Signal Hill Blog: Analysis & Perspectives

Stock piles of cash, strategic buyer interest and healthy valuations are catalysts ready to ignite the technology M&A market as we approach the fourth quarter of 2010. With the IPO market still slow — no tech companies have priced IPOs over the past month — the door is wide open for companies to turn to M&A instead.

Tech giants are finally starting to spend — and are spending a lot. HP announced this week it would acquire security and compliance provider ArcSight for $1.5 billion, nearly 7.5x revenue. And two weeks ago, HP won an aggressive biding war with Dell for storage architecture provider 3PAR, paying over $2.3 billion, at approximately11.5x trailing revenue and a 250% premium over the 30-day stock price. These multiples are healthy valuations in any market condition, let alone a market coming out of the stranglehold of a recession.

Large-cap technology companies with billion dollar cash-war chests are slowly but surely loosening their purse strings, and in turn, helping push valuations higher. As the economy continues to level out, corporate development executives are finding they finally have the gall to dip into these cash reserves and make a play for companies which, in many cases, are still a bargain buy. We expect many of the big players, including IBM, Oracle, Microsoft, HP and CA, to continue to fill their arsenals with strategic buys throughout the remainder of 2010 as they have more than $42 billion in cash and cash equivalent to spend, as well as huge margins keeping the cash flowing. In addition to this, these companies also have access to cheap debt to finance acquisitions, which is an even bigger enticement for companies to make M&A plays.

Early in the merger cycle, it is typical for there to be more strategic buyers than financial, and that is precisely what we are seeing. Private equity buying in tech has remained somewhat slow over the past several quarters, although when they spend, they spend big. In Q2, PE firms were only the buyers in 5% of all deals tracked by Signal Hill Updata but contributed over 32% of total enterprise value. These firms are also sitting on stock piles of investor money that needs to be put to use. We expect that as financial buyers see the large tech companies making big plays that pay off, M&A activity by PE firms will increase as well.

Signal Hill Updata is very optimistic about the remaining months of 2010. Our own pipeline is full and we expect to close a significant number of IT M&A transactions over the next few months.