CONSOLIDATION - Heads you twin

Mergers are being cancelled left, right and centre amid growing paranoia about the future of the IT industry. But is it worth taking a gamble for long-term prosperity?

As the horologist said to the actress, timing is everything. And thisoia about the future of the IT industry. But is it worth taking a gamble for long-term prosperity? time 18 months ago, had you been inclined to sell off your company and set sail for the Bahamas, the omens could not have been more favourable.

As recently as this summer, IT stocks were still at a record high, with the FTSE IT index revealing a staggering 88 per cent increase in growth on the previous year.

But have a look at the same index today and that growth has slowed to a mere 18 per cent. That's good compared with most trading sectors, but it's a far cry from the Arcadian days of 1997.

Even giants of the UK industry such as Computacenter, which floated on the market this year at 670p and saw shares rocket to 800p almost instantly, must be wondering whether the good times are already over; its shares are currently hovering around the 490p mark.

Others have fared worse still. SAP specialist Druid's shares have almost halved in value in the past few months, while MicroFocus has seen its shares nosedive from a high of more than 700p to about 235p, despite a smoothly handled #300 million merger with Intersolv.

Countless tales of woe could be told, although most in the channel know the reasons: fears of a full-blown recession, aligned with the twin blights of year 2000 and the euro, which have prompted corporate customers to put less demanding IT projects on hold.

In short, FUD - fear, uncertainty and doubt - has really hit the fan, as mergers and acquisitions are suddenly cancelled or postponed amid growing paranoia about where the industry is heading.

Richard Holway, analyst at Holway Research, claims that countless UK firms have been getting cold feet in recent months and withdrawn from deals either as buyers or sellers.

But client confidentiality forbids him from divulging names.

'No one wants to see newspaper headlines revealing that they've had to pull out of a deal because of plummeting share prices,' says Holway. 'But take my word for it, the number of deals put on ice in recent months is considerable.'

A large part of the problem, he says, is that the norm for takeovers among quoted IT companies is through a share swap. But if the predator firm's stock price suddenly plummets, the seller's interest in the deal diminishes equally rapidly.

Of course, cash-rich predators could have a field day right now, acquiring smaller rivals at bargain basement prices. But, counters Holway: 'Do you know many cash-rich dealers or Vars out there at the moment? I certainly don't.'

Holway predicts that once the issues of year 2000 and EMU are out of the way - probably around 2001 - the industry could witness another renaissance.

But when it comes to buying, selling or merging, is it purely a case of timing or are there some other factors to consider?

If you're selling a business, the price offered by a would-be buyer is of paramount importance, although it is also down to timing, especially when a share swap is involved or the market is showing an upturn.

Perhaps more important is how you value your own company if it is not listed, especially when there is no simple market measure of its worth.

This was exactly the sort of problem facing John Fison, managing director of Bracknell reseller Keltec when, recently, he decided to merge with Progress Computer Systems. The companies shared similar visions and had a history of providing Digital - now Compaq - systems.

The merged company, Keltec Progress, begins life with 110 staff and a turnover of #40 million, and is positioning itself for a full stock market listing.

It was up to Fison and his opposite number at Progress, Chris Davis, to go about the delicate business of apportioning value to their own companies and translating it into mutually acceptable equity stakes in the merged venture. They did it, quite simply, by doing what already quoted companies do: swap shares pro rata of combined turnover. There was no cash redress to either side and shares could be exchanged on a one-to-one basis.

That said, the two sides still needed expert advice to ensure a smooth transition, and KPMG acted as the nuptial advisers.

Fison has this advice for anyone contemplating a merger: 'Expect the process to take far longer than anyone admits. Ours took us six months from start to finish - and that was a very simple case.'

His other tip is to find a merger partner with a profile as close as possible to your own, if only to maintain the momentum of the merged company and to lessen the likelihood of redundancies among existing staff. In the run-up to the Keltec Progress deal, both sides held off recruiting staff, keeping their respective operations lean and mean.

Fison adds: 'The upshot is that we're now in a position to take on more staff in keeping with the growth, especially on the administration and finance side.'

While the Keltec Progress merger was effected through a simple share exchange, other unquoted firms wishing to sell for cash have to find a formula for pricing their assets. This is where investment banks such as Broadview Associates, which specialises in mergers and acquisitions, come into their own.

According to Victor Basta, European managing director of Broadview, the valuation of a company is usually worked out according to one of three permutations:

- by reference to the capital valuations of similar companies that do have a listing

- by comparisons to the prices that have been fetched in previous deals

- by the simple expedient of calculating how badly the suitor wants to purchase you. The more desperate, the higher the price.

Basta adds that anyone contemplating the tried-and-tested formula of calculating the sale value as triple the latest annual net profits would be making a serious error. 'I'd say that in the channel, 10 to 30 times profits is more the norm, if only because of the speed at which IT companies grow and the potential they offer,' he says.

As an effective marriage broker to the IT, communications and media industries, Broadview last year presided over 81 transactions worth more than $4 billion worldwide. Most of the deals were in the US and involved values of between $20 million and $500 million. But in Europe alone, it has acted as intermediary on deals each worth more than $20 million in the past year.

In the UK, the top distribution deals in terms of value listed by Broadview include Datrontech's purchase of International Computer Products for $13 million; Action Computer Supplies' acquisition of SHL Technology for roughly the same amount; and Compel's purchase of Astex Computer Systems for just over $5 million.

Since January 1997, an estimated 48 mergers and acquisitions took place within the channel, worth $155 million in total.

The one area in which Basta disagrees with Holway is in the latter's view that merger mania in the sector has been stricken by sclerosis. In the US at least, Basta contends, plummeting share prices have had the opposite effect - prompting a stampede towards acquiring smaller rivals or merging with others too big to swallow in one gulp.

Basta says: 'In the UK, companies are generally smaller. They're not listed so there's not that much pressure to act, whether or not share prices are falling.

'But in the US, size is everything. There's a valid fear that if your share price is falling behind and you're not making positive steps to get bigger, sooner or later you'll be marginalised by the market as an also-ran. The bigger companies, the harder they fall.'

The good news for UK sellers valued at more than, say, #10 million, is that they are likely to be of interest to their bigger cousins across the pond, says Basta.

Conversely, UK operations with cash to spare might equally be looking to buy - and could find themselves bidding against Americans for the same company.

At Keltec Progress, not only was the recent merger effected by an exchange of shares, but as neither side had relied on the support of venture capitalists in the past, there were no messy complications. The merger has put the company on a sound financial footing and, as John Fison readily admits, the lower share prices and valuations go, the more interesting the acquisition prospects become. 'There are certainly some good opportunities out there and we're going to keep our eyes open,' he says.

If, on the other hand, your company is already quoted and you want to get maximum returns, Holway's advice is to hang on at least until 2001, when he expects share prices to return to the high levels experienced in late 1997.

'Valuation is all about outlook,' he says. 'The industry is currently performing better than it has ever done, with revenue for the first half of this year growing by 30 per cent.

'The problem is those growth rates are expected to fall dramatically next year, with growth down to less than 10 per cent. In the past, valuations went up because buyers anticipated high growth, but now they're factoring that out and any new valuations are being based on anticipated growth rates in 2001.'

Otherwise, Holway notes, there are no easy yardsticks to help bosses decide when the time is right to sell or merge. 'I'd liken it to making a decision about putting your child into adoptive care - a child that you've given birth to, raised and cherished for years,' he says.

'But then, you might also think that it would be better off with new parents, someone who could give it a better chance in life. These are very emotional decisions - and often the outcome doesn't always come down to just money.'

This sentiment is endorsed by Joss White, marketing director of Cirencester-based RBR Networks. Just over a month ago, the Cisco-only distributor was acquired by South African-based Datatec in a deal worth #32 million.

White says: 'We were a very attractive target because of our unique business model. We were actually approached by CHS and several others before Datatec made its move.

'At the time, we felt it was perhaps a bit too early to sell. But the offer Datatec made - in terms of keeping our independence, our location and business model, along with the prospect of having the financial backing to take that model across Europe - was, in the end, one that we couldn't refuse.'

He adds: 'Everyone says you should sell when you're at the peak, but you never really know when you've reached that point.

'Though it's obviously exciting when companies show an interest in buying you, deciding whether to sell or not is still a very emotional thing - especially when you've spent years building up a company .

'Other potential acquirers really just wanted to merge us into their overall operations. Though they offered more cash, we felt we would be selling our souls if we allowed ourselves to be absorbed into some great, faceless corporation. It would have been really sad to have let that happen.'