Good deals are accretive in year 1, but unless there are immediate sales synergies or cost cuts, even for single product line acquisitions, most deals hit stride in year 2.

M&A is often considered to be another form investment, like CAPX or R&D. It is external versus internal, but at experienced acquirors, it is analyzed with similar capital budgeting tools. Absent strong champions within acquiror sales organizations, CEOs and their corporate development staffs are being cautious about deal-making, as with any discretionary spending. This situation obviously creates a growing backlog of good deals waiting to happen.

Our prediction for the back half of the year is that growth in M&A will rebound strongly with pressure on acquirors for top-line growth, and increased customer IT spending. We expect particular emphasis on enterprise productivity-oriented cloud, SAAS and mobile offerings.