Opinion: Jamie Hope

Cloud based services remain front and centre in the TMT space. In a previous post I predicted a flurry of private equity activity in datacentres, which may be the less exciting part of the cloud, however, it is still essential.

Not a week seems to go by at the moment without hearing about another private equity deal in the space - Synova, Bridgepoint Development Capital, ISIS, RJD have all made investments and I am aware of a number of other private equity houses that are trying to close out deals before Christmas.

There are a number of attractive drivers to the market – high growth, demand still massively outstripping supply and recurring contracted revenue which make it a very interesting investment proposition. The sector is still in its infancy and whilst all of these investments will be portrayed as sophisticated managed services offerings, some of these businesses will be more at the ‘storage’ end of the sector, no doubt looking to bolster their services to increase the ‘stickiness’ of their customer base.

It is going to be an exciting time seeing how the sector moves forward - I for one can see no let up in M&A activity. Given the demand drivers there will be a few more platform deals here and I am sure there will be bolt on acquisitions. Rather than develop in house, companies go hunting for other outsourced services they can provide to their customer base.

Excuse the pun but watch this (rack)space!

There is no doubt, talking to our many contacts in the education and information services sector, that times are tough right now if you run a company supplying into the UK education industry.

It is with interest therefore that I note this week the appointment of Martyn Ratcliffe as the new chair of sector powerhouse RM plc.

Ratcliffe is known for his attention to detail and relentless focus on cost control. Whilst there is no doubt that RM has been tremendously successful over recent years with its strategy, right now given the carnage that is the UK public sector, Ratcliffe may prove to be a very shrewd appointment.

2011 is not going to prove a very pretty year for shareholders, and 2012 does not bode well either for many.

However prospects will take a turn upwards at some point. When they do a streamlined, well capitalised RM may well prove to be a winner in the M&A battles that follow, thanks to steps kicked off with this appointment.

As part of some work I am doing on the ‘cloud’ phenomenon, 'boring old' data centres have caught my eye once again.

I must admit, I'd thought that this was an area of the ITSS market that had gone away for good, at least in M&A terms. However now I've had a chance to consider it in relation to cloud technologies, I must admit I got it wrong. I now think that it is an area where I can see a flurry of M&A this year and beyond.

Key reasons for this include the fact that:

• This sector is really benefiting from the trend towards outsourcing by large corporates. In particular the SME market looks set to continue to grow – most recent industry commentators that i've read suggest the sector will continue to experience double digit growth for some time to come
• Corporates are not looking to invest in the high fixed costs associated with upgrading old data centres or building new ones of their own
• SMEs once upon a time were nervous about using data centres because of their perceived weaknesses in security. I'm not sure that this is any longer the case
• SMEs now have a thirst for capacity which they cannot cope with – adopting cloud services will only fuel this need

Given these factors, there are recent signs in the market that operators have started to gather, eager to seize the opportunity presented above. Telecity is one of these players, and whilst traditionally focused on Pan European growth and large corporates, has recently bought IFL, a data centre in Manchester, presumably the first of many such acquisitions. In terms of private equity interest, Bridgepoint Development Capital have backed Lumison as part of a UK IT Services buy and build focus on the SME market and I'm aware from my contacts that there other PE houses looking at the market actively.

So do data centres remain boring? I'll leave the conclusion with you, however in pure M&A terms, I can see the M&A land grab continuing over the next 12-18 months, starting with a focus on those providing services to the SME market.

Following on from the interesting opinions by my colleague Sun Jen (Click here to read), I'm struck by the number of recent retail launches there have been on mobile devices here in the UK in recent months.

Tesco, Mark & Spencer, John Lewis - all have launched mobile applications this year, and when you see these retail giants developing serious applications for the mobile device you realise quite how far mobile has come as an environment.

For years, people have predicted that this is the 'Year of the Mobile'. Finally, it would appear that this has come true.

With it of course there are a number of smaller, more agile developers and applications being built, and I've noticed an increase in business plans and ideas coming into Catalyst in recent months in particular. Mobile isn't going to go away, and with the likes of Monitise having already shown that money can be made by british entrepreneurs, I look at this sector as a real opportunity for what the chancellor is seeking to create, an entrepreneur-led recovery.

Looking at a number of recent buyouts such as Pets at Home and ICS along with other deals that I know are not far from completion, there are some full prices being paid in the private equity world at present. This is further reinforced from speaking to a number of private equity houses, as they are bemoaning aggressive auction processes being run by certain corporate financiers and the prices these assets are attracting (granted their view may be slightly different if it was one of their assets being sold!).

Does this mean that the recession has ended, liquidity is no longer a problem and the aggressive auctions that were a feature of 2007 (which I have never been a fan of) have returned? The short answer is no, so the question is why is this happening? There are a couple of reasons why these assets are attracting such high prices:

• There are too many private equity houses chasing too few deals
• Of the deals that are around, there is a scarcity of real high quality assets
• Given the scarcity of assets, larger private equity houses are looking at mid market private equity portfolios to identify assets that could provide a platform for a roll up strategy in a particular sector
• For the right businesses banks are now prepared to lend more which ultimately inflates the price
• Some private equity houses have not done a deal for 2 to 3 years and are desperate to get money out of the door
• Private equity houses are prepared to pay a higher price for a ‘safe asset’ at the expense of potentially generating the returns their investors demand

As one private equity house joked to me they plan on selling all their portfolio to other private equity houses given the prices they could attract for their performing assets. Whilst this was tongue in cheek, it does highlight the point - ultimately this bubble will burst as supply and demand level out, however, when this will be is hard to call.

Given the economic background it is still true to say that on the whole it is a buyers market. Businesses with healthy balance sheets will be able to prey on the struggling assets, however for a real high quality asset it still remains a sellers market.

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.