January 23, 2014

VMWare’s $1.54 billion acquisition of mobile device management firm AirWatch highlights an interesting and evolving trend: high-priced M&A is increasingly winning instantaneous praise from investors in publicly-listed acquirers. This is a reversal of historic patterns.

Mobile device management software allows firms to manage the evolving world of “bring your own device”, namely the movement towards granting individual employees of a corporation the opportunity to choose and use their preferred smartphone (an iPhone or a Samsung, for example). This contrasts to the old model of everyone being kitted out with a Blackberry. Under this BYOD model, corporate data is segregated and controlled, not the device. This also allows users to divide their usage of a device into business and personal spheres, presumably retaining control of the latter if and as they leave a company.

VMWare’s headline price was 20.5x current year revenues for AirWatch, though the $1.54 billion was split $1.17 billion cash and $365 million in instalment payments. Either way the valuation was a rich one, reflective of the promise of the market segment.

VMWare’s shares opened up 2.6% on the news. The historical norm is for the shares of an acquirer to sag on news of a large deal that, however promising, may bring with it short term dilution.

The pattern began to change in 2013. Data from Dealogic suggests that the average M&A deal where a publicly listed acquirer announces an M&A deal of $1 billion or more resulted in a 4% increase in share price on announcement. Indeed last year some deals made the 4% look a trivial amount. Gannet’s $1.5 billion all cash acquisition of television station operator Belo caused the former’s shares to climb by a quarter.

We believe that this state of affairs is under-girded by several factors.

Firstly, corporate cash balances (especially in the technology sector) are high, and this liquidity is generating exceptionally low returns. Some activist investors have targeted companies with high cash balances (see an earlier blog post discussing this phenomenon in the context of Alcatel and Juniper)

Secondly, share prices have recovered from post-crisis lows. It seems unarguable that further share price gains will depend on corporations generating growth, which can either come via capital expenditures and investment in existing or new operations or via acquisition. M&A seems increasingly to be the preferred route: at the time of writing news came across the wire that capital expenditures by U.S. corporations will dip below the levels of the past four years. Commentary attributed this to widespread unease regarding the robustness of global demand.

Thirdly, companies are still able to issue debt at relatively cheap levels. This access to low cost debt financing makes M&A-driven debt loads more manageable and provides runway for companies to buy, grow cash flow and pay down debt.