The Surge in Software Activity

The article below is from our BRIEFINGS newsletter of 30 July 2021
 

What’s driving the surge in M&A activity in the software industry? We sat down with Goldman Sachs’ Ryan Nolan and Nick Pomponi, global co-heads of the Investment Banking Division’s software business, to get the inside scoop.

We’ve heard about how the pandemic and remote work dramatically accelerated digital transformations across industries, creating opportunities for software companies. How is the software industry faring now that companies are going back into the office and the economy is reopening?

Ryan Nolan: We saw how software was one of the most critical areas of focus and investment during the pandemic. Remote work and the need for the digital-first office challenged nearly every aspect of an organization’s software stack to evolve and scale nearly overnight, from security to collaboration and communication applications to resiliency and infrastructure platforms. It’s still early but the strong financial results in the first half of the year combined with a solid recovery of valuations in growth software would suggest that the near-term outlook for software remains very bright. Anecdotal signals would suggest that the return to the office and the reopening of the economy have only highlighted the benefits and productivity gains businesses have enjoyed by accelerating digital transformation. Businesses across all industries now have to build infrastructure to support an employee base that likely expects greater flexibility in how and where they work, and a customer base that expects nearly every aspect of their interactions with a vendor to be digital-first. From our perspective, technology and software are at the heart of facilitating that new paradigm, and the flywheel only continues to accelerate.

Software M&A activity has been elevated for several years but we’ve seen a sharp uptick in the last 12 to 24 months. What’s driving that activity?

Nick Pomponi: Several factors are converging to create a dynamic software M&A market. For one, major companies across all industries—not just technology—are realizing they need to essentially become software companies themselves in one form or another to keep up. Case in point is Rockwell Automation’s recent acquisition of Plex Systems, a software-as-a-service smart manufacturing company, which will transform Rockwell’s manufacturing operations. Private equity firms, which are sitting on large reserves of dry powder, are increasingly deploying that capital in the tech and software markets, leading to some large acquisitions, such as Thoma Bravo’s $12.3 billion acquisition of the cybersecurity and compliance company Proofpoint. And finally, among large corporations—known as strategic buyers—we’re seeing the next generation of large software companies (think: Salesforce, Zoom, Twilio and ServiceNow among others) compete with the mega-cap tech players (like Google, Amazon and Microsoft) to provide companies’ entire software suite, resulting in landscape-shifting transactions, such as Zoom’s acquisition of Five9.

Can you describe the IPO market for software companies?

Ryan Nolan: The short answer is “volatile but durable.” Volatility creeped into the software IPO market early spring when valuations in growth software fell from their 2020 record highs, ending a software IPO market where a company could do no wrong. Valuations have since recovered from the spring lows, but what I find more remarkable is the quality of software companies we saw come to market despite the volatility and the strong investor receptivity.  We saw software companies come to market that change the way we work, such as Monday.com, or reinvent how we manage data, such as Confluent. Given the quality of the companies we see in our IPO pipeline, combined with software-as-a-service business models that deliver significant visibility in financial models, we expect the new issuance market for software to remain robust and active even in the relative turmoil of volatile markets.

So where are we headed? What is the next big thing in software?

Nick Pomponi: We expect to continue to see AI-enabled software applications that will change the way we work, whether it is through programs that automate worker processes or transform companies’ legacy platforms. The exciting part is that we believe we’re still in the early innings of this data, and AI and automation revolution.