M&A robust for tech sector

Merger and acquisition activity within the technologies service sector is robust, with strategic

buyers targeting companies that provide help desk, data center, hosting, outsourced IT departments and other services.

Strategic buyers are more active in the IT sector than private equity investors.

“The big difference is that in IT, it’s virtually all strategic buyers,” said Victoria Fox, managing director with Emory & Co., a Milwaukee-based investment banking firm. “There is really not a big private equity interest.”

Strategic buyers generally look for two things in the IT service sector – geographic location or an add-on offering they do not currently provide. Many IT service providers are trying to have as many offerings as they can for clients, making niche providers especially attractive.

“Most of the acquisitions I’ve seen are a consolidation around a functionality or geography,” said Steve Michalicek, managing partner at Greentree Partners LLC, a Cedar Rapids, Iowa-based M&A advisor and private equity investor that specializes in mid-market software and technology services.

“What you will begin to see is acquisitions around a solution. We’re involved in one right now that is a $5 billion public company buying a smaller player that has a functionality that allows them to have nation-wide focus and deliver a fuller service solution.”

Fox pointed to Milwaukee-based Tushaus Computer Services Inc., which purchased Bedrock Managed Services and Third Millennium Design in late 2006 and early 2007, respectively.

“That’s the trend, being able to offer the full package (of IT services) for people,” she said.

Greentree Partners has made several IT service investments as a private equity investor. Mason Wells, a Milwaukee-based private equity firm, also has made several technology investments through its Mason Wells Biomedical Fund I. The firm announced several months ago that its Biomedical Fund II was being spun off as a separate entity.

Private equity investors have purchased some Wisconsin IT service providers. Mortgagebot, located in Mequon, was acquired by Spectrum Equity Investors IV LP in 2005. Dedicated Computing, of Brookfield, was acquired by Mason Wells in 2006. Berbee Information Networks, of Madison, was acquired by CDW in 2006, and CDW was acquired by Madison Dearborn Partners earlier this year.

Private equity investors haven’t become heavily involved in more Midwestern technology service businesses for several reasons, Fox said. Most of the IT service providers here are relatively small, and many of the folks working in private equity don’t see ways to significantly improve the businesses for a future sale.

“If there is $50 million in revenues or less, there’s not a lot of private equity in that,” Fox said.

Many private equity investors also believe that IT service companies are not sustainable enough for investment, because many of those providers offer similar services.

“What private equity is looking at now is sustainability,” Fox said. “And the IT service sector is not. Any customer at any time could go away. And the margins are not as high with the generalist IT (service) companies. People switch so often, and there’s nothing to stop them.”

Michalicek agreed, and said multiples paid for IT service companies are relatively low.

“It can be very difficult for (venture capitalists) to fund them, partially because the multiples we see in services,” he said. “In the final analysis, it’s a body shop. You’ll never see them compared with software or other technologies. A good staff aug company will sell for 0.4 to 0.7 (times) revenues and a good professional services company involved in some high end infrastructure capabilities will sell for maybe 1.5 times revenue.”

“When you look at what the private equity buyer is targeting to buy, they frequently look for something with a bigger scope that they can use as a platform,” said Ben Brown, an investment banker with R.W. Baird & Co. Inc. in Milwaukee.

Many IT service companies aren’t attracting the attention of private equity investors because they don’t fit the profiles of buyouts that those firms look for, said Kelley Starr, president of Thin Air Software.

“If they’re not national, not growing or are not a niche technology, they won’t get that kind of profile,” Starr said. “In a lot of ways, the general (IT) services-based businesses aren’t interesting to those types of (private equity) businesses.”

Brown agreed, and said most strategic buyers are more likely to know which IT service providers would make good geographic or service add-ons.

“Strategic firms have got their guys on the street and they might know these firms,” Brown said. “They have a better feel for what’s out there.”

Many private equity investors simply don’t have a wealth of knowledge about the information technology marketplace, Fox said. That is especially true for web-based companies.

“The web is really a strategic market,” Fox said. “They can’t add value to it. A strategic buyer who might be selling a similar product can.”

IT Transactions Involving Wisconsin Businesses

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