European IT Sector Sees M&A Surge Acquisitions Hit All-Time High as Market Leaders Targeted US

European merger and acquisition activity in the information technology (IT) industry increased by 25% in 1998 compared to the previous year, according to Regent Associates, the specialist M&A advisor to European IT companies.

Regent Associate’s annual analysis of M&A activity, released by the firm’s UK and French offices, reveals that European IT companies last year were involved either as buyers or sellers in 1,301 acquisitions, which for the purposes of the study are defined as deals involving the purchase or sale of more than 50% of a company’s equity.

The UK retained its position as the most active IT market in Europe, heading both the acquisition and sale tables; for the first time, the UK IT industry became a net buyer of companies, generating 47% of buy-side transactions in Europe, while providing 44% of acquisition targets.

However, the 7% increase to 457 in the number of UK IT companies sold was modest in comparison with growth in the German market, where 198 IT companies were sold in 1998, 45% more than in the preceding year. France saw a comparable increase in activity; 137 French IT companies were sold, a 41% increase from 1997.

All other major European markets, including Benelux, Scandinavia, Italy and Spain, saw an increase in IT company sales, albeit in some cases from very low bases. Broadly speaking, the geographic distribution of M&A activity among Europe’s IT companies changed only slightly in relative terms from 1997 to 1998 and transactions involving North American firms, either as vendor or as target, continued to account for more than one third of overall activity.

European companies made 139 acquisitions last year in the US compared with 107 in the previous year, in line with the growing trend towards globalisation throughout the IT sector.

Unsurprisingly, the UK plays a pivotal role in transatlantic IT deal flow.Last year, 45% of transatlantic acquisitions in the IT sector involved UK companies, which were the target for 27% of US acquisitions in Europe. UK buyers in turn accounted for 18% of European IT acquisitions in the US and Canada, while the comparable figures for German and French acquirors were, respectively, 13% and 11%. French companies were the target for 8% of European IT purchases by US groups last year.

Across Europe, software and services once again proved the most fertile market segment, giving rise to 49% of sell-side and 41% of buy-side transactions. Communications equipment firms and information services groups were the next most active acquirors, each accounting for 12% of acquisitions.

After software and services companies, information services firms appealed most strongly to sellers and comprised 17% of 1998 M&A targets.

Closer analysis of software and services activity reveals that demand was highest for companies producing packaged software and other software products, which accounted for 32%, or 183, of the 579 sell-side deals in the software and services sector. Acquirors also manifested strong appetites for horizontal value added resellers (VARs) and systems integrators, which accounted for 17% of software and services acquisitions.

There were, however, no software and services companies represented among 1998’s ten largest IT deals. This is not necessarily surprising, since the highly innovative European software and services sector is characterised by a high rate of company formation in the consulting, integration and software products segments. Such firms, while still relatively small, often form attractive acquisition targets for larger organisations, thanks to their specialist skills and products and the entry route they can provide to new geographic or sectoral markets.

Principal drivers for the continued high level of M&A activity in Europe’s software and services sectors include the need for larger IT groups to offer an international product and service range and the shortage of skilled IT personnel in the recruitment market.

The biggest increase in UK transactions last year was in the information services sector, where 112 transactions were recorded, a 51% increase from 1997.

Internet Service Providers and information content companies were the primary targets in this sector, which also showed early signs of a surge in M&A deals targeting call centres and E-commerce companies. Given the rapid development of technologies and markets in those areas, the recent UK trends are likely to be replicated in the Continental markets in the near future.

The largest transactions in any given industry do not necessarily reflect where M&A activity is concentrated within that sector, and it is true that most of the 1998 “Top Ten” European IT deals fell outside the “hot” segments for the market overall. What the “Top Ten” does highlight is the increasingly international, and potentially global, perspective of Europe’s IT industry. Excluding the Seagram/Polygram deal, which falls somewhat outside the mainstream IT business, the year’s largest deals involved European groups making acquisitions in the US or in Canada. Unlike 1997, when the acquisition of Teledanmark by Ameritech Corp. of the US topped the table, no US-based acquiror featured in the 1998 “Top Ten”. The year’s largest purchase by a US group, NTL Corp.’s euro 780 million acquisition of KPN Telecom of the Netherlands, ranked only 13th.

It is particularly satisfying to note France’s two entries in the “Top Ten”, thanks to the Alcatel/DSC Communications and Framatome/Berg Electronics deals. These transactions mirror an increasingly international mindset within the French IT sector as a whole. Last year, there were 54 domestic M&A deals involving French companies but 134 cross-border transactions. In 1997, by contrast, deals involving a foreign target or acquiror comprised slightly less than 52% of French M&A in the IT sector.

The substantial increase in European IT M&A activity last year reflects the underlying vigour of the sector overall, and the continuing emergence of new technologies as well as the ongoing search for productivity and profits among larger corporate acquirers. One reason for the extreme buoyancy of IT M&A in the UK is that, US acquirers have regarded the country as a prime route for entry into the broader European market. Peter Rowell, chief executive of Regent Associates identified additional factors that account for the consistently high levels of activity in the UK IT sector.

Activity is driven in part, he said, by the “natural trading mentality” of UK companies. More important, however, Peter Rowell said, are the typically higher levels of external equity investment in UK IT businesses than in their Continental counterparts, meaning that in many cases, exit through trade sale or flotation forms a key component of a company’s medium- or long-term plans.

Given current high levels of private equity investment in IT companies throughout Europe, it seems safe to predict that the “exit plan” will in due course also emerge as an important driver of M&A activity in the Continental markets.

Recently, venture capitalists appear to have overcome much of their earlier aversion to “technology” investment, while a number of major buyout houses that previously targeted maturer industries have manifested a growing appetite for IT businesses. The UK last year saw 41 IT sector buyouts, an increase from 32 such deals in 1997.

At the same time, although Europe has not yet seen anything approaching the soaring valuations of Internet stocks in the US, the new stock markets – EASDAQ, the Nouveau Marchc and EURO.NM – have demonstrated their potential to provide liquidity to fast-growing IT businesses. A private equity industry with unprecedented levels of liquidity and Europe’s new stock markets could combine to create a “virtuous circle” for Europe’s IT companies. Recent levels of M&A activity, in conjunction with a growing culture of innovation, will ensure that there is no shortage of investment opportunities for those fund managers with the skill and vision to exploit them.