Cisco Systems (CSCO.O.) landmark $28 billion agreement to acquire Splunk (SPLK.O.) is poised to ignite a trend among technology titans, compelling them to explore similar acquisitions of software vendors boasting reliable subscription revenue, according to insights from investment bankers and analysts.
Splunk, renowned for its expertise in cybersecurity and data analytics, had been in the process of transitioning from a software licensing model to subscription-based revenue when it announced its merger with Cisco last week. This acquisition ranks as the third-largest software deal in history.
Cisco CEO Chuck Robbins, in explaining the rationale behind the merger, emphasized that the deal’s appeal lay in the $4 billion in annual recurring revenue expected from Splunk’s subscription services. This revelation underscores the attractiveness of companies with subscription-based revenue models, making them potential acquisition targets for tech conglomerates such as Microsoft (MSFT.O), Adobe (ADBE.O), and Oracle (ORCL.N). These giants are grappling with corporate clients seeking cost-cutting measures, industry experts noted.
Requests for comments from Microsoft, Adobe, and Oracle regarding this development were met with silence at the time of reporting.
The positive outlook for software mergers and acquisitions comes as a welcome respite for dealmakers. In the first eight months of 2023, technology sector M&A activity witnessed a 61% decline to $231.5 billion, according to data from the London Stock Exchange Group (LSEG).
Private equity firms have dominated the software sector’s dealmaking landscape over the past year, facing minimal competition from technology giants. In July, for example, New Relic (NEWR.N), a Splunk competitor, agreed to be acquired by private equity firms Francisco Partners and TPG Inc. (TPG.O.) for $6.5 billion.
David Chen, co-head of global technology investment banking at Morgan Stanley (MS.N.), anticipates that a robust performance in the Nasdaq 100 index this year, coupled with receding concerns about an economic downturn, will embolden technology firms to follow Cisco’s lead and pursue significant acquisitions. “I think the buyers’ outlook on their own business has really improved from four months ago, and that gives confidence to pull the trigger on transformational transactions,” Chen stated in an interview.
Jefferies analysts noted that the Federal Reserve’s decision to pause interest rate hikes has provided acquirers with greater certainty regarding their funding costs, thereby facilitating dealmaking.
Even prior to Cisco’s deal, there were indications that technology giants had already begun exploring software firm acquisitions in 2023, albeit on a smaller scale. In June, IBM (IBM.N) agreed to acquire technology spend-management platform Apptio for $4.6 billion.
The takeover of Splunk was facilitated by its stock performance, which had created a favorable environment for acquisition. Although its shares had risen by 39% in 2023 before the announcement of the deal, they remained 44% below their peak in October 2020 when the COVID-19 pandemic prompted increased spending on information technology due to widespread remote work. Many of Splunk’s peers experienced similar stock performance.
Software stocks currently trade at comparatively low valuations by historical standards, rendering them appealing targets for acquisition. Jefferies analysts noted that the average software stock trades at 5.8 times projected 12-month revenue, which is 28% below its eight-year historical average when excluding the temporary valuation boost attributable to COVID-19. Cisco’s deal valued Splunk at 7 times projected 12-month revenue, a figure considered reasonable by analysts.
In a note last week, BTIG analysts underscored that the typical security company with 20% growth trades at approximately 7 times sales.
Furthermore, private software companies may also be more receptive to takeover offers. Keith Skirbe, managing director in Houlihan Lokey’s technology investment banking group, pointed out that some firms, which had raised capital at high valuations during the 2021 fundraising cycle, may prefer acquisition over raising funds from investors at lower valuations.
In light of these factors, Wedbush analysts wrote in a note last week that a “tidal wave of software M&A is on the horizon.”