Urge To Merge

Rising values, of course, can only mean one thing: Deals, both big and small, are bound to increase, as they did last year when companies flexed their newly strengthened muscles. Many companies on the VARBusiness 500 list of top IT solution providers in North America made significant moves to merge or acquire fellow VARBusiness 500 firms last year. And they continue to make smaller acquisitions that fly below the radar screen but have a big impact just the same.

Take the high end of the VARBusiness 500. Last year saw several blockbuster deals that have reshaped the competitive landscape and illustrate how competitive the market for commodity products has become. CDW VB16, for example, acquired the assets of Micro Warehouse last September. The deal gave the $4.7 billion product reselling powerhouse some additional inventory and technical capabilities, while effectively reducing the number of its competitors by one. General Dynamics VB30, meantime, snapped up Veridian last August, while Expanets wound up in the hands of telecom vendor Avaya a few months later.

While the CDW deal eliminated a rival, the net result of the majority of deals made last year was an array of new entities that are essentially more capable. Companies that made acquisitions last year demonstrated more interest in expanding their strengths than merely knocking out a competitor. That's especially true of those that have made acquisitions part of their growth strategy.

For example, in the past five years, Digital River VB211 has purchased 18 companies. Recently, it bit off its biggest acquisition to date, element 5, for $120 million. That deal gives the company strength overseas where Digital River has not been a strong player. But with more customers wanting truly global software distribution deals that depend on multilanguage support, 24/7 uptime and the ability to complete closed-loop transactions involving multiple taxing authorities over multiple countries, Digital River CEO Joel Ronning says he had to make a move to secure that expertise lest he would miss out on a bounty of new revenue opportunities. Founded in 1996, element 5 is a leading outsourcer of e-commerce solutions for software publishers in more than 150 countries. More than 60 percent of its business is done overseas, and it has a strong foothold in Europe. The company processes more than 2 million transactions annually for more than 10,000 clients.

Although 18 deals in five years might sound excessive, Ronning notes that most of the companies he buys are small, usually less than $1 million in size. What he typically looks for in an acquisition is new customers, new technological capabilities or market penetration. To get that, he has had to sift through as many as 150 candidates; because his company has been in acquisition mode for some time, Ronning is typically bombarded with offers. And he expects more to come pouring in now that the economy is headed in a positive direction.

"We are definitely seeing the deal market heating up," he says. "People are less concerned about the economy and feeling more optimistic in general. They are feeling that the economy is headed in the right direction and, thus, thinking [about possible combinations]."

Spending Spree
FusionStorm VB297, too, is thinking about combinations At press time, it was looking at a variety of deals--as many as six. CEO John Varel says the time is right to create regional powerhouse companies (see "Looking To Deal," page 115). The same goes for Ciber VB71. The Greenwood Village, Colo.-based company completed several deals that expanded its technical prowess in several areas. And it continues its spending spree to this day.

In March, Ciber closed on its acquisition of SCB Computer Technology, a $125 million professional services firm that specializes in sales to government clients. That greatly expanded the company's reach into the public sector, where Ciber hopes to generate as much as $100 million in new sales this year. This deal followed closely on the heels of its acquisition of the services arm of FullTilt Solutions, a King of Prussia, Pa.-based IT consulting and IT services provider. The latter deal gives Ciber a greater geographical presence in the Philadelphia and Pittsburgh metropolitan areas, along with several key customers.

While several companies continue to make deals to build out their geographic footprints, more are looking at possible MandAs for other reasons, experts say. Jim Markisohn, vice president of business development at Arrow, the nation's fourth-largest distributor of high-end systems, components and software, says he is seeing the increasing importance of vertical practices in determining who buys whom. In fact, vertical expertise is more highly prized than geographic presence, he says.

"If you're the top POS solution provider, you're more likely to look for similar expertise to acquire in Chicago than another Northeastern company to expand your footprint," he explains.

Commenting in general on his company's customer base, which comprises VARs and solution integrators that sell IBM, Sun and HP gear, Markisohn says Arrow did not experience the turnover in 2003 that it did in 2002 and 2001. There were fewer collapses and fewer deals. Nonetheless, he still anticipates consolidation to occur. Experts agree, for a variety of reasons. New deals traditionally follow as companies react to the initiatives of their deal-crazy rivals. For example, although HP says it is not looking at following in the footsteps of rival IBM, which bought PricewaterhouseCoopers' consulting arm in 2002, worldwide services head Ann Livermore previously told VARBusiness she never says "never," though she maintains HP doesn't need an acquisition to be able to compete effectively in the marketplace.

There are also practical, tax-based reasons that generate new deals. MandA specialist Mark Shappee, managing principal with Venture Management of Ventura, Calif., says anticipated changes in tax codes could wind up having a significant impact on how many deals go down in the near future. "The impact on private-company owners of the threatened increase in the federal tax rates for capital gains and dividends--i.e., the current 15 percent rate on long-term gains and dividends is due to expire in 2007 and could be repealed earlier with a Bush loss in 2004--could become another major driver for MandA activity in the middle market in 2004 to 2005."

Another reason for possible acquisitions: Those in roll-up and build-out mode may not yet be done. Take SBI Group VB169, for example. The Salt Lake City-based IT integration and consulting organization previously expanded its technical capabilities and customer reach with the acquisitions of failed Web integrators Lante, MarchFirst, Scient and Viant, among others. Though it slowed merger activity in '03, vertically aligned companies may look awfully attractive. Take Proxicom, for example. The one-time division of Dimension Data was recently spun out from the India-based organization that generated $346 million in the United States last year through its Dimension Data Solutions Group VB105 division. Proxicom has built a sizeable business in the automotive sector, helping to build marketing and sales Web sites for Volkswagen, Toyota and, most recently, Mazda. The likes of SBI may yet find a Proxicom too interesting to pass up.

What's also likely to spur additional consolidation is the fact that money is beginning to pour into the IT services and reselling space after being on the sidelines since the collapse of the Web-services integration space.

For example, last year 4Front Systems was acquired by Xcelecom VB368, now backed by UIL Holdings, which has financial interests in such businesses as American Payment Systems and United Bridgeport Energy. Shappee notes that scores of companies with limited ties to the IT-services sector now have a financial interest in IT services and consulting companies for the first time. Some are expected to flip these investments as they update their portfolios and rotate out companies that are not part of their core investment focus. As they do, the amount of money moving in and out of this space is expected to trigger a new wave of consolidation that could further reshape the landscape.

The evolution continues.