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Tech M&A accelerates

Created:
20 December 2007
Written by:
Tim Bradshaw

Late December has seen a rash of takeover news hit the technology sector. Northgate Information Solutions says it is in talks and NSB Retail has agreed a bid from US business software provider Epicor. With technology and telecoms stocks underperforming the market, analysts expect low valuations to attract yet more bidders to the sector.

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The software and computer services sector underperformed the FTSE All-Share by around 10 per cent during 2007, according to analysts at Landsbanki, with IT hardware and telecoms services also down for the year. That could have been even worse without standout performances from the sector's leaders, such as Autonomy and Aveva. But even these quality companies are well off their highs, with previous star performer Axon losing 40 per cent of its value in the last three months.

The tech sell-off suggests investors are taking a dim view of the prospects for IT spending in 2008, with consumer demand also looking shaky. Nonetheless, trade buyers - and perhaps private equity - are returning.

"The market is discounting a doom scenario that companies and corporates just don't share," says Evolution analyst Roger Phillips. "Recent M&A multiples from trade buyers don't leave the software sector looking expensive by any means." He suggests Intec Telecom and Coda could be prime takeover targets in the medium term.

Technology companies traditionally have more cash on their balance sheet, leaving them well placed to gain customers or niche solutions by acquisition. But companies that are themselves roll-ups of several acquisitions, such as Sage or Microgen, may be too complex for a buyer to integrate.

"Companies that can't prove they're consolidation targets are going to have a very tough time," says Andrew Darley of KBC Peel Hunt. "Those that are unappreciated by the market might consider going private while prices are so low."

Dozens of companies trade below the software sector's average forward PE of around 14. "The trick is to find the ones that are not going to warn - because most of them probably are," says Landskbanki analyst Kevin Ashton. But with Northgate in talks, Civica looking cheap and Anite talking up the prospects for selling one or more of its disparate divisions, Mr Ashton adds: "It's deafening the amount of interest we are hearing in public-sector IT."

IC VIEW

Alphameric's failed bid talks demonstrate the risks of opportunist approaches and value traps certainly litter the sector. Our preferred picks on fundamentals as well as bid potential are Coda (Buy tip, 181p, 9 February 2007), which is at the end of a period of investment in its Neon product, and System C Healthcare (Buy tip, 25p, 2 February 2007), which has almost half its market cap in cash. Axon is looking vulnerable at 11 times 2008 forecasts, but unless a bidder swoops, the departure of chairman Mark Hunter has left a stock overhang and sentiment remains weak. Long-rumoured takeover targets to avoid include Colt and Misys.

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