The Effect: Valuing Your Services Business

The amazing thing is that many solution providers say this is only the beginning as the economy and IT spending improve. "A few years ago, there was a lot of activity, but it was tough to tell what a company's condition and valuation was because the economy was so bad and fundamentals were askew," says John Leahy, CFO at Keane, a Boston-based software services firm that has made its share of acquisitions. "Today, it's a lot easier to figure out what you're really getting."

Thus, more solution providers will be bought and sold as time goes on, and not because the companies are in bad shape. Take Denver Solutions Group, which pulled in $191 million in 2003, a 30 percent increase in revenue from the year before; it didn't exactly have vultures circling overhead, yet it decided to take Sirius' offer and create a stronger IBM-focused firm. The result is a combined company with more than $550 million in sales this year and an intimidating lineup of IBM-oriented solutions.

Whether the flood of high-profile mergers and acquisitions itself will benefit the channel in the near term remains to be seen. But the pickup in activity will have a positive side effect for a number of solution providers.

Let's take a hypothetical example: Solution Provider A has $1 billion in total sales, but only $250 million comes from IT services. The rest is composed of hardware and software product sales. Solution Provider B, on the other hand, has about $300 million in total sales, but the bulk of its revenue comes from managed services and consulting, while product sales make up a meager 10 percent of total sales.

Here's the catch: Both solution providers are bought for roughly the same price. Despite B's having less than one-third of the annual revenue of A, it commands virtually the same price as its larger counterpart because both companies have about the same size IT-services business. That is the benchmark that most suitors, investors and analysts are using to value solution providers these days.

"Our product sales are of no value out there," says William Turpen, COO of Pifer Financial Systems, Barrington, N.J. "We've been pursued by a lot of companies, and they've focused on our services revenue." Pifer is one of many solution providers growing its consulting services and putting an emphasis on long-term fixed contracts. Turpen says that's where the key to his company's profitability lies.

Even companies that are doing the acquiring know that in many people's eyes, you're only as good as your services business. For Phil Norton, CEO of ePlus, managed services and IT outsourcing have become top priorities for his firm. "We're able today to take our software sales and complement them, and even drive them with services as a total solution," Norton says. Solution providers, therefore, are finding that services can actually take the lead role in their businesses. Dave Gilden, partner at Acuity Solutions, Tampa, Fla., says his firm's consulting and managed-services practices are propelling his security product sales.

As visibility improves in the market, it's likely the wave of consolidation will continue and even increase. "There's definitely a lot of channel companies that are at least partially on the market and looking for the right deal," Keane's Leahy declares. "The next 12 to 18 months will be even more active."