Opinion: Jamie Hope

I don’t need to cover old ground and bleat on about how tough 2009 was across all sectors, I thought I would drop some positive comments on how the first quarter of 2010 has played out for technology M&A.

Whilst there have been no mega deals in the first quarter, US deals have tended to take most of the headlines – such as the AVNET/Bell Microproducts deal. However, what has really grabbed my attention is what has been happening here in the UK. There has been a significant uplift in M&A activity compared to this period last year (which I appreciate wouldn't be hard!), and I have noticed some interesting trends amongst trade acquirers, namely:

• Buy and build in fragmented markets. There are a number of businesses which are having great success in their buy and build strategy. In the Healthcare IT space, ACS has made a number of acquisitions in 2009 and has continued this into 2010 with the potential transformational acquisition of COA Solutions for £100m. In the telecoms space Daisy Telecom continues from where it left off in 2009, as it hoovers up smaller telco providers, such as Managed Communications, and bolts them into its successful acquisition model.

• Strategic acquisitions. It is becoming increasingly evident that trade players are seeing now as a good time to supplement organic growth with some exciting acquisitions. One of the best examples of this is Capita’s recent purchase of Ramesys. Back in 2009 Capita bought Carillion IT Services and then Synetrix, both which span education and BSF contracts, the addition of Ramesys will massively enhance their offering in this arena. I am sure RM will be looking nervously over its shoulder.

• Stressed assets. Aside from strategic acquisitions, trade acquirers are also buying stressed assets. Last year, as you would you expect in a recession, there were a lot of distressed sales as companies ended up in administration, and acquirers had rich pickings. Now what you are beginning to see is the stressed type of asset, for example a business may be constrained by its existing funding structure and seeing revenue tail off, ultimately it could end up in a distressed situation. A great example of this in the IT Services arena is 2e2’s recent acquisition of Morse. Morse had been struggling for some time and subject to almost constant bid speculation. Any acquisition has risk attached to it, however, this is even more prevalent when buying a stressed asset. It is not until you own the asset that you will really know how ‘stressed’ it is as a business. 2e2 obviously see a great opportunity in Morse, I will wait and see if they can deliver.

Reflecting back on the last quarter and what lies ahead I actually see a mood of optimism and opportunity returning from trade players. Hopefully the outcome of the election will not dampen this mood!

The current topic of conversation with my software and services contacts supplying into the public sector is what is going to happen post election? Whilst I have not got a crystal ball, irrespective of your political allegiance the one certainty is that there will be significant cuts in spending and this will inevitably impact suppliers in some shape or form.

There are a lot of doom and gloom merchants around, however, from my perspective I see plenty of opportunity for M&A activity in the coming months. Historically market growth in public sector IT has been very attractive, this will undoubtedly slow down. Companies will no longer have the luxury of strong organic growth to fall back on, however, shareholders in both public and private businesses will still want to see a continued growth profile. Companies may just switch focus to the private sector, however, I believe a number of companies will go on the acquisition trail to achieve their growth aspirations, with ACS's acquisition of COA Solutions as evidence for this.

The question will be, who should they acquire? Whilst overall growth in the public sector IT market will fall, I am a strong believer that to achieve the desired spending cuts the government will continue a drive towards outsourcing, which will benefit the large outsourcers such as Capita and Serco. I have also met a number of small to medium size businesses having great success in providing outsourced services into education, health and criminal justice and I know these will increasingly become more and more attractive as acquisition targets, just look at Capita’s acquisition of Synetrix as a case in point.

For those that aren't familiar with the Catalist framework, then it gives those who quality for inclusion access to circa £6 billion of public sector IT spend in the UK. Not making it onto the list is therefore potentially catastrophic since it excludes suppliers from a major part of public sector IT spend for at least 3 years from now.

The existing framework covers 29 suppliers across 10 lots and is due to expire in February 2010. The new framework has been consolidated from ten into three lots - desktop hardware, IT infrastructure hardware and channel partners for software and it is expected that the number of suppliers will be significantly reduced.

The first round in the tender process has been completed and only 45 suppliers have made it through (compared to 170 last time round), with some high profile casualties such as existing supplier DSGi Business. There are also some rumours from my contacts in the trade that there are other high profile multi-nationals not making it through either.

The tender should now be well into the second phase, however, there has been a backlash against the first round process with a number of companies successfully appealing against the way parts of the tender have been written. These particular questions have now been excluded and there appears to currently be a hiatus in the process.

This leads me to my main point - if it is true that some large corporates have failed at the first hurdle, will they be allowed back into the race at a later stage? If not, what does that mean for M&A in the UK, since I cannot believe that the shareholders of the larger companies will be too pleased at being excluded for 3 years. IT is in the balance - literally!

I caught up with a client earlier this week and we discussed the changing dynamics of the building products sector, in particular the role of the distributors.

Until recently the distributors have badged themselves as offering a wide range of product which is immediately available. However, given the downturn in trading volumes and re-trenchment of the credit insurers they are now pushing stock holding back up the supply chain, as they do not have the cash resources to maintain high levels of stock. This obviously reduces the ability to offer immediately available product and the distributors differentiator becomes the range of product they can offer.

Inevitably, the already slim margins of distributors will further reduce as there will be a cost associated with pushing stock back up the supply chain. The sustainability of the business model will come into question for some of the smaller players. As a consequence we may well see a rise in M&A activity as these smaller players are acquired by either larger distributors or picked off by other parts of the supply chain.

Whilst my discussion was focused on the building products supply chain, it is relevant to any sector where there is a significant stock holding requirement such as the IT Hardware sector.

You may have seen that Capita have recently announced their H1 2009 results. It was not the financial performance that caught my eye, it was the acquisition of Carillion’s in house IT department for £36m. The division is not a stand alone entity, however, the opportunity for Carillion to realise some cash and for Capita to bring their outsourcing expertise to the table made for a successful conclusion to the deal.

This transaction is not the first of its kind, you can go back a number of years to businesses such as ITNET, the IT department spun out of Cadburys. However, given the current economic climate you can see that this type of deal will appeal to larger organisations looking to de-leverage their own balance sheets. These types of functions will be very attractive to the likes of Capita and you may even see the incumbent management teams being given the opportunity to buy the function out of the larger corporate and run it for themselves.