Momentum 2014 Middle-Market Technology Industry Outlook A CohnReznick LLP Report FEBRUARY 2014
Table of Contents
Today’s Technology Business Environment....................1 Critical Issues Facing Middle-Market Technology Companies in 2014........................................4 The Road Ahead..................................................................21
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Preface The technology industry is well-positioned for an optimistic 2014. Discretionary consumer spending is rising at the same time as businesses are investing in Big Data and computing platforms that take advantage of the cloud.
mo • men • tum
noun: impetus and driving force gained by the development of a process or course of events While government reforms supporting the sector have not kept pace with the recovering economy, a soaring IPO market, strong forecasts for merger and acquisition activity, and abundant funding options and capital availability, middle-market technology companies are positioned to build upon the momentum established in 2013. CohnReznick’s Momentum 2014: Middle-Market Technology Industry Outlook is an annual report covering the Firm’s perspective and outlook on some of the most pertinent issues facing the technology industry in 2014. We’ll analyze how 2013 reshaped the technology industry and highlight how issues such as the availability of capital in the equity markets, potential tax reforms, and crowdfunding will continue to influence decision-making at middle-market technology companies. Over the course of this report, we’ve highlighted strategies for middle-market technology executives to respond to the above issues so they can best compete in this complex, evolving market. Though it is impossible to predict precisely what opportunities and challenges 2014 will present, we conclude with an abundantly optimistic outlook for increased momentum in the technology sector. We hope you find Momentum 2014: Middle-Market Technology Industry Outlook to be a thought-provoking commentary on the state of the industry that provides actionable insight useful to your business operations.
Alex Castelli Partner, Technology Industry Practice Leader
Today’s Technology Business Environment
Industry Climate: 2014―Amid Growth, Powerful Forces Reshape the Industry With the economy continuing to recover, a soaring IPO market, strong forecasts for merger and acquisition activity, and abundant funding options and capital availability, middle-market technology companies are positioned to extend 2013’s surge in revenue and profits. Funding sources are proliferating, as entities with capital that sat on the sidelines―venture capitalists, private equity firms, and strategic acquirers seeking cutting-edge technology and talented engineers―are vigorously searching for solid investment opportunities. Worldwide information technology spending is expected to grow 5% in 2014 to $2.14 trillion1, however, this growth is not uniformly distributed. The industry is undergoing an exciting but disruptive period, as the forces of mobility, social media, cloud computing, and big data reconstitute the computing platform that will drive technology, and the economy, in 2014 and beyond. Middle-market technology executives would be wise to revisit their strategic plans and prepare their management teams to take advantage of these maturing technologies and the capital that is following them. These forces are weaving digitization into the very fabric of society and changing the way consumers and businesses use technology. Internet access is being integrated into every aspect of daily living including toothbrushes, appliances, cars, and wearables such as shoes, watches, and eyewear. The cloud is allowing applications to be served up remotely as a software-as-a-service. Consumers’ demand for storage that allows for access to data anytime, from any device, is sky-rocketing―hence, the success of Google Drive, Dropbox, and iCloud. Through the cloud, companies and consumers will demand more software-as-a-service, pay-as-you-go computing resources, and online storage in 2014.
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International Data Corporation, “IDC Predictions 2014”
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Today’s Technology Business Environment While revolutionary technology shifts may have technology executives’ heads in the “cloud,” regulations and taxes will bring them back down to earth. Technology companies are at an innovation disadvantage going into 2014―the valuable research and development tax credit expired as of December 31, 2013. Few expect much movement in Congress this year on the industry’s other top policy issues, including corporate tax reform, immigration reform, and patent reform. CohnReznick encourages technology companies to focus more on the activities of state legislatures in 2014, as many are actively pursuing more tax revenue by passing laws to tax cloud services and the sale of physical goods over the Internet.
Technology Industry Segment Revenue Forecasts for 2014
Worldwide IT
5.1%
Big Data
30%
Cloud Computing
25%
Data Analytics
21%
Smartphones and Tablets
Personal Computers
13%
-3.8% -5
0
5
10
15
Source: International Data Corporation, “IDC Predictions 2014”
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Middle-Market Technology Industry Outlook
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25
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Legislative Update: Mid-Sized Businesses Need More Congressional Progress in 2014 After a year of paralysis and dysfunction in This means that middle-market technology companies Washington, Congress gave the country a 2013 have an extra year to determine the best strategies holiday gift: a budget compromise that funds the for navigating healthcare reform. government for the next two years. “If Congress Patent reform remains an issue of pressing could keep up that cooperative momentum, concern for middle-market technology companies, maybe it could address some of the top policy but despite costing the industry $29 billion in 20112, concerns of the technology industry in 2014. attempts to enact a bill to protect the industry from Unfortunately, Congress is patent trolls that buy-up patents solely to extract unlikely to take up potentially settlements gained no traction. divisive issues such as tax reform and immigration reform until Consumers received a wake-up ...Congress is after the 2014 midterm elections,” call regarding who can access said Bob Moss, CohnReznick their personal data and the unlikely to take up Principal and National Director extent of personal information of Governmental Affairs. potentially divisive available online. Congress has
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been debating data privacy There was little positive tax reform issues such as legislation for years; however news in 2013. The research and it has not passed a comprehensive tax reform and development credit, worth an federal law that governs the estimated $14.3 billion over immigration reform collection and sale of personal the next 10 years, is one of information. Several states are until after the 2014 approximately 50 tax provisions passing their own privacy laws3. that expired at the end of 2013. midterm elections. California, for example, now has “Lack of the credit can impair a law obliging companies to tell the ability of small and mid-sized Bob Moss, consumers whether they follow technology companies to fund Principal, National Director the “do not track” signals― innovation and compete with of Governmental Affairstal embedded code requesting larger rivals,” added Moss. Even Affairs that companies not track less certain are broader reforms. user activity―incorporated For example, an estimated in many web browsers. $2 trillion in foreign profits is being held offshore by U.S. multinationals because under current U.S. tax “Technology companies are caught in a bind when law, companies who repatriate foreign revenues it comes to data privacy legislation,” said Alex Castelli, are taxed twice on that revenue. CohnReznick Partner and Technology Industry Practice
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Immigration reform faces its own ambiguity
as to whether a bill will be passed to increase the number of legal U.S. immigrant workers. For technology companies, immigration reform would make it easier for foreign-born students who earn advanced degrees in science, technology, engineering, and computer science to remain in the U.S. The Congressional Budget Office estimated that enacting the Senate immigration reform bill will increase real GDP by 3.3% in 2023—an increase of about $700 billion in today’s dollars. Scheduled to take effect in January 2014, the so-called Obamacare employer mandate has been deferred for one year, to January 1, 2015.
Leader. “On one hand, they do not want legislation to severely restrict their ability to collect and retain information on consumers and users. Big data analytics is at the heart of social media and Internet search businesses, for example. On the other hand, if consumers feel that their personal information has been unwillingly compromised, there could be a severe backlash.” Technology companies that collect and mine personal data need to be sensitive to how this data is used and provide safeguards for users to opt to protect their personal information. 2 www.bu.edu/law/faculty/scholarship/workingpapers/ documents/BessenJ_MeurerM062512rev062812.pdf
3 www.nytimes.com/2013/10/31/technology/no-us-actionso-states-move-on-privacy-law.html
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Critical Issues Facing Middle-Market Technology Companies in 2014
Technology Sector Fuels Brisk M&A Activity The U.S. technology merger and acquisition (M&A) market heated up in 2013 and CohnReznick believes conditions are ripe for the temperature to rise again in 2014. Overall, U.S. M&A activity increased 14% in 2013, making it the strongest year for U.S. deal-making since 20074. The highlights for the sector include: • Telecommunications M&A transactions increased 119% on a global basis to $263.7 billion led by Verizon’s $130 billion acquisition of the remaining stake in Verizon Wireless • High technology M&As were up 8% year-over-year • Information technology comprised almost 50% of all venture-backed M&A deals in 2013 (332 of 673 deals)5.
Thomson Reuters Preliminary M&A Review: http://share.thomsonreuters.com/pr_us/Prelim_MA_ Financial4Q13_Review.pdf
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Source: Pitchbook
Middle-Market Technology Industry Outlook
Venture-Backed Technology M&A Deals in 2013* Venture-backed Technology M&A Deals in 2013 INDUSTRY
Computer software and services
Q1 Q2 Q3
Internet-specific
Q1 Q2 Q3
Computer hardware
Q1 5 Q2 2 6 Q3
Semiconductors / electronics
Q1 2 Q2 8 5 Q3
Communications and media
Q1 2 Q2 4 Q3 2
Total
Q1 Q2 Q3
30
18
20
35
40
25
57
10
20
30
40
50
69
60
78
70
80
*Includes all companies with at least one U.S. VC Investor that trades on U.S. exchanges, regardless of domicile. Source: Thomson Reuters & National Venture Capital Association
CohnReznick believes M&A activity will continue to accelerate in 2014 as corporate buyers, emboldened by record-high cash positions and readily available debt, make strategic acquisitions to fuel future growth. “Many large technology companies, as well as private equity and venture capital firms, have significant amounts of cash on their balance sheets. They are under pressure from shareholders and investors to invest that capital,” said Christopher Mahon, Partner, Technology Industry Practice. Apple, the poster child for companies harboring large cash reserves, acquired at least 10 technology companies in 2013, but that barely made a dent in Apple’s $147 billion mountain of cash.
What does CohnReznick think? Whether driven by pressure to deploy dormant capital to access intellectual capital and innovative technologies, market factors clearly portend significant increases in M&A activity. Innovative middle-market companies are attractive targets, particularly to large technology companies.
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Middle-Market Technology Industry Outlook