Whos Knocking on Your Door?

Compaq, HP scour the consulting market for potential takeover targets.

Many internet consulting firms are desperate to get married, but only those with strong brand names and deep technical skills will find their way to the altar.

So, whens the next wedding in the consulting market? Were not predicting any firm dates, but Compaq Computer Corp. and Hewlett-Packard both may be eyeing Sapient, according to sources close to the three companies.

Its no secret that HP CEO Carly Fiorina and Compaq CEO Michael Capellas want to build consulting organizations that rival IBM Global Services,

HP has been probing the consulting market for potential acquisition targets since last year. After failing to acquire PricewaterhouseCoopers last fall, HP was said to be eyeing Scient, a consulting firm in San Francisco. Now, some anecdotal evidence tracks HP to Sapients doorstep in Cambridge, Mass.

"HP has been talking to Sapient about getting together. It would make sense for HP if they are looking to beef up their services," says an industry executive, who spoke on condition of anonymity.

HP isnt the only company at Sapients door. A Sapient insider says that Compaq is strongly interested in the consulting firm. However, the timing for such a deal may not be right, the source says, because Sapients stock trades for less than $10—down from a 52-week high of $74.

Unlike many of its rivals, Sapient isnt desperate to sell itself. The company has about $200 million in cash and doesnt need a financial infusion to stay afloat.

The Sapient source does not see HP as an ideal match, though outsiders certainly see potential synergies between both companies. "Sapient is fabulous. It has about 2,700 people, it has great system integration skills. They have built strong silos," says Mike Whitney, VP of equity research at FAC Equities.

To be sure, HP is actively seeking to build up its services organization. In March it created a new business unit headed by HP veteran Ann Livermore, with the mission to aggressively grow HPs IT services practice.

Though it remains in the shadow of IBM Global Services, HPs IT services effort has made some respectable strides in recent quarters. HP generated $7 billion in consulting, outsourcing/support and financing services revenue last year. And for its recent fiscal Q2, IT services garnered $1.9 billion, up from $1.67 billion in the year-ago quarter.

Meanwhile, Compaq also wants to bulk up its services arm, where revenue growth has been slow but promising. During its most recent quarter, revenue at Compaq Global Services was $1.935 billion, up four percent from $1.863 billion during the corresponding quarter last year.

Eager to muscle up some more, Compaq tried to buy Proxicom a few weeks ago, but the deal fell apart when Proxicom received a counter bid from Dimension Data.

Aside from Sapient, only a handful of consulting companies—such as DiamondCluster, Answerthink, Inforte and Tanning Technology—have a strong enough brand to gain attention from Compaq or HP, experts say. "If you are Compaq, you need a strong brand name," says Whitney from FAC Equities. "There are a lot of nice little companies [out there] that dont make sense for Compaq to buy."

Clearly, not every Internet consulting firm can expect to find a White Knight. Many weaker public firms will likely fade into bankruptcy, like MarchFirst and USinteractive, or become obscure microcap stocks. And cash-strapped private firms that cant get new funding from VCs will continue to look for buyers, experts say.

During Q1, there were about 62 mergers and acquisition deals of venture backed firms and 11 of those deals involved computer software and services firms, according to Venture Economics, a research firm.

But even with depressed valuations,a wholesale buyout of Internet services and related firms is not likely to occur.

"What we are seeing is a fragmentation in the marketplace," says Tom Rodenhauser, president of Consulting Information Services. "Companies are buying bits and pieces. Many people expected huge deals and they wont see many of them. Maybe PwC (PricewaterhouseCoopers) will go, but the Big Five consultants are all going in their own direction."

Recent events such as the merger between C-bridge and eXcelon, the leveraged buyout of Agency.com by Seneca Investments, and the acquisition of RareMedium by Motient are redrawing the landscape, but not to a dramatic point.

In other cases, acquisitions may fill a niche or skills gap. For example, IBM recently plugged a hole in the consulting piece of IBM Global Services when it acquired Net strategy firm Mainspring.

Industry observers say a couple of factors are holding up mass consolidation. First of all, in many cases sellers are looking to be valued on last years performances or on how they will do a year from now, says Wolf.

The other factor is that potential buyers are not looking to add to their benches until they start seeing their own utilization rates rise, experts say.

Mark Mehler contributed to this story