Why we expect M&A in tech to continue

Now is a great time for M&A and notable acquisitions of late include Microsoft’s acquisition of LinkedIn, Salesforce’s acquisition of DemandWare, and Verizon’s acquisition of Yahoo. Given the strength of many tech company balance sheets, we expect the trend to continue.  Below is the analysis.

First, we grouped 80 tech companies by their 5 major respective industries (Social, Marketplaces, Content Distributors, Gaming, SaaS) and laid out some of their key financials including OCF (operating cash flow), debt, and cash.  The data is below.

 

$in MM's   TTM TTM  TTM          Debt/ Cash/
Company Ticker Revenue EBITDA OCF   Debt Cash   OCF OCF
Social                    
Facebook FB $22,160 $11,080 $11,200   $0 $23,290   0.00x 2.08x
Linkedin LNKD $3,430 $396 $1,000   $1,150 $3,310   1.15x 3.31x
Line Corp LN $1,300 $159 $206   $420 $430   2.04x 2.09x
Twitter TWTR $2,480 -$4,890 $578   $1,620 $3,590   2.80x 6.21x
                     
Median   $2,955 $277 $789   $785 $3,450   1.6x 2.7x
                     
                     
Marketplaces                    
Priceline PCLN $9,810 $3,710 $3,500   $7,260 $4,370   2.07x 1.25x
eBay EBAY $8,790 $3,070 $3,130   $9,050 $8,090   2.89x 2.58x
Sabre SABR $3,250 $739 $539   $3,280 $68   6.09x 0.13x
TripAdvisor TRIP $1,470 $205 $440   $92 $853   0.21x 1.94x
Shutterstock SSTK $464 $61 $87   $0 $266   0.00x 3.06x
Match Group MTCH $1,120 $289 $229   $1,210 $174   5.27x 0.76x
IAC IAC $3,250 $381 $330   $1,710 $1,330   5.19x 4.03x
Expedia EXPE $7,740 $838 $1,430   $3,210 $2,340   2.24x 1.64x
Etsy ETSY $321 $30 $35   $12 $278   0.36x 8.04x
Lending Club LC $508 $0 $52   $0 $573   0.00x 11.06x
Angie's List ANGI $340 $33 $18   $58 $58   3.26x 3.29x
Zillow Z $741 $7 -$54   $230 $420   -4.26x -7.78x
Groupon GRPN $3,120 $7 $85   $227 $780   2.69x 9.22x
GrubHub GRUB $418 $94 $51   $0 $270   0.00x 5.25x
Care.com CRCM $151 $0 $14   $0 $56   0.00x 4.02x
                     
Median   $1,120 $94 $87   $227 $420   2.1x 3.1x
                     
Content Distributors                  
Yahoo! YHOO $4,890 $151 $1,050   $1,270 $6,380   1.21x 6.08x
Google GOOGL $81,760 $26,900 $28,980   $6,270 $76,940   0.22x 2.65x
Yelp YELP $629 -$9 $60   $0 $398   0.00x 6.61x
TrueCar TRUE $264 -$34 -$1   $29 $103   -31.89x -114.56x
WebMD WBMD $671 $163 $151   $1,040 $1,020   6.89x 6.75x
Netflix NFLX $7,620 $314 -$896   $2,370 $1,830   -2.65x -2.04x
Pandora P $1,290 -$159 -$118   $243 $293   -2.07x -2.49x
                     
Median   $1,290 $151 $60   $1,040 $1,020   0.0x 2.7x
                     
                     
Gaming                    
Activision Blizzard ATVI $5,370 $1,520 $1,640   $5,030 $2,270   3.07x 1.38x
Electronic Arts EA $4,460 $1,120 $1,050   $1,120 $3,430   1.07x 3.27x
Take-Two Interactive TTWO $1,450 $121 $109   $504 $1,190   4.65x 10.97x
Zynga ZNGA $750 -$20 $10   $0 $868   0.00x 91.41x
                     
Median   $2,955 $621 $579   $812 $1,730   2.1x 7.1x
                     
SaaS                    
2U TWOU $177 -$22 -$4   $0 $188   0.0x -49.5x
Athenahealth, Inc. ATHN $1,010 $85 $171   $295 $134   1.7x 0.8x
Bazaarvoice, Inc. BV $200 -$15 $19   $42 $95   2.2x 4.9x
Benefitfocus, Inc. BNFT $212 -$36 -$35   $75 $68   -2.1x -1.9x
Box, Inc. BOX $327 -$156 -$38   $56 $183   -1.5x -4.8x
BroadSoft, Inc.  BSFT $314 $38 $64   $195 $264   3.0x 4.1x
Castlight Health, Inc.  CSLT $82 -$77 -$58   $0 $121   0.0x -2.1x
Cornerstone OnDemand, Inc. CSOD $389 -$52 $48   $234 $267   4.9x 5.6x
Cvent, Inc.  CVT $211 $8 $46   $0 $177   0.0x 3.8x
Five9, Inc.  FIVN $145 -$5 -$1   $44 $58   -48.3x -64.0x
Fleetmatics Group PLC FLTX $311 $67 $99   $23 $194   0.2x 2.0x
Hortonworks, Inc. HDP $155 -$219 -$98   $0 $109   0.0x -1.1x
HubSpot, Inc. HUBS $225 -$41 $11   $1 $117   0.1x 11.1x
IntraLinks Holdings, Inc. IL $285 $14 $35   $80 $39   2.3x 1.1x
Jive Software, Inc. JIVE $202 -$14 -$10   $2 $108   -0.2x -10.9x
Lifelock LOCK $632 $35 -$38   $0 $156   0.0x -4.1x
LinkedIn Corp. LNKD $3,430 $396 $1,000   $1,150 $3,310   1.2x 3.3x
LivePerson Inc. LPSN $232 $16 $36   $0 $52   0.0x 1.4x
LogMeIN, Inc. LOGM $309 $37 $91   $45 $225   0.5x 2.5x
Marin Software, Inc. MRIN $108 -$8 $5   $2 $35   0.5x 7.2x
Marketo, Inc. MKTO $241 -$51 -$4   $1 $100   -0.3x -25.5x
Medidata Solutions, Inc. MDSO $421 $52 $96   $256 $318   2.7x 3.3x
MobileIron, Inc. MOBL $158 -$65 -$35   $0 $85   0.0x -2.5x
NetSuite Inc. N $846 -$59 $117   $286 $408   2.5x 3.5x
New Relic, Inc. NEWR $202 -$61 $10   $0 $196   0.0x 20.6x
Proofpoint, Inc. PFPT $313 -$60 $57   $356 $412   6.2x 7.2x
Qualys, Inc. QLYS $182 $43 $75   $0 $214   0.0x 2.9x
RealPage, Inc. RP $514 $68 $108   $124 $47   1.2x 0.4x
RingCentral, Inc. RNG $339 -$9 $19   $17 $148   0.9x 7.7x
salesforce.com, Inc.  CRM $7,070 $522 $1,930   $2,070 $2,030   1.1x 1.1x
ServiceNow, Inc. NOW $1,190 -$91 $98   $491 $807   5.0x 8.2x
Splunk, Inc. SPLK $729 -$291 $163   $0 $1,020   0.0x 6.3x
SPS Commerce, Inc. SPSC $176 $18 $21   $0 $128   0.0x 6.2x
The Ultimate Software Group, Inc. ULTI $700 $66 $120   $10 $98   0.1x 0.8x
Veeva Systems Inc. VEEV $439 $87 $148   $0 $457   0.0x 3.1x
Wix.com Ltd. WIX $241 -$45 $27   $0 $128   0.0x 4.8x
WorkDay, Inc. WDAY $1,260 -$194 $328   $514 $2,080   1.6x 6.3x
Zendesk, Inc. ZEN $261 -$78 $15   $0 $224   0.0x 15.3x
Secureworks SCWX $362 -$57 -$18   $0 $124   0.0x -6.9x
Appfolio, Inc. APPF $90 -$8 -$2   $0 $22   0.0x -13.9x
Atlassian Corporation TEAM $457 $9 $130   $0 $743   0.0x 5.7x
Twilio TWLO $219 -$30 -$2   $0 $261   0.0x -164.4x
Instructure INST $92 -$48 -$21   $0 $62   0.0x -3.0x
Mindbody, Inc MB $120 -$24 -$13   $16 $88   -1.2x -6.9x
Shopify SHOP $282 -$21 $11   $0 $180   0.0x 16.0x
Xactly XTLY $81 -$17 -$7   $15 $46   -2.3x -7.0x
                     
Median   $272 -$16 $20   $2 $152   0.0x 2.2x
                     
*OCF defined as Net Income + Depreciation and Amortization, Total + Other Amortization +   
Other Non-Cash Items, Total + Change in Working Capital          

 

Looking at their OCF figures, we can see that many of the companies are quite healthy generating significant cash before debt service: in Social, MarketPlaces, Content Distributors, Gaming, and SaaS, the median OCF of each category for the last twelve months has been a healthy $789mm, $87mm, $60mm, $579mm, and $20mm.   On median, all categories are cash flow positive which is important because it means cash isn’t needed to sustain current infrastructure.  That leaves four primary ways these businesses can use current cash flow: growing the current business, a dividend, debt service, and M&A.

 

A dividend is unlikely as Wall Street would punish the stock (dividends are viewed as conceding there is little growth left in the business).  That leaves growing the current business, debt service, or M&A as alternatives, so let’s first look at debt service as a potential use of cash.  Looking at debt levels, these businesses have very healthy debt levels: Social, Marketplaces, Content Distributors, Gaming, and SaaS have median Debt/OCF ratios of 1.6x, 2.1x, 0.0x, 2.1x, and 0.0x respectively.  Any finance nerd can tell you that’s a very low level of leverage.  So, we can eliminate dividends and debt service as the primary uses of cash which leaves plowing cash into organic growth and M&A. 

 

Companies will always plow cash into initiatives which result in organic growth so long as the opportunity and return is there.  So, in order for M&A to be a possibility, there needs to be a significant level of cash on the balance sheet already or in other words, there needs to be more cash than the business currently needs to grow organically.  Looking at the Cash/OCF levels of the businesses, we believe the argument for more M&A is compelling: Cash/OCF for Social, Marketplaces, Content Distributors, Gaming and SaaS is a strong 2.7x, 3.1x, 2.7x, 7.1x, and 2.2x.  Said another way, the Social category already has 2.7 years of cash generation (OCF) sitting on the balance sheet as cash, so the only logical use of that cash after organic growth is exhausted is M&A. 

 

Overall, the market looks ripe for more M&A, so keep building the best business you can and be patient as the M&A will eventually come to you.  The balance sheets of tech companies are too healthy not to.  

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