Vertical market acquisitions are consistently strong as strategic companies broaden and target their offerings. Not surprisingly, Financial Services was hands down the most targeted sub-sector. Energy, Healthcare and Government verticals were also active vertical tech M&A arenas.
As the economic downturn becomes more marked, companies' spending becomes more cautious. This creates a need for IT vendors and providers to segment the market accurately to leverage opportunities at hand. Despite a general negative impact on IT spending, some vertical markets will prove to be more resilient in the slumping economy
Deals were done in nearly all aspects of Financial Services technology including banking systems, compliance, trading platforms, investment and portfolio management, payment systems, front and back office and others. Though M&A was strong this past year for the Financial Services software vertical, there could be a different picture for ensuing quarters, a picture that could impact the entire tech industry.
Energy
At the time of this writing in January 2009, petroleum crude is selling near $45BBL and aluminum prices are hovering around $1,580 per metric ton. Schlumberger, the world’s largest oilfield services firm (by market capitalization), announced plans to eliminate about 5% of its workforce in North America and is cutting some of its 65,000 overseas workers. Halliburton, its largest rival, has also announced job cuts. Alcoa, the world’s largest aluminum producer, has announced a reduction in production of 18%, elimination of 15,000 jobs and a 50% cut in capital expenditures in an attempt to adjust to a steep drop in demand and prices and to keep pace with its rivals. Hugo Chavez even modified his ideological stance and is now inviting Western oil companies to participate in petroleum production.
How times have changed. This state of play is a reversal of the environment in the first half of 2008. In June 2008, I wrote that soaring energy prices dominated our headlines and steered our economy. Sustained high energy prices stifled demand and were shifting resources toward alternative energies and conservation. The price of oil, the bellwether for all activity in energy, tends to drive the investment across other segments of energy. As oil prices rise, so does the investment in technology to generate efficiencies and alternate energy. Consequently, we saw continued run up of investment not only in conventional energy but also to commercialize alternate energy and sustainable technologies and to generate efficiencies throughout the supply chain. In Q1, 2008, we wrote about oil rising above $100BBL. In Q2, oil broke the $140BBL mark, nearly doubling in the last year.
Energy M&A activity in the second half of 2008 reflected the general downturn in energy related commodity prices and the economy as a whole. M&A activity also mirrored the trends in the broader M&A market, highlighted by:
· An absence of really big deals, a reflection of large buyers protecting their cash, the tightening in the credit market and the challenges associated with financing big deals with debt or equity as share prices declined.
· Reduced activity in small and mid-market acquisitions. Strategic buyers continued to shop for tactical additions to their businesses to expand their product set, shore up product weaknesses, grab market share and expand geographic reach. However, deal volume and valuations are down.
· Private equity and financial buyer activity was low in 2H and particularly Q4 except where PE firms supported highly targeted acquisitions by portfolio companies.
Looking forward, it’s reasonable to expect a continuation of 2008 2H trends for another six months. As the economic collapse begins to bottom out and we see signs of stability, we should see an uptick in the volume of deals as consolidation takes hold. Consolidation will be robust at the small end of the market but expect some big deals, too. Depressed commodity prices and the credit crunch will push an increasing number of weakened companies into the market. The number of small and mid-market companies merging for survival should increase. The forward thinking software companies will move early recognizing that they have no leverage when in crisis mode. There’s still pent up interest for M&A activity from private equity and sovereign wealth funds, however, don’t expect a great deal of activity from these buyers until we see some economic stabilization. Good sellers will get good deals done. The Obama administration’s economic and energy policies should also have a positive impact on activity in traditional and sustainable technologies.
Financial Services
According to the451 Group, the financial services industry accounts for 20% of total IT spending around the globe. It is the largest slice of the IT pie and has experienced by far the most turmoil of any industry segment in 2008. There has been a huge wave of consolidation of banks, brokers, insurance companies and other financial institutions – to the tune of $1 trillion last year. When corporate entities merge, decision making slows or even stops, especially at the acquisition level. Of course, spending will continue in the industry driven by the need to integrate the disparate systems brought together by such consolidation, to manage risk which has not been done very well in the past, and, ultimately, simply to compete. These drivers all sound like good news for vendors serving the industry and are certainly the silver lining that these vendors believe to see in the stormy skies; however, the darkness in those very same clouds is that many of their potential customers – if not busy with their own mergers – are in survival mode and that usually leads to halting of investments geared towards long term returns.
Hence, we believe 2009 will be very challenging for many vendors, especially those serving the banking and trading platform providers, as these players continue to cut spending and delaying investments. Vendors continue maintaining a relatively stable pipeline, however, many projects are not moving forward. So while the vendors are not losing deals, they are put into a very difficult situation: on the one hand, they wish to maintain the resources to execute when financial institutions free up budgets and place orders and, on the other hand, the need to preserve cash in case it takes much longer for those POs to materialize.
This dichotomy, if not properly managed, will lead to some vendors landing on the fire sale heap as they desperately seek a safe haven before their cash runs out. At the same time, exactly this phenomenon will provide fantastic opportunities to those vendors with adequate liquidity. Of course, there will also be plenty of deals that can and will be made before such a situation arises.
Last year we monitored a continuation of the consolidation trend amongst financial services vendors, but at a significant decrease from the levels we previously tracked. During the three years prior to 2008, we had witnessed annually roughly 360 transactions amongst financial services software and IT service vendors. Last year, the number of transactions had dropped one-third to 240 with a volume of only $15 billion, the lowest in five years and a dramatic plunge from the 2007 leverage-fueled buyout days where the volume had hit almost $70 billion. We envision continued activity in this segment in 2009, though it will remain at a lower volume similar to last year´s. There will probably be an increase in distressed sale activity as well.
For those that may not be adequately financed – and now is no time to be looking for new or additional funding when serving the financial services industry – a fair deal can be made if you are properly prepared, get in dialog around the world with all potential partners and remain flexible. Recent work by our firm in this segment has shown that, in addition to M&A opportunities, there is a significant potential for strategic alliances. The forms of these alliances vary from cross selling products, sub-contracting agreements to optimize resource utilization, to minority investments.
Healthcare
Healthcare Technology and Recession - There is an emerging consensus that the healthcare model in the U.S. is broken. Healthcare costs continue to outpace the rate of inflation, although since 2003 the percentage rate of increases has diminished each year. According to employers and health plans, premium increases are to be expected, though rates aren’t rising as fast as in previous years. We are in a recession, and in recessions healthcare has historically increased its portion of gross domestic product (GDP) as medical prices rise faster than other prices. This time will be no different.
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Technology Trends: Analyzing Global Enterprise IT Budgets 2008 reveals that the majority of enterprises globally are planning to cut back increases in IT expenditure. However, the healthcare sector is planning a significant number of increases in IT spending in 2009. |
As healthcare costs spiral higher and the number of uninsured increases, public policy on healthcare is likely to change. The incoming Obama administration has already sent a strong signal that technology will have a large part to play in their solution (EMR is specifically mentioned as a priority). The Obama administration and Congressional leadership would like to fund technology initiatives as part of a fiscal stimulus package for the states and localities in 2009. Healthcare technology will get its share since virtually all states are complaining about the burden of Medicaid patients and are asking for help. All of this bodes well for financially sound software companies in the healthcare arena, and for healthcare technology M&A activity since financially challenged companies will not fare well in 2009 and many will look for an acquirer.
Recessions tend to result in lower M&A activity and most of the pundits are predicting no recovery until 2010. However, M&A in counter-cyclical industries such as healthcare tend to be stronger than other segments. Healthcare technology companies in poor economic times are attractive acquisition candidates because healthcare is somewhat recession proof, people are living longer and the aging population will require significant amounts of healthcare services. Additionally, advances in medical technology and increased access to healthcare in developing countries are increasing demand. These growth factors mitigate the global economic woes to some degree.
As we’ve been predicting for some time, the care software niche will consolidate and, particularly as the economy sours, we expect to see a higher level of M&A in this sector. There are still far too many companies in the niche and a large percentage of the companies in the EMR niche specifically will become casualties of the economy. Not all will be able to fund the development of new products, such as the need we see for a truly transportable patient record. Strategic acquirers will play an outsize role in healthcare M&A heading into 2009 and deals dependent upon large amounts of private equity debt will likely be postponed. Expect to see foreign buyers; the Misys PLC – Allscripts deal is representative. The cheap U.S. dollar has made acquisition of U.S. companies less costly for foreign buyers and very expensive for U.S. companies to buy foreign companies. Small software companies in general should pay attention to what’s going on and consider whether or not their company should be looking for an acquirer.
Buyers of healthcare technology must be more careful choosing which companies to do business with. Do your due diligence and don’t make price the most important decision point. Software is a product with high switching costs and it can be very disruptive to business if your chosen service provider is acquired or worse, goes out of business. If you are happy with the product and services you have, do some due diligence anyway. If you find signs of a shaky situation, you might be wise to look to for a stronger technology partner.