IT under scrutiny as M&A activity soars

The value of companies' IT is coming under the microscope in potential takeovers, and expert opinions differ about how it should be assessed.

The value of companies' IT is coming under the microscope in potential takeovers, and expert opinions differ about how it should be assessed.

Many IT directors could be asked some tougher-than-usual questions by the board this year about their IT cost base and outsourcing arrangements.

The grilling is likely to be driven by the number of corporate raiders seeking out UK takeover targets after a busy 2005, which saw European merger and acquisition activity at its highest level for five years.

With firms looking to maximise value to shareholders in part as a defensive measure against possible takeover, the value being derived from IT is coming under increasing scrutiny by chief financial officers and chief executives alike.

And it is not just IT cost-cutting that is on the agenda, but how strategic choices about a firm's technology arrangements can increase the share price of a prospective takeover target.

Last year, overseas firms spent almost £50bn on acquiring UK businesses - up from just under £30bn a year earlier. The number of deals was up 31%. UK firms were similarly busy shopping in Europe, spending £30.9bn on acquisitions, up from the previous year's £18.7bn.

Among the major pan-European deals was the £7bn acquisition by France's Pernod Ricard of drinks group Allied Domecq, and Saint-Gobain's £3.9bn hostile bid for BPB, the UK building materials manufacturer.

This year the pace has hotted up still further on the continent, with the first six weeks of 2006 seeing the volume of merger and acquisition deals in Europe reach £88bn - almost three times the number recorded in the same period last year. This includes a £12.8bn hostile bid by Mittal Steel for rival steel group Arcelor and a £6.2bn offer by banking group BNP Paribas for Italy's Banca Nazionale del Lavoro.

Consultancy Ernst & Young says this growth in activity is pushing UK firms to review every aspect of their competitiveness - and the value of a firm's IT assets is climbing up the boardroom agenda. Giles Watkins, who is in charge of IT due diligence services for Ernst & Young, told Computer Weekly that in the past year there had been an increasing focus by would-be buyers on their likely IT systems inheritance - and on how to derive maximum benefit from the technology mix acquired once a deal is signed.

Ernst & Young says it has been pushing the IT agenda for five or six years, but it is only now that firms are taking a detailed look at IT as a key factor.

With thinking around the subject still in its infancy, there are several different schools of thought about just how to assess the value of a firm's technology.

Chris Digby, a partner at global consultancy Deloitte, warned in last week's Computer Weekly that the impact of IT in a deal varies enormously.

He said, "If the sale is likely to attract commercial trade buyers, issues such as integration with the buyer's IT systems will be high on the agenda because although this involves additional one-off costs, there should also be considerable operational and back-office savings following the integration. But if the buyer is more interested in grooming the company for future sale, integration is less likely to be important. In this case, working, self-contained IT operations could be more attractive."

But Robert Morgan, director of specialist outsourcing consultancy Morgan Chambers, emphasises a different set of variables.

"One critical question about a potential takeover target is what its fixed IT cost base represents," he said. "The average will vary enormously - depending on the target firm's industry sector, it can be anywhere between 4% and 12%. This will often give a broad indication of the health of a firm, since undue expenditure will allow huge consolidation savings, while evidence of too little will ring alarm bells on the state of its interrelated business processes and drive down the price.

"However, another crucial part of the equation is outsourcing. Potential target firms are only now waking up to the value of outsourcing relative to their overall value. I would argue that being significantly outsourced can really add to your corporate value."

Morgan's argument is that, because outsourcers are professional integrators and rationalisers of business processes, setting up a strong outsourcing relationship is a great way for firms to have a stronger hand in the face of a hostile takeover bid.

"The advantage for acquirers is that, if a target is not outsourced, they can bring in a trusted outsourcer to undertake a consolidation plan in a fixed time and at a guaranteed lower price," he said. "This iron-clad commitment laid before the analysts instils confidence in the value of the deal which will be reflected in the acquirer's stock price."

Morgan adds, "But this can be used defensively too. What the institutional investors want to hear when a hostile takeover is being proposed is that the target's executive can radically reduce costs without business risk. A costed, guaranteed outsourcing programme sends out a powerful message that can push up the share price of a takeover target - avoiding the takeover."

Morgan estimates that a quarter of outsourcing deals are now being done for strategic purposes, but says awareness of the strategic potential of outsourcing still has a way to go. "Chief executives and chief financial officers are starting to see the possibilities of using outsourcing for strategic positioning, with cost savings as a secondary factor, but it is a harder sell to CIOs," he said.

Outsourcing as a defensive measure

One major UK-based financial services company used outsourcing to rationalise its business and cut overheads in a bid to prevent a hostile takeover bid when its share price slipped, according to Morgan Chambers.

After a period of growth through acquisition, the group had become unwieldy and its IT fixed costs had risen to 14%. It decided to embark on a major IT outsourcing programme which involved integrating many of its recently acquired businesses.

Once the programme was completed, it had cut the number of applications it was using from 114 to 26, slashed its IT costs by 41% – and effectively warded off the threat of a hostile takeover.

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