Cisco’s $28 billion Splunk deal may ignite software deal frenzy. Investment bankers and analysts expect that Splunk’s (SPLK.O) $28 billion purchase by Cisco Systems (CSCO.O) will inspire other technological behemoths to pay out on comparable deals for software providers with steady subscription income.

When Splunk, a cybersecurity and data analytics company, revealed last week that it had reached a deal to sell itself to Cisco, it would become the third-largest software purchase in history. Splunk was in the midst of switching its business model from licensing its software to charging for subscriptions.
The $4 billion in yearly recurring income that Splunk would bring in via its subscriptions, according to Cisco CEO Chuck Robbins, who has been increasing his company’s service offerings to make up for its failing telecoms equipment division, was cited by analysts as a major factor in the transaction.

This demonstrates how Splunk’s competitors that focus on subscription revenue, like Elastic NV (3E1.F), Datadog (DDOG.O), Crowdstrike Holdings (CRWD.O), and Dynatrace (DT.N), are potential acquisition targets for technology giants like Microsoft (MSFT.O), Adobe (ADBE.O), and Oracle (ORCL.N), which are battling corporate customers looking to cut costs.

Requests for comment from Microsoft, Adobe, and Oracle were not immediately fulfilled.

For dealmakers, who have seen activity in the technology sector decline 61% year-to-date in the first 8 months of 2023 to $231.5 billion, according to LSEG statistics, the increasing forecast for software mergers and acquisitions is a welcome lift.

Private equity companies have dominated dealmaking in the software industry over the last year with minimal opposition from technological behemoths. A rival of Splunk named New Relic (NEWR.N) agreed to be acquired by private equity firms Francisco Partners and TPG Inc (TPG.O) for $6.5 billion in July.

A rise in the Nasdaq 100 index this year and waning market concerns about an impending recession, according to David Chen, co-head of global technology investment banking at Morgan Stanley (MS.N), will give technology companies the confidence to spend heavily on acquisitions like Cisco did.

In an interview, Chen stated, “I believe the purchasers’ viewpoint on their own business has much improved from four months ago, and it gives confidence to pull the trigger on transformative mergers.

The Federal Reserve holding off on interest rate increases, according to analysts at Jefferies, has provided acquirers more clarity about their finance costs, facilitating dealmaking.

Even before Cisco’s transaction, there were some indications that technology behemoths were considering smaller-scale acquisitions of software companies this year. For instance, IBM (IBM.N) decided in June to pay $4.6 billion for the technology spend-management platform Apptio.

AFFORDABLE VALUATIONS

Splunk was open to a takeover due to the success of its shares. Although its shares had increased 39% in 2023 before the announcement of the acquisition, they were still down 44% from their peak in October 2020, when the COVID-19 pandemic compelled businesses to spend more on information technology since the majority of their staff were working from home. Similar stock behavior has been seen across several of Splunk’s competitors.

By historical standards, software stock prices are low, which makes them desirable acquisition targets. When COVID-19, which briefly boosted values in the industry, is taken into account, the typical software stock trades at 5.8 times estimated 12-month revenue, which is 28% below its 8-year historical average, according to Jefferies analysts.

According to Jefferies, the Cisco acquisition valued Splunk at seven times anticipated 12-month sales. They said that the price Cisco was paying was fair, as did other experts.

In a report published last week, BTIG analysts stated: “We note that the typical security company with 20% growth trades at about 7 times (sales).”

Private software firms can also be more open to acquisitions. Some firms that raised money at high values during the 2021 fundraising cycle prefer to be sold rather than be compelled to seek money from their investors again at a lower valuation, according to Keith Skirbe, managing director at Houlihan Lokey’s (HLI.N) technology investment banking group.

A tidal wave of software M&A is imminent, according to a report published last week by Wedbush analysts.