With the The $19 billion Facebook acquisition of WhatsApp, 2014 opened with the largest exit of a venture capital-backed company in history. It looks like that isn’t just an aberration as this year is projected to be a big year for technology mergers and acquisitions.  

In contrast, 2013 started as a terrible year for technology deals. The first half of the year saw tech deals drop below the levels seen during the recession in 2009. But, as the year went on, momentum began to build and confidence began to grow; paving a way for a big year of deals in 2014.

“It was a disappointing year, with a very promising second half. That momentum has continued and the announcements that have yet to close point to acquisition activity that will be driven by technology shifts affecting the enterprise customer and affecting the consumer.”

That was how Rob Fisher described the situation. Fisher is the U.S. Technology Deals Leader for PricewaterhouseCoopers(PwC), a professional services firm that is considered one of the big four auditors, alongside Deloitte, Ernst & Young, and KPMG. PwC recently released their US technology deal insights – Analysis and trends in US technology M&A activity 2014 which was, collectively, a look back at deals in 2013 and a look ahead to the deal landscape for 2014.

The momentum has been building for the last two or three quarters and it should continue through 2014. If the deals we have seen so far are any indication, we should expect some great deals this year. We probably won’t see another Facebook/WhatsApp deal, but we will see more divestitures like the Lenovo/Motorola deal as companies look to harvest some of their business units to compete in areas like cloud.

Increased diversification means that tech deals will be taking place across different sectors and infiltrating many different verticals. This means that several categories will now be affecting the technology deals market at the consumer level and in the enterprise. As a whole, software and social will continue to lead deals in volume and value. At the consumer level, social and mobile will be strong while the enterprise should expect a focus on cloud deals.

Let’s make a deal

According to the report, 34 percent of the total 2013 deal value was represented by software and Internet deals, a decrease from 53 percent in 2012. It is worth noting that this drop was likely influenced by the nearly $25 billion privatization of Dell, which counted as a hardware transaction and offset the total.

Software will remain at the forefront of tech deals as businesses look to new software solutions to enable growth. Social will remain high as it has historically trended that way, but the WhatsApps deal has the potential to skew the data for 2014 as the Dell deal did for 2013.

Pat Kenealy, a managing director at IDG Ventures, noted that as stocks for major public companies like Google and Yahoo gain value they are emboldened to acquire new companies and they have the cash to do it. On the startup level, when an IPO goes well, “we see newly public companies get brave in using the funds for acquisition.”

We saw both of these instances in the WhatsApp deal as Facebook waited for its share price to rise, after a less-than-thrilling IPO, to make a huge purchase. Bear in mind that 2013 was a pretty good year in the stock market, and if that continues it could mean many tech companies will have the ammunition to acquire.

The PwC report notes that industry-specific acquisitions will drive mergers and acquisitions (M&A) in 2014 as verticalization increases in industries such as healthcare, retail, banking, and industrial products. It remains to be seen if 2014 will see a true “healthcare boom,” but the advent of the Affordable Care Act and new regulations for electronic health records are paving the way for an uptick in acquisitions by major healthcare companies. According to the report, trends like the Internet of Things will impact deals as well.

“Many non-traditional industries are adapting technology to gain a competitive edge. As we see medical devices, automotive, and other industries continue to add high technology to their product offerings, volume growth may increase interest in suppliers of these more specialized offerings. Expect to see players in the industry look toward diversification via targeted industry products with sufficient growth trajectories,” the PwC report said.

While software and Internet deals led in total value, the top deals by price were in hardware, software, and semiconductors. Let’s take a look at the top five deals:

  • The privatization of Dell cost $24.9 billion. It’s debatable whether Michael Dell and Silver Lake Partners‘ purchase of the computer giant constitutes an industry-illuminating deal, but it did carry the highest price of 2013.
  • Koch Industries $7.2 billion acquisition of Molex Inc., a company that makes electronic components for devices like the iPhone. The deal was the biggest that Koch had made in eight years and was the second largest deal in their history.
  • BMC Software, which offers IT services including cloud services, was bought by a group of investors for $6.9 billion. The group was led by Bain Capital and Golden Gate Capital.
  • Cymer, a company that makes tools for manufacturing semiconductors, was bought by ASML Holding NV for $3.7 billion. According to Fisher, the semiconductor industry could see consolidation soon.
  • Network giant Cisco buys network security company Sourcefire for $2.7 billion. With the increase in cloud services, security will be a factor but will exist more as table stakes for future acquisitions.  

Save for the Cymer deal, all of these deals closed after June, which propelled the end of the year momentum. The Cymer deal was also the only cross-border deal of the five, with ASML Holding NV headquartered in Europe. The technology sector and M&A is largely a U.S. phenomenon. Fisher claimed that “70 to 90 percent of these deals involve a U.S. company,” but we could see more international tech deals in 2014. While Europe is projected to maintain its deal strength, the report also mentioned growth in Asia and, echoed by Fisher, growth in Israel.

Israel has a vibrant startup scene, which has led to many acquisitions. Fisher, who has worked in M&A for over a decade mentioned that he has seen more notable deals happening in Israel. The Google purchase of Waze and SlickLogin are indicative of a growing startups culture that could help Israel create its own Silicon Valley.  

The tech deals momentum gained in 2013 helped to set the stage for a, hopefully, hearty set of deals in 2014. The momentum for deals last year was due, in part, to emerging IPO market trends. The PwC report mentioned that IPO market trends hit their highest level in six years, which is great for tech startups, but could negatively impact the existing public companies who need new tech to compete or even stay relevant.

Mind the gap

Until recent years, startup valuations over $1 billion were unheard of. Now, valuations are regularly clearing that mark. This is increasingly common in the enterprise cloud space with companies like Box and Dropbox leading the charge. As great as that is for those companies and their investors, it has the potential to create problems as incumbent public companies seek to join that space.

“There’s been a valuation gap between buyers and sellers,” Fisher said.

Newly public companies are driving such high valuation expectation for new companies that it is becoming an expectation for some startups to hit a valuation in the billions. That’s the dilemma for existing incumbents—they need to acquire cloud companies, but they can’t afford these new companies.

This forces public companies to look at acquiring these hot tech companies in trending sectors before they become public, or before they even mature as a company. Kenealy mentions the acqui-hire M&A and micro M&A scenarios that are not reported by firms like PwC. These are acquisitions of a young company for a few million dollars to help the acquiring company start to get on board with a new technology.  

If looking to acquire the bigger companies, capital allocation will be a major factor as some companies are going to have to choose which of their business units they will continue to invest in and which units they will sell off to competitors or private equity firms. This is the concept of a divestiture transaction, which the PwC report defines as: “the sale or spin-off of a piece of a company, not the entire company.” Although divestitures increased three percent for 2013, the PwC report notes that divestitures will likely remain steady this year.

“Divestitures are likely to remain at a similar level in 2014, pulled downward by the level of IPO activity but offset by the ongoing desire of many companies to reduce the size of their portfolios and focus attention on assets core to their growth strategies,” the report said.

One of the best examples of this would be IBM. Most recently, IBM sold its x86 server business to Lenovo for $2.3 billion. In 2004, IBM sold its PC division to Lenovo as well. According to Kenealy, they have remained IBM by not standing still. IBM, like many other large companies, uses M&A as a tool to stay relevant.

“The companies that stay relevant in any vertical for a long period of time are the ones that constantly evaluate new technologies that are going to become important, and they make them or they buy them,” Kenealy said.

This renewed focus on core competencies makes divesting a huge opportunity in the coming year. Combine that with a bullish stock market, increasingly innovation-centric verticals pushing demand in sectors like cloud and software, and you have recipe for major tech deals in 2014.