[co-author: Cristina Lombardi]

Tech M&A in 2022 was a tale of two halves. The year started off with a bang, with mega-deals such as Microsoft’s pending $69 billion acquisition of Activision Blizzard, Elon Musk’s $44 billion acquisition of Twitter and Broadcom’s pending $61 billion acquisition of VMware inked in quick succession. However, deal activity fizzled in the second half of 2022, as high inflation, aggressive anti-inflation monetary policies, geopolitical instability, assertive antitrust regulators and tightening financing markets depressed target valuations, reduced strategic acquirer confidence and sidelined private equity sponsor buyers. Deal volumes dropped from $531.13 billion[1] during the first half of 2022 to $189.17 billion in the second half, resulting in total 2022 volume of $720.3 billion, a 36% decrease from 2021’s record high of $1.1 trillion.[2] Despite the downtrend, global tech M&A activity in 2022 remained strong relative to pre-pandemic levels and accounted for a record 20% of all global M&A activity. As was the case in 2021, software deals remained the strongest performer within the tech sector, representing approximately 90% of tech M&A deals.

The numbers provide only a partial picture of the trends we saw in 2022 and where tech M&A activity is headed in 2023. Let’s take a closer look, with an eye toward what we can expect to see in the coming year.

Take-private transactions take center stage

As we entered 2022, the ongoing correction in US public market valuations in the formerly high-flying tech sector seemed to auger a private equity tech take-private boom. Private equity sponsors, loaded with record levels of dry powder and less burdened by the antitrust challenges faced by strategic acquirers, were poised to pounce on the most attractive entry valuations in years. As the year went on, however, macroeconomic factors, particularly rapidly rising financing costs and a significant deterioration in the availability of committed acquisition financing, weighed down activity. Still, in a year where global private equity M&A volumes across sectors declined 36% from 2021,[3] private equity take-private transactions of US-listed tech companies remained a bright spot, with 21 announced deals in 2022, flat from 2021 levels.[4] As was the case in 2021, Thoma Bravo led the pack, with six announced take-private deals of US-listed tech companies in 2022 – three of which were in the identity and access management category, to the interest of US antitrust enforcers as discussed below – and Vista Equity Partners was next in line with three announced transactions (including its acquisition of Citrix Systems with Elliott Management’s private equity arm).

Sponsors got creative with their financing structures to get deals done. While direct lenders have historically struggled to compete with the syndicated lending market on price and covenant packages, as the year progressed, sponsors increasingly spurned the syndicated lending market in favor of debt packages arranged solely by direct lenders. Committed preferred equity also found its way into a number of financing packages, particularly for larger deals such as Citrix. Going further, rather than arranging upfront committed debt financing, Thoma Bravo opted to fund the purchase price for its announced $2.3 billion acquisition of ForgeRock entirely with equity commitments that could be reduced prior to closing with debt proceeds.

Some sponsors, while unable to present compelling take-private proposals to targets, have deployed capital in private investments in public equity (PIPEs) of public targets, marketing these investments as both a vote of confidence for the incumbent board and much-needed liquidity to help the target weather the downturn. We’ve yet to see a significant uptick in sponsor-backed PIPEs at tech companies, but it remains a trend to watch for in 2023, particularly for newly public companies that are not generating positive free cash flow or that need a white knight to help defend them against activist attacks. Further, these investments may be a toehold for future take-private transactions. Similarly, we expect sponsors to actively pursue carve out opportunities – like Francisco Partners’ carve out acquisition of the data and analytics assets from IBM’s Watson Health business – in 2023 as tech giants streamline their portfolios to focus on their core businesses.

Global regulators maintain assertive posture

The shadow of regulators loomed large over tech M&A activity in 2022. Still, outside of mega-deals of more than $10 billion and acquisitions by mega-cap tech, the shadow proved to be just that in most cases – an ominous presence that had dealmakers on high alert but ultimately did not prevent most announced deals from getting done.

In the US, the Federal Trade Commission and the Department of Justice under the Biden administration have shifted their priorities and rhetoric in favor of tougher enforcement, with consolidation in the tech sector being one of their top targets. These changes have included increases in the agencies’:

• Willingness to challenge vertical mergers (e.g., the FTC’s December 2022 challenge to Microsoft’s proposed acquisition of Activision Blizzard).
• Focus on acquisitions of nascent and adjacent competitors, particularly by large and mega-cap tech, such as Meta/Giphy, which was blocked by the UK’s Competition and Markets Authority (CMA) after the transaction closed; Meta/Within, which is currently being challenged by the FTC and the CMA; and Amazon/iRobot and Broadcom/VMware, which are each responding to second requests.
• Focus on new potential theories of harm, such as the impact of mergers on labor markets.
• Distrust of divestiture offers.
• Willingness to litigate and risk losing.
• Focus on private equity sponsor roll-ups (e.g., the second request in Thoma Bravo’s acquisition of ForgeRock after Thoma Bravo’s two earlier 2022 acquisitions in the identity access management sector).

Even though most announced deals are still getting done, ex-US merger control and foreign direct investment review continues to extend or complicate deal timelines, particularly in jurisdictions such as China, with acquisitions of critical technology in particular under the microscope. To date, the FTC and the DOJ have publicly challenged 22 mergers since President Joe Biden took office in January 2021, more than double the level of activity of former President Donald Trump’s first two years in office. Fifteen of those challenged deals ultimately were abandoned, while others remain pending. Still, the regulators at times face an uphill battle convincing courts to adopt new theories of competitive harm – in 2022, the agencies lost four cases seeking to enjoin mergers at trial (all outside the tech space) and have largely failed to win most nontraditional cases (e.g., challenges to vertical mergers and nascent competitor acquisitions). Even so, the threat of litigation alone undoubtedly deters some buyers from pursuing acquisitions in the current climate.

Regulators’ losses in litigation may help build a case that regulatory or legislative change is necessary to achieve pro-competitive policy goals. Regulatory reforms that have been introduced in past US Congresses and abroad already seek to arm regulatory agencies with further ammo to block M&A activity. For example, proposed legislation has been introduced in the US that would expand the transactions subject to antitrust review or create presumptions against certain types of mergers. The European Union’s Digital Markets Act, which took effect in November 2022, similarly increases the types of tech-related transactions that would require notification to the EU’s competition commission, regardless of deal size.

Looking forward, we should expect even more enforcement as the agencies continue to execute the Biden administration’s mandate for increased enforcement and receive additional funding for that mission. In December 2022, Congress made good on its promise to increase resources for the FTC and the DOJ by changing the Hart-Scott-Rodino (HSR) filing fee structure in a way that substantially increases the fee for the largest transactions. The changes, which are expected to be implemented in 2023, are estimated to increase HSR filing fees approximately 800% – from $280,000 to $2.25 million – for transactions valued at more than $5 billion and will be adjusted for smaller transactions.

Tech remains in activist crosshairs

Shareholder activists capitalized on the plunge in tech valuations in 2022 to launch new campaigns, with campaigns at tech companies representing 27% of all public US activism campaigns, the highest of any sector and a multiyear high.

M&A-related campaigns remain a favored tool for tech-focused activists. Continuing a 2021 trend, the first half of the year saw a number of high-profile “sell-the-company” campaigns, including at Anaplan, Peloton, Everbridge and Zendesk. Despite the mixed success of these campaigns, their prevalence has led public company boards to focus on activist preparedness –particularly as private equity sponsors increasingly team up with, or quickly follow, activists advocating for a sale. Momentum for these campaigns slowed dramatically in the second half of 2022 as many would-be acquirers were sidelined by the macro factors discussed above. The second half of the year instead saw activists pivot to capital allocation and operational improvement campaigns, highlighted by the cost cutting and capital return campaigns launched at Meta and Alphabet in the fourth quarter. Throughout the year, incumbent shareholders actively resisted sponsor take-private transactions perceived to be undertaken at depressed valuations or without robust sale processes. Similarly, as tech dealmakers explore mergers of equals or other stock-for-stock transactions to bridge valuation and financing gaps caused by the macro environment, they will need to contend with incumbent shareholders and activists who have been quick to wage “scuttle-the-deal” campaigns against stock-for-stock transactions perceived to lack a compelling strategic rationale, as Zendesk found out the hard way in its abandoned acquisition of Momentive.

In addition to market forces, regulatory change is expected to spur activist activity in 2023. The Security and Exchange Commission’s universal proxy rules are now in effect, making it easier for shareholders to “mix-and-match” individual directors rather than having to choose a full slate. The rules are expected to increase the frequency of proxy contests (particularly by less-established activists), afford dissidents increased leverage in settlement negotiations, and increase focus on the strength and qualifications of individual directors. These developments may ratchet up the pressure on target boards to dismantle structural governance protections, modify their capital allocation policies or pursue divestitures of non-core businesses.

Newly public tech companies (particularly companies that went public via deSPAC transactions) may find themselves particularly in the crosshairs, given that they as a whole dramatically underperformed the broader market in 2022. While these less-established companies tend to have strong defensive profiles – including classified boards, dual-class share structures and/or large pre-initial public offering shareholder blocs – they may face increased activist pressure to go private or change board/management composition or their capital allocation policies if they are unable to convey credible stand-alone strategies for navigating the challenging macro environment.

Convergence of tech and healthcare drives digital health deals

As discussed in our 2022 Life Sciences M&A Year in Review blog post, decreased valuations and challenging capital markets also impacted healthcare companies last year, and digital health companies – health companies that build and sell technology – were no exception. Faced with depressed venture funding activity (which for digital health declined nearly 50% from 2021), an uncertain IPO market and pressure to provide liquidity to investors, M&A offered digital health startups a solution to deliver liquidity, streamline costs and bridge funding gaps as they continue to develop their products. In some instances, tech buyers looking to disrupt the healthcare space capitalized on the tight market conditions in some of the biggest deals of 2022, such as Amazon’s pending acquisition of One Medical and Microsoft’s acquisition of Nuance. In other cases, digital health companies used M&A to build scale in a crowded market, whether with an inorganic growth strategy, such as Monument’s acquisition of Tempest (both companies in the alcohol-use sector), or with a “buy-and-build” strategy, such as CVS Health’s purchase of Signify Health.

While deal activity in digital health was down in 2022 – like in all of tech M&A – there was a notable uptick beginning in Q3, and we would expect this momentum to continue in 2023. One of the impacts of COVID-19 was increased innovation in healthcare through technology, and many established players are looking toward an acquisition strategy to adapt to the new normal as early-stage digital health companies continue to face headwinds.

Mergers of equals as the new SPACs?

Another interesting, albeit somewhat subtle, trend that emerged in 2022 was an uptick in mergers of equals among VC-backed private tech companies. These transactions are typically structured as stock-for-stock combinations between similarly valued companies at a low or no premium. As result, mergers of equals preserve and combine the preference structure of each of the constituent parties, and they provide each party with significant participation in the combined enterprise through representation on the combined company board of directors and management team or other bespoke post-closing governance arrangements.

Historically, mergers of equals among private companies have been somewhat rare because they require parties to agree on value and governance matters, and a horizontal combination of competitive businesses may pose a greater antitrust risk. In 2022, however, IPOs or cash sales were not viable exit opportunities for many investors – particularly investors of underperforming or cash-burning investments. Mergers of equals can be an attractive alternative for investors unable to find a viable cash buyer or path to the public markets, as combining two companies with the same or complementary product offerings can yield significant strategic benefits and cost synergies. These transactions, if structured appropriately, also can result in beneficial, tax-deferred treatment for the shareholders of the ostensible selling entity.

Looking ahead to 2023

This year could bring an uptick in deal volumes from the doldrums of the second half of 2022, as boards and investors find their footing in the “new normal” environment. A return to the go-go tech M&A market of 2021, however, is unlikely, as the macroeconomic, regulatory, and financing environment continues to weigh on dealmaker confidence and capacity. Instead, we expect creative structuring and bespoke transactions to carry the day, along with a healthy dose of sponsor take-private activity. Activists will continue to target companies that fail to adapt (with more capital allocation and board/management regime change campaigns to come, enabled by universal proxies), while take-private sponsors and other acquirers of publicly traded US targets will need to consider the application of the new 1% excise tax on certain stock repurchases (including certain leveraged buyouts) that is now in effect. If financing markets remain weak and cash exit valuations remain depressed, we may see private company mergers of equals or similar stock-for-stock transactions become an increasingly important tool for VC-backed tech companies and their investors in 2023. One thing is for certain – we’ll have lots to talk about this time next year.

[1] Global Mergers & Acquisitions Review – First Half 2022 – Refinitiv

[2] Global Mergers & Acquisitions Review – Full Year 2022 – Refinitiv

[3] Id.

[4] Deal Point Data; Cooley analysis.

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