KUHN CAPITAL Wednesday, October 18, 2017
Dispatches from the front

The M&A Round-Up's 2003 Round-Up
(1/11/2004)

Now that 2003 is history, we've taken a moment to comment on five of the the year's more memorable tech industry and related M&A developments.

One More Time with Feeling: Outsourcing & Offshoring
Well, in our opinion, it built into the biggest story of 2003. Of course, the outsourcing/offshoring trend began years ago with the US losing manufacturing jobs overseas. Then, starting about five years ago, it became IT’s turn. Today, Peter Drucker claims that any American product or service with a 20% or greater labor content is fodder for offshore outsourcing.

In 2003, we saw additional, increasing nichy American professional services industries debut their offshore counterparts: for example, sophisticated industry and equity research firms are popping up in India that target the American market (beware Yankee Group, Forrester and McKinsey), and we know of a new venture that pipes radiological files to India for diagnosis. (Many analysts consider the medical school in New Delhi to be the finest in the world.) We’re sure other sorts of professional services, yet unimagined, will soon find themselves caught up in this maelstrom.

But IT services have undergone the most spectacular offshore outsourcing penetration, and now that the industry is maturing, 2003 brought the beginnings of an inevitable migration by the leading Indian outsourcers from commoditized services (e.g., software coding and maintenance, and call center operations) to higher-end strategic consulting, and the recruiting of rain-making sales and marketing executives. In our work, this drive toward high-margin business lines is expressed in the purchase by Indian firms with established lower-margin business lines of American IT shops with high-margin “close-to-the-customer” capabilities. Such Indian acquirors are fueled by war chests filled from years of successful commerce, and sky-high Indian stock market valuations.

How can American IT shops protect themselves from the devastating effects of such offshore competition? Some ideas: develop proprietary new products that exploit intimate knowledge of what end-users need to do their jobs better. Climb up the chain of command by establishing strong contact with senior executive decision-makers. Develop services that require strong local “feet-on-the-ground” to deliver: e.g., claims adjusting or security consulting. Specialize in smaller clientele with insufficient scale to entertain offshore solutions.


The Dawn of Wireless Ubiquity
It became obvious in 2003 (at least to us) that the bounding growth of mobile communications, most visibly by cell phone and Wi-Fi technologies, will be further accelerated by a much less developed but hugely important emerging technology – RFID, or radio frequency identification. As RFID tags continue to shrink in size and price, industry pundits have difficulty covering the many ways they will enhance the speed and accuracy of product supply, assembly and demand functions. Already RFID has made inroads in the tracking of expensive, loss-prone products like drugs and aircraft components. As tags drop toward 15 cents apiece, look for their application on thousands of consumer goods, a development that monster retailer Wal-Mart is actively fomenting in ways reminiscent of how -- in an earlier generation -- the giant auto companies imposed EDI on their suppliers. One day every UPS overnight envelope will be tagged; and don’t forget RFID’s myriad uses in security.

We’re particularly excited about the demand generated by RFID for high-end database consulting and DBMS software related to the real-time tracking of millions of items through time and space.


Gimme Security
Spending on IT security and homeland defense lurched into high gear in 2003, brought on by metastasizing spam, virusus and worms; and by the release of billions of government dollars in response to continuing terrorist threats. IT-related security products and services come in many flavors, offering investors the added attraction of diversity. Some of the industry’s sectors include weapons detection and monitoring, person ID, object ID (e.g., RFID again), secure communications, surveillance and training systems. For more detail on this rising sector, see our prior Dispatch on the subject. We estimate that security industry M&A activity, measured in number of deals closed, increased about 50% in 2003.


Remote/Distributed/Virtual/Cluster Computing
What began with edgy peer-to-peer music file sharing services and the much ballyhooed but disappointing debut of" Web Services" has finally this year begun to emerge as real business. Salesforce.com legitimized the concept of renting applications processing, and as wireless devices proliferate, their limited local processing capabilities will drive rising levels of Internet access to giant server racks. What’s intriguing is the development of ways to access the huge quantities of computing power and storage lying unused through the Net, and the emergence of business models that compensate the owners of this excess capacity.

So in 2003 we began to see all three computing functions -- applications, processing capacity and storage -- increasingly available online. Again, such access will drive demand for high-powered security, and for massive, sophisticated transaction and data management systems.


The Year’s Mixed IT M&A Report Card
2003 was characterized by --

1) The welcome return of hostile bidding for IT properties, the most spectacular example being Larry Ellisons’ still unconsummated June feint at PeopleSoft. We like hostile activity not just because it generates more deals, but mostly because it can put capital into more productive hands;
2) Evidence of a rising M&A deal pipeline (according to KPMG, October 2003 showed the highest monthly value of global deal activity in three years and the highest number of deals in any month last year);
3) Stronger IT product and service demand. Commerce Department undersecretary Bond said in December on the topic of IT demand and investment, "This isn't another train coming. This really is the light at the end of the tunnel. Technology is firmly on the comeback trail.” Demand is important: it provides a floor of confidence in the profitability and stability of both acquirer and target;
4) And finally, surprisingly robust Nasdaq tech stock prices.

What all this means is that 2003 planted the seeds of a recovery of sorts in M&A activity, or at least in a slowing rate of decline. Again, according to KPMG, the number of closed deals in all industries worldwide declined 25% between 2002 and 2003, with deal value falling less, by 15%. Believe it or not, these declines are less severe than what we experienced between 2000 and 2002.

Specifically in US IT, Indian-American combinations drove a large chunk of total activity, as did consolidation of some of the older, over-funded sectors like SCM, ERP and EAI. In these sectors, we witnessed the emergence of VC-invested players like SSA Global and Silver Lake Partners, scooping up distressed or marginal performers in a bid to dominate the growing small and medium-sized enterprise (SME) market, a market unable to tolerate the expensive, complex solutions sold by giant vendors like SAP.

Other active sectors in which we participated were business intelligence software (BI), and energy industry software/IT services. Click these links to see our prior Dispatches on these topics…, and a prosperous New Year to you!

Ryan Kuhn


Copyright, © 2017. Kuhn Capital.
website designed & developed by alcasid.com