Evaluating 2012 - and Looking Ahead to 2013

Download print-friendly version

Evaluating 2012—and Looking Ahead to 2013

by Taft Kortus, National Technology Practice Leader

Uncertainty. It’s a word we’ve learned to live with over the past few years, the result of tepid economic growth, vast regulatory upheaval, and relentless competition in the marketplace. And while positive trends in the capital markets and the economy in general continued to emerge in 2012, there were also downside pressures and pockets where these trends never fully took hold.

In short, it was the kind of year that validated the prognostications of the cautiously optimistic. And even though 2012 appears to have departed on an upward path, whether 2013 turns out to be an even better year for the technology industry depends on a number of wild cards. In other words, more uncertainty. Companies that want to navigate 2013 to success will need to face certain change with increased knowledge and insight.

We’ve at least settled one big problem: We aren’t going over the so-called fiscal cliff. However, the partial agreement reached by Congress and the president merely pushes many tough decisions down the road, and any ultimate long-term agreement in 2013—or the absence of one—will certainly move the markets. Indeed, we’ve already seen companies and investors act to mitigate their risk from these uncertainties, whether by issuing dividends to avoid higher tax rates, exiting portfolio investments to lock in gains, or simply adopting a policy of inaction and waiting out the uncertainty and its potential impact on the overall economy and capital markets.

Regardless, the black cloud of the increasingly volatile political bargaining and the increasing US deficit will certainly impact how 2013 unfolds for the vast majority in the technology industry and capital markets. Let’s take a look at a few key areas beyond the political landscape that will be good barometers of trends in 2013. And look for a series of articles in 2013 that will cover each topic in greater depth.

Initial Public Offerings

The technology industry and its investors entered 2012 in a generally upbeat mood, and they leave the year feeling similarly optimistic. After all, technology was one of the few industries to outperform the broader markets. One of the positives was the launch, albeit some not so successful, of close to 140 IPOs, nearly 33 of which were US technology companies. Some of these offerings, such as Workday, exceeded expectations; but many other noteworthy IPOs, such as Facebook and Groupon, raised concerns among investors about whether trendy technology ideas can deliver significant and sustainable long-term value.

The bottom line is that all companies, even household names such as Facebook, must be well prepared, well seasoned, and ready to perform if they decide to tempt the public markets—which, more so now than ever, can be very unforgiving to a newly issued registrant. After all, an IPO is a key financing and liquidity event for many companies and shareholders and is seen as a milestone in terms of corporate maturity and success. The headlines of 2012 tell us that this milestone can be another positive event in a company’s life cycle—or it can be a major distraction that can derail an enterprise’s underlying objectives.

The solution? Assembling the right team internally and externally, finding the right mix of strategic vision and operational success, and meeting the market’s (and the media’s) expectations. Now more than ever, management teams and investors need to be diligent in their assessment of IPO readiness. This includes digging deeply into revenue and earnings predictability, investor expectations, and internal controls and corporate governance.

An unsuccessful IPO can cause significant negative implications to even the most fundamentally sound business. Thinking and operating like a public company 18 to 24 months before an IPO and learning the lessons outside the public eye can help set a positive course for the post-IPO environment.

Mergers and Acquisitions

From enterprise solutions to business services to consumer entertainment, the technology industry saw increased consolidation, buyouts, and better deal trends in 2012. Many deals gained considerable attention, garnering valuation multiples that had eluded the markets in recent years. Good examples here were deals that gobbled up Double Down Interactive, PopCap Games, and Wave Broadband. Apptio’s $600 million valuation on its Series D round from institutional investor T. Rowe Price also participated.

But even with all the publicized success, there are still a large number of companies—maybe even the vast majority—wondering about their future in markets that are anything but normal. So while deal flow and valuations are trending positive, it’s too early to say we’re well on our way to solid markets when it comes to both the volume of buyers and investors as well as a predictable valuation model. You could also argue that some of the drivers in recent deals were known or expected changes in regulatory policy or continued rapid conversion of traditional markets to the digital delivery spectrum.

Regardless, companies must be ready to be bought, and they must have a keen understanding of their own market so they too can spot acquisition opportunities. While the markets are showing positive signs and valuations are becoming very attractive at the upper end of the spectrum, even the deals that do get done aren’t happening by chance. They’re the result of both sides being nimble, opportunistic, and ready to jump.

Sellers need a clear understanding of the value drivers for potential buyers, the ecosystem in which they operate, and the key risks that could derail a transaction once the process begins. For their part, buyers need to conduct extensive diligence and understand the operations and assets they’re acquiring—as well as what obligations they entail. But they also need to know the market they’re entering and what opportunities and risks they’ll be exposed to, as well as what the financing appetite is to fund their endeavors, which in itself can be a good test of whether they’re betting on the right deal.

A recent example of a good deal gone bad was HP’s acquisition of Autonomy. HP, a blue-chip company that you’d think would set an example around diligence, insight, and execution. If it can happen to HP, it can surely happen to any company or investor that thinks it has all the right answers and believes it’s operating to mitigate transaction risk.

It comes down to this: Capital is precious, and material missteps are costly. Opportunities are made real through execution. With the increase in M&A activity, growth in leveraged buyouts, and improved valuations that are more attractive to sellers, both buyers and sellers must perform thorough due diligence and have a clear plan as to how any given M&A opportunity will—or won’t—contribute to their overall long-term business strategy.

Global Markets

Companies subject in whole or part to the US corporate tax environment must be operationally and structurally strategic about the way they conduct business. In other words, they must be careful where they plant their global footprint. The challenge, of course, is how to maximize global opportunity while minimizing global tax rates. What do you do with assets stored outside the United States and off the US tax grid, especially if you’re not sure what US government policy will eventually be toward those assets?

General Electric, for example, recently had $90 billion in cash, $65 billion of which was generated through its global operations and being held offshore. Other companies are behaving similarly. What, if anything, will Congress do to encourage repatriation of
those assets and spur domestic investment? Or will companies keep those assets offshore regardless, prioritizing global expansion over everything else?

This isn’t just speculation. Technology companies have seen continued success, both domestically and globally, during 2012, but there’s a special sense of increased opportunity abroad. This stems from the fact that developing countries are becoming consumers on the world stage and global markets in general continue to become more available to companies of all sizes. Even emerging and growth-stage technology companies are seeking to expand globally sooner and sooner in their life cycle—it’s a trend that figures to continue.

What’s more, as companies are quickly realizing, to dominate a market, gain competitive advantage, and reach customer needs, they can’t put off global entry for very long. The numbers clearly reinforce this. Many predict that by 2015 the Chinese economy alone will outsize the US economy, a single data point that highlights the trend of the growing opportunities outside the US domestic market. Many other emerging markets will follow.

Yet global opportunities also come with increased risk—market risk, execution risk, and regulatory risk—that less experienced and less sophisticated companies must navigate. That’s why a well-conceived global expansion plan is so important. The questions should focus not on where you want to be in six months or a year but instead on where you want to be in five or 10 years. Where will your customers, employees, and intellectual property be? The need to understand local regulatory, tax, and business law is also crucial, as is knowledge of issues related to IP migration, transfer pricing, repatriation of profits, withholding taxes, and how to best finance and fund international operations. Setting things up improperly or taking the wrong road early on can result in significant costs and risks that could have been avoided.

Corporate Social Responsibility

With continued global expansion, greater environmental pressure, and increased consumer desire for sustainable products and services, companies are trying to be more transparent—for example, shedding light on workplace conditions in global factories and the sourcing of their materials. All of this will continue to push companies to balance growth and profitability with social responsibility.

Recent trends in sustainability reporting will also continue to evolve—and they may likely become the expected norm, thanks to industry leaders such as Costco, Starbucks, Microsoft, Apple, and other large corporations that are pressuring their suppliers to operate more sustainably and transparently. In addition, regulations passed under the Dodd-Frank Act regarding conflict materials, several of which are found in products manufactured by technology companies, such as smartphones and PCs, will require increased diligence, cost, and transparency. Overall, as we move into 2013 and beyond, businesses will need to better understand the demands for transparency in their operations around the world.

The Bottom Line

The past few years have been exciting, but they haven’t been easy, and that’s no less true for the technology industry, despite its relative success, than it is for other business sectors. But some good things came out of the recession: Companies learned to operate leanly. They doubled down on innovation. And they avoided many of the financial pitfalls of their dot-com predecessors.

That bodes well for 2013. But it remains to be seen whether regulatory changes, market volatility, or other external factors will complicate the operating environment. So uncertainty remains the watchword. Smart technology leaders will counteract that uncertainty by strengthening their financial operations, conducting thorough due diligence on potential transactions, and working to reduce risk across the enterprise. In a fundamentally turbulent marketplace, it’s always a good idea to pay attention to fundamentals.

Taft Kortus has more than 15 years of public accounting experience. He serves technology companies ranging from venture-backed start-ups to multinational public entities.