Cisco Systems’ recent $28 billion purchase of Splunk, a cybersecurity and data analytics firm, is poised to set off a surge in acquisitions of software vendors with dependable subscription revenue, according to industry experts and analysts. Splunk, which was transitioning from software licensing to subscription-based pricing, marked the third-largest software acquisition in history with its deal with Cisco.

Cisco’s CEO, Chuck Robbins, emphasized that Splunk’s annual recurring revenue of $4 billion from subscriptions was a significant motivator behind the acquisition. This development highlights the potential for other tech giants like Microsoft, Adobe, and Oracle to pursue similar deals with subscription-focused peers like Elastic NV, Datadog, Crowdstrike Holdings, and Dynatrace. As corporate customers look to reduce spending, these tech conglomerates may target such acquisitions.

The software merger and acquisition landscape has faced a slowdown in activity, with a 61% drop to $231.5 billion in the technology sector during the first eight months of 2023, as reported by LSEG data. Private equity firms have dominated this sector, with companies like Splunk competitor New Relic being sold to private equity firms Francisco Partners and TPG Inc for $6.5 billion in July.

David Chen, co-head of global technology investment banking at Morgan Stanley, anticipates a resurgence in tech company acquisitions, driven by a Nasdaq 100 index rally and reduced concerns about an impending economic recession. He believes that improved confidence in their own businesses will embolden technology firms to follow Cisco’s lead in making substantial acquisitions.

Jefferies analysts noted that the Federal Reserve’s decision to halt interest rate hikes has provided acquirers with greater certainty regarding their funding costs, thus facilitating dealmaking. Even before Cisco’s acquisition, there were indications that tech giants were eyeing software company acquisitions in 2023, albeit on a smaller scale. For example, IBM agreed in June to acquire technology spend-management platform Apptio for $4.6 billion.

Splunk’s stock performance made it an attractive takeover target, having risen 39% in 2023 before the acquisition announcement but still down 44% from its October 2020 peak, when the COVID-19 pandemic led to increased IT spending due to remote work. Many of Splunk’s peers exhibited similar stock performance.

Software stocks are currently trading at historically low valuations, making them enticing targets for acquisition. On average, software stocks are trading at 5.8 times projected 12-month revenue, which is 28% below their eight-year historical average, excluding the temporary valuation boost caused by COVID-19, according to Jefferies analysts.

Jefferies also noted that Cisco’s deal valued Splunk at seven times projected 12-month revenue, a price considered reasonable by analysts. Additionally, private software companies may be more receptive to takeovers, as some companies that raised funds at high valuations in 2021 prefer to be sold rather than seek additional investment at lower valuations from their existing investors.