Credit: Look for the dry spell in software company mergers and acquisitions to end in 2018.
[ibd-display-video id=3049836 width=50 float=left autostart=true]M&A slowed among software companies in 2017 as a booming stock market sent the trading multiples of possible targets higher, and as some looming buyers - Microsoft ( MSFT ), Oracle ( ORCL ), Salesforce.com ( CRM ) and SAP - digested earlier prey.
Analysts say the stars are aligning for more deal-making. For one, Trump tax reform will enable tech firms to bring back cash held overseas at lower rates.
A rising interest rate environment may temper stock market gains, making target companies look more affordable, says RBC Capital Markets. And, large software companies will aim to acquire promising technology or software designed for specific industries.
"Less multiple expansion, (overseas cash) repatriation and innovation tailwinds could drive a bigger M&A year," said RBC Capital analysts in a report.
Adam Holt, analyst at MoffettNathanson, has a similar view. Holt says uncertainty over tax reform and rising valuations slowed software industry M&A in 2017 while private companies were under no pressure to sell because of easy access to capital.
"M&A will accelerate in 2018 with the passage of tax reform serving as kerosene on the fire," he said in a report.
Holt says Microsoft, Oracle, Adobe Systems ( ADBE ) and others will continue filling in strategic holes with acquisitions. VMware ( VMW ) is another large industry player that has stockpiled cash, he says.
Holt says initial public offerings in 2018 are possible from the likes of Anaplan, Slack Technologies, Cloudflare, Smartsheet and Qualtrics. But, some could get attractive offers before going public. Microsoft and Salesforce.com, for example, have both expressed interest in buying business communications platform Slack.
For many buyers, the focus is expected to be on fast-growing software-as-a-service companies. The customers of SaaS vendors purchase renewable subscriptions, rather than one-time, perpetual software licenses. Customers receive automatic software updates via the web.
The SaaS software market rose 23% to $43 billion worldwide in the first half of 2017, says market research firm IDC. The overall software market will grow 8.5% in 2017 and 2018, says Gartner, so SaaS companies are gaining share overall.
While some SaaS markets are maturing, such as human resources and customer relationship management, SaaS companies are expanding into analytics, IT services, financial and other areas.
As for targets, Holt says Workday (WDAY) and ServiceNow (NOW) are on "several wish lists" but their valuation soared in the first nine months of 2017. Both stocks have weakened recently amid a broad sell- off in tech stocks.
ServiceNow is still up 54% in 2017 while Workday has gained 47%.
Workday sells software for human relations, payroll and other business functions. Workday has expanded from the human capital management (HCM) into financial software. Salesforce.com, a pioneer in SaaS, sells software that helps businesses organize and handle sales operations and customer relationships. Salesforce.com has expanded into marketing, customer services and e-commerce.
Salesforce.com has forecast organic revenue growth over 20% through 2022. But, it could be a buyer, say analysts at William Blair.
"There is the potential for a mega SaaS tie-up (Salesforce/Workday being the granddaddy of them all), though our sense is the odds are greater for acquisitions to be driven by the on-premise (Microsoft, Oracle) vendors," said a William Blair 2018 outlook report.
Oracle recently raised $10 billion in the bond market, giving it cash to tap for acquisition, noted Terry Tillman, a SunTrust Robinson Humphrey analyst in a report.
"Oracle has made its strategic intentions well known publicly and it includes maximizing growth opportunities associated with SaaS, Platform-as-a-Service (PaaS) and Infrastructure-as-a-Service (IaaS)," said Tillman in a report.
One trend that could accelerate M&A within the software industry are partnerships with cloud computing vendors Amazon Web Services, part of Amazon.com (AMZN), Microsoft and Alphabet -Google (GOOGL).
AWS and Microsoft's Azure service rent computing power and data storage to large companies via the internet. They're also moving into software-related "PaaS" - selling apps that run on cloud infrastructure.
More large companies are shifting business workloads from private data centers to cloud computing services.
"Oracle will need to adapt as the market shifts away from the company's data center stronghold to a less certain future in the cloud, said UBS analyst Jennifer Lowe in a report.
"PaaS is disrupting traditional enterprise software much faster than most realize," said a Cowen report. IDC says the worldwide PaaS market jumped 50% to $8.5 billion in the first half of 2017.
Cloud vendors AWS and Google could make software acquisitions, though they're likely to focus on smaller, technology-related deals, speculates Holt.
For now, AWS has forged a partnership with VMware, whose "virtualization" software is widely used in corporate data centers. Google, meanwhile, in November formed a cloud alliance with Salesforce.com.
While Microsoft, Oracle and SAP by far have the most cash to go shopping for SaaS companies, Holt says that other companies building up cash on their balance sheets include VMware, Adobe, Workday, ServiceNow, Red Hat (RHT) and security firm Palo Alto Networks (PANW).
While revenue growth has been the strong point of many SaaS companies, Goldman Sachs says some could face top-line pressure going forward, making them more amenable to being acquired at the right price.
"Our view is that the wave of M&A is slowly beginning to build, and we would expect to continue to see a healthy dose of best-of-breed vendors consolidated into both legacy software vendors like Oracle and SAP, as well as 'born-in-the-cloud' vendors like Salesforce and Workday," said a Goldman Sachs report.
Goldman Sachs says targets could include Zendesk (ZEN), Cornerstone OnDemand (CSOD), or HubSpot (HUBS).
Analysts say the most likely targets will provide their prospective owners with new market opportunities. Salesforce.com acquired Exact Target in 2013, jump-starting its move into marketing software. Salesforce.com followed up in 2016 by snapping up e-commerce firm Demandware, which helps companies run their online shopping sites. Oracle acquired NetSuite, a provider of cloud-based enterprise resource planning (ERP) software in 2016.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
