Mega Merger Mania

There is a bigger picture observation to be made in the wake of the AT&T and Time Warner merger/acquisition. It is an observation a long time coming as we have observed a number of larger merger/acquisitions already go down in the semiconductor industry with even more coming. I have continually been predicting the consolidation of the semiconductor industry and others have been making similar predictions about the media industry. It is worth looking at why this is happening and will continue to happen and what that may mean going forward for startups.

The Big Get Bigger
In an article I wrote in 2015, called When the Easy Growth is Over, I detailed how when a growth cycle ends it makes the environment for M&A ripe for the picking. Here was how I articulated it:

The other telltale sign of a growth cycle slowing is the increase of mergers and acquisitions. Something we have clearly seen accelerate over the past few years. Smart companies acquire to get ahead of the slowing momentum, while others may just be waking up to the fact their growth wave is subsiding and are now looking for complementary assets to add to their revenue lines. Some companies may wait too long and end up as the ones who get acquired.

Given a number of market fundamentals which are becoming quite clear around this first initial internet growth cycle, I believe we will see an even more dramatic increase in mergers and acquisitions over the next 3-5 years. We can speculate all day on who needs to acquire who, but the general philosophy I like to use is to think through which companies will be stronger together than apart. The other is to look at who has the most cash, or valued/growth stock, to use.

This dynamic has been true of all the big growth periods since the industrial revolution. You can look at shipping, trains, automotive, and even consumer packaged goods and see how the initial growth curve lead to many companies competing against each other on different vectors. Then as the growth curve slowed, the industry consolidated to a few dominant companies. We are seeing this exact dynamic play out now and we will inevitably be left with very big and very powerful companies in each industry.

The semiconductor industry will continue to consolidate to just a few dominant companies, media and entertainment similarly will consolidate. Telecoms also looks to be heading in this direction and we may start to see more global consolidation as well in the years to come.

The big question in my mind is how far can this consolidation go and how much can it cross industries. For example, do the big platform providers like Apple, Microsoft, Google, or Amazon start acquiring media and entertainment companies? Or would they acquire telecom companies? In the age of conglomerates, the only question is how big can they get, and similarly, how big will governments let them get.

The bottom line is conglomerates are here to stay and they are likely to only get bigger and stronger.

Can Startups Survive When Tech Conglomerates Dominate?
The above observation is something I talk regularly about with all the VC firms in the valley. Most of them have raised a substantial amount of money and a number of different funds, betting on their companies competing and growing against the incumbents. The problem is the incumbents have only gotten bigger and stronger and through M&A are becoming harder to compete with due to the leverage they have with their legacy businesses paired with the complementary solutions they have acquired.

You may recall the brief trend of startups calling themselves “full stack.” This was an attempt of startups to provide as much as a full solution as possible, which included components of competing offerings to what incumbents were offering and new solutions that incumbents weren’t. The problem was, the incumbents had entrenched businesses they used to leverage and bought companies to fill the gaps to compete with these full-stack startups. Essentially, the incumbents became full stack providers.

Now, in some cases, the companies the incumbents purchased were startups which was a win for the investment community. But what is becoming clear to me, and now to some investors is the valuations companies are raising money at today are predicated on scale and business size growth that is likely extremely difficult and rare in an era where conglomerates rule and they keep getting bigger and stronger.

The challenge for most investors today is the size of funds they raised and the amount of capital they need to deploy is not in line with this trend. They need high valuations and big exits and that is going to be extremely difficult in the conglomerate phase we are entering into. Yes some of those startups will get bought by said conglomerates but my hunch is not for the amounts needed to return many multiples in value back to later stage investors.

Interestingly, startups that are extremely capital efficient, and lean, and can focus on highly profitable niches who don’t need to raise as much money are much better positioned for this conglomerate era. They will have extremely profitable businesses and can focus on the niche and high-value parts of the market the conglomerates may not waste their time with. But these companies are rare and most investors are looking for home runs rather than more wisely looking for these companies that are more doubles and base hits to use a baseball analogy. But the larger problem looms for silicon valley VC who did not raise their massive funds in the last few years to be able to look for base hits and doubles, rather they raised their funds needing home runs and that is going to be very hard in the conglomerate era.