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M & A's pick up steam

We all keenly watch the software market, but it's rare, for me anyway, to come across a cogent and well-researched study thoroughly describing the financial dynamics driving it. So I was really pleased to discover Software Equity Group's (SEG) "Software Industry Equity Report," a remarkably comprehensive study of mergers and acquisitions, initial public offerings and venture capital investments. For nearly 14 years, SEG has been a leading investment bank and advisory group serving the software industry, and while space limits me here from going into much detail, it's important to highlight the report's key findings. (Go to Software Equity Group to get a copy of the report.)

The software industry accounted for 16% of total North American M&A activity in 2004, leading all other industry sectors. A total of 1,630 software companies sold, up 23% from 2003. The aggregate $52.1 billion spent on software companies was 18% greater than 2003's total as a result of increased valuations, a higher number of transactions and a jump in very large deals.

SEG explains the median software company M&A valuation in 2004 was 2.4x trailing-twelve-month (TTM) revenue, a solid climb from 2003's median valuation of 1.6x TTM revenue. The median M&A valuation in Q4 was 2.8x TTM revenue. Software M&A valuations continued to vary widely by product category, ranging from a median 6.9x TTM revenue (storage management) to 1.1x TTM revenue (supply chain management).

Despite forecasts of relatively flat IT spending in 2005, a number of other factors are expected to spur software deals this year: hefty cash reserves of public software companies, a record number of private equity firms willing to pay strategic multiples, and new buyers entering the M&A market with cash after successful IPOs. SEG projects North American deal volumes will increase 18% in 2005 to 1,925, and median valuations will grow from 2.4x TTM to 2.8x TTM revenue. In terms of M&A dollars by industry, software placed fifth, SEG reports.

Although SEG considered 2004 to be a pretty good year for M&A activity, it cites sources predicting significantly greater action in 2005 due to sustained GDP grown, huge transactions, lending markets with deep pockets and improved corporate balance sheets. On the IPO front, 16 software companies went public in 2004, 13 in the second half of the year. SEG reports that the newly listed companies raised some $3.7 billion and at the end of the year closed up an average of 66% over their initial prices, compared with a mere eight software IPOs in 2003, closing up an average of 21%.

In an upcoming issue I'll interview Kenneth Bender, SEG's managing director, who gives us his take on what to expect the rest of the year.

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