The technology sector led takeover activity during the second quarter and is now just one of three S&P 500 sectors where M&A deals remain above median levels. Such tech-sector dealmaking isn’t about to let up either, even as other sectors retrench amid the broad market anxiety over ongoing trade tensions and signs of slowing global growth. Using its Acquisition Likelihood Estimate Rankings Tool, or ALERT, Morgan Stanley recently identified a number of likely tech takeover targets, according to Business Insider.
Here are nine of those likely targets, along with their market caps: DXC Technology Company (DXC), $10 billion; Western Digital Corp. (WDC), $16 billion; Leidos Holdings Inc. (LDOS), $12 billion; Zebra Technologies (ZBRA), $11 billion; PTC Inc. (PTC), $8 billion; Zendesk Inc. (ZEN), $9 billion; Juniper Networks (JNPR), $9 billion; RingCentral Inc. (RNG), $12 billion; and DocuSign Inc. (DOCU), $8 billion.
What It Means for Investors
Morgan Stanley’s ALERT model ranks excludes stocks that have recently been reported or rumored to be a potential takeover target, meaning that if the bank is saying it’s a potential target, it’s likely not already been publicly identified as such. Among factors used to screen for likely targets, market cap, debt-to-assets ratio, and dividend yield are all significant. Stocks in sectors that have seen a flurry of recent offers tend to rank highly.
“Investors can use the ALERT model as a screening tool for fundamental research on potential M&A candidates,” said Morgan Stanley’s analysts led by Boris Lerner. “Being underweight or short potential takeover targets can be risky; ALERT can flag this possible risk for managers.”
Some M&A Trends
Big tech companies have deep pockets, and with rapid changes in technology creating pressure to constantly evolve in order to stay ahead of the competition, these tech giants find it expedient to buy up the smaller newcomers rather than develop similar technology in house. Combine that with the long and costly IPO process for newcomers, and M&A starts to make a lot of sense on both sides of the deal.
A BDO Technology Outlook survey conducted back in February of this year indicated that the most popular exit strategy for private tech companies in 2019 would be M&A. Among the tech executives surveyed, 53% expected M&A to be the top strategy, while just 22% expected IPOs (either in the U.S. or abroad) to take the number one spot, according to tech-industry research firm CIO Dive.
Sometimes, however, startups obtain public status through an IPO shortly before being acquired as a way of “proving” their value. This “dual-track” strategy, despite the costliness of pursuing an IPO, can be advantageous to high-quality startups who might otherwise suffer from undervaluation due to information asymmetries characteristic of the M&A process. Public disclosures and the scrutiny of public equity markets subsequent to going public help minimize the asymmetries, and which may justify a higher takeover premium.
Some Potential Targets
DocuSign, which offers electronic signature solutions, first went public in April 2018, raising $629 million with its shares initially priced at $29 a piece. On the first day of trading, its share price opened at $38 and has since risen 19%. The company has consistently beaten earnings and revenue estimates since its stock debut and is expected to post earnings-per-share (EPS) growth of 111.10% for the year. As a leader in the e-signature business, DocuSign could be a beneficial addition for either tech or financial service companies.
RingCentral, which provides software that allows a firms employees to communicate via voice, text, HD video and web conferencing, first went public in 2013 and has seen its stock rise nearly 900% over the past five years. While forecast to post EPS growth of just 1.3% this year, that growth is expected to increase by 23.1% over the next year. The company would make a nice addition to larger cloud companies looking to boost their telecommunications services.
Increasing signs that the current business cycle is coming to an end and that the economy may find itself in a recession sooner rather than later could slow the pace of M&A activity. Then again, for big tech companies in strong strategic and financial positions, an economic downturn could present some rare opportunities to acquirer smaller players at discounted prices.