Pandemic Not Slowing Proptech M&A Activity As Buyers Seek Distressed Deals
When John Ensign flew from Cleveland to London in mid-February to meet with executives from two companies his real estate tech firm was looking to acquire, he said the coach section of his plane was only 10% full, and Heathrow Airport was half as crowded as usual.
The negotiations have since been limited to videoconferences, but Ensign’s company, MRI Software, has still managed to close one of the acquisitions and sign an agreement with the other company. Ensign doesn’t plan on any handshakes anytime soon, but that doesn’t mean MRI is slowing its buying spree.
“We talked about, ‘Hey, where are we? Do we want to be moving forward with deals or not?’” Ensign said. “Where we landed is that acquisitions are going to happen through this, but I think it’s going to be more selective.”
The ongoing pandemic and economic crisis hasn't stopped the consolidation of the proptech sector that many in the industry saw as inevitable. But proptech experts say it will change the type of acquisition deals that close, with well-capitalized industry giants looking to scoop up distressed startups in need of a lifeline.
“There’s no doubt there was consolidation going on, and that’s getting accelerated given the current environment,” said Altus Group Executive Director Scott Morey, a commercial real estate veteran who now researches the proptech industry.
“The stronger companies will either use the capital behind them to ride the cycle if sales are stalling or they will use their capital to do acquisitions where they see value.”
The proptech industry in recent years has grown exponentially, with hundreds of companies emerging and investors pouring billions of dollars into the space. Last year, 528 funding deals closed in the proptech sector for a record $31.6B combined, according to CREtech's year-end report.
The crowded landscape has made it more difficult for real estate companies to decide which products to use and slowed the industry’s adoption, experts say. This made the industry ripe for consolidation, and many proptech leaders before the coronavirus crisis expected 2020 to be a banner year for M&A activity.
An Altus Group survey of 400 commercial real estate executives released in January found 89% believed consolidation is needed for proptech to more effectively deliver on the industry’s needs. Asked when they expect to see “significant consolidation” of proptech firms, 43% said it had already started or would start within 12 months, and another 38% said it would start within 24 months. While the survey was taken before the pandemic, several industry insiders say the crisis has not stopped M&A deal-making.
“Without a shadow of a doubt, M&A is happening all over the place, consolidation is happening, and it is set to continue, and even more so through 2020, COVID aside,” said Lerner Associates Managing Director Ben Lerner, whose firm specializes in M&A advisory for the proptech sector. He sold his family business, Qube Global Software, to MRI in 2017 before launching his advisory firm.
The Industry Giants Looking To Buy
The crisis has slowed down some deals because of logistical issues, Lerner said, but it hasn’t reversed the strategy of companies that were looking to buy. He said he sees large, well-capitalized companies like MRI and Realpage continuing to be active on the acquisition front.
“From a strategic perspective, the market is resilient,” Lerner said. “They’re still keen to buy. It might take a little bit longer, but the outlook is good, and there are deals happening.”
CREtech and Lerner announced April 14 they are partnering in a new venture to advise real estate tech companies on acquisition strategies. Many proptech companies have experienced growing revenue during the crisis as the commercial real estate industry is forced to adopt digital solutions, and CREtech CEO Michael Beckerman said the beneficiaries are looking to make acquisitions.
“There are a lot of companies with dry powder,” Beckerman said. “It’s not just going to be the big guys. I think there is going to be a lot of activity. On the buy side, there are probably 15 to 25 companies that have the wherewithal to be very active now, and you’ll probably see mergers in the middle.”
The dominant player in the commercial real estate data space, CoStar Group, is actively seeking out acquisitions. The D.C.-based data giant in October announced the $450M acquisition of hotel research firm STR, and in February it announced it was paying $588M to buy RentPath. On the company’s Q1 earnings call Tuesday, Chief Financial Officer Scott Wheeler said CoStar borrowed $745M to fund the RentPath acquisition and to increase cash reserves for other acquisition opportunities.
CoStar CEO Andy Florance said the company is looking at acquisitions that are responsive to the changes currently taking place in the economy.
“We believe that we will have a rich set of attractive acquisition opportunities ahead, and we're currently exploring a number of such opportunities,” Florance said on the call.
CoStar declined to comment for this story.
MRI is having conversations with multiple acquisition targets, Ensign said. The economic uncertainty has made it harder to value companies, he said, leading MRI to be more selective in its acquisition process.
“We’re looking for mission-critical, system-of-record software that serves a critical need for clients and we believe is going to have a use case regardless of economic condition,” Ensign said. “You’re digging into the data, looking at client retention. … Is that recurring revenue something we believe is going to stick through time?”
LightBox, a proptech company backed by venture capital firm Silver Lake Partners, made five acquisitions over the last 18 months: Real Capital Markets, Digital Map Products, EDR, ExactBid and ClientLook. LightBox CEO Eric Frank said he doesn’t expect to maintain that pace going forward, but his company isn't stopping either.
“From an M&A perspective, we are looking during this period. We are active,” Frank said. “When there are opportunistic situations where companies are coming to us and saying, ‘Hey, we want to be part of LightBox,’ we are spending a lot of time looking at those transactions.”
Goodwin partner Blake Liggio, a proptech-focused M&A attorney, said he saw rapid deal activity before the coronavirus, then buyers took a brief step back as the economic crisis began. But he is now seeing activity heat up.
“There are going to be both opportunistic buyers across sectors but also buyers that need to get these technologies in order to help resume operations,” Liggio said. “Those two trends are the biggest pieces that have driven the pickup of activity in the last two weeks.”
The Startups That Could Be Forced To Sell
The ability of these hungry buyers to make acquisitions will depend on companies putting themselves up for sale during an economic crisis, a period when valuations are likely to take a hit. Experts think many startups that didn’t have strong balance sheets may now have trouble raising money and have no other choice than to sell.
Venture capital is slowing as investors focus on maintaining the health of the portfolio companies, experts said. Many startups may be unable to secure funding necessary to continue operations and be forced to put themselves up for sale.
“There will be those startups that will be very nervous about running out of cash and will be forced to do something, and if they can’t find investors, it’s either going out of business or selling,” Lerner said. “Unfortunately, they won’t get a high value.”
While selling would be a more attractive option for a startup than going out of business, some may not have enough value to add to a potential buyer and may not have a choice, Reonomy CEO Richard Sarkis said.
“In some cases, the body is going to be DOA, so there’s nothing really worthwhile to consolidate or merge,” Sarkis said. “It’s more likely companies are just going to fade away, unfortunately. We’re starting to see layoffs, some pretty deep in some of these companies.”
Several proptech companies have made layoffs, including OpenDoor laying off 600 employees, Compass laying off about 375 people and Nested laying off more than 20% of its workforce.
Compstak CEO Michael Mandel said the companies that wanted to sell pre-crisis were strong startups looking to exit at a high valuation, and many of those companies may not want to be acquired during an economic downturn.
“Most companies that would be selling opportunistically are going to avoid selling because any buyer is a distressed buyer and is looking for a deal,” Mandel said. “Certainly there are some companies that now will be able to sell under distress and blame it on the economy, even though maybe they were in a tough spot before this happened. It will mostly be distressed deals in the near term.”
Ensign said MRI doesn’t look to acquire distressed companies and typically seeks to buy startups that improve its functionality or geographic reach, but he expects a large portion of the overall M&A volume this year will involve distressed startups. MRI provides a variety of software products to real estate companies to help with property management, investment portfolio management and other services.
“Sadly we’re going to see companies that need to come to market because they’re distressed, they’re undercapitalized and they were at the wrong point in their life cycle to work through this,” Ensign said.
But even in these distressed situations, Ensign said those companies looking to sell still need to prove their worth to the buyers. If companies have an innovative technology but a weak balance sheet, they could still be attractive acquisition targets.
“If someone’s having a balance sheet issue, does anyone want to let that product fall by the wayside because of capitalization?” Ensign said. “That’s where companies could be interested in stepping in and helping maintain that product in the marketplace or take that product to a broader audience.”
Tech startups were already coming under greater scrutiny from investors and buyers to prove their profitability before the crisis, Liggio said, and he thinks this trend is now going to accelerate.
“In order to do M&A, you’re going to have to demonstrate some model around recurring revenue and profits, rather than high-growth future promise,” Liggio said. “Buyers will still be opportunistic but might shy away from future upside companies that haven’t demonstrated historical metrics in key areas like profits and revenues.”
While there may be distressed companies looking for an exit and buyers looking to scoop them up, the parties still will face the logistical challenges of closing a deal during a pandemic. Ensign said MRI has adjusted to doing more business over videoconferencing, a practice it started before the crisis hit the U.S. as it expanded across the globe.
“You’ve got to be able to be nimble enough to change with the times, and we were able to get through it,” Ensign said.
MRI closed on its acquisition of Orchard Information Systems March 31, and it announced it reached an agreement with Castleton Technology April 15.
Because the industry has long relied on face-to-face meetings, Liggio said some companies he worked with initially put transactions on pause when travel became more difficult. But now, as the pandemic continues on, he said people are adjusting.
“Today there is a shift, and people are digesting the fact that we’ll have to make some modifications in order to do business the way we historically have,” Liggio said.
The result of this activity will be a proptech industry that looks vastly different from the one that existed before the crisis. With some distressed startups being gobbled up by big companies and others going out of business, proptech will emerge much more consolidated in the hands of the giants.
“At the end of the day, the byproduct of this pandemic and economic crisis is going to be there will be fewer companies. I think they will be bigger, they will be stronger and they will be more diversified,” Beckerman said. “It was inevitable they were not all going to survive."
