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2018 M&A Outlook for IT Services: More of the Same or Bold Moves Ahead?

 

Here I look back at how M&A activity has impacted the IT services industry over the past year and make a few broad predictions for the type of activity to be expected in the next twelve months.

2016 had been marked by some large M&A announcements, with:

  • Hardware companies moving out of services:  HPE announcing the sale of Enterprise Services to CSC (completed in April 2017 with the creation of DXC), Dell completing the sale of Perot to NTT DATA
  • Consolidation in the U.S. government sector, for example Leidos acquiring Lockheed Martin’s IS&GS business in a $4.6bn deal.

In 2017, we saw none of these large-scale transactions. The general trend was for small specialist acquisitions as vendors continued to look to beef up their digital capabilities.

Perhaps the most active acquirer in 2017 was Accenture, who continued its multi-year spree of tuck-in acquisitions bringing in capabilities in ‘The New’ or in business consulting: in its FY17 (to end August 31, 2017), the company spent $1.7bn in M&A, acquiring in a total of 37 firms.

Other large IT service vendors such as Cognizant, Capgemini, and Atos acquired between three and seven small tuck-in acquisitions.

In contrast, IBM, Fujitsu, and TCS (respectively the top, fourth and fifth largest IT service vendors globally) continued to be largely absent in M&As.

So, here are our 2018 M&A expectations for the ten largest IT service vendors globally…

IBM: 2017 saw just one acquisition related to IT services (a digital agency in Australia for its iX business). With its renewed focus on services, and the alignment of GTS and GBS, we are expecting IBM to accelerate its acquisition strategy, perhaps in areas such as digital consulting.

Accenture: the $1.7bn investment in acquisitions in FY17 is expected to contribute around 2.5%-3.0% of the 5%-8% revenue growth guidance in FY18. We think the level of investment in M&A may now slow down slightly.

DXC: the short-term priority is to achieve the $1bn in cost synergies it has promised to investors for FY18. The company has been making several small tuck-in acquisitions, focusing on expanding its ServiceNow and Microsoft Dynamics capabilities. Do not expect a lot of M&A activity: DXC had a net debt of $5.9bn at the end of September 2017. In all likelihood, the spin-off of its U.S. federal organization will make only a modest change to its net debt profile.

Fujitsu: its last acquisition in IT services goes back to 2013, and its last major transaction (Kaz in Australia) occurred nearly a decade ago, back in 2009. Fujitsu Services continues to focus on restructuring its IT services activities in Europe and on improving its profitability. We are not expecting any significant M&A activity this year.

TCS: has the financial means to proceed on any acquisition but is a rare acquirer, its last transaction dating from 2013 (Alti in France). And yet TCS continues to enjoy best in class CC revenue growth. Digital revenues reached ~20% in Q2 FY18 and grew by 31%. We do not expect to see any change in approach: TCS will continue to focus on organic growth, including investing to increase its local presence in the U.S.

NTT DATA: priorities continue to include the integration of Dell Services in the U.S. and improving profitability in its EMEA and Latin American operations. 2017 saw just one tuck-in acquisition that brought in SAP HANA skills in India. NTT DATA has significant debt: while the company may proceed to tuck-in acquisitions, integration and cost savings will remain the priority in the short term.

Deloitte: made several tuck-in digital acquisitions, around SAP Concur, digital marketing, DevOps, and data analytics in 2017. Given the nature of the network, do not expect a major change in this strategy.

Cognizant: in February 2017, Cognizant reached an agreement with Elliott Management and has committed, inter alia, to margin expansion, an ‘aggressive’ shift to digital, and M&A activity, focusing on IP, industry expertise, and technology. 2018 is likely to see several small to mid-sized acquisitions in these areas.

Capgemini: made four acquisitions in 2017 (with the intention to complete between 5 and 10 per year, focusing on digital). One element limiting Capgemini from making a large acquisition is its net debt, which stood at €1.9bn at end H1 2017.

Atos: after several years of larger transactions, in 2017 Atos completed several tuck-in acquisitions with ServiceNow, expanded its healthcare capabilities in the U.S., and Worldline acquired some local payment processors in Europe and a firm servicing Indian banks. We were expecting Atos to consolidate the European payments services market, and indeed in December made a €4.3bn offer for Gemalto. The failed deal (Gemalto soon after accepted a €4.8bn offer from Thales) showed that Atos still has the appetite for large acquisitions, and the financial ability to borrow €4bn from banks. 2018 is likely to see Worldline continue its drive to be the consolidator in Europe. And Atos? Will there be transactions that expand the scale of its Business and Platform Solutions business in the U.S.?

Outside the top ten IT service vendors, other major players continue to be actively interested in acquiring. Several vendors come to mind, including CGI and most U.S. government specialists in North America. Among the IOSPs, HCL Tech and Wipro will continue to be active in small to mid-size acquisitions, and under C Vijayakumar, HCL has been quietly investing hundreds of millions of dollars in ‘strategic IP partnerships’ in what is a long-term play. The M&A strategy at Infosys, under the new leadership of Salil Parekh is not yet clear but we expect to see an increase in activity.

Overall, we think M&A activity in 2018 will be at least on a similar level to 2017, and throw up a mixture of the usual players buying the likely targets (smaller digital agencies, cyber specialists, local agile specialists, etc.) with perhaps the less predictable, more audacious move such as a large-scale acquisition: other telecom service providers may divest their datacenter businesses (see the Verizon and CenturyLink transactions) to co-location and hosting specialists or to private equity in their realignment towards IoT, investment around 5G and fiber optics, and around media and content.

Finally, the engineering and R&D industry may prove attractive to IT service vendors, thanks to IoT and industry 4.0, which is bringing together the world of IT and ER&D. So far, only HCL Tech has invested in this space through Geometric and Butler America. Accenture and Capgemini are the most likely acquirers in this space in the future.

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