European tech financings have cooled since early 2015, while European tech exits remain strong and M&A deal sizes are approaching US levels for the first time ever, according to Magister Advisors’ H1 report – The State of European Tech up to Brexit.
The cooling of European late stage financings reverses a five-year trend of ever-larger financings that have fuelled the next generation global challengers who are choosing to compete from Europe.
Companies as diverse as Delivery Hero, Transferwise, Blablacar, Spotify and Supercell have emerged as potential European “unicorns” attracting unprecedented interest, and money, from international investors.
This has now fundamentally changed. Series C and later financings have dropped by more than half in value since H1 2015. Even adjusting for the large Spotify financing in H1 2015, later stage rounds have still fallen by almost 50 per cent in value these last 18 months. This is in sharp contrast to Series A and B rounds, which remain strong as local EU investors continue to support start-ups.
Magister says big-ticket rounds have dropped for several reasons: US investors have generally cooled on large, later stage deals everywhere, and this has in turn slowed the flow of capital from US investors to these rounds in Europe; there are still just not that many European tech companies worth USD200 million-plus (which is generally required to attract USD75 million-plus); it takes five to 10 years to create a potential future leadership company, slowing quality supply; many European tech companies are dependent on EU economic growth since much of their business is, for example, tied to consumer spending in the EU.
The EU is now growing at half the rate of the US and shows no sign of accelerating.
But perhaps the single biggest reason is the lack of VC-backed USD1 billion-plus exits in Europe. Of the 16 exits since 2013 valued over USD1 billion, only two were VC backed. Nearly all were former PE backed buyouts which were then sold or IPO’d (e.g. Worldpay and Nets). The lack of a clear path from Series C/D to USD1 billion-plus exits will continue to restrict invested capital.
The surprise is that M&A activity remains strong, and consistent. In fact, European tech M&A deals averaged USD72 million in value H1 2016, not far off the USD104 million average US level. It’s one of the smallest gaps Magister has ever recorded; normally US deals on average are close to twice the value of European ones, reflecting the much deeper pool of US tech companies available, and the maturity of the US industry overall.
Overall European M&A totalled USD39B in H1 2016, up nearly 100 per cent from the same period last year, while M&A deals numbered 203, essentially flat in the same period. USD100 million-plus M&A deals now represent two-thirds of all USD100 million-plus exits (the rest are leveraged buyouts, and IPOs).
Magister believes the strength of European tech M&A is due to several factors: European companies across many tech segments have “come of age” and are now both attractive to international buyers, and have reached a scale where they are worth “real money” (i.e. USD50 million to USD100 million-plus deal values); several of tech’s hottest segments, in particular AI and fin-tech, are equally well developed in Europe and the US, and deals for European targets are done at international not European prices; international buyers across all sectors of tech are facing a slow-growth, zero interest rate environment, while sitting on an unprecedented USD1 trillion-plus aggregate cash pile – they can afford to pay record-setting prices to buy fast-growing earnings and high quality products/technology, irrespective of where the targets are based.
Finally, the cost of developing technology in the US’s core Silicon Valley hotbed has become prohibitive, with real estate, salary, and benefit inflation running way ahead of the US average. It makes more sense than ever for tech majors to ramp up their development capabilities in lower cost areas, including many sites across Europe, which is a driver of interest.
Brexit can only create greater uncertainty as time passes, the report says. Uncertainty is most likely to dampen the late stage financing environment even more as we roll into 2017. Perversely, Brexit seems to have had little impact on tech M&A. Since Magister completed its analysis, Softbank has committed USD30 billion to acquire ARM plc, and more USD1 billion-plus M&A deals are mooted for European segment leaders.
It is Magister’s view that many larger private tech companies will begin to take advantage of this trend by running “dual track” processes in the next year or two. This means that while they gear up to raise their next required round of funding, in the face of growing uncertainty, many will also want to consider M&A at the same time, if only to reduce risk and uncertainty.
Inevitably some people will be concerned that more European “stars” will end up “selling out.” The reality is that nothing will fuel the European tech eco-system more than a spate of high value exits in the next one to two years.
Perversely, says Magister, Brexit (or rather, the uncertainty created by Brexit) could end up benefitting the European tech industry over the next decade.
