7 steps Tech CFOs can take to prepare for an accelerating M&A market

While 2023 was about efficiency, 2024 is shaping up to be the year of growth, driven by mergers and acquisitions (M&A). In fact, according to the EY April CEO Survey, 43% of tech CEOs plan to pursue M&A in the next 12 months. Because the M&A market is warming up, it’s critical for tech CFOs to act quickly now so they're not left behind.

Given the explosion of significant advancements in artificial intelligence (AI), it’s important for tech companies to consider AI acquisitions because it’s one of the quickest ways to maintain a competitive advantage vs. taking the time to develop something in-house. Moreover, per the 2023 Global EY DNA of the CFO Report, some of the highest CFO priorities — such as technology and digital innovation — can be improved by undertaking M&A.

Another factor that tech companies have on their side is that growth in the share price within the tech sector has outperformed the S&P 500 by about 10% since the start of 2022, according to an EY analysis. This is leading to high valuations that can be used as share capital to acquire capabilities such as AI to build their product portfolios.

To seize opportunities in this accelerating M&A market, tech CFOs can prepare by taking these seven essential steps:

1)????? Use M&A as fuel to supercharge growth

M&A is more than just a reactive strategy, and rather, a way to proactively align with the company’s long-term goals and strategic objectives. By gaining a better understanding of how M&A can fill gaps between current capabilities and future growth targets, tech companies can use dealmaking to enhance business growth, enable geographical expansion or diversify the company’s portfolio.

For example, a major tech company acquired a self-driving car startup with the aim to add capabilities in autonomous vehicle technology, enabling it to diversify its logistics and transportation services. It also facilitated geographical expansion by providing access to the startup’s expertise and resources in the autonomous driving industry, positioning the company to potentially enter new markets and offer innovative solutions in transportation and delivery.

Besides the usual considerations of growth, profitability and synergies, it’s also important for companies to weigh how many deals of each type they’re planning. Depending on the company's appetite for change, CFOs should strategize as to whether transformative (larger-sized) or tuck-in (smaller-sized) transactions would be most beneficial for the organization.

Using the underlying data in our recent analysis(1) on S&P 500 companies, we examined tech companies and discovered that those focusing on tuck-in transactions could benefit from building “muscle memory” and increasing their deal volume to boost total shareholder returns (outperforming annually by approximately 6%). Also, companies concentrating on transformational deals could benefit from focusing on fewer transactions for a similarly beneficial outcome (approximately 12% outperformance annually). Deciding on the deal size can help CFOs start to develop a list of target priorities tailored to the company’s strategic objectives, while also considering market priorities.

2)????? Monitor macro conditions

We see the US economy advancing a moderate 1.8% in 2024, with a deceleration in the first half of the year and the expectation of a reacceleration in the second half. However, since the timing of M&A activities can be as crucial as the deals themselves, it’s critical to track global economic indicators to understand how fluctuations can affect M&A opportunities. Factors such as interest rates, market liquidity and investor confidence can significantly influence the attractiveness and feasibility of deals.

For instance, over the past two years, challenging market conditions have made it increasingly difficult for tech startups to raise funds and maintain healthy cash flow. With venture capital dwindling and investors focusing on profitable ventures, many early stage startups are turning to M&A, despite the possibility that it may be under less favorable terms. Companies looking to acquire startups may want to seize these opportunities now, before the economy fully recovers, so that they don’t miss out on deals.

In a recovering market, monitoring indicators — such as cash flow constraints due to high interest— can help CFOs time the transaction. It’s essential to get the timing right for M&A pipeline management to evaluating targets, signing when valuations are low, planning the duration until close and understanding by when you can expect to capture synergies.

3)????? Watch out for market and sector detours

An in-depth understanding of market and sector-specific trends is critical. Keep an eye on events such as changes in customer behavior, technological advancements and competitive strategies within the sector. This can help identify the most suitable targets that can create the most revenue and cost synergies.

We anticipate that tech companies will continue to focus on strategic acquisitions in artificial intelligence (AI) and emerging technologies. In the EY April 2024 CEO Outlook Survey, 47% of CEOs reported that they‘re planning to invest in technology, including AI, in the next 12 months to improve growth and productivity. However, before making an AI acquisition, it’s critical to develop an understanding of how AI will align with the company’s strategic goals.

In addition, it’s essential for CFOs to consider how AI technology acquisitions could tell a clear story of their companies’ value-add strategy and communicate this to investors. Providing them with a return on investment (ROI) scenario analysis and a projection for a potential AI acquisition can help investors better understand the company's financial prospects, leading to increased trust.

4)????? ?Become a defensive driver

The technology, media and entertainment, and telecommunications (TMT) sector has been the second-most frequently targeted industry over the past 10 years. Most activism campaigns work behind the scenes with the company to effect change, but around one-third of shareholder activism campaigns are hostile takeover actions — such as proxy fights and takeover bids.(2)

For years, shareholder activism in the tech sector often focused on top-line growth metrics. However, with the recent downturn in tech stock performance, activists are now increasing their scrutiny of a company's internal operations. When facing such threats, CFOs should collaborate with other executives to develop a detailed value creation plan, such as enforcing ROI-based capital allocation, maximizing cash flow, and optimizing finance functional structures and processes.

For instance, a prominent software company faced a takeover threat from a major hedge fund investor due to poor financial performance. By implementing drastic cost-cutting measures and launching a series of well-received transformation initiatives, the company achieved strong fiscal year performance and convinced the activist investor to withdraw the takeover attempt.

5)????? Navigate the road to financing

CFOs can help companies maintain a healthy financial position on the balance sheet, putting them in a favorable stance when securing financing options for M&A activities. Exploring various financing methods, such as equity, debt or hybrid instruments, and understanding their implications on the company’s balance sheet are essential for executing an efficient and timely M&A transaction.

Historically, tech acquisitions have been a mix of cash and stock deals, with stock often favored to keep a healthy balance sheet. For example, a Fortune 100 software company used its own stock as currency to acquire a software development platform, which meant it didn’t need to deplete cash reserves. By taking this approach, they were able to maintain a robust balance sheet.

6)????? Tune up your organization before you start

In our research on how large-cap companies conduct M&A transactions(1), we observed that establishing dedicated resources and teams for a company’s M&A activities is one of the key elements in executing a successful M&A transaction.

By dedicating top-tier talent and setting up a corporate development office, companies can:

·?????? Identify targets early

·?????? Conduct commercial, financial and operational due diligence efficiently

·?????? Evaluate multiple targets simultaneously

·?????? Make timely decisions

·?????? Drive the integration successfully

A seasoned corporate development office with robust M&A muscle memory can better streamline the complex integration process and maximize synergy realization. Since integrating is one of the most complex tasks in the M&A lifecycle, it’s essential for CFOs to be heavily involved in the integration and appoint finance functional leaders who strategically support the whole organization.

When it comes to talent, there are multiple ways of building capabilities. Whether it’s finding resources in-house, hiring externally or seeking consultation from M&A professionals, it’s beneficial for CFOs to consider the available options and decide on the most effective and efficient method based on needed capabilities and capacity.

7)????? Follow the rules of the road

The U.S. Department of Justice (DOJ) and the U.S. Federal Trade Commission (FTC) released the final version of the new merger guidelines(3) at the end of 2023, laying the groundwork for bringing and winning big cases against major technology companies. Under stricter guidelines, it’s essential for tech CFOs to work closely with the deal team to address new antitrust considerations.

CFOs play a pivotal role in this because they’re instrumental in conducting comprehensive economic analyses using the company's current and forecasted financial data. It’s also crucial that they collaborate with other leaders to prepare detailed documentation early to clearly demonstrate why the merger is not anti-competitive.

CFOs also supply regulators with precise and exhaustive financial information that extends beyond the traditional scope of financial statements. This comprehensive preparation can help regulators make faster, more informed decisions to avoid delay in the deal timeline.(4)

In addition, earlier in 2024, the FTC launched an investigation into Big Tech’s generative AI investments to understand if they risk distorting innovation and undermining fair competition. Tech companies planning to pursue such acquisitions to boost their digital content and media offerings should also carefully consider relevant regulatory risks before making the move.

Another factor to focus on is for CFOs to establish a transparent communication process with investors about M&A plans, potential impacts and the strategic fit to help secure their support. That includes seeking investor feedback regularly to understand their perspectives and address any concerns related to M&A activities.

Conclusion

It’s important for CFOs to champion innovative capital spending and closely monitor economic indicators, as well as advocate for a robust risk management process to prevent hostile takeovers and regulatory noncompliance. It’s also essential to foster transparent communication with investors regarding the company’s long-term strategy.

These actions are aimed at not just surviving but thriving. CFOs who prepare for M&A can play a significant role in navigating through these strategic endeavors with agility and a vision that can help set their companies apart in a competitive, ever-evolving market.

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Coauthored by Lukas Hoebarth , Markus Neier , Amanda Licciardi, CPA and Dalu Zhao, CPA .

The views reflected in this article are the views of the authors and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.

1 Hoebarth, Lukas, “Unleashing value: how the number and size of M&A transactions shape shareholder returns,” LinkedIn website, https://www.dhirubhai.net/pulse/unleashing-value-how-number-size-ma-transactions-shape-lukas-hoebarth-82jfc%3FtrackingId=aJQhO%252ByRS3qrPEA4P3p%252FaQ%253D%253D/?trackingId=aJQhO%2ByRS3qrPEA4P3p%2FaQ%3D%3D, accessed May 2024.

2 Scheid, Brian, Lexova, Ingrid, “Investor activism surges as companies react to proposed changes,” S&P Global website, www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/investor-activism-surges-as-companies-react-to-proposed-changes-80689296, accessed May 2024.

3 “US antitrust enforcers release final version of merger guidelines,” Reuters website, www.reuters.com/world/us/us-antitrust-enforcers-release-final-version-new-merger-guidelines-2023-12-18/, accessed May 2024.

4 Berlin, Mitch, “3 Steps CFOs Must Take to Prepare for the New Merger Guidelines,” CFO website, www.cfo.com/news/3-steps-cfos-must-take-to-prepare-for-the-new-merger-guidelines/709909/