More than 80 Israeli companies, most of them technology companies, are "on the shelf" and could be acquired in the near future, according to analysis by Barclays. The bank estimates that recently reported large deals - the acquisition of cyber company Perimeter 81 by Check Point, and that of Laminar, in the same field, by Rubrik - are just the first signs of a revival in the mergers and acquisitions market.
Barclays divides the companies that might be acquired into two groups that, looking to the future, have few alternatives for continuing to finance their businesses. The first consists of privately-held companies that reached unicorn status (that is, a valuation of over $1 billion) during the peak period for technology companies, in 2020-2021, but that last raised capital more than eighteen months ago, and that have had to make one or more rounds of layoffs. Barclays identifies 44 companies in this group.
The second group consists of 38 public companies with negative EBITDA that missed their sales guidance in 2022 and/or 2023 and that have also made one or more rounds of layoffs.
The bank does not provide a list of company names, but several Israeli autotech companies that made IPOs in New York in 2021 through mergers with SPACs (special purpose acquisition companies) fall within the criteria that it specifies, for example REE Automotive (Nasdaq: REE) and Valens Semiconductor (NYSE: VLN).
An example of a company that meets Barclays’ criteria for privately-held companies is taxi hailing app company Gett, which attempted a merger with a SPAC at a valuation of $1 billion, but the deal fell through. Other examples are Lightricks, developer of video- and image-editing mobile apps, and Sisense, a business intelligence software company, which held its last funding round in 2020.
Valens Semiconductor said in response: "Valens is a financially strong company active in a range of areas, chiefly audio-video and automotive, that sells millions of chips annually to a broad and loyal customer base. The company is building itself for years ahead as an independent company with long-term growth plans, and it has even announced that it expects to reach breakeven in adjusted EBITDA towards the end of 2023."
The other companies declined to comment.
Barclays’ analysis indicates the possibility of a revival in the mergers and acquisitions market, but out of a lack of choice for the companies concerned. These are companies that held their last funding round a relatively long time ago, and that realize that they will not obtain a similar valuation in the near future. Barclays Bank country manager for Israel Ilan Paz says, "These are companies that are in a situation, let’s call it ‘problematic’: their last funding round was a while ago, and their business is not taking off in the way that the investors in the last round expected it to. For their part, the investors are being defensive, so if the company is not profitable and it needs the cash, it has a problem."
In other words, we are seeing a sobering up after the peaks of 2021?
"It certainly is a sobering up. In the end, for a listed company, it’s very easy to see. If there was a flotation at a valuation of X, and today the company is traded at a tenth of X, the market has spoken, and that’s the value. In the case of private companies, it’s harder to see it, and so we see deals such as that of Perimeter 81, which was an interesting deal: the investors who invested in its last funding round lost money, and those who invested in earlier rounds made money (the company was sold to Check Point for less than its valuation in its last funding round, S. H.-V.).
"I think we’ll see more and more of this phenomenon, whereby venture capital funds that invested in companies in early rounds will say to themselves, ‘OK, there won’t be a crazy valuation here, but we’ll make money,’ and they need the money, and they often push for a sale."
Are there also companies that have not internalized the situation?
"I meet such companies, but more and more companies are realizing that the situation has changed. There are still companies in denial, but not many. It’s often the investors and shareholders from the early funding rounds that are responsible for the sobering up. After all, if the company needs more cash, it comes to them, and they say ‘I’m not putting any more money in,’ and push for a sale process."
Are there more such processes at present?
"There are more companies starting the sale process, the most in the past two to three years. When the markets were good, they preferred to go public. Today, in many cases, the only alternative for continuing in existence is to be sold."
Half the potential buyers are from North America
According to Barclays’ analysis, 1,204 companies are potential buyers. These are companies with a market cap in excess of $10 billion, with more than $1 billion cash, from all sectors and geographical regions. One Israeli company that meets these criteria is Check Point (Nasdaq: CHKP). As mentioned, Check Point recently announced the acquisition of Perimeter 81 in a $500 million deal. Other Israeli companies that could fit the Barclays buyer profile are Nice Systems (TASE: NICE; Nasdaq: NICE) and Amdocs (Nasdaq; DOX).
From checks by "Globes" it emerges that more than half the potential acquiring companies are from the US and Canada, about a quarter from the EU, 21% from the Asia-Pacific region, and 1% from Latin America.
In the breakdown by industry 21% of the potential buyers are in financial services, and while consumer goods and retailing, technology, and media and telecommunications, account for 19% each.
In your analysis, you identify over 1,200 potential buyers, but in all cases these are commercial companies, and not financial buyers, such as private equity firms. Why is that?
"Something unpleasant has happened to the private equity funds in the past two years, as we all know, and that is the rise in interest rates. In general, private equity funds put debt into the acquired company, and that is their way of presenting very high returns on equity, but two things have happened. The debt has become much more expensive, and if in the past it cost them 4-5%, today it’s 9-10%. Meanwhile, banks and financial institutions are much less keen nowadays to give loans to private equity funds, unlike the situation two to three years ago. So these funds are more cautious today. What’s more, the current situation changes all the mathematics for them of the value at which they’re prepared to buy. So there are fewer private equity deals."
In other words, strategic investors, that is, major companies in their fields that want to buy competing companies or companies in a specific niche in their sector in order to continue growing, now face less competition for their acquisition targets. This is the reverse of the situation that prevailed two years ago, when the financial buyers with the deep pockets were the main players in the M&A market.
The strategic buyers, most of them public companies, have another advantage these days. Particularly in the technology sector, but not just there, share prices have risen substantially so far this year, which enables these companies to use their shares as a strong currency in stock-based acquisitions, or those that involve stock and cash.
According to Paz, the fact that the strategic buyers are almost the only players in the market at the moment has a considerable effect on the negotiations. "M&A processes are taking significantly longer than in previous periods, and the negotiations are tough," he says. He believes that, towards the end of the current year and in early 2024 we shall start to see processes taking place now come to fruition. "In 2024, we’ll see many more M&A deals than we saw in 2023, and certainly more than in 2022, which was a drought year."
After a fairly dry period, the IPO market on Wall Street also seems to be starting to recover. Several large companies that recently filed prospectuses are expected to reach the market and to raise large amounts (among them British semiconductor and software design company Arm).
Paz does not think that the flotations market will have an impact on the Israeli companies that, according to the Barclays analysis, are likely to be sold. "The benchmark in the public market has risen a great deal in the past two years," he says. "If at one time, for example, a company close to ARR (annual recurring revenue, S. H.-V.) of $100 million went to the public market, today it has to be around $200-250 million. All the companies realize that this is not going to change any time soon, so they’re thinking about the alternatives."
And what effect does the macro environment have? Paz says that the higher interest rates are presumably making it harder for companies to raise money, but he mentions another interesting point: "If a big company is sitting on a cash mountain that gives it 5% interest, the alternative for the money (that is, using it for acquisitions, S. H.-V.) becomes more expensive. To the extent that the central banks stop raising interest rates and then start cutting them, that will help these companies to open the purse strings and give higher valuations."
What about the situation in Israel, and the uncertainty over the judicial overhaul?
"There are those who behave as though nothing has happened, and those who say ‘We’ll wait for a decision in Israel before we jump in,’" says Paz. "If it’s a matter of a technology company that happens to be in Israel but 95% of its sales are overseas, it’s less of a consideration, but if it’s a company that is totally dependent on the Israeli economy - food, insurance, and the like - I believe they’ll wait until the situation becomes clearer."
Published by Globes, Israel business news - en.globes.co.il - on September 4, 2023.
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