US Tech M&A Booming

The stage is set for another wave of mergers and acquisitions in the U.S. technology sector as the big players, who are flush with cash and looking to expand their horizon, are acquiring aggressively in quest for new products and technology.

Technology companies, which have withstood the recent recession, are keen to expand their product profiles and boost revenue growth. Acquisitions provide quicker access to new technologies than developing them in-house.

There has been a flurry of major acquisitions in the technology sector in recent weeks, with market heavyweights HP and IBM being the most active.

Monday, Data storage company EMC Corp. said it agreed to buy Isilon Systems, Inc. for $2.25 billion in cash to expand its storage products line. On Nov. 2, Oracle Corp said it will acquire Art Technology Group, Inc. for about $1 billion to enhance its eCommerce portfolio. HP trumped Dell to get its hands on storage firm 3PAR, while also bagging security companies Fortify and most recently ArcSight.

Meanwhile, chip giant Intel agreed to buy security firm McAfee, and bought Infineon's wireless solutions business. IBM acquired both marketing software firm Unica and document and data capture specialist Datacap.

One factor driving acquisitions is the narrowing gap between hardware and software companies and the increased adoption of cloud computing. For instance, the line between hardware and software became blurred when Oracle bought Sun Microsystems.

Further, acquiring a new technology is often more cost effective than developing it in-house, which takes time.

Additionally, clients prefer a one-stop shop rather than separate vendors. The acquisitions by HP, IBM and Intel suggest that these suppliers are keen to be single sources for their customers, with storage and security topping the list.

Intel's acquisition of McAfee allowed it to integrate the latter company's security software in its chips, thereby providing a bundled product to its clients. This will provide enough leverage for Intel to negotiate with clients not only on pricing but also on the product as a whole. The acquisition also allowed Intel to say it could offer additional features, such as bundling security software into its chips.

Slowing revenue growth of the big technology companies, primarily due to macro economic factors, is forcing them to find new sources of expansion.

These technology giants have also accumulated large amount of cash due to cautious spending last year. These technology heavyweights, may deploy the excess liquidity for further consolidation and growth.

Year-to-date, there have been 2,004 technology-related deals valued at a total of $75 billion. In comparison, there were 1,669 deals in technology sector worth $68.6 billion in 2009, according to Dealogic.

Deutsche Bank analysts see the sectors most prone to consolidation as those that accelerate the adoption of cloud or data center computer product lines, remove cost overheads from legacy categories in slowing-growth segments, both hardware and software.

Analysts believe the ability to provide networked computing systems is the core driver prompting consolidation in the sector.

In their view, few companies today have all the pieces necessary to offer a comprehensive networking service, and they will likely seek to fill these holes through acquisitions, Deutsche Bank analysts wrote in a recent note to clients.

Technology giants, including Apple, Cisco and Google, are likely to make acquisitions as they have solid cash balances. Deutsche Bank has shortlisted eleven companies that could enter into big deals.

The brokerage feels scale of these eleven firms far exceeds those of the rest of the industry and we think these are likely to be the most acquisitive in terms of making industry-changing deals.

Following table shows the cash positions of the eleven companies based on their latest published quarterly reports.

Source: Company Financials

Potential Targets

Deutsche Bank analysts have identified 18 firms that could be potential targets in the coming months.

These include Acme Packet, Benchmark Electronics, BMC Software, Brocade Communications, CA Inc, Compellent Technologies, Salesforce.com, Citrix Systems, Dell Inc., EMC Corp, F5 Networks, Fortinet Networks, Juniper Networks, NetApp, Riverbed Technology, SAP, SuccessFactors and STEC, Inc.

DELL, EMC and JNPR could be either acquirers or targets, the analysts said.

All the above companies have excellent technology, as well as a customer base that enables the acquirer to enter new markets and boost their portfolios.

The following shows what each potential target companies have in store for its buyers.

Leveraged Buyouts (LBO)

The private equity firms are also looking at niche technology companies. The deal volume among private equity firms is increasing after the credit crisis in 2008 limited access to debt financing. But the improvement in financing markets and cheap corporate debt is driving the recovery of the private equity business.

Buyout firms, which are under pressure to invest billions of dollars of capital raised in the past few years, have made deals worth $173 billion this year, an increase of 95 percent from last year, according to data from Thomson Reuters.

Carlyle has been the most active. Late October, Washington-based Carlyle announced a $2.6 billion deal for voice and data services provider Syniverse Technologies, only a day after its $3.9 billion deal to buy CommScope, a maker of telecommunications equipment.

We expect an increased level of LBO activity in the market over the next few quarters and we think Semiconductor Equipment companies screen as attractive candidates for an LBO, Credit Suisse analysts wrote in a recent note to clients.

Last month, Seagate confirmed in a statement it has been approached by an unnamed party to take it private. Reports from Bloomberg said private equity firms TPG, Kohlberg Kravis Roberts and Bain Capital are among those interested for the hard disk drive maker. Seagate said it hired Morgan Stanley and Perella Weinberg Partners to advise them on the deal.

Meanwhile, Phoenix Technologies Ltd. got an increased offer from private equity firm Gores Group to take the company private, in an ongoing bidding war for the California company.

Credit Suisse analysts said Novellus Systems (NVLS), Teradyne (TER) and Verigy (VRGY) as the most likely LBO takeover candidates from a valuation perspective.

These three stocks show 22 percent to 56 percent upside in an LBO event under a stressed and base line capex scenario, and yet return 20% internal rate of return to potential private equity buyers, Credit Suisse analysts wrote.

The analysts said Verigy and Applied Materials may also be of interest from a strategy change perspective - in both cases, focusing on profitable product divisions by exiting unprofitable ones, optimizing operating costs to stream line R&D.