Factors Impacting Tech Mergers and Acquisitions

A business valuation is an assessment of the value of a company’s stock shares. In addition, business valuations offer insight into the value of a company’s equity without an active market price. Business valuations analyze a company’s life cycle, observable growth, history, market competition, and prospects, as well as costs associated with building the company from the beginning.

In the case of tech mergers and acquisitions (M&As), interest rates, inflation, and liquidity — or lack thereof — affect stock valuations. Appraisers evaluate a company for an M&A in one of three ways.

The first is from a cost approach, which looks at how much it would cost to replace the company from scratch. This approach is suitable for companies that operate with tangible assets.

The second method for calculating M&A valuations is to rely on the market. In this approach, the appraiser determines value by looking at companies in the area that recently sold. This method works best if the comparison is with other companies in the same niche and region.

Finally, the discounted cash flow approach compares the future earning power of a company with its current cash flow. The appraiser works backward from the five-year projected valuation to calculate the present-day stock value.

In 2022, tech M&As have experienced lower valuations because of inflation. The central banks often address inflation by hiking interest rates, and this harms business valuations because most valuations are based on future earnings performance. After applying a higher discount rate to future earnings, these valuations drop more than the present business valuations. As rates rise, future earnings become less valuable, and stock valuations fall.

Inflation and interest hikes impact the liquidity of tech M&As. With high interest rates, there is less cash flow in the market, so not as much money is available for speculative investing. A cryptocurrency bear market and the slowdown of the special-purpose acquisition company boom indicate the market is illiquid, except for big high-tech firms, which are performing.

As cash and speculation leave the market, stock prices drop, leading to lower valuations. Additionally, high interest rates result in the devaluation of future earnings. However, low valuations are attractive to investors.

The tech M&A market may also see the appearance of strategic investors as buyers. These investors search for ways to buy two companies that will generate more money when joined than they did as separate entities.

Another interested party is the private equity (PE) investor. In the past few years, PE investors have funded M&As described as mission critical, such as companies that manufacture technology. The cloud and all technology related to it have become attractive to PE investors.

For example, firms involved with the creation of technologies related to the increasingly expanding Internet of Things have become attractive to PEs. During the pandemic, these companies drew the attention of PE investors. Post-pandemic, PE investors are looking at companies that produce technologies that reduce labor costs or streamline supply chain processes. Labor and supply chain technologies represent opportunities for investment, and cybersecurity software companies are attractive at a time when many people work remotely.