M&A Activity in the Business Services Sector It has been a very interesting year for Business Services M&A thus far in 2009. Although corporate IT spending has dropped in tandem with recessionary macroeconomic trends, multi-billion dollar M&A transactions have been prominent, especially in the latter half of this year. While aggregate M&A enterprise value and average M&A multiples dipped to their lowest levels in years, the largest M&A deals featured revenue multiples higher than many pre-recession transactions. Services equity prices have also gained since the beginning of the year, with Updata's Services Index up over 40% since January 1 (see Figure 1 below). As of October 31, this index had outperformed every Updata technology sub-sector, except Internet and Financial Technology.
Figure 1: Updata Sector Indices vs NASDAQ, YTD October 31, 2009
In addition to an intriguing mix of M&A deals, promising signs suggest that the Business Services market may be entering an expansionary phase. Discrete, but powerful, examples include Accenture's announcement that it plans to add 8,000 positions in India 2 and 45,000 people worldwide as business conditions improve. Tata also announced plans for expansion in other parts of the world to develop a full suite of services and to generate "nonlinear" growth.3 Infosys Technologies said it will nearly double its workforce in the U.S. with the addition of 1,000 employees and that it remains on the lookout for acquisitions in Germany, France and Japan.4 With these announcements, we expect a healthy uptick in Services M&A from strategic combinations and growth-hungry companies in 2010.
Recent M&A Trends Updata expects that a number of trends in the sector will change the face of M&A over the next several years.
Services Universe Is Consolidating. While the sector has seen a slowdown in deal activity over the past two years due mainly to the recession, the universe of public companies has also shrunk notably through acquisitions and going-private transactions. Since January 2007, 19 public Services companies tracked by Updata have been acquired or taken private. The largest publicly-traded companies have become quite large, often through acquisitions, and the M&A target-size thresholds for these firms have risen correspondingly. This makes it more challenging for small and mid-sized companies to attract attention of large acquirers and further mandates that mid-tier, independent Services players offer very differentiated expertise and delivery to avoid the perception of commoditization and corresponding market valuations. These factors, along with the recession, have contributed to substantial decreases in year-to-date deal volume (29%) and announced enterprise value (47%) compared to the same period in 2008, and even larger decreases since the sector's recent peak in 2007 (see Figure 2 below).
Figure 2: Business Services Deal Metrics, 2005-2009
Multi-Billion Dollar Deals Boast High Multiples. A handful of visible, multi-billion dollar transactions have spurred great interest in the Business Services space in recent months, somewhat masking that total deal volume and aggregate M&A enterprise value (EV) have slipped. In particular, during the first three quarters of 2009, three deals totaling $13.1 billion in EV captured wide market attention and generated considerable excitement. These were Xerox's acquisition of BPO services firm Affiliated Computer Services, Dell's purchase of BPO provider Perot, and Adecco's acquisition of staffing-centric MPS. One could argue that these three deals in 2009 compared favorably with the largest Services M&A deals of 2008 (see Figure 3 below), where aggregate EV totaled $21.3 billion, of which HP/EDS represented $13 billion alone.
It is also interesting to note the timing of the major deals of 2008 and 2009. In 2008, all four major deals were announced just prior to the impending recession. The major deals in 2009 have all been announced in the second half of the year, as market participants gained confidence that the economy is improving. There was a very notable 13-months gap between Detica's sale to BAE in July 2008 and the subsequent multi-billion dollar deal, Perot/Dell.
Figure 3: Transactions With Enterprise Value Over $1 Billion, 2008-2009
As Figure 3 highlights, other than Xerox/ACS, the largest Business Services deals of 2009 commanded EBITDA multiples greater than 12x -- something relatively rare in the Services sector, defying the downward pull of a still struggling economic environment. Granted, in the case of MPS, EBITDA had fallen rapidly as the company shrank in 2009, which helped drive up a higher than usual EBITDA multiple. Still, these multiples underscore the rarity of large, high-quality Services targets. They also highlight the business models of the target firms, which by and large, involve recurring revenue BPO and/or very predictable customer bases, including healthcare and government.
Exciting, large deal metrics mask the fact that median deal multiples for 2009 are at their lowest levels in years (see Figure 2), and by excluding the largest deals, one is left with a mere $3.5 billion of aggregate reported EV, fragmented across 200+ deals. Still, even some of the smaller deals in 2009 commanded above average multiples (see Figure 4 and Figure 5 below).
Figure 4: Highest EV/TTM Revenue Multiples, 2009
Figure 5: Highest EV/TTM EBITDA Multiples, 2009
Traditional Lines Are Blurring Between Product and Services Vendors. As we noted on the Updata blog back in September, traditional IT "product" vendors are acquiring Services targets in pursuit of domain expertise, more strategic and senior customer relationships, and opportunities to pull broader offerings through solutions sales strategies.5 One can see these attributes embodied in several recent, visible deals, among them Xerox/ACS and Dell/Perot, which marked two of the top 10 outsourcers to be acquired in the past 16 months. Other high-end Services companies which could prove to be interesting acquisition targets in this model include companies such as Unisys, CGI and Convergys (see Figure 6 below).
Figure 6: Potential Business Services Acquisition Targets
Prolific Acquirers Are Being Acquired. Business Services consolidation is yielding a smaller universe of large players, and a handful of historically active acquirers have been purchased this year. Specifically, both ACS and Perot, which were both acquired in September, had previously completed 16 and 10 acquisitions since 2005, respectively (see Figure 7 below). Axon Group, which made four acquisitions in 2008 alone, was acquired by HCL in September 2008, although HCL has continued adding to Axon, buying UCS Group's Enterprise Solutions SAP Practice in July. The major impact we see in our business from this trend is that M&A target-size thresholds are steeply higher for the big buyers. This has dual effects: on the one hand, it lessens competition for mid-tier acquirers and enables new M&A market entrants to pursue peers and consolidate smaller targets. However, it also reduces aggregate demand for small and mid-sized targets from the most proficient and cash-rich large acquirers, meaning that small and mid-sized deals are more complex to complete.
Figure 7: Business Services Most Active Buyers, 2005-2009
Sub-Sector Analysis Updata segments the Business Services market into a number of sub-sectors whose basic M&A metrics we highlight below.
Figure 8: Services Sub-Sector Metrics, 2008-2009
Outsourcing: Outsourcing has been a particularly active M&A sub-sector over the past two years. In addition to the mega-deals for Perot and ACS, one of the more interesting M&A sagas involved the various transactions and partnerings for eTelecare and Stream Global, which were each bought, sold, and ultimately merged with each other in less than 24 months. eTelecare went public in March 2007, while HIG-backed Stream was taken public through a SPAC ("Global BPO Services") seven months later in October 2007. eTelecare Global Solutions was taken private by Ayala Corporation and Providence Equity Partners a mere 18 months after its IPO in September 2008 for $290 million. Then in August 2009, Stream initiated a merger with eTelecare in a stock-for-stock transaction. Today the combined companies generate approximately $288 million and trade under the Stream name (SGS).
Offshore Outsourcing: The largest Offshore deal of 2009 was Tech Mahindra's acquisition of Satyam Computer Services for $1.1 billion in April. Satyam's collapse, as a result of financial fraud, stirred up a number of bidders looking to acquire its still-valuable customer relationships, people and assets, with Tech Mahindra outbidding many other prestigious firms. In addition to this transaction, several "captive" offshore Services units of global operating companies were sold to pure Services players, such as EXL's acquisition of Czech-based Schneider Logistics' BPO unit and the acquisition of AIG Systems Solutions in India by MphasiS. Nonetheless, there have been relatively few deals in this sub-sector since the beginning of the year, mostly due to the selectivity of India-based buyers coupled with the offshore scale already achieved by most global outsourcers and systems integrators. Interesting markets where we do see M&A potential include China (BNI Systems/NTT Data, Taihoo Technologies/Exigen Services, Krugle/Aragon Consulting), Brazil and countries formerly part of the Soviet Union. As we noted earlier, Accenture, Tata and Infosys have plans to expand their business offerings next year, so we may see more activity, specifically spurred by these two companies, in 2010.
Consulting: The Consulting sub-sector has had the most M&A activity since the beginning of the year (54 deals). Many of these acquisitions have involved high-end, strategic businesses, whose domain expertise and differentiation have driven revenue multiples for this sub-sector upward. One of the largest Consulting deals of 2009 was Computershare's $135 million acquisition of Kurtzman Carson Consultants, a claims and noticing agent serving companies undergoing Chapter 11. Others include LEGC Corp.'s acquisition of SMART Business Advisory & Consulting for an EV of $72.3 million, the acquisition of Katzenbach Partners by Booz & Co., and the combination of Towers, Perrin, Forster & Crosby and Watson Wyatt Worldwide.
Systems Integration. Arguably the most visible deals in 2009 were acquisitions of dissected assets out of BearingPoint by a number of global SI's. Most prominent among them were PWC's purchase of BearingPoint's commercial Services division (revenue $618 million; EV $44 million), and CSC's purchase of BearingPoint's Brazilian operations (EV not disclosed). These BearingPoint deals, coupled with a relative paucity of transactions with disclosed metrics, pulled down mean and median multiples for the sub-sector in 2009 (see Figure 8). Among closed deals, SAP continued to be a dominant technology theme, with 10 of 37 deals involving SAP-centric firms, followed by four Oracle- and four Microsoft-focused transactions.
Government Services: There has been a relative decline in Government M&A activity in 2009 as prior years' consolidation by large contractors has left fewer mid-tier targets. Some of the more notable deals of 2009 have included three BearingPoint asset sales (to Deloitte, Keane and CMA), as well as the more recent sale of Northrop's TASC consulting unit to a consortium of General Atlantic and KKR. The latter was by far the year's largest Government deal at $1.65 billion EV, while Deloitte scored a prestigious $1.4 billion revenue BearingPoint practice for only $350 million, or 0.2x revenue. Other than BearingPoint deals, the sector continues to command premium valuations, especially for targets engaged in Intelligence and Defense projects. Examples include NCI's acquisition of TRS Consulting in August for $24 million at 1.7x revenue and 15x EBITDA and Applied Signal Technology's acquisition of Pyxis Engineering for $20 million, a 1.4x EV/TTM revenue multiple (EBITDA was not disclosed).
IT Staffing: The IT Staffing sub-sector boasts one of the year's largest Services acquisitions, Adecco's $1.3 billion acquisition of MPS Group. Adecco also purchased MPS rival Spring Group for $167 million during 2009. Both of these deals commanded some of the highest Services multiples of the year -- MPS at 14.3x EBITDA and Spring at 12.1x. Both were also fairly unique properties and, in the case of MPS, size mattered greatly. It is important to note that these were the only two Staffing deals with disclosed multiples out of 10 transactions year-to-date. The majority of the year's Staffing deals were acquisitions that strengthened the acquiror's existing business, such as Mitchell Martin's acquisition of the Garrett Sayer Group, and American CyberSystems acquisition of The SURVIS Group. There was only of one private equity deal -- Sycamore Hill Capital's acquisition of Ascent Services Group, a VMS and MSP specialist procurement firm. It is notable that after 2008, when not a single IT Staffing deal multiple was disclosed, having two such data points in 2009 -- however rarified -- is an interesting development in the sector.
Conclusion: There are plenty of promising signs for the Business Services sector, even though 2009 data shows some weaknesses. The economy is beginning a turn-around, balance sheets are opening up for more IT spending, and firms are ready for a new wave of business. We noted above how Business Services firms are preparing to bulk up their workforces in expectation of more activity in 2010. Multi-billion dollar deals are continuing through the end of 2009 with the previously mentioned $1.6 billion Northrop Grumman/TASC Unit acquisition by KKR and General Atlantic and Bain Capital's $1 billion acquisition of Bellsystems24. The last of these deals highlight that private equity firms are opening their wallets once again as they find value in the Business Services space. The climb back up to pre-recession deal activity levels will not be easy, but we believe that the market bottom is behind us and, as IT spending begins to perk up, so will M&A.
References: 1. Matzke, Pascal and John C. McCarthy. "The State Of Enterprise IT Services: 2009 Business Data Services North America And Europe." Forrester Research: November 6, 2009.
2. Ribeiro, John. "Accenture to Add 8,000 Staff in India." IDG News Service: November 9, 2009
3. Sharma, Amol and Paul Beckett. "Software Exporter to Expand Footprint in Emerging Markets." Wall Street Journal: October 28, 2009.
4. Thoppil, Dhanya Ann. "Infosys to Nearly Double Work Force in U.S. Market." Wall Street Journal: December 2, 2009.
