Salesforce buying Slack would mark the first big software deal in a boom year for the cloud

• Software acquirers have been quiet this year because the market rally in the cloud sector has made deals too pricey.
• Should Salesforce buy Slack it would be by far the largest software acquisition in the U.S. in 2020 and one of the biggest ever for the industry.
• Slack had a strong first half but the stock has sold off in recent months amid heightened competition from Microsoft.

The tech industry has seen some hefty deals announced during the 2020 pandemic, including several in the tens of billions of dollars. But not in software.

That could change soon. Salesforce, which has been one of tech's biggest acquirers in recent years, has been in talks to buy Slack, CNBC and other media outlets reported on Wednesday. Slack shares surged almost 38% after the initial report, lifting its market cap to $23 billion.

It would be one of the biggest software acquisitions ever, and potentially the largest since IBM bought Red Hat for $34 billion, a purchase announced in 2018.

The dearth of big software deals this year reflects the outsized growth much of the industry has experienced during the past eight months of pandemic-induced remote work. Once niche products and applications have become more popular and seen surging demand, leading to inflated stock prices on the public market and increased investment from venture firms on the private side.

Zoom and Shopify are each now worth over $125 billion, Twilio is valued at $50 billion and Snowflake has a market cap of close to $90 billion, less than three months after going public.

By contrast, the semiconductor industry has consolidated, with the top players capturing the bulk of the growth in cloud and mobile devices. That's enabled Nvidia and AMD to open their wallets, announcing two of the three biggest acquisitions ever in the chip industry.

AMD agreed to buy Xilinx for $35 billion in September, after Nvidia said the prior month that it was buying Arm from SoftBank in a deal worth $40 billion. Both deals still have to clear regulatory hurdles. 

Like other software companies, Slack has benefited from the work-from-home boom. However, the competitive environment has simultaneously become much more intense, particularly from Microsoft Teams, leading to investor concern about Slack's growth prospects and margins.

Microsoft includes Teams with subscriptions to the Office 365 suite and has heavily promoted the chat and video service this year. CEO Satya Nadella said last month that Teams now has over 115 million daily active users, up from 75 million in April.

"With Salesforce's distribution and selling capabilities, Slack would instantly be propelled into C-level executive discussions across industries," RBC analyst Alex Zukin, who has the equivalent of a buy rating on Salesforce and Slack, wrote in a note on Wednesday.

A Salesforce spokesperson declined to comment and and Slack representatives didn't respond to requests for comment.

Microsoft's growth has pressured Slack shares in recent months. Prior to Wednesday's pop, Slack's stock was down 14% from its peak in June, while the S&P 500 was up 17% over the same stretch. According to Bessemer Venture Partners' Nasdaq Emerging Cloud Index of 54 cloud software stocks, Slack has an enterprise value to forward revenue ratio of 20.5, a lower multiple than 14 others in the index and less than 5 points higher than the average.

"An acquisition by Salesforce would give Slack greater opportunity to compete against Microsoft Teams for wall-to-wall enterprise deployments," Zukin wrote.

Based on Slack's current market cap, it would be Salesforce's largest acquisition, exceeding last year's $14.8 billion deal to buy data visualization software company Tableau.

That deal also had a Microsoft angle, because Tableau competes with Microsoft's Power BI. Salesforce and Microsoft have become significant rivals across much of the enterprise software landscape in recent years, from sales and analytics tools to collaboration. Salesforce tried to buy LinkedIn and wound up in a bidding war against Microsoft, which ended up paying $27 billion for the business networking site in 2016.

Don't expect the Salesforce-Slack chatter to necessarily kick off a wave of mergers and acquisitions. Public investors still have an appetite for high-growth software companies, which have filled the IPO pipeline with cloud-based developers that are poised to capture high multiples when they hit the market.

Asana, Palantir Snowflake and Unity all went public in September. Bankers and investors told CNBC that at least a dozen software companies could raise $1 billion or more in offerings next year, though some may choose to go public through direct listings.

WATCH: Salesforce acquiring Slack would be a 'no brainer'

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