Of the top 50 IT services which ComputerWire has ranked by revenue, only one was bought out in 2005 – SunGard was purchased by private equity firms – and just two more were acquired last year – LogicaCMG bought WM-Data, and Belgacom bought Telindus.
There have been signs that 2006 could be a landmark M&A year, with private equity firms calling the shots. While there have yet to be acquisitions of any of the top 50 players completed this year, there are a number of buyouts in the pipeline now.
The acquisition of South Africa’s Business Connexion by incumbent operator Telkom is still rumbling on, as the deal is yet to be given the go-ahead by the regulators, and Keane is going private through an $854m purchase by Caritor which is expected to be completed in the second quarter.
Other major IT services companies have signalled the possibility of a takeover, the largest of which is Affiliated Computer Services. Its founder and chairman, Darwin Deason, has teamed up with private equity firm Cerberus Capital Management to table a $6bn cash offer, which may be pushed higher in coming weeks.
Troubled infrastructure services vendor Getronics has been linked to local rival Ordina, though its boss denied this and most market commentators believe that it is more likely to be taken out by a telecoms operator looking to extend into IT services. Telefonica was the rumor in December, and now it’s KPN, with the Dutch press claiming the two sides have held talks. If that deal fails, private equity looks likely to be its only option.
Atos Origin is also on the brink of capitulating to the financial might of private equity — the Paris-based company has recruited Rothschild and Goldman Sachs to assess the expressions of interests from parties it did not name, but who are widely believed to be buyout specialist Permira and hedge fund Centaurus Capital.
Private equity firms have cash to spend, and the outsourcing business is one which offers recurring, predictable cash flow and IT services stocks are seen by some to be trading at a discount. This discount is in part generated by the short term nature of the equity markets which is at odds with the industry’s long term contracts — vendors have to stake a lot of upfront investment for returns years later.
This misalignment of objectives can be seen clearly in the case of HR outsourcing vendor Hewitt Associates, which – under pressure from Wall Street after it revealed poor execution at its long term HR BPO business – switched emphasis to its more mature benefits outsourcing and consultancy units.
The entry of private equity cash into the IT services market is having a dramatic effect. Any company looking to restructure is not thought of as a target for its rivals to pick-off, but as an opportunity for financial wizards looking to strip it down in private.
For some public companies the lure of privacy is enticing, especially in the current climate of increased financial regulations such as Sarbanes-Oxley and the inexplicably delayed halt on stock option fraud. The range of companies rumoured to be targets covers almost the entire market, with only the very biggest hitters exempt from speculative whispers. IBM, Accenture, Fujitsu, EDS, BT and HP are all unlikely to be taken out, but anything smaller is in range.
Computer Sciences Corp for example, the world’s seventh largest IT services firm, was in talks last year with private equity firms who were teaming up with Lockheed Martin. The deal stalled not on price, but on the structure, and afterwards CSC decided upon a $2bn share buyback, cancelling any further uncertainty. The buyback hasn’t stopped its share price from underperforming the market though, and it may reconsider its stance if it is otherwise unable to offer better shareholder rewards.
Unisys is another major player which has seen happier times. Private equity firms may see an opportunity to create value through splitting its hardware unit from its services business. It has been carrying the two distinct businesses for years, with little in the way of synergies between them to justify the split of management focus required to run them. It has been in restructuring mode for some time now though, so private equity firms may deem that too much of the cost cutting has already been done.
HP has said they are going to focus on niche buys rather than major purchases, and BT has said that it won’t make a big move this year. Capgemini will be busy digesting Kanbay, and other major western players such as T-Systems have enough problems of their own to deal with. It will be interesting to see if the Indian players will purchase.
Their stock price valuations means they have the power, but they may not have the inclination. It would be difficult to justify a purchase of a Western-based company, which would in all likelihood dilute margins, and they are growing at such a rapid rate that they do not need to buy for scale, so why gamble? Instead they are likely to look inward for the moment and shop domestically for those companies that have managed to build key skills and personnel in their target verticals.
