It’s Not You, It’s Me: Why Big Tech is Breaking Up

What’s been building up the tech industry over the last several decades, is also what’s working to split up big names.

According to data from PricewaterhouseCoopers, the third quarter saw 64 deals amounting to $30.1 billion in value. Alone, the final 20 days of the quarter saw an “unprecedented” number of announcements from big names in the industry, which PwC said signals a fundamental shift in the technology landscape.

Small newcomers have made the sector ripe with one rich valuation after another –and it’s the small companies with big pocketbooks that are making the glory-day tech behemoths question their roots, and slim down their operations to grow their bottom lines.

In 2013, the tech industry has seen its titans announce spinoffs, divestitures and breakups. In just the last several months, IBM (NYSE:IBM) announced it would spin off its chip division; Hewlett-Packard (NYSE:HPQ) revealed plans to split itself into two businesses – one for its hardware, software, and services businesses, the other for its PC and printing units; eBay revealed plans to spin off its payment processing unit PayPal; Symantec (NASDAQ:SYMC) in October split its security and data-storage units into two separate units; and back in 2013, Cisco said it would split ways with Linksys.

While it’s not a new trend, it’s one that’s gaining speed, and analysts have a few theories about what’s driving the momentum.

Better Economy, More Deal Making

In its third-quarter technology deal insights analysis, PwC noted though the global economy has begun to exhibit signs of stress – taking into account sustained weakness in Europe and China – the U.S. economy is showing continued positive signs of recovery.

The report pointed to strength in the U.S. dollar, and though Wall Street expectations for GDP were revised down after a volatile first half, IT spending projections have been bumped up to 2.6% for the year, thanks to higher expectations for devices and data center systems.

In the U.S., equity indexes continued to notch new record highs, and PwC notes the top 25 global tech businesses added to their cash piles, which have grown to more than $360 billion. It’s an environment the firm says gives those companies “ample ammunition for strategic acquisitions,” especially in the tech space where IPOs set a new record of $23.5 billion, and year-to-date returns surpassed overall growth of the indices, averaging 42%.

Matt Porzio, vice president of strategy at Intralinks, said the improving macro picture has really helped drive activity in the tech space.

“While there’s been some question about Europe, there [are] still signs of life, and people want to get ahead of a recovery there and invest or buy into those markets,” he noted.

He added the sustained low-interest rate environment will continue to be a driver as lenders are willing to lend, and borrowers are looking to put good money to use quickly.

“The buy side is under [such] extreme pressure to grow top and bottom lines that they have to put capital to work,” Porzio said. “While valuations climbed in tech, some say some of the acquisitions are rich right now. The point is, if you feel like you can’t take stockpiled capital and find other options, or do it organically, you have to buy the growth and be competitive because everyone has similar inorganic strategies.”

But, Porzio added firms should really consider where exactly they want to invest that money, and deals might be riper overseas. He said Intralinks is expecting the M&A environment in Europe to pick up in 2015, which could help drive overall activity higher for the next year.

“Some of the deals in the U.S. have become a little rich and (investors) can’t get multiples to work even with a good rate environment and levering up assets. They’re looking abroad where valuations are more reasonable across industries,” he said. “Tech has an opportunity to be a leader in those economies.”

Divest, Break Up, Spin Off…and Consolidate 

Call it a re-fragmentation of the tech industry. That’s how PwC sees it.

“Looking broadly, we went through a strong consolidation cycle in the last decade. As a result, a dozen or so companies have shifted capital from innovation investment to consolidation of tech companies that had gone public across all segments in the 90s as a result of new tech, but also in response to Y2K tech spending,” Rob Fisher, U.S. Technology Deals Leader for PwC, said.

Now, Fisher said the sector is experiencing a second round of fragmentation that takes advantage of new, modern technologies and ideas  -- and some of the biggest drivers include cloud and mobile computing, and social segments.

It is the new tech companies that are starting to really pressure big names of the past to refocus and determine what they really want to be as they grow older.

“That’s why we see the activity announcements over the last year over divestitures, spinoffs and go-private activity among the population of the last wave of tech leaders,” Fisher said.

As new tech takes center stage and old tech begins to fall behind, for the big conglomerates, it’s a matter of “finding themselves” and figuring out a way to be more nimble in order to better compete for the same slice of a broader market share.

“It’s no longer just about pure innovation and growth across all different tech segments,” Sebastian DiGrande, senior partner and managing director at the Boston Consulting Group, said. “When you look at shareholder returns over the last five years, differentiate them, and plot them against the degree of scale and diversification, you find small, more focused and nimble players generate more significant returns than the larger, more diversified players because there’s a focus on core strategy, talent, and capital they can use.”

DiGrande said those behemoths are now faced with a reality of a new kind of business that does have structural limitations on growth. The break-ups the industry has seen are all about trying to figure out what business to be in and optimizing to fit that business, rather than diluting every lever and applying one broad brush stroke.

Amid the slim down and consolidation, looking further out over the next several years, PwC sees an interesting trend of reinvestment that could begin to shake out. Many, if not all of the currently planned spinoffs could end up as acquisition candidates.

“Several of the newly liberated businesses present alluring alternatives for former competitors. In which case, instead of breaking up, shareholders may wish to see them making up again,” the firm’s quarterly report noted.

Regardless of how it transpires, Intralinks’ Deal Flow Predictor indicates all signs point to sustained activity in the deal space well into the New Year.

“Looking at 2015, people are cautiously optimistic, saying 2014 announced deals are going to be up more than 6% to 11%: We haven’t seen that number of deals since we came out of the crisis in 2010,” Porizo said. “Don’t think we’re going to see more growth on top of that, but sustaining it might be possible…don’t see it dipping in 2015. If anything, corporate development, investment banks, M&A law firms will be staffing up. The momentum is here to stay.”

A is for Activist

Just look at eBay and PayPal – two firms that the e-commerce giant’s CEO John Donahoe said were “better together” just months before announcing plans to spin off the payments processor. It’s a classic case, many speculate, of activist pressure winning out over company culture.

DiGrande said the increasingly dominant activist investor culture is also a major driver of breakups, especially in the tech industry, where those shareholders sense frustration and desperation to fit in, and an opportunity to capitalize on the trend of consolidation.

“I think in some cases, they’ve played a very significant role in focusing discussion and even proposing these actions,” he said.

PwC’s Fisher said with respect to the re-fragmentation trend, activists play a “huge, very significant” role in deal activity in the tech space. The main driver, he said, is to force the company to focus on profitability, and narrow the often broad-view focus to concentrate on capital in research and development and on narrowing a list of priorities to drive differentiation.

“The massive changes are an opportunity affecting consumer tech and enterprise tech as well as component suppliers,” he said. “It seems the entire industry is driven by disruptive forces and opportunities. It’s a dynamic time.”