BofA predicts breakout in mergers due to downcycle

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Mergers in software may be about to break out.

Top investment banker Rick Sherlund of Bank of America sees a wave of struggling companies putting themselves up for sale at cheaper prices due to the economic downturn.

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“You do need to see greater capitulation,” the firm’s vice chairman of technology investment banking told CNBC’s “Fast Money” on Thursday. “Companies will have their valuation expectations soften, and that will combine with more fully functional financial markets. I think it will accelerate the pace of M&A [mergers and acquisitions].”

His broad analysis comes on the heels of Adobe’s $20 billion dollar deal Thursday for design platform Figma. Adobe failed to generate excitement on Wall Street. Its shares plunged 17% due to questions about the price tag.

Sherlund, a former software analyst who hit No. 1 on Institutional Investor’s all-star analyst list 17 times in a row, worked at Goldman Sachs during the 2000 tech bubble. He believes the Street is now in the beginning stages of a difficult market cycle.

“You need to get through third quarter earnings reports to feel confident that maybe the bad news is largely out into the market because companies will be reporting lengthening of sales cycles,” he said. “We need to reset expectations for 2023.”

Sherlund and his team are very active in the M&A market.

“You have private equity with a boatload of cash, and they need functioning debt markets for leverage to do deals,” Sherlund noted. “They’re very eager and actively looking at this sector… It suggests that [for] M&A, in absence of an IPO market, we’re just going to see a lot more consolidation coming in the sector.”

He notes the IPO has been hurt in connection with rising interest rate headwinds and inflation.

“[The IPO market] is not open. But when the window does open back up, you are going to see a lot of companies going public,” he added.

The long-term prospects for software are extremely attractive, according to Sherlund.

“You’ve got to be very bullish on the long-term fundamentals of the sector,” Sherlund said. “Every company is becoming a digital enterprise.”

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