Dive Brief:

• Mergers and acquisitions involving mid-market tech companies are expected to pick up this year after a slowdown, but how quickly and by how much is dependent on whether trade tensions persist and what central bankers do, a report by consulting firm BDO says.

• "We expect North American tech mid-market mergers and acquisitions (M&As) to recover" from last year's drop, the report said. But "if antagonism grows between the U.S. and its major trading partners or a profits recession forces the Fed to maintain or even raise interest rates, we may see performance [at the level seen in the first half of this year] repeated."

• Separately, a report finds 60% of M&A deals end up depleting stockholder value, pointing to the risk of these deals even when the market is good for them.

Dive Insight:

Worldwide, M&A activity dropped by 25% from the fourth quarter of 2018 to the first quarter of 2019, says the BDO report, using Mergermarket data. It dropped an additional 2% from the first quarter to the second quarter of this year. Year over year, merger activity was down 23% at the end of the second quarter.

Apart from broader economic uncertainty, some governments are throwing regulatory roadblocks in the way of deals to protect intellectual property of companies headquartered in their countries. Stepped-up antitrust efforts and evolving privacy laws, including the General Data Protection Regulation (GDPR) and California's Consumer Privacy Act, are also slowing deals.

Tech M&A fared slightly better than the merger marker as a whole, down only 20% year over year. 

"This resilience, combined with continued interest in the tech sector from strategic and financial buyers alike and the proven value of M&A as a vehicle for growth, could bode well for a rally in the second half of this year," the report said.

Tech CFOs are optimistic merger activity will increase later this year, a survey in the BDO report shows. About 55% say deals will increase, 43% say valuations will increase, and 60% say they plan to pursue their own M&A deals before the year is out.

Don’t skimp on due diligence

Separate from whether merger activity picks up, a report on CFO.com points to the perils of M&A activity done too hastily.

About 60% of mergers end up destroying shareholder value, an analysis of 2,500 deals by L.E.K. Consulting found, according to the CFO.com report.

Cutting corners on due diligence underlies many of the issues. Among other things, the acquiring companies don't always investigate whether the company they want is compliant with regulations. About 55% of 300 executives surveyed by law firm Baker McKenzie said they dedicated too little effort to investigating the company they acquired.

"Compliance due diligence is the stepchild of many transactions," William Devaney of Baker McKenzie told CFO.com.

This can be a particular problem if the company being acquired is based in a country that isn't consistent in enforcing its laws. Companies in these countries may not have good compliance mechanisms, resulting in a potential headache for the acquiring company down the road. "Under U.S. law, you are buying that problem," Devaney said.

The Baker McKenzie survey also found inadequate attention paid to due diligence on data security and privacy, with 43% of CFOs saying data privacy, and 35% saying cybersecurity, were not considered major compliance risks during mergers. 

Another risk for mergers, especially while the economy is growing and labor markets are tight, is the ability to retain the employees who are integral to the acquired company’s success.  

“That key salesperson who has critical relationships with the target’s five largest customers, for example, might make or break the deal’s success,” Curt Gendron, a practice leader at Crowe, a consulting firm, said in the CFO.com report.

More deals, but are they worth doing?

The BDO report makes clear conditions are mostly right for M&A activity to pick up as 2019 winds down. That’s especially the case for deals involving mid-market tech companies. But the CFO.com report provides a cautionary tale that mergers, if undertaken without adequate due diligence, risk destroying shareholder value.