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Waiting to pounce?
With cash from tax reform, companies could be lying in wait for the right tech targets
Tax reform gave many global tech companies a cash windfall by allowing them to repatriate profits from foreign operations at a lower tax rate. This puts the large tech companies in prime position for mergers and acquisitions (M&A).
May 30, 2019
We’ve seen a surge in total M&A deal value in the US technology industry during 2018, driven largely by a handful of big acquisitions. But we haven’t witnessed the spike in the number of transactions one might expect. That may be due largely to the perceived lack of quality assets available, or assets priced right. But if history is a guide, companies may be waiting to pounce—the way they did after the last big US tax reform legislation in the mid-1980s.
“Goodwill” hunting in 2018: M&A deal activity in technology industry, United States, 4Q 2016 to 4Q 2018
Undistributed corporate profits (cumulative retained earnings) in the US technology, media, and telecommunications (TMT) industry reached $467 billion as of Q3 2018.1 However, although there was no dearth of cash resources, the volume of M&A deals in the technology industry increased only 7 percent in 2018 versus 2017.2 And, were it not for a handful of megadeals in 2018, M&A deal value in the industry would have remained in line with 2017 levels.
Bruce Gribens, partner, Deloitte Tax LLP, noted one possible cause of this limited M&A activity: “The parachute that keeps M&A somewhat in check is lack of quality assets”. Moreover, a Deloitte survey of executives identified high valuation multiples as another obstacle for M&A during 2018,3 as valuations of US small- and mid-cap technology companies have continued to soar.4
A tight market for quality assets and share buybacks5 have played a role in dampening the M&A market. But M&A may simply take time after tax reform. Consider the 1986 US tax reforms, which radically altered the US corporate tax landscape. Research reveals that after those tax reforms were introduced, M&A activity rose during 1988–89, indicating a lagged effect.6
A Deloitte survey of corporate executives revealed a positive outlook for M&A activity in 2019. The TMT industry was the most optimistic, with 73 percent of its respondents anticipating that deal sizes would grow in 2019 versus 2018.7 As seen after the 1986 tax reform, it can take time to repatriate cash, and to select M&A targets once they have cash in hand.
Nevertheless, time is not on the side of tech companies. Joost Krikhaar, principal, Deloitte Consulting LLP noted that “companies do not have the luxury to contemplate what to do with the increased financial firepower for too long.” With the relentless pace of technology innovation and disruption, TMT companies continue to make rapid strategic bets in high-growth areas such as robotics and autonomous technologies, blockchain, augmented reality, and artificial intelligence.8 “Preserving cash positions has never created lasting competitive advantage, while R&D investments and bold bets in products and go-to-market models have,” he added.
1 US Bureau of the Census, Quarterly Financial Report; retained earnings by industry, quarterly, not seasonally adjusted. Data updated as of Q3 2018, retrieved from Federal Reserve Bank of St. Louis, last accessed January 11, 2019. Regarding the methodology used to determine the retained earnings figure for the TMT industry, the following industry categories were included: computer and peripheral equipment, communications equipment, publishing (except internet), motion picture and sound recording, broadcasting (except internet), telecommunications, and computer systems design and related services.
2 Deloitte analysis based on data extracted from Thomson SDC Platinum between October 1, 2016, and December 31, 2018. Transactions included in our analysis relate to any company/entity (including nontech or investor groups) acquiring a US-headquartered tech company. Data excludes deals involving the following acquisition techniques: debt tender offers, exchange offers, open market repurchases, and share repurchases.
3 “Technology Acquisition, Increased Cash to Drive M&A Growth in 2018,” The Wall Street Journal-Deloitte Risk & Compliance Journal, March 12, 2018.
4 Bala Yogesh, “5 Top Weekly NASDAQ Tech Stocks: Small- and Mid-cap Companies Gain,” Investing News, January 6, 2019.
5 Dion Rabouin, “Tech again leads 2019 buybacks toward record,” Axios, April 29, 2019.
6 Alan A. Auerbach and Joel Slemrod, “The Economic Effects of the Tax Reform Act of 1986,” Journal of Economic Literature, Vol. XXXV (June 1997), pp. 613.
7 “State of the deal–M&A trends report,” Deloitte, January 2019.
8 “Technology, media, and telecommunications (TMT) quarterly update, Q3 2018,” Deloitte Corporate Finance, 2018.