On the Prowl

Small may be good, but big is better—at least in the eyes of an exploding number of solution providers busily buying other channel companies to bolster bottom lines, expand into new regions or markets, and gain access to additional skills.

Perimeter Internetworking is one such company. Not content to be a midsize player in the managed services and security sector, the company has embarked on a shopping spree to supplement its organic growth and expand its reach nationwide. The Milford, Conn., MSP (managed services provider) has acquired 12 channel companies since 2003, said CEO Brad Miller, and four of those purchases took place in the past year.

Acquisitions are key to the companys growth strategy, Miller said. "We grew from zero to $10 million, purely organically, then from $10 [million] to $24 million in two years—half was organic, and half was acquisition," Miller said. "This year, well do about $35 million, and the growth will be one-third acquisition and two-thirds organic."

Perimeter is far from unique in its acquisition strategy. Each quarter, thousands of transactions take place in the IT channel. In most cases, solution providers are buying other solution providers, but in a growing number of instances, vendors are picking up providers to boost their service practices.

In the first two quarters of 2006, there were 671 transactions worth $18.5 billion in the IT and the IT-enabled outsourcing services arena, according to Martin Wolf Securities, a San Ramon, Calif., broker that specializes in the IT solutions space. In the same period in 2005, there were 470 transactions worth $34.9 billion, primarily due to the $11.6 billion SunGard Data Systems deal during the first quarter of last year, the firm found.

"Theres a lot of activity. I think youre going to see a lot, lot more transactions," said Martin Wolf, president and managing director of Martin Wolf Securities.

Other industry executives concur.

"We have seen more M&A activity over the past 12 months than we did over the past couple of years," said Peter DiMarco, general manager of sales at Ingram Micro, in Santa Ana, Calif., the worlds largest IT products distributor.

One of the main drivers of M&A activity in the channel is a change in business model to one that ensures recurring revenue for solution providers. Through managed services, solution providers remotely take over the IT environments of customers and charge them utilitylike fees for the service.

"Theres no question that the managed services piece of the puzzle is part of the equation," said Jeff Kaplan, president of analyst firm ThinkStrategies, in Wellesley, Mass. "To a certain extent, its only the latest example of an age-old dictum of why companies merge or acquire other companies."

And why they do it, said Kaplan, is to expand their customer base, strengthen their services and solutions portfolio, and achieve greater economies of scale. "If its not one of those three things, its not worth doing."

Managed services, because of the predictability of recurring revenue, boost company valuations, making companies more attractive to potential buyers.

Companies with well-documented recurring revenue customer contracts have valuations of as much as three times their revenue, according to Rob Scott, managing partner at law firm Scott & Scott in Dallas, which specializes in IT legal matters. That compares with traditional product-centric, break/fix channel companies, whose valuation typically is a fourth of their revenue, he said.

Companies that already offer managed services are also doing some acquiring. In some cases, they pick up other channel players with an eye toward expanding their customer bases by shifting customers to the managed services model and boosting recurring revenues. One of the first priorities for Netivity Solutions, of Waltham, Mass., whenever it makes an acquisition is to convert the customers of the acquired company to the managed services model, said Skip Tappen, Netivitys vice president of managed services.

For its part, Perimeter, whose primary focus is on-demand network services, acquires businesses to boost the number of services it can offer to clients—and to expand its reach into other regions, Miller said.

"We really do it because most companies we buy only offer one, two or three services, and our clients usually buy six, seven or eight services," Miller said. "We offer 50 services. Forty percent of our revenue comes from existing clients buying new services. I think there are a ton of companies in our space, and most of the companies are very small. Most of the activity is of midsize companies like me, buying smaller companies."

The company has no intention of halting its shopping spree any time soon. "Were certainly buying more," Miller said. "We have another two or three lined up, and we expect it to be a continuous part of our business."

No End in Sight

Kaplan says he expects m&a activity in the managed services space to continue for the foreseeable future.

The same goes for the overall IT industry, according to experts. The past quarter featured more technology M&As than the year-ago period, said Don More, a partner in Updata Capital, of Red Bank, N.J., which has completed almost 400 IT M&A transactions worth about $15 billion in shareholder value since its founding in 1987.

June Weddings

June, a month favored by blushing brides, proved to be a good time to form another type of union, and each day seemed to bring another merger or acquisition.

Perimeter acquired ANE Technologies, an MSP specializing in intrusion prevention, penetration and vulnerability testing. Miller said ANEs expertise in penetration and vulnerability testing and intrusion prevention will strengthen Perimeters existing capabilities.

Symphony Services, a provider of collaborative, global outsourcing solutions, acquired VMOplus, a consulting company.

Domin-8, which develops and supports a range of software solutions for the multifamily housing industry, acquired Logicbuilt, a developer of applications for real estate, construction, maintenance and other service-based industries. Thus, the third acquisition this year for

Cincinnati-based Domin-8 is expected to generate additional service revenue to existing—and future—Logic-built clients and extend the capabilities of Domin-8s solutions, said Greg McGrath, president of Domin-8.

Some of the unions taking place in June were a bit more untraditional, as some vendors sought to boost their service revenues or create service divisions by acquiring channel companies. While it was not a large deal, Canon USAs January 2006 purchase of Uinta Business Systems—which had 80 employees and 2005 revenue of $22.4 million—marks the vendors first foray into a channel acquisition since 1990, according to Gartner.

"This acquisition positions Canon to buy other strategic dealers and weld them into a single national sales organization that can offer large, geographically dispersed customers consistent service-level agreements," said Don Dixon, principal research analyst at Gartner, in Stamford, Conn. "By moving in this direction, Canon will be able to compete more directly with Xerox on national bids. Equally important, by building its service network through acquisitions rather than organically, Canon will become more nimble and better prepared to fend off rivals acquisitions of strategic Canon dealers."

Xerox expects to expand its footprint in the document management services business with its purchase of Amici for $174 million in June. Amici, of Albany, N.Y., provides e-discovery services, primarily supporting litigation and regulatory compliance—an industry expected to reach $2.5 billion in the United States by 2009, according to IDC.

Moving On

As an array of lawyers, executives and consultants worked on the transactions announced in June, Greg Talburt, president of Nashville-based solution provider Automated Accounting, was moving on. Though he hadnt planned to sell the business, he realized after relocating with his family to Santa Rosa Beach, Fla., that selling was the best option for his business, his clients and primary vendor partner, Sage Software.

Before relocating, Talburt spent nine months training a manager to run Automated Accountings day-to-day business, but he wasnt satisfied with the results. "The problem was the arrangement didnt work out as Id hoped it would," Talburt said. "I was spending a great deal of time in Nashville. I was essentially running the business long distance."

So Talburt, who was also building a consulting company in Florida, put Automated Accounting up for sale, with a caveat: It had to be a match made in heaven. He decided on the purchaser—Atlanta-based Macdonald Consulting—after winnowing the list of suitors to three, consulting with Sage Software and holding discussions with clients, informing them of his intention to sell.

"Even before the initial negotiation process began, I talked to my clients. At the end of the day, if they choose to, theyre going to be working with the new business," Talburt said. "Before the transaction closed, we had at least the top 20 percent—and it was probably more—of our clients meet with the owners of the company we sold to."

His presale efforts paid off, he said. "There havent been mass defections. The transaction was very clean. All parties—the customers, me, the buyers—are still talking and on very friendly terms. When you sold a business to somebody and you say youd do it again, that says something," Talburt said."

Watching the Wallet

Talburt had no shortage of suitors, since there is no shortage of companies on the prowl for acquisitions.

The entire technology sector—including software and services—continues to thrive. One reason: High-tech companies are more willing to take on debt to finance M&A activities, said Updatas More. "Cisco Systems in February obtained a credit rating for the first time and sold bonds to raise $6.5 billion in what is thought to be the biggest-ever tech debt offering," he said. "Oracle sold $5.75 billion worth of bonds in January to fund its takeover of rival enterprise software vendor Siebel Systems."

This may only be a prelude to additional adoption of debt by the industrys largest players. "Other tech players are thinking about following the industry leaders. Symantec just hired a new debt-savvy CFO from American Airlines for that very purpose," More said. "Most of the technology companies we track have little or no debt. Its been a growing trend for technology companies to bring on funding through M&As, so the cost of that may go up."

Following the disappointments and financial fiascoes of the dot-com crash, surviving channel companies and their vendor partners matured quickly—often returning to an emphasis on balanced books and cash in the bank. This return to business as usual has put a number of high-tech businesses in a strong acquisitive position, More said.

Of course, as interest rates rise, the cost of debt increases—which could eventually slow economic growth, More said. But those businesses with cash on hand will obviously realize a better return on their bank deposits, and will have additional resources to fund acquisitions, if they wish. "If they have cash in the bank, the interest on that most certainly leverages their balance sheet in terms of doing deals," he said.

Whether a solution provider seeks to acquire or be acquired—or prefers to merge operations with a complementary VAR—the climate certainly seems to favor an ongoing wave of M&A activity into the foreseeable future.

Alison Diana is a freelance writer based in Merritt Island, Fla. She can be reached at alisondiana@hotmail.com.

Top 10 ways to prepare for M&A activity

1. Keep clients, especially top customers, in the loop.

2. Have leading customers interview or at least meet with the prospective buyer: Everyone benefits by this minimal investment in time.

3. Cash is not always king, especially if you plan to operate a similar business elsewhere and need references.

4. Always operate as if your company is for sale, by keeping records up-to-date and having an exit plan mapped out.

5. No profit? no problem Even if youre not operating at a profit, you often still can sell the company, say some M&A experts.

6. keep it real Overrating your companys value can be a deal-killer.

7. Consult your trusted advisers—vendor partners, customers, noncompeting solution providers—before inking a deal, either as a seller or buyer, to determine the other companys reputation.

8. Be upfront about problems—existing or potential—that could affect the company operations.

9. Cover yourself Consider an asset sale, as opposed to the whole company, since asset sales typically clarify exactly whats in play.

10. will they bail? Realistically try to determine which customers may bail out after the merger or acquistion.