Global Software Sector Update - Winter 2023

Global software M&A activity showed resilience when viewed on an annual basis in 2022 both by number of deals (2,400+) and total disclosed value ($290bn). Quarterly data, however, reveals a continuous slowdown through the year, with a sharp drop in deal value in Q4 (77% decrease versus Q4 2021) and with no >$10bn deals for the first time in ten quarters. PE activity was not immune to the slowdown, with the number of PE exits in Q4 the weakest since 2009. Tougher credit markets, macro uncertainty and a large bid-ask spread are key factors.

Heightened recessionary risks and a hawkish Fed have prevented public market valuations recovering. At 5.2x next twelve months revenue, Kroll’s Software-as-a-Service (SaaS) index has dropped back to levels not seen since 2017, perhaps pricing in investor sentiment that earnings growth is likely to disappoint as sales cycles elongate. In contrast, private market software valuations have been less impacted, with average disclosed multiples for strategic deals softening to 5.4x while PE multiples averaged 6.3x last twelve months revenue. This reflects a higher bar in getting deals done and a sticky bid-ask spread.

Pipeline and deal preparation activity, is robust, and market participants are exhibiting an acceptance of the recalibration of multiples over the last year to levels that many accept represent a “new normal”. A recent survey by S&P Global/451 Research revealed expectations for deal activity to increase despite a decrease in valuations in 2023. The latter could be a welcome catalyst for activity to pick up. With Gartner seeing enterprise software spending globally accelerating back above 10% in 2023, we remain optimistic that any slowdown in sales will taper off with diminishing uncertainty. Putting aside the recent unprecedented COVID-fueled activity, there are many reasons to welcome a return to pre-COVID levels of activity in 2023.