With convergence becoming very much a trend that’s here to stay, valuations are set to head north

Survey respondents in Reed’s Smith’s Wired Up: The convergence of technology, media and entertainment report predict that valuations will increase across all three sectors over the next two years. Tech valuations are expected to rise most – 34% expect a significant increase in this sector.

“The low interest rate environment and the aggregation of significant cash resources in the hands of tech-focused private equity funds has also helped drive valuations,” says Reed Smith’s Herb Kozlov.

TME is perceived as a sellers’ market, with valuations spurred by a glut of buyers and a shortage of high quality targets. But breaking down survey responses by sector reveals a more complex picture. In the technology sector, for example, 56% of respondents consider valuation multiples to be high, with a large minority (44%) considering them fair. Nobody considered tech asset valuations to be low.

Technology businesses are also often overvalued because there is a premium on IP, which is hard to value. “These companies buy a bunch of patents that seem to have inherent value, but it is hard to determine what exactly that value is. We have seen some high valuations in North America, especially pre-revenue businesses. Part of that could be due to fundraising processes, when valuations become baked into the overall value of targets,” says Reed Smith’s Gregor Pryor.

Striking a bargain in this complex pricing environment is no easy matter. Convergence deals amplify the challenge: buyers are at a disadvantage because they are entering new and unfamiliar sectors.

Many technology companies that have entered into content and entertainment are seen as deep-pocketed. To avoid overpaying, “the first thing is to approach a competitive situation in a disciplined way,” says Reed Smith’s William Doran. “Go in with your budget, but avoid the temptation to exceed it.”

He also suggests searching for deals outside the auction process. “While easier said than done, buyers should seek out opportunities that are not being marketed competitively. This helps to avoid overpaying, because the auction dynamic always bears that risk.”