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In 2024, 60-70 M&A Deals in IT and Telecom are Expected: What are the Multipliers and What Could Go Wrong?

In 2024, the technology industry will remain the most attractive for investors and a leader in the number of M&A deals. This year, approximately 60-70 deals are expected, with 19 already completed. For comparison, the real estate sector currently holds the second place with six M&A deals. Sergey Goncharevich, founder and managing partner of Capital Times, discussed this and much more at the webinar “When and Why IT Companies Need an M&A Deal” organized by the IT Ukraine Association. Mind took notes of the most interesting points.

How is the M&A market reviving? After a record-breaking 2021 (200 deals, of which 76 were in IT and telecom), the market fell by more than 50% in the first year of the full-scale invasion. Although the technology industry declined the least: 54 M&A deals in 2022. However, investors gradually began to adapt to the war: in 2023, 74 deals were made in IT and telecom, and approximately the same number is expected in 2024. Capital Times does not observe any preconditions for another market decline in 2024. The technology industry will continue to lead M&A. Currently, the main “stopper” is the risk of mobilization: sometimes potential buyers postpone final agreements until the situation is resolved.

Which companies are promising for mergers and acquisitions by foreign investors? It is necessary to distinguish businesses that are only present in Ukraine from those operating abroad. The former find it increasingly difficult to attract investors, but it is possible. Chances increase if the company opens offices in Poland, Romania, etc. This primarily applies to IT outsourcing companies. For product companies, location is less important: if there is a promising product and good growth rates, investors will be found.

What is better: organic growth or M&A? Sergey Goncharevich explains that both outsourcing and product IT companies do not always understand the added value of M&A. Currently, they more often choose organic growth: they open offices abroad, hire people, etc. For example, recently, N-iX started an office in Romania. There are other cases: for example, Intellias actively uses M&A for growth, acquiring profile assets abroad.

Companies that choose M&A save time and effort on creating a business in another location, gaining a team, vertical, customer base, revenue stream there, raising the hourly rate, etc. In the case of organic growth, the margin at the initial steps will be significantly lower: costs for team recruitment, regional promotion, etc., will “eat it up.” Thus, the main advantage of M&A is faster business growth.

Both M&A and organic growth abroad partially neutralize military risks. The war has significantly accelerated the diversification of Ukrainian companies’ presence in different countries. It is now becoming increasingly difficult to secure new contracts and maintain existing ones if the team is only in Ukraine.

From the perspective of a company owner, having a presence abroad also means a higher company valuation. Goncharevich provides examples of worked-out cases: a product company with clients only in Ukraine could be worth 2-3 years’ revenue, whereas one present in the US market – 7-8.

What reasons most often prompt strategic investors to engage in M&A? For IT outsourcing businesses, the main reason is geographical expansion. These companies are also interested in acquiring expertise, verticals, teams, etc. IT product businesses primarily seek know-how that can improve their own product or assist with financial optimization and R&D. E-commerce sector companies mainly buy products, customer experience, and bases.

What affects the valuation of an IT company? In projects currently managed by Capital Times, buyers primarily pay attention to growth rates, profitability, EBITDA, and the geographical presence of the team. The customer base, the long-term nature of clients, IT infrastructure, etc., also affect the valuation. Compared to 2021, valuations have significantly decreased. Currently, multipliers for Ukrainian IT companies average 5-7 EBITDA. For IT outsourcing businesses, team size matters. If it’s a small company, achieving a high multiplier is unrealistic. Currently, a firm with 50-100 specialists is valued at 3 EBITDA, 250 people – 3-5 EBITDA, 300 – 6 EBITDA.

However, the valuation given during negotiations is far from what will be paid in the end. The final price is determined at the final stage when all conditions are agreed upon.

What does the whole deal process look like? M&A should be viewed as a separate project managed by the owner. The process consists of several stages:

  1. Initial analysis: 1-2 months. It is important to understand where the business is now, what it can cost, and outline a roadmap of actions.
  2. Preparation of investment materials: 2 months. This involves a comprehensive information memorandum. At this stage, it is worth preparing a financial model and a Virtual Data Room (VDR). VDR is a great tool that helps promote the deal and speeds up its closure.
  3. Marketing: 2-3 months. Forming a list of potential investors: financial or strategic.
  4. Waiting for proposals: 1-3 months. The term depends on how interesting and attractive the business is. Any uncertainties or difficulties, such as war, increase this term. It becomes more challenging to gather offers from potential buyers.
  5. Audit: 2-3 months. Conducting financial due diligence, HR audit, technological audit, etc. The potential buyer needs confirmation that the company looks as described. Capital Times advises sellers to conduct their own due diligence in advance: to see themselves through the eyes of an investor. This helps mitigate risks, correct mistakes, and achieve a higher deal valuation.
  6. Closing the deal: from 3 months to several years. According to Capital Times observations: if the deal progresses very slowly, it significantly increases the risk of never closing.

What else can go wrong? Most often, issues arise when the due diligence procedure is not done well, the wrong M&A strategy is chosen, there is no integration plan, or the wrong approach to synergy is taken.

There are cases where problems arose due to cultural conflicts. After the deal, part of the specialists left the company: the corporate cultures of the two businesses were completely different. This happens if teams are not warned in advance, there is no integration plan.

Sometimes problems arise when incorrect or incomplete information is provided at the agreement stage. Later, the investor discovers conflicts among shareholders, etc.

Another issue: when an M&A proposal is actually used for competitive intelligence. Sergey Goncharevich recalls a case when a company asked Capital Times to check whether investors were really interested in the deal. It is important to understand who you are negotiating with, the risks to your business, and sometimes structure the process so that your know-how, sensitive information, etc., are shared at a stage when there are no longer any doubts about the buyer’s intentions.

Source Mind.ua

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