Deals Dispatch - UK Technology
M&A update for Q3 2024
Author: Mark Allen, Partner and Pete Marshall, Assistant Manager, Corporate Finance.
The end of the third quarter of 2024 brings to a close another active period for the UK Technology sector, despite the summer months. Following a period of stabilisation, the deals market is now being heavily influenced by speculation associated with the first Budget decisions under a new Labour government. The spotlight is focused specifically on fiscal policies and, importantly for the deals market, likely changes to Capital Gains Tax (CGT) rates and reliefs.
The economy continues to show signs of cautious optimism following GDP growth across Q1 and Q2. We also saw the first interest rate cut in more than four years from the peak of 5.25% down to 5% and the recent announcement that the Consumer Prices Index (CPI) rose by 1.7% in the 12 months to September 2024, down from 2.2% in August, increasing the possibility of further interest rate cuts this year.
Notwithstanding the macro-economic picture, the deal volume/value chart below suggests UK Technology M&A has settled at above pre-pandemic levels. We think this reflects improved confidence and optimism in the sector, particularly from financial investors, after what has been a tough market for M&A over the past 18 months due to various headwinds. Although Q3’s disclosed deal values were down on Q2, there were some larger deals in the previous quarter and deal volumes were up 7% to 179, the first quarterly increase since Q3 2023 last year.
Highlights
- The first Bank of England base rate cut since March 2020: acquirers and investors have certainly felt the impact of an increase in the cost of debt, so this was an important milestone. Further interest rate reductions should have a positive influence on appetite for deals.
- Open AI raised $6.6 billion (largest VC round of all time) in its latest funding round at an implied valuation of $157 billion (i.e. a similar market cap to General Electric). This is a striking valuation, particularly as the Open AI is on track to generate projected losses of $5 billion this year, but the company can already claim 250 million weekly active users as well as a million paying business customers.
- Major European IT Services businesses ALSO Group announces its merger with what was the largest privately owned business in the Thames Valley region and one of the largest in the whole of the UK, Westcoast.
Observations
- An uptick in software M&A: We have seen an increase in software deals in each of the past few quarters with strong appetite for UK assets, from both domestic and international investors. The sector being at a pivotal moment of AI/machine learning adoption and monetisation continues to drive activity as ambitious companies look to acquire specialist technologies and IP to accelerate their strategic plans.
- PE activity remains muted: The heat map shows PE deal volumes remaining significantly lower than last year. There has been a particular slowdown in activity amongst the larger PE backed IT services businesses that had been serial acquirers, driving M&A activity. We suspect this is partially due to the tougher debt environment but also because of a reducing number of quality available targets.
- Longer and more vulnerable deal processes now accelerating: The trend towards longer and slower transactions has taken a dramatic turn in light of growing concerns about likely tax rate increases. In stark contrast, processes are now vulnerable for the opposite reason, being time constraints and stakeholder/adviser bandwidth.
Outlook
We feel the outlook for UK Technology transaction activity is continuing to improve, but that view comes with a significant health warning as we await the outcome of the Autumn Statement, particularly in relation to private shareholders and investors. It will also be interesting to see how capital markets react to policy changes announced in the Budget on 30 October as an early indicator of market sentiment.
We are intrigued to see where October deal numbers land due to the obvious acceleration of deal processes this month. We anticipate Q4’s deal activity will be front-end loaded, at the possible expense of overall volumes. The most important factor, however, will be long-term confidence as we look forward into 2025, particularly in light of the backlog of PE exits.
Technology M&A Heat Map
Below is a heat map of UK technology M&A activity, showing the key statistics in the sector and their movements on both prior quarter (QoQ) and prior year (YoY).
Key: Green (positive change) and Red (negative change)
Please note we have excluded all deals over £5 billion and any valuations above 50x EV/EBITDA and below 2x EV/EBITDA in this report. The average deal size excludes deals with no EV reported.
Capital Markets
Key highlights
- US listed tech stocks continue to sit near record highs: Capital markets continue to price in lower projected interest rates and the opportunity presented by AI.
- The UK IPO market shows signs of life: We saw two IPOs in the quarter; Optima Health and Rezolve AI.
- Market still hangs in the balance of a soft vs hard landing: Despite the strong capital market performance for the US tech sector in particular in 2024, we saw the short-term impact of weaker employment data in August, revealing ongoing nervousness in the market.
Sector Spotlight
Cyber security
Our focus this quarter is on cyber security due to the significant outage that happened on 19 July when endpoint security business Crowdstrike distributed a faulty update to its Falcon software, causing global outages across some of the world’s largest businesses. The magnitude of the impact showed firstly how reliant we are globally on a few major software businesses, but also the importance of data security and business continuity, particularly for Critical National Infrastructure (CNI). It was recently announced that UK nuclear site Sellafield was fined £332,500 for cybersecurity failings after a breach of their technology systems.
Escalating global geo-political tensions and attacks on government organisations will continue to drive demand for cyber security solutions and talent, as only a few days ago the head of MI5 said in a rare speech that his team is dealing with the “most complex and interconnected threat environment we have ever seen”. He also highlighted the cyber threat we are currently facing from Russia. Cyber prevention and management is therefore an expensive and highly sought after skill in the market. High quality cyber assets can trade at double digit revenue multiples and the chart below shows the premium in share price growth for cyber security companies over the wider market, represented by the S&P 500.
Cyber security is also a very active area of the market for PE due to the growth opportunity, mission critical nature of the software and services provided and the predictability of recurring revenues as cyber investment is turning into a non-negotiable for most organisations.
Highlights from the UK cyber sector
Recent UK Cybersecurity deals:
- Thoma Bravo acquisition of Darktrace
- Charlesbank investment into Quorum Cyber
- Integrity360 acquisition of Grove Group
Current largest PE Backed UK cyber assets:
- Sophos
- Integrity360
- ITRS
SME Focus
Key highlights in the lower-mid market this quarter
- A notable increase in both trade deal volumes and values for the lower-mid market: We suspect this could partially be the flurry of activity to get smaller deals over the line before the October budget decision, but is also a good sign that more smaller deals are getting over the line.
- New PE platform investment activity remains relatively quiet: There has been a notable downturn in PE investment activity this year. While some of this is due to the tougher debt environment, we also think there is pent up demand for quality assets as the marketawaits clarity from the election and budget results.
- An encouraging PE highlight this quarter was Palatine’s investment into global digital transformation services provider, Bluprintx. We consider this an interesting new platform investment by Palatine who plan to support Bluprintx’s geographical and technology coverage expansion. The investment coincided with Bluprintx’s acquisition of Adobe Commerce specialist, ITG Commerce and we expect further acquisitions.
Supporting you
Our Corporate Finance team are here to assist you with every step of your M&A journey. Please contact Mark Allen or your usual Crowe contact for more information.
