Industry M&A: Another “Final Four”

The signs have been all around us, and they are in fact accelerating. Oracle merges with Sun to muscle in on the solutions, cloud and consumer spaces. Verizon sells rural lines to lean telco like Frontier, husbanding cash for a deeper FTTH push. HP integrates EDS to mount an all-services challenge to IBM. Dell enters mobiles; Apple attacks all-apps. Nortel crumbles into enterprise and carrier piece parts; Time Warner carves out content from access (and even within access). What’s next? Will Indian BPOs make a move on a professional services or a telecom company? Will Google tackle the enterprise space?

Sports fans view the success of a season based on how their favorite team does in the playoffs, the post-season tournament. What’s unfolding in this “infocom” space of converged, managed communications services is a similar high-stakes, single-elimination, but much longer-term, tournament for industry success. We are actually entering the last quarter of a twenty-year tournament that had pitted four separate “brackets”: technology vendors (Oracle, IBM, HP), professional services (Accenture, IBM, CSC) telecom (AT&T, BT) and Indian BPOs (Infosys, Wipro). Who will win these brackets?  Also, to complicate matters, the boundaries are blurring, and the final tournament play will be increasingly cross-bracket. Just watch.

Of course, these sectors have been consolidating for quite a while already. The triggers were obvious at the time: inefficient, redundant players, shortage of growth capital to go around, desire for a more global footprint, rise of “solutions-based” marketing. The number of total players in each sector has already come down by well over 50%. And, who can forget the hilarious AT&T “Terminator” video from Comedy Central, detailing the breakup/rise of AT&T? But clearly more consolidation is yet to come, despite the recently-announced Justice Department inquiry.

The recession has actually been good for industry M&A. In the last year, since June 2008, we count somewhere north of 50 pending/announced deals of greater than $250MM in value. In technology, for instance, remember Brocade/Foundry, Cadence/Mentor, JDA/i2, NetApp/Data Domain (with EMC still in the hunt), and or course Oracle/Sun? In telecoms, we mentioned Frontier/Verizon but what about AT&T/Centennial, CenturyTel/Embarq, Vodafone/Polkomtel, Vodafone/Hutchison Telecom, Telefonica/Chile Telecom SA, China Unicom/Netcom KT/KT Freetel, Qatar Telecom/Indosat, and Verizon/Alltel? These were not small deals. The Indian BPOs have been active as well, despite the emerging markets meltdown: Tata/Citigroup Global, Wipro/Citigroup Technology, Infosys/Axon plus dozens of smaller cross-border rollups.

The march of further M&A will continue, simply because the sectors still don’t pass the eye test. For example, if we look at the list of representative global professional services firms (Accenture, CGI, ACS, Perot, CSC, Cap Gemini Convergys, Atos), each trading at market cap to revenue ratios of less than or around 1, would it be outlandish to expect further service provider consolidation within the sector, and perhaps buyouts from majors from the other “brackets” such as the Indian BPOs and technology vendors--who themselves are generally trading at market cap to revenue ratios in excess of 2, and actually getting to close to 3? Is it too crazy to to imagine Infosys, Cognizant, Tata or Wipro making a play for companies in the professional services sector to get instant clients, credibility and global access? It would be a much faster way to get scale, rather than the nip and tuck recruiting they have been attempting. Or, shouldn’t the mega-tech players, like Oracle (4.5 ratio), SAP (2.9) Cisco (2.8), IBM (1.3) and maybe HP (.7) also launch further adjacent expansion into “services and solutions”, complementing their technology platform sell. Sun was a natural seller to Oracle at a .5 ratio; the entire professional services bracket is also in this camp. And, within the technology vendor sector itself, what about the possible merry-go-round of HP buying up Sun’s hardware from Oracle to complete its death star strategy versus IBM, and Cisco playing the eventual new-entrant spoiler in data services infrastructure, to both?

In telecoms too, the wireless meltdown of the last few quarters (which had been one of the last few remaining bastions of top line vitality) underlines the fundamental point that there are too many wireless players to justify forward capital plans, both north and south of the border. And, this is all before the prepaid segment matures in North America…imagine prepaid smartphones. And, this is while cablecos are now scratching their head as to whether quad play actually makes economic sense to invest in, from a shareholder’s perspective. 4G network-sharing makes sense, as does finally fixing the archaic consumer supply chains, but let’s face it--at least 5 more major players must merge in order for industry EBITDA to return to investment-worthy levels, and that is just in North America.

How you ultimately feel about all this depends on your time horizon. This is not a lot of un-related industry noise. This is not a short-term phenomenon, triggered by the domino effect of collapsing sub-prime lending derivatives. The inevitable push to fewer, richer, better players happens in every sector, but the next 2-3 years will signal two parallel and reinforcing trends: business-as-usual M&A within the sector, and an increasing mix of “cross-bracket” M&A. The road to this Final Four is paved with both multi-services ambition and economic necessity.

Alex Liu is a partner with A.T. Kearney and leads the firm’s communications, media and technology practice in North America. A list of his other recent articles follows.

Alex.Liu@atkearney.com 310-864-9001