Cisco’s $28 billion Splunk deal is likely to spark a surge in software acquisitions. Splunk had been in the process of shifting its business model from software licensing to subscriptions before it announced its sale agreement to Cisco last week, marking the third-largest software acquisition in history.
Chuck Robbins, the CEO of Cisco, emphasized the significance of Splunk’s $4 billion annual recurring revenue potential from subscriptions as a key driver behind the deal. This has ‘opened the gate’ for other tech giants like Microsoft, Adobe, and Oracle to consider subscription-focused companies such as Elastic NV, Datadog, Crowdstrike Holdings, and Dynatrace as potential acquisition targets, especially as they seek to meet the demands of cost-conscious corporate customers.
This positive shift in the software deal landscape comes as a welcome development for dealmakers who have seen tech sector transactions plummet by 61% year-to-date in the first eight months of 2023, amounting to $231.5 billion, according to LSEG data.
The software sector’s recent dealmaking has been predominantly driven by private equity firms, leaving technology giants with limited competition. In July, New Relic, a Splunk competitor, was acquired by private equity firms Francisco Partners and TPG Inc for $6.5 billion.
Industry experts suggest that a rally in the Nasdaq 100 index and a reduction in concerns over an economic recession will embolden technology companies to follow Cisco’s lead and pursue significant acquisitions.
“I think the buyers’ outlook on their own business has really improved from four months ago, and that gives confidence to pull the trigger on transformational transactions,” David Chen, co-head of global technology investment banking at Morgan Stanley, said in an interview.
The Federal Reserve’s decision to halt interest rate hikes has also provided acquirers with more certainty regarding their funding costs, further facilitating dealmaking in the software sector.
Even before Cisco’s acquisition, there were signs that technology giants had begun exploring software firm acquisitions, albeit on a smaller scale, with IBM’s $4.6 billion purchase of technology spend-management platform Apptio in June.
Splunk’s acquisition became more suitable due to its stock performance, having risen 39% in 2023 before the announcement but still down 44% from its October 2020 high, when the COVID-19 pandemic prompted increased IT spending for remote work.
Similarly, many of Splunk’s peers have experienced similar stock performance patterns. Software stocks currently present attractive acquisition opportunities, trading at an average of 5.8 times projected 12-month revenue, which is 28% below the sector’s eight-year historical average, excluding the temporary valuation boost from COVID-19.
Cisco’s acquisition of Splunk was valued at 7 times projected 12-month revenue, a reasonable price according to analysts.
“We note that the typical security company with 20% growth trades at about 7 times (sales),” BTIG analysts wrote in a note last week.
Private software companies may also be increasingly open to acquisitions.
According to Keith Skirbe, managing director in Houlihan Lokey’s technology investment banking group, some companies that raised funds at high valuations during the 2021 fundraising cycle may prefer selling rather than seeking lower valuations from investors in subsequent rounds.
The confluence of these factors has led analysts at Wedbush to predict “a tidal wave of software M&A on the horizon.”