While software company stocks have taken a brutal hit from the volatility that closed out 2018, tech dealmakers have their eyes on a $1 trillion figure that tells a much different story.
That number: the total net cash that the top 10 tech companies could have on their balance sheets by 2020. Even if the economy enters a major downturn, the top tech companies will have a lot of cash throw around.
In the words of TV’s favorite financial criminal George Bluth, there’s always money in the banana stand.
When asked whether Apple’s downgraded guidance and 10% stock decline was a sign of rough times ahead for the tech sector, Union Square Advisor president Ted Smith told Business Insider that nobody is “packing up and closing up business.”
Companies still have access to capital, and they’re still eager to move forward with the mergers-and-acquisitions deals on the docket, Smith said.
For Evercore ISI analyst Kirk Materne, this means even if tech stocks continue to nosedive, software M&A “will provide a bit of a backstop for valuations.”
“While we acknowledge that software stocks are ‘at the mercy’ of the broader markets right now, we believe one of the overlooked aspects in software is the likelihood of more M&A (and alpha generation) if stocks were to continue to pull back in 2019,” Materne wrote in a note on December 19.
This means big players like Google and Microsoft will see lower price tags for companies they’ve had an eye on through the boom. Now that prices are lower, buyers can acquire their target companies at a steep discount.
Specifically, Materne called out the vast amount of “dry powder” that could make this happen. The top 10 tech companies have a combined $350 billion in net cash on their balance sheets as of the third quarter of 2018, and they’re expected to generate another $600 billion in free cash flow through 2020, according to the note.
Enough cash to buy the entire software market
Assuming an unlikely world in which none of that money gets spent between now and 2020, the top 10 companies could have a total $1 trillion in cash by next year, according to the note.
The next 40 largest US software companies have a combined value of just $660 billion, Materne wrote. That means the top 10 companies could — at least in theory — buy up the whole market.
Of course, much of that money will be spent, most likely through share repurchases and dividends, like the ones promised by Apple CEO Tim Cook to return the company’s $130 billion in net cash to shareholders.
But Materne writes that even if only 10% of the free cash flow and net cash from those companies was spent on M&A, that would mean nearly $100 billion in M&A activity just from strategic buyers.
Think SAP’s all-cash acquisition of Qualtrics for $8 billion in November.
And even if software stocks continue to tank, Materne thinks M&A alone could keep software valuations afloat.
“It only takes one larger deal (great than $2 billion) to potentially lift relative valuations across the entire sector,” he wrote.