Tippapatt
Tippapatt
By Ronnie Kihonge
Conditions for IG tech deals are improving, creating potential for sector overhang but, in our view, limited credit impact.
Mergers and acquisitions activity among investment grade technology companies has been relatively muted over the last couple of years.
A combination of higher rates, which increased the cost of capital, and slower IT spending growth made companies cautious in pursuing inorganic growth.
Macroeconomic volatility was also elevated due to rising rates, while greater regulatory scrutiny led to blocked transactions and longer approval timelines.
Thus far in 2024, however, we have seen green shoots in M&A activity as some of these constraints abate.
Two big deals were announced in January, with HPE (HPE) acquiring Juniper (JNPR) for $14 billion and Synopsys (SNPS) purchasing Ansys (ANSS) for $35 billion. Moreover, interest rates are off their 2023 highs, reducing market volatility and funding cost pressure.
Importantly, the technology cycle is generally expected to trend back up in 2024, with Gartner forecasting 8% year-over-year growth in global IT spending.
Company balance sheets are also in a position of strength, with sector leverage at 1.4x EBITDA on average per NB estimates, creating capacity for debt-funded M&A. Additionally, the rally in tech stocks over the past year gave companies strong equity currency for transactions.
On the regulatory front, the environment looks to be thawing following China’s approval of the Broadcom (AVGO)-VMware (VMW) deal and EU approval of Microsoft’s (MSFT) acquisition of Activision Blizzard.
In the U.S., the FTC has struggled in seeking to block transactions through the courts. Finally, we believe artificial intelligence and other secular growth trends should spur more consolidation as tech companies position themselves to capitalize on them.
That said, we think the timing of M&A this year will likely be dictated by the path of rates. The upcoming U.S. election could also pull deals forward - or push them back - depending on expectations around an FTC regime shift.
Geopolitical issues remain a risk and could arise unexpectedly, for example changing the seemingly improving regulatory dynamic in China.
For the market, increased M&A activity would likely pressure credit profiles and valuations. Debt-funded deals would increase leverage of the acquirers, while sector valuations would be constrained by an overhang of supply, in our view.
Overall, despite near-term concerns around increasing M&A, we remain constructive on the technology sector for the long term.
In our view, secular growth trends including AI, enterprise digitization and industrial and auto electronification should support credit profiles. We see debt-funded M&A as a potential opportunity to add to positions in the sector.
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