Updata Advisors IT Services Mergers &
Acquisitions News
In this issue:
Overview: “Rationality” While 2007 was a strong year for M&A activity in the IT Services sectors covered by Updata, it was also a year of marked contrasts… read more>>
2008 Outlook While we expect to see the tempering impact of slow economic growth in 2008 across several Services subsectors, we also predict that M&A activity will remain reasonably strong… read more>>
2007 In Review
Repeat Services Acquirers: Certain Services companies have been extremely active buyers in recent years… read more>>
Deal Size Rose and the Roster of Publicly-Traded Firms Shrank: 2007 was notable for an above-average number of large Services M&A transactions... read more>>
Premiums Paid in Certain Sectors: The deals presented in Figure 7 commanded much higher multiples than we traditionally associate with Services M&A averages… read more>>
Valuation Differentials by Subsector: Using median metrics across a wide range of 2007 Services M&A transactions, Digital Marketing Services firms were at the top of the list of high… read more>>
Conclusion As we enter 2008, our sense is that we have the makings of a good Services M&A year ahead of us… read more>>
Appendix: Updata IT Services Stock Performance Index by Sub-Sector Updata’s IT Services Publicly-Traded Stock Indices for seven sub-sectors vs. NASDAQ performance over 2007… read more>>
2007 In Review: “Rationality”
While 2007 was a strong year for M&A activity in the IT Services sectors covered by Updata, it was also a year of marked contrasts. As shown in Figure 1, Updata tracked a substantial increase in the aggregate number of Services deals announced in 2007 as well as a rise in median and average deal sizes over 2006 levels. We also noted a healthy up-tick in median EBITDA multiples year-over-year, even though revenue multiples remained largely constant.
Figure 1
Bullish sentiment and easy credit in the first half of the year drove an unusually high level of private equity M&A activity in a sector rarely commanding such attention. As a result, the total number of M&A transactions jumped 13% year-over-year, in tandem with a 70.9% rise in the average deal value to $264 million, propelled to a notable extent by private equity involvement. Such private equity M&A interest in the IT Services space seems a dissipating memory -- to the great benefit of traditional strategic acquirers -- as macroeconomic constraints deepen.
Our analysis was substantiated by similar complementary metrics from the FactSet Mergerstat database. The worldwide announced value of M&A transactions in its “Computer Software and Services” sector increased 16% in 2007 – this despite the fact that deal flow slowed considerably in late-summer when credit markets began to contract.
Even though recent U.S. Bureau of Labor Statistics data suggest record high IT industry employment rates, bearish recessionary winds are blowing, impacting stock market valuations for the IT Services sector and the broader markets in early 2008. This was highlighted by the lackluster 3.5% S&P 500 return for the year, and a -0.2% drop in the Updata Services Composite Index in 2007 – in our view a leading indicator of forward economic prospects. These indexes closed the year off of their 2007 highs by 7.3% and 12.4% respectively, and are currently (as of February 13, 2008) 15.3% and 25.1% off their 52-week highs. While the tech-heavy NASDAQ Composite ended up as the best-performing major stock index for the year, its impressive 9.8% gain during 2007 seems uncertain at 20.5% below its 2007 high as of February 13, 2008.
Within the Services universe, specific subsectors performed very differently based on growth rates and profitability. While each IT Services sub-sector followed by Updata is reasonably healthy, profitable and growing, as evidenced in Figure 3, the equity markets are discriminating sharply based on the subsectors’ perceived value propositions and opportunities. Notable equity market outperformers in 2007 included Government and Offshore Outsourcing vendors, whose Updata Indexes rose 16.6% and 10.6% respectively, based on spending trends, revenue visibility, and profit models. This was followed by the Updata Consulting Index, which rose 5.6% for the year. But even these strong-performing subsectors were susceptible to the broader market correction, with every subsector meaningfully off of its 52-week high.
While we expect to see the tempering impact of slow economic growth in 2008 across several Services subsectors, we also predict that M&A activity will remain reasonably strong based on meaningful drivers of market consolidation. Some of these themes are described below.
We continue to receive strong buyer demand for acquisition candidates offering aggregations of talent in particular technology or vertical areas. SAP services firms are most prominent in this group for consistent response, but we also have noted fairly high buyer interest in companies delivering enterprise-class services around Oracle and Microsoft application suites. Some of the deals reflecting this trend in 2007 were:
CIBER*/Metamor Enterprise Solutions, a division of Headstrong Corp
NTT Data/itelligence AG
Visionary Integration Professionals/MyITgroup
Zensar/ThoughtDigital
* Updata Advisors’ client in this transaction
Select verticals will also experience robust Services M&A demand, including businesses focused on IT and related outsourcing for life sciences, healthcare, data center infrastructure, government, and to a lesser extent financial services and transaction processing. Specialized domain knowledge in these spaces related to technology and business processes drives M&A activity and valuations, including deals such as:
We have been impressed by the huge strides that the traditional technology “product” vendors have been making in building out large, compelling and competitive IT Services offerings, often through M&A activities which are still young, if sizeable. These product companies are pushing toward material business model transformations through the addition of solutions to their corporate offerings and mindsets. Seeking to deliver holistic IT offerings to their clients, encompassing upfront consulting, product sales, and sophisticated integration services, they are scouring the landscape for targets which elevate their customer value propositions and relationships. HP, EMC and Dell were among the most prominent buyers of services companies in 2007 and remain in the hunt in 2008, although even hyper-growth virtualization software vendor VMware bought consulting talent recently. Examples of these deals include:
Lastly, we expect to see ongoing, exciting consolidation in the Digital Marketing Services space in 2008. This is a sector where true talent is in short supply and firms which have aggregated it are instantly compelling. It is also a sector enjoying increasing online advertising spending, to the detriment of traditional marketing media such as print, television and radio. Consultancies in this sector often weave together technology, branding, and corporate strategy expertise toward marketing solutions which are cutting-edge, sophisticated, and designed to drive the right traffic through a compelling experience leading to a desired action. Interestingly, these firms are often surprisingly regional in their scope, spurring geographic consolidation as well. A few such deals in 2007 included:
Microsoft/aQuantive
WPP/Blast Radius, Quasar Media, Schematic and Refinery
Certain Services companies have been extremely active buyers in recent years. The 10 buyers in Figure 4 have accounted for 105 Services M&A transactions since the beginning of 2005. These acquirers represent a cross-section of subsectors tracked by Updata – Outsourcing (ACS), Consulting (Accenture), Systems Integration (Perficient) and Government (CACI) – with the notable exception of Offshore Outsourcers. Wipro led the Offshore Outsourcers, but failed to make the top 10 most active Services buyers, having announced 7 services M&A transactions since 2005. But Wipro’s relatively large acquisition of publicly-traded Infocrossing, coupled with rumors circulating about its management’s desires to do a very large deal, indicate to us that we may see more pronounced M&A activity emanating from Wipro and from India in 2008.
Figure 4
Most Active Buyers of IT Services Companies Since 2005
Deal Size Rose and the Roster of Publicly-Traded Firms Shrank
2007 was notable for an above-average number of large Services M&A transactions. The aggregate Enterprise Value of the 10 largest deals in 2007, highlighted in Figure 5, totaled $28.5 Billion, virtually double the $14.7 billion Enterprise Value of the 10 largest deals in 2006. Among the largest deals in 2007 were a significant number of private equity transactions, including CDW, Ceridian, and Northgate Information Solutions plc; each of which was taken private. Microsoft’s acquisition of digital marketing services firm aQuantive, for a staggering 11.6x revenue, was by far the largest strategic deal in the Services sector.
Figure 5
In a related trend, the ranks of publicly-traded Services companies tracked by Updata thinned meaningfully again in 2007. 18 public firms were acquired during the year and no longer trade independently on a stock market. Given the dearth of Services IPO’s in recent years, the overall Services sector and related market metrics continue to consolidate into a smaller number of larger firms. Deals which took public companies private in 2007 included:
Figure 6
Premiums Paid in Certain Sectors
The deals presented in Figure 7 commanded much higher multiples than we traditionally associate with Services M&A averages. Leading this premium pack are Digital Marketing Services firms which are enjoying an M&A boom with multiples reminiscent of the dot.com era. BPO firms and high-end Consulting organizations are also selectively commanding strong activity and premiums, often driven by deep expertise in a particular vertical industry and/or business process. The top deals by revenue multiple in 2007 were:
Figure 7
Valuation Differentials by Subsector
Using median metrics across a wide range of 2007 Services M&A transactions, Digital Marketing Services firms were at the top of the list of high revenue M&A multiples. This is a direct function of the rapid growth in online ad spending and the increasing demand for expensive and valuable expertise in this area. The IT Outsourcers also broke through the 2x median revenue multiple, but several sectors stepped back. Among the most interesting sectors were those involving the acquisition of an Offshore Outsourcing target. In 2006, several large offshore deals, including Capgemini’s acquisition of Kanbay and EDS’s acquisition Mphasis, drove multiples well over 3x revenue. However, in 2007, other than CSC’s acquisition of Covansys at 2.6x revenue, most Offshore Outsourcing transactions were significantly smaller and more tactical, and closed at lower multiples. Figure 8 highlights M&A valuation trends year-over-year by Services subsector.
As we enter 2008, our sense is that we have the makings of a good Services M&A year ahead of us. Yes, macroeconomic cautionary flags are flying. But closer to the ground, we see no waning of M&A interest from long-term strategic buyers with whom we speak on a regular basis. Nor do we see any notable downward shift in the financial and operating performance of our clients and prospects, particularly those with differentiated, value-added customer service offerings and honed execution practices. Could the mix of strategic buyers shift somewhat in 2008 to incorporate more Offshore and IT Outsourcing transactions than we saw in 2007? Yes, it could. Will the Digital Marketing Services firms and Government IT Services contractors continue to consolidate? Definitely. Will the large and even mid-tier technology vendors seek Services targets to escalate their customer value propositions? Absolutely. Might we see a slight up-tick in consolidation among the IT Staffing firms, which have languished as M&A candidates but whose business models have remained resilient? Possibly. Will high-end, vertically-aligned Services firms remain attractive acquisition prospects? Yes. Will 2008 be different from 2007? Very much so. We believe that a firm dose of rationality and discipline will underscore M&A activity across all Services subsectors. Some of the healthiest years for Services M&A in our experience are those where strategic fit trumps market hype and financial balance leads to valuation equilibrium. These are some of the key attributes we expect to see in the coming year.
Updata Advisors, Inc. Disclaimer
The information and opinions in this report were prepared by Updata
Advisors, Inc. ("Updata"). The information herein is believed by Updata to be reliable and has been obtained from and based upon public sources believed to be reliable, but Updata makes no representation as to the accuracy or completeness of such information. Updata may provide, may have provided or may seek to provide M&A advisory services to one or more companies mentioned herein. In addition, employees of Updata may have purchased or may purchase securities in one or more companies mentioned in this report. Opinions, estimates and analyses in this report constitute the current judgment of the author as of the date of this report. They do not necessarily reflect the opinions of Updata and are subject to change without notice. Updata has no obligation to update, modify or amend this report or to otherwise notify a reader thereof in the event that any matter stated herein, or any opinion, estimate, forecast or analysis set forth herein, changes or subsequently becomes inaccurate. This report is provided for informational purposes only. It is not to be construed as an offer to buy or sell or a solicitation of an offer to buy or sell any financial instruments or to participate in any particular trading strategy in any jurisdiction.
Data cited herein is sourced from Updata’s database and derived from publicly available sources – additional information is available on request.
2007 In Review: “Rationality”
