TMT M&A: Fat Wallets and Attractive Targets

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The pace of M&A in TMT has accelerated in 2011, with more and larger deals than in 2010.   Through 3 quarters, 169 TMT deals have been done in 2011 for $84.4B, compared with 168 and $49.7 for the same period of 2010, yielding a 49.2% premium on public targets.  We expect the robust M&A environment to continue for the visible future for three reasons: 1) The sector is undergoing unusual and dramatic change; 2) Large players are either poorly positioned or see opportunities to extend their advantage; 3) Most large players are cash rich and well capitalized; and 4) Targets are historically cheap.  In this context, we classify deals into two categories, transformational – meaning the buyer is looking change course – and incremental – meaning the buyer is looking to add synergistic pieces to an existing strategy.  In this, we believe that a company’s position in emerging growth opportunities is the biggest indicator that it might become a target

We have written extensively about the changes that we believe are wracking the TMT sector.  PC architecture is giving way to portable device platforms that will be tightly integrated into cloud-based environments that will subsume stand-alone devices and applications.  Enterprise data centers, now growing with virtualization, will evolve to the public cloud, commoditizing data center hardware and opening opportunities for software solutions that make best use of the benefits of the cloud.  4G technology is on a development trajectory that will allow wireless operators to compete effectively for residential broadband and facilitate a transition from channelized video to internet delivered entertainment on demand, likely tied to the previously mentioned cloud-based environments

We expect these changes to remake the TMT landscape, just as the changes of the ‘80’s gave us the rise of Wintel, clone makers, cable operators, networkers, IT services and mobile telephony, and the demise of a laundry list of old-line computer makers and Nifty-Fifty dinosaurs.  This time, the PC value chain, data center IT vendors, and cable MSOs face the evolve-or-die ultimatum and will look for game changing targets, while a handful of big players on the right side of change shop opportunistically for synergy.   Potential game changers will be hard to find, expensive and risky, while opportunistic buyers have more degrees of freedom to find attractive deals

These shoppers have fat wallets despite battered share prices.  Despite previous deals and a weak economy, 172 large cap TMT companies are collectively carrying $618B in cash and equivalents, a whopping 101% of sales and up 55% over the past two years.  The top 30 cash holders are carrying $426B.  At the same time, the weak tech tape makes targets cheap and willing to consider offers.  The average TMT small cap stock in our universe currently trades at just 3.49 times sales

We split the ranks of potential shoppers into three buckets: at risk companies possible in search of game changers, well positioned companies looking for missing pieces, and companies that are somewhat insulated from change.  Taking the first two categories, we filtered by available cash and previous propensity to acquire.  For the 25 companies that emerged as high potential acquirers, we assessed their strategic needs, previous deals and known wish lists to identify categories of interest

On the target side, we filtered the universe of small/mid cap (less than $10B market cap) TMT names for companies that participated in business areas likely to prosper as the landscape shifts.  While small companies will acquire smaller companies, and large caps may be swallowed by still larger acquirers, we believe most of the M&A action will be large cap on small.  This universe, split into rough categories was ranked on the basis of their demonstrated sales growth and a subjective assessment of their strategic positioning

Surveying the lists of likely buyers and attractive targets suggests the potential for high impact deals in many areas, but also both buyers and sellers who may find it difficult to find an appropriate fit.  We believe that companies that have not yet gained a foothold in the technologies and services that will lead in the future will be unlikely to be able to buy their way out of their quandary with a truly transformative acquisition.  This struggle has been apparent in the recent, unsuccessful acquisition history of companies with little presence in the emerging new paradigms, such as HP and Dell.  That said, recent history and deep pockets suggest that they will try

On the flip side, deals for smaller companies that are competing unsuccessfully in attractive arenas have worked out well for buyers (see HP-Palm, NewsCorp-MySpace) , bringing tougher scrutiny to damaged goods properties and raising the premium for players with established leadership, public or not.  We note that hot story valuations can run beyond the budget of potential acquirers, often spurring competitive market entries rather than competitive bidding.  This can end well (see Facebook) or badly (see Research in Motion)

We have charted the likely interests of shoppers in the TMT M&A market and ranked potential targets on the basis of their business positioning.  We have no specific knowledge of interest on the part of these companies and have made no attempt to place a value on any of the targets

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